Microeconomic
Analysis
Duong Le
What Is Microeconomics?
Microeconomics is the science that investigates the
social consequences of the interaction of
rational beings that pursue their perceived
self-interest.
• Economics as a Science
• Rationality and Self-Interest
• Social Consequences
What Is Microeconomics?
Economics as a Science
Unlike in physics we generally don’t have labs where we
recreate real-world conditions in order to test our
hypotheses.
But all science progresses through the formulation and
testing of models that generate hypotheses. In this
sense Economics is a science.
Testing Statistics /
Economic Models -
with real-
Theory Hypotheses Econometrics
world data
What Is Microeconomics?
Rationality and Self-Interest
Rational in People make the best
pursuit of their choices they can given their
perceived self- circumstances
interest.
This does not presume that “best” is defined relative to an objective
standard
Instead, “best” is subjectively defined by each individual
What Is Microeconomics?
Social Consequences
What we ultimately want to know are the social
consequences of the interaction of rational, self-
interested individual behavior.
“Equilibrium”
The situation that arises when everyone is doing the best he/she
can given his/her circumstances (and given what everyone else is
doing.)
Economic Theory, Hypotheses, and
Economic Models
Testing Statistics /
Economic Models -
with real-
Theory Hypotheses Econometrics
world data
An economic analysis always begins with a question
Economic questions can be of macro importance (economy-wide)
Does monetary tightening reduce inflation?
Does improvement in institutional quality benefit economic growth?
…or micro importance (firms, workers, households)
Do mergers between firms increase product prices?
Will raising minimum wages improve workers’ welfare?
Does providing cash-transfers support poor households?
…but some of the most important questions can be personal (about you!)
Should I allocate time for physical exercises?
Should I spend more time with my family?
Does going to college improve my earnings?
Economic Theory, Hypotheses, and
Economic Models
Testing Statistics /
Economic Models -
with real-
Theory Hypotheses Econometrics
world data
Economic questions are often formed into “testable” hypotheses
A hypothesis is a statement about what we would observe in the world
Economic questions can be of macro importance (economy-wide)
Raising interest rate reduces inflation
Improvement in institutional quality boosts economic growth
…or micro importance (firms, workers, households)
Firm mergers lead to product price markups
Raising minimum wages increase workers’ earnings
Providing cash-transfers to poor families increase household income
…but some of the most important questions can be personal (about you!)
Regular physical activity increases average life expectancy
Spending time with family increases happiness through emotional support
Having a college degree increases job earnings potential
Economics, Incentives, and Economic
Models
Testing Statistics /
Economic Models -
with real-
Theory Hypotheses Econometrics
world data
Economic Model
• Economic models distill complicated human behavior
down to a level that we can describe with pictures or
mathematics.
• Often ignore complications that make humans more
interesting than computers.
• Example: Supply and Demand Curves
Class Activity
Get in group of 3-4.
1. Come up as a group a (micro)economic
question that interests you.
2. Form a hypothesis for that question.
3. Introduce an economic model that would help
you test the hypothesis.
• Feel free to use a graph to help your description of the
model
Class Activity
Based on the model you just described, answer the
following questions:
1. Who is making the decision?
2.What is motivating them in making this decision?
3. What prices does the decision-maker face?
4. What constraints does the decision-maker face?
5. What happens to the decision-makers choice if:
a) The price changes
b) The constraint changes
Course Outline
Individual Choice
Competitive Firm Choice
Competitive Equilibrium and
the “Invisible Hand”
Distortions of the
“Invisible Hand”
The Plan for this Course
1) Individual Choice
2) Competitive Firm Choice
3) Competitive Equilibrium and the “Invisible
Hand”
4) Distortions of the “Invisible Hand”
The Plan for this Course: Individual Choice
Investigate choices made by individuals in their roles as
consumers, workers, and people who plan for the future
(savers and borrowers).
Tastes and Preferences: Individuals are viewed as having
tastes
E.g., over different kinds of goods, over leisure and work, over
consuming today versus consuming in the future.
Constraints: They would like to have more of
everything, but they are constrained by limited
resources such as income and time.
Optimization: As a result, they try to “do the best they
can” given the economic circumstances and incentives
they face.
The Plan for this Course:
Competitive Firm Choice
Firms seek to maximize profit by producing goods or
services, using labor and capital as inputs.
The analysis of competitive firm choice then leads to
the concepts of supply curves (or functions) for goods
as well as demand curves (or functions) for labor and
capital
The analysis of individuals (as consumers, workers and
savers), on the other hand, leads to demand curves (or
functions) for goods and supply curves (or functions) for
labor and capital
The Plan for this Course: Competitive
Equilibrium and the “Invisible Hand”
Individuals (or firms) have no
Non-strategic impact on their economic
behavior environment because each of them
is a very small part of what
generates that environment.
• Under certain conditions, self-interested behavior is not inconsistent
with the collective “good”.
• “The Invisible Hand”: Markets can generate socially desirable
outcomes that could not be achieved under government planning.
First Welfare Theorem
Distortions of the “Invisible Hand”
Under competitive market: Instances when competitive markets
fail to produce efficient outcomes.
1. Market prices are “distorted” through policies like price
controls or taxes.
2. Externalities (e.g. pollution)
3. Asymmetric Information
From strategic decision making: Situations in which strategic
considerations by individuals create additional reasons why self-
interest and the collective “good” may not be fully aligned.
1. Market power: monopoly, oligopoly
2. Free riding in the Civil Society
3. Political power and Government
Distortions of the “Invisible Hand”
Under perfect competition: Instances when competitive markets
fail to produce efficient outcomes.
1. Market prices are “distorted” through policies like price
controls or taxes.
2. Externalities (e.g. pollution)
3. Asymmetric Information
From Strategic decision making: Situations in which strategic
considerations by individuals create additional reasons why self-
interest and the collective “good” may not be fully aligned.
1. Market power: Monopoly, oligopoly
2. Free riding in the Civil Society
3. Political power and Government
Syllabus
TEXTBOOK
“Microeconomics: An Intuitive Approach with Calculus” – by Thomas Nechyba
• Either the 1st or 2nd edition will work
GRADING DISTRIBUTION
Problem Sets 40%
Midterm Exam 25%
Final Exam 35%
1. Problem Sets (40%)
There will be a total of 4 problem sets for you to complete – each will count for 10%. You can
choose to complete these problem sets independently or in groups of maximum 4 students.
One hardcopy of your solutions will be due in class on the due date specified in the course
outline. We will go over the solutions together in class.
2. Exams (60%)
There will be 2 in-class exams throughout the semester. The Midterm Exam will count for 25%
of your grade and the Final Exam 35%. Exam questions will be similar to those from in-class
questions, problem sets, and review materials that will be distributed.
Next class
Topic: Budgets and Constraints
Suggested reading: Textbook’s chapters 2 and 3
