Econ 281

Intermediate Microeconomics
•Consumer Behavior
•Theory of the Firm
•Various Market Structures
Lorne Priemaza, M.A.

Lorne.priemaza@ualberta.ca

Various material courtesy of Katharine Rockette and

Wiley & Sons INC.
 Chapter 1
What is economics?
Microeconomics and
Macroeconomics
Economic Tools
Positive and Normative Analysis
 What Is Economics?

• Economics is the science that deals with

choices about the allocation of limited
resources to satisfy unlimited wants.

Limited Resources
Choices Outcome
Unlimited Wants
 Microeconomics and Macroeconomics
• Microeconomics
-from the Greek mikros meaning small
-studies economic behavior of individual
decision makers (people, firms, etc.)
-What price should Apple charge for
iPhones?
-How much Youtube should Kim watch?
-How does reading and watching Game of
Thrones affect Jon’s utility?
 Microeconomics and Macroeconomics

• Macroeconomics
-from the Greek makros meaning large
-studies aggregate economic behavior
(nation, world, business cycles, etc.)

-What should the tax on smartphones be?

-Should the federal government subsidize
tv shows filmed in Canada?
-How does the used market for Game of
Thrones novels fluctuate?
 Economics and Models
• “Economists work with models.”
-Life is too complicated for an economist
to analyze all at once
-In order to analyze one aspect of life,
economists build a simplified model to
represent that aspect of life
-The results of the model are then tested
against real life
-Models require assumptions
 Economics and Assumptions
• “Assume there’s a can opener!”
-Every economic model relies on
assumptions (much like a house relies
on foundations)
-ie: Assume people are rational; assume
firm A understands people’s tastes
-If the assumptions are invalid, the model
suffers
-ie: Assume all students read the text
 Exogenous and Endogenous Variables

• Exogenous Variables
-values that are taken as given
-values that are decided outside the
model

Ie: GIVEN that Joe’s input (material)

costs are $10 per shoe (exogenous
variable), how much should he sell
shoes for?
 Exogenous and Endogenous Variables

• Endogenous Variables
-values that are determined within the
model

Ie: What price (endogenous variable)

should Joe charge for shoes and what
quantity demanded (endogenous
variable) will he face?
 Exogenous and Endogenous Variables

• Relationship Model
John is trying to woo his sweetheart
Jenni.
-Jenni’s feelings towards John are
exogenous
-John’s attempts to woo Jenni are
endogenous
-Jenni’s reaction is endogenous
 Mathematical Tools
-Economic agents react rationally or
irrationally given their available
information.
-Economists assume agents react
rationally to maximize their utility/profit
or minimize their work/cost using:
Constrained Optimization
Equilibrium Analysis
Comparative Statics
 Mathematical Tools
• Constrained Optimization
-People and firms operate using limited
resources (time, money, etc.).

-Constrained Optimization maximizes

utility, profit, etc. given a constraint
(time, money, etc)
 Constrained Optimization Example
Greg H enjoys two things: riding his
motorcycle and playing board games.
Unfortunately, he cannot do both at the
same time. Therefore Greg’s model is:

Max U(Riding,Games) ->Objective Function

Subject to the constraint (s.t.)
Hour Per Day = 8 = Riding + Games
 Optimization Example

One may say Greg should spend his full 8 hours

on riding or board games; whichever he likes
more.

But Greg probably enjoys the first few hours of

riding his bike or gaming more than the last
few hours.

We’re concerned with MARGINAL happiness.

(Happiness gained from the last hour’s activity)
 Optimization Example

Assume Greg gets the following

satisfaction from riding his bike or
gaming
2 Hours 4 Hours 6 Hours 8 Hours

Riding 4 7 9 10

Gaming 3 6 7 8

Exercise: What should Greg do to maximize

his happiness? (Remember that he’s
planning his day 2 hours at a time –
marginally)
R Example: Greg’s Happiness

Greg will pick the

Riding + Gaming = 8 mixture of riding
and gaming that
8 maximizes his
happiness, subject
to the fact he only
4 has 8 hours.
U2(Riding, Gaming)
U1(Riding, Gaming)
0
4 8 G
 Dealing with the marginal

Assume that you bought a lemon car – a 2010

Pontiac Sunfire that has caused you nothing
but problems. You paid $8,000 for it and have
spent $2000 in repairs over the last year.

Your kartoflemonometer just broke and will cost

$1000 to fix. After this last job you’ve basically
replaced the entire car. On the other hand,
you can buy a reliable 2011 Honda CR-V for
$7000.
What do you do?
 Dealing with the marginal

If you fix your Pontiac, it will have cost you

a total of $11,000 to buy a car that works,
whereas the Honda would have cost you a
total of $7000.
But right now you already have the Pontiac.
To get a car that works, you need an
ADDITIONAL $1,000 or an ADDITIONAL
$7,000. You will fix the Pontiac.
Rational people deal with marginal
decisions.
 Mathematical Tools
• Equilibrium Analysis
-Equilibrium is a state that will continue
indefinitely as long as exogenous
factors don’t change
-If a variable is higher than equilibrium,
market forces will pull it down,
-If a variable is lower than equilibrium,
market forces will pull it up
Price
Example: The Market for iPhones

Surplus Supply If price is too high,

supply will exceed
P1
demand and price
will fall.
P* • If price is too low,
P2 demand will exceed
Shortage supply and price
will rise
Demand

Q* Quantity
 Mathematical Tools
• Comparative Statics
-In the real world, many exogenous
variables are moving at the same time;
affecting many endogenous variables
-Comparative Statics aims to measure the
effect a change in one exogenous
variable on one endogenous variable.
 Comparative Statics Example

Originally, assume that the iPhone market is in

equilibrium, with Qsupply = QDemand. Originally, we
have equilibrium price and quantity.

Assume that due to a lifting of tarrifs, iPhone

input costs have decreased. Analyze this effect
on equilibrium price and quantity.
 Price Example: iPhones
Reduced
tariffs have
Old Supply resulted in a
New Supply decrease in
iPhone
POld
• prices and
an increase
PNew • in iPhones
Demand (P,I)
sold.

Quantity
QOld QNew
 Positive and Normative Analysis
• In order to carry out effective policy, the
policy maker must understand how the
economy works

• The is called POSITIVE ECONOMICS;

The economics of facts & theory

-ie: Minimum wage increases causes

unemployment increases
 Positive and Normative Analysis
• In order to conduct policy, the policy maker
must have some goals in mind

• NORMATIVE ECONOMICS is the

study of what the goals of the economy
should be

-ie: We should lower the minimum wage in

order to lower unemployment
 Positive and Normative Analysis
• Positive economics is important to understand
the economy
• Normative economics is important to policy
makers
• Classify the following:
– “When the price of the Xbox X rises,
more people buy the Playstation 5.”

– “We should buy Lorne a Playstation

5 to increase his utility.”