Econ306 - Economics 306: Introduction Economics Professor...

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Unformatted text preview: Economics 306: Introduction Economics Professor John Rust 4115 E Tydings, 5-3489 4115 Tydings What is microeconomics about? What How markets work, i.e. how the “invisible hand” How of competition and self interested behavior results in allocations of resources that have good properties collectively, i.e. collectively, allocations that are Pareto efficient. allocations Pareto Definition: an allocation of resources is Definition: an Pareto efficient if there is no other allocation Pareto if that makes everyone strictly better off. Other themes in microeconomics Other • Rationality: a person/firm is rational if they person/firm they behave “as if” they were optimizing a well defined objective function (utility function or defined profit function) profit • Equilibrium: competition in market economies Equilibrium: leads to allocations where supply and demand leads where are equated, firms are maximizing profits, and consumers are maximizing utility consumers Microeconomic “first principles” Microeconomic • In micro theory, we try to derive supply In derive supply and demand curves from underlying theories of utility maximization and profit maximization profit • To solve these profit and utility To maximization problems, we will need some mathematical tools: calculus and calculus and dynamic programming dynamic Demand and Supply Functions Demand • Once we can solve the individual utility and Once • profit maximization problems, we can study how prices affect the utility or profit maximizing prices affect bundle chosen by a consumer or a firm. bundle The resulting optimal choices, treated as a The function of price p consitute iindividual demand consitute ndividual functions Di(p) and supply functions Sj(p), functions and ), where the subscript i denotes a particular consumer, i and the subscript j denotes a particular firm, j. particular Slopes of supply and demand Slopes • Ordinarily we think that supply curves are Ordinarily • upward sloping, i.e. Sj(p) iis an increasing s function of p since the firm should want to produce more (and earn higher profits) when prices are higher prices Ordinarily we think that demand curves are Ordinarily downward sloping, i.e. Di(p) iis a decreasing s function of p since the consumer should want to since buy less (and gets lower utility) when the price of the good is higher of Market vs. Individual Supply and Demand Demand • We derive the market supply function We market by summing the individual firm supply by functions, i.e. S ( p) Sj ( p ) j • We derive the market demand function We by summing the individual consumer demand functions, i.e. D( p) Di ( p ) i Competitive Equilibrium Competitive • Definition: A competitive equilibrium iis a s Definition: competitive price p* that equates aggregate supply and demand, i.e. demand, S ( p*) D( p*) • Notice that at this price consumers are Notice maximizing utility, firms are maximizing profits, and supply and demand are equated. The Competitive Equilibrium Allocation is Pareto Efficient Allocation • Notice that a competitive equilibrium leads to a Notice • particular allocation of resources: firm j produces amount Sj(p*), j=1,…,J and consumer ), produces i consumes amount Di(p*), i=1,…,I. A much deeper result, which we will show later much in this class is that this allocation is Pareto in Pareto efficient, ii.e. there is no way we can change efficient .e. this allocation and make everybody better off this ...
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