Microeconomics CHAPTER 1

Positive analysis asks

explanatory questions such as "What has happened?" or "What is happening?" It may also ask a predictive question: "What will happen if some exogenous variable changes?"

constrained optimization

An analytical tool for making the best (optimal) choice, taking into account any possible limitations or restrictions on the choice.

positive analysis

Analysis that attempts to explain how an economic system works or to predict how it will change over time. just looks at facts.

normative analysis

Analysis that typically focuses on issues of social welfare, examining what will enhance or detract from the common good.

Marginal cost

measures the incremental impact of the last unit of the independent variable (output) on the dependent variable (total cost).

Constrained Optimization: The Farmer's Fence Suppose a farmer plans to build a rectangular fence as a pen for his sheep. He has F feet of fence and cannot afford to purchase more. However, he can choose the dimensions of the pen, which will have a length of L feet and a width of W feet. He wants to choose the dimensions L and W that will maximize the area of the pen. He must also make sure that the total amount of fencing he uses (the perimeter of the pen) does not exceed F feet. a) What is the objective function for this problem? (b) What is the constraint? (c) Which of the variables in this model (L, W, and F ) are exogenous? Which are endogenous? Explain.

(a) The objective function is the relationship that the farmer is trying to maximize—in this case, the area LW. In other words, the farmer will choose L and W to max- imize the objective function LW. (b) The constraint will describe the restriction imposed on the farmer. We are told that the farmer has only F feet of fence available for the rectangular pen. The constraint will describe the restriction that the perime- ter of the pen 2L 2W must not exceed the amount of fence available, F. Therefore, the constraint can be written as 2L 2W F. (c) The farmer is given only F feet of fence to work with. Thus, the perimeter F is an exogenous variable, since it is taken as given in the analysis. The endogenous vari- ables are L and W, since their values can be chosen by the farmer (determined within the model).

exogenous variable

(creating from outside) - A variable whose value is taken as given in the analysis of an economic system.

endogenous variable

- A variable whose value is determined within the economic system being studied.

THREE KEY ANALYTICAL TOOLS

1. Constrained optimization 2. Equilibrium analysis 3. Comparative statics

Regardless of its market system, every society must answers 3 questions:

1: what goods and services will be produced and in what quantities. 2. who will produce the goods and services and how? 3. Who will receive the goods and services?

equilibrium

A state or condition that will continue indefinitely as long as factors exogenous to the system remain unchanged.

Suppose that the price of housing, H IS $1 and the price of food F, is $2, while the consumer income is $40. the consumer's level of satisfaction is measured by H + F and the consumers wishes to maximize satisfaction.The consumer objective function is: A) max 1H + 2F B) max H + F C) H+F < 30 D) 1H + 2F < 30

B

How is the concept of equilibrium related to this discussion of supply and demand?

In a competitive market, it is achieved at a price at which the market clears—that is, at a price at which the quantity offered for sale just equals the quantity demanded by consumers.

What is the diffecrence between Microeconomics and Macroeconomics`

Microeconomics studies the economic behavior of individual decision makers, such as a consumer, a worker, a firm, or a manager. Macroeconomics studies how an entire national economy perform such as: interest rates, inflation and the nature of business cycles.

How does the tool of constrained optimization help decision makers make choices?

The constraint optimization allows the decision maker to select the best (optimal) alternative while accounting for any possible limitations or restriction possibles.

What role does the objective function and constraints play in a model of constrained optimization?

The objective function represents the relationship to be maximized or minimized. the constraints place limitations on the choice the decision maker can select and defines the set of alternatives from which the best will be chosen.

constraints

The restrictions or limits imposed on a decision maker in a constrained optimization problem.

True or False Opportunity cost are an important concept in economics because that show that all actions involve tradeoffs.

True

Constrained Optimization: Consumer Choice Suppose a consumer purchases only two types of goods, food and clothing. The consumer has to decide how many units of each good to purchase each month. Let F be the number of units of food that she purchases each month, and C the number of units of cloth- ing. She wants to maximize her satisfaction with the two goods. Suppose the consumer's level of satisfaction when she purchases F units of food and C units of clothing is measured by the product FC, but she can purchase only limited amounts of goods per month because she must live within her budget. Goods cost money, and the consumer has a limited income. To keep the example simple, suppose the consumer has a fixed monthly income I, and she must not spend more than I during the month. Each unit of food costs PF and each unit of clothing costs PC. a) What is the objective function for this problem? (b) What is the constraint? (c) Which variables (PF, F, PC, C, and I ) are exogenous? Which are endogenous? Explain. (d) Write a statement of the constrained optimization problem.

a) The objective function is the relationship that the con- sumer seeks to maximize. In this example she will choose the amount of food and clothing to maximize her satisfac- tion, measured by FC. Thus, the objective function is FC. (b) The constraint represents the amounts of food and clothing that she may choose while living within her in- come. If she buys F units of food at a price of PF per unit, her total expenditure on food will be (PF)(F). If she buys C units of clothing at a price of PC per unit, her total ex- penditure on clothing will be (PC)(C). Therefore, her total expenditure will be (PF)(F ) (PC)(C ). Since her total expenditure must not exceed her total income I, the constraint is (PF)(F ) + (PC)(C ) < I. (c) The exogenous variables are the ones the consumer takes as given when she makes her purchasing deci- sions. Since her monthly income is fixed, I is exogenous. The prices of food PF and clothing PC are also exogenous, since she cannot control these prices. The consumer's only choices are the amounts of food and clothing to buy; hence, F and C are the endogenous variables. (d) The statement of the constrained optimization prob- lem is max FC (F,C) subject to: (PF)(F) + (PC)(C) < I

normative analysis asks:

asks prescriptive questions, such as "What should be done?"

Multiple choice Which of the following could be an example of a constraint? a) Max xy b) K + L c) 2A + 4B < 30 d) min zQ

c

Multiple choice Which of the following statements about economics is false? a) Microeconomics is the study of the economic behavior of individual economic decision makers b) Macroeconomics is the study of how an entire national economy performs. c) Economics is the science that deals with the allocation of limited resources to satisfy unlimited human wants. d) All of the above statements are true

d

The term marginal in microeconomics tells us

how a dependent variable changes as a result of adding one unit of an independent variable.

suppose the market for wheat is competitive, with an upward-sloping supply curve, a downward-slopping demand curve, and equilibrium price of $4.00 per bushel. why would a higher price (e.g. $5.00 per bushel) not be an equilibrium price? why would a lower price (e.g. $2.50 per bushel) not be an equilibrium price?

if the price in the market was above the equilibrium price, consumers would be willing to purchase fewer units than suppliers would be willing to sell, creating excess supply. When the price is below equilibrium, consumers will demand more units than suppliers have made available. this excess demand will entice consumers to bid up the prices to purchase the limited units available. since price will change, it cannot be equilibrium.

Objective function

is the relationship that the decision maker seeks to "optimize," that is, either maximize or minimize.

Why is economics often described as the science of constrained choice?

while our wants for goods and services is unlimited the resources necessary to produce those goods and services is limited (scarce) e.g. labor, capital, raw materials. this scarcity implies that we are constrained in the choices we can make about which goods and services to produce. Value comes with scarcity : lowering cost.

Explain microeconomics phenomena

Þ Interested in a good analysis with theory. Þ Theory: two or three phenomenon's together. Its replace by better theories.