1 Copyright (c)2014 John Wiley & Sons, Inc CHAPTER Analyzing Economic Problems Chapter One Overview 1 Defining DefiningMicroeconomics Microeconomics 2 Who WhoShould ShouldStudy StudyMicroeconomics? Microeconomics? 4 The TheTypes TypesofofMicroeconomic MicroeconomicAnalysis Analysis Chapter One Copyright (c)2014 John Wiley & Sons, Inc 3 Microeconomic MicroeconomicModeling Modeling •• Elements ElementsofofModels Models •• Solving Solvingthe theModels Models Microeconomics Defined Microeconomics is the study of how individual economic decision-makers such as consumers, workers, firms or managers allocate scarce resources among alternate uses This study involves both the behavior of these economic agents on their own Chapter One Copyright (c)2014 John Wiley & Sons, Inc and the way their behavior interacts to form larger units, such as markets Who Should Study Microeconomics?  Policy Makers  Managers  Union Leaders  Business Owners Chapter One Copyright (c)2014 John Wiley & Sons, Inc  Lenders Key Societal Questions What goods and services will be produced and in what quantities Who will produces these services and how will they produce them Who will receive these goods and services and how will they get them Chapter One Copyright (c)2014 John Wiley & Sons, Inc Societies must answer these questions that relate to microeconomics: Microeconomic Modeling Choice vs Alternatives Models are like maps – using visual methods, they simply the process and facilitate  Resemble Reality  Be Understandable  Be an Appropriate Scale Chapter One Copyright (c)2014 John Wiley & Sons, Inc understanding of complex concepts Microeconomic models need to: Exogenous & Endogenous Variables Defined: Variables that have values taken as given in the analysis are exogenous variables Variables that have values determined as a result of the model’s workings are endogenous variables “How “Howwould wouldaamanager managerhire hirethe themost mostpossible possibleworkers workerson onaabudget budgetof of$100?” $100?” vs vs OR OR “How “Howmuch muchfood foodand andclothing clothingshould shouldthe theconsumer consumerpurchase purchasein inorder orderto tomaximize maximizesatisfaction satisfactionon onaabudget budgetof ofI?” I?” vs vs “What “Whatisisthe theminimum minimumlevel levelof ofexpenditure expenditurethat thatthe theconsumer consumermust mustreceive receivein inorder orderto toreach reachaasubsistence subsistencelevel levelof ofsatisfaction?” satisfaction?” Chapter One Copyright (c)2014 John Wiley & Sons, Inc Examples: “How “Howwould wouldaamanager managerminimize minimizethe thecost costof ofhiring hiringthree threeworkers?” workers?” The Objective Function Dependent on How the Objective Function is Specified The Objective Function specifies what the agent cares about Example: •• Does Doesmanager managercare caremore moreabout aboutraising raising profits profitsor orincreasing increasing“power”? “power”? Chapter One Copyright (c)2014 John Wiley & Sons, Inc Defined: The Constraints Constraints are whatever limits is placed on the resources available to the agent  Time  Budget  Other Resources  Technical Capabilities  The Marketplace  Rules, Regulations, and Laws Chapter One Examples: Copyright (c)2014 John Wiley & Sons, Inc Defined: The Constraint Optimization Behavior can be modeled as optimizing the objective function, subject to various constraints Example: Manager’s Investment Choice •• •• •• •• Facilities ( F ): N = budget / $30 Facilities ( F ): N = budget / $30 R&D ( R ): R&D ( R ): N = budget / $100 N = budget / $100 Cost Per Unit of Time Cost Per Unit of Time Max N Max N •• •• (F,R) (F,R) Subject to: expenditure < $100 Subject to: expenditure < $100 Facilities workers cost $30 Facilities workers cost $30 R&D workers cost $100 R&D workers cost $100 Where: N is the number of workers Where: N is the number of workers Chapter One 10 Copyright (c)2014 John Wiley & Sons, Inc •• •• The Constraint Optimization Example: Consumer purchases Consumer purchases Food (F), Clothing ( C ), Income (I) Food (F), Clothing ( C ), Income (I) Price of food (pf), price of clothing (pc) Price of food (pf), price of clothing (pc) Satisfaction from purchases: S = (FC)1/2 Satisfaction from purchases: S = (FC)1/2 Chapter One 11 Copyright (c)2014 John Wiley & Sons, Inc Max S(F,C) - subject to: pfF + pcC < I Max S(F,C) - subject to: pfF + pcC < I The Constraint Optimization Example – Consumer Purchases F Example: C Chapter One 12 Copyright (c)2014 John Wiley & Sons, Inc PFF + PCC = I The Constraint Optimization Example – Consumer Purchases F Example: 1/2 (FC) = S0 C Chapter One 13 Copyright (c)2014 John Wiley & Sons, Inc PFF + PCC = I The Constraint Optimization Example – Consumer Purchases F Example: 1/2 (FC) = S1 1/2 (FC) = S0 C Chapter One 14 Copyright (c)2014 John Wiley & Sons, Inc PFF + PCC = I The Constraint Optimization Example – Consumer Purchases F Example: PFF + PCC = I S2 > S1 > S0 1/2 (FC) = S1 1/2 (FC) = S0 C Chapter One 15 Copyright (c)2014 John Wiley & Sons, Inc 1/2 (FC) = S2 Marginal Impact Defined: The Marginal Impact of a change in the exogenous variable is the incremental impact of the last unit of the exogenous Chapter One 16 Copyright (c)2014 John Wiley & Sons, Inc variable on the endogenous variable Equilibrium Chapter One 17 Copyright (c)2014 John Wiley & Sons, Inc Example – Sale of Coffee Beans Equilibrium Example – Sale of Coffee Beans • Chapter One 18 Copyright (c)2014 John Wiley & Sons, Inc Demand (P,I) Equilibrium Example – Sale of Coffee Beans • Demand (P,I) Q* Chapter One 19 Copyright (c)2014 John Wiley & Sons, Inc P* Equilibrium Equilibrium is defined as the point where demand just equals supply in this market (i.e., the point where the demand and supply curves cross) Equilibrium Equilibriumanalysis analysisisisan ananalysis analysisofofaasystem systemininaastate statethat thatwill will continue continue indefinitely indefinitely asas long long asas the the exogenous exogenous factors factors remain remain unchanged unchanged Chapter One 20 Copyright (c)2014 John Wiley & Sons, Inc Defined: Comparative Statics Analysis Defined: A Comparative Statics Analysis compares the equilibrium state of a system before a change in the exogenous variables to the Chapter One 21 Copyright (c)2014 John Wiley & Sons, Inc equilibrium state after the change Comparative Statics Analysis Sale of Chapter One 22 Copyright (c)2014 John Wiley & Sons, Inc Pistachio Nuts Microeconomic Analysis Some Types Positive PositiveAnalysis: Analysis: •• IsIsanananalysis analysisthat thatattempts attemptsto toexplain explainhow howan aneconomic economicsystem systemworks worksor or to topredict predicthow howititwill willchange changeover overtime time Normative NormativeAnalysis: Analysis: Chapter One 23 Copyright (c)2014 John Wiley & Sons, Inc •• IsIsanananalysis analysisof ofwhat whatshould shouldbe bedone done Microeconomic Analysis Some Examples Example: Example:“Should “Shouldwe weincrease increaseincome incomeequality equalityrather ratherthan thanfocus focuson on economic economicefficiency?” efficiency?” Example: Example:“Should “Shouldwe weimpose imposeaaprogressive progressiveincome incometax taxororaasales salestax taxtoto increase increaseincome incomeequality?” equality?” Example: Example: “Will “Will aa progressive progressive income income tax tax reduce reduce aggregate aggregate hours hours Chapter One 24 Copyright (c)2014 John Wiley & Sons, Inc worked?” worked?” .. .Chapter One Overview 1 Defining DefiningMicroeconomics Microeconomics 2 Who WhoShould ShouldStudy StudyMicroeconomics? Microeconomics? 4 The TheTypes TypesofofMicroeconomic... Example: C Chapter One 12 Copyright (c) 2014 John Wiley & Sons, Inc PFF + PCC = I The Constraint Optimization Example – Consumer Purchases F Example: 1/2 (FC) = S0 C Chapter One 13 Copyright (c) 2014 ... the last unit of the exogenous Chapter One 16 Copyright (c) 2014 John Wiley & Sons, Inc variable on the endogenous variable Equilibrium Chapter One 17 Copyright (c) 2014 John Wiley & Sons, Inc Example