Microeconomics

(PGP-I)

Session 1
 Session One : Overview

1.Defining Microeconomics

2. Analytical tools of Microeconomics

• Constrained Optimization
• Equilibrium Analysis
• Comparative Statics

3. The Types of Microeconomic Analysis

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 Microeconomics Defined

Microeconomics studies the economic behavior

of individual decision makers, such as a
consumer, a worker, a firm or a manager.

How individual economic decision-makers

allocate scarce resources among alternate uses.

This study involves both the behavior of these

economic agents on their own and the way their
behavior interacts to form larger units, such as
markets.
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 Microeconomic Modeling
Choice vs. Alternatives

Models are like maps – using visual methods, they

simplify the process and facilitate understanding of
complex concepts. Microeconomic models need to:

 Resemble Reality
 Be Understandable
 Be an Appropriate Scale

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 Exogenous & Endogenous Variables

Defined: Variables that have values taken as given in the analysis are
exogenous variables. Variables whose values are
determined as a result of the model’s workings are
endogenous variables.

“How would a manager hire the maximum possible workers on a budget of

$100?”
vs.
“How would a manager minimize the cost of hiring three workers?”

OR

“How much food and clothing should the consumer purchase in order to
maximize satisfaction on a budget of Rs. 2000 ?”
vs.
“What is the minimum level of expenditure that the consumer must receive in
order to reach a subsistence level of satisfaction?” 5
 The Objective Function

Defined: The Objective Function specifies what the

agent cares about.

• Does manager care more about

raising profits or increasing
“power”?

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 The Constraints

Defined: Constraints are whatever limit is placed on the

resources available to the agent.

 Time
 Budget
 Other Resources
 Technical Capabilities
 The Marketplace
 Rules, Regulations, and Laws

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 The Constraint Optimization

Behavior can be modeled as optimizing the

objective function, subject to various constraints.

• Consumers • Producers
Maximize Utility Maximize Profits
Subject to the Budget Constraint Subject to
1. Consumer Demand
2. Input Costs

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 The Constraint Optimization

Behavior can be modeled as optimizing the objective

function, subject to various constraints.

Manager’s Investment Choice

• Facilities ( F ): Facilities workers cost $30

• R&D ( R ): R&D workers cost $100

• Max N
(F,R)
• Subject to: expenditure < $250
• Where: N is the number of workers

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 The Constraint Optimization

Consumer purchases

Food (F), Clothing(C), Income (I)

Price of food (Pf), Price of clothing (Pc)

𝐹𝐶
Utility from purchases: U =
2

Max U(F,C) subject to: Pf F + Pc C < I

(F,C)

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 Fundamental Questions

Societies must answer these questions

that relate to microeconomics:

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 these goods and services and how will they get
them

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 Equilibrium

Defined: 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 analysis is an analysis of

a system in a state that will continue
indefinitely as long as the exogenous
factors remain unchanged.

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Equilibrium
Example – Sale of Coffee Beans

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Equilibrium
Example – Sale of Coffee Beans

Demand (P,I)

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 Equilibrium
Example – Sale of Coffee Beans

P* •

Demand (P,I)

Q*
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 Comparative Statics Analysis

Defined:
A Comparative Statics Analysis
compares the equilibrium state of a
system before a change in the
exogenous variables to the
equilibrium state after the change.

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Comparative Statics Analysis

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 Marginal Impact

Defined:
The Marginal Impact of a change
in the exogenous variable is the
incremental impact of the last unit
of the exogenous variable on the
endogenous variable.

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 Microeconomic Analysis

Positive Analysis (the way things are):

• Is an analysis that attempts to explain how an
economic system works

Normative Analysis (the way things should be):

• Is an analysis of what should be done

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 Microeconomic Analysis
Some Examples

• If USA lifts the prohibition on imports of Cuban cigars, the price of

cigars will fall.

• To provide revenues for public schools, taxes on alcohol and

tobacco should be raised instead of increasing income taxes.

• If telephone companies are allowed to offer cable TV service, the

price of both types of service will fall.

• Government subsidies to farmers are too high and should be phased

out over the next decade.

• If the tax on cigarettes is increased by 50 cents per pack, the

equilibrium price of cigarettes will rise by 30 cents per pack.

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 “Take-Home” Messages

• Economics is the study of the allocation of limited resources to satisfy

unlimited human wants : science of constrained choice.

• Microeconomics examines the economic behavior of individual

economic decision units.

• Microeconomic studies are often conducted by constructing and

analyzing models of a particular problem.

• In analyzing any model, one needs to understand what variables will

be taken as given (exogenous variables), as well as what variables will
be determined within the model (endogenous variables).
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 “Take-Home” Messages

• Three essential tools of microeconomic analysis are (1) constrained

optimization, a tool that decision makers use to maximize or minimize some
objective function subject to a constraint; (2) equilibrium analysis, used to
describe a condition or state that could continue indefinitely in a system, or at
least until there is a change in some exogenous variable; and (3) comparative
statics, used to examine how a change in some exogenous variable will affect
the level of some endogenous variable in an economic model, including
equilibrium.

• The term marginal in microeconomics measures the amount by which a

dependent variable changes as the result of adding one more unit of an
independent variable.

• Microeconomics provides tools to examine positive and normative issues.

Positive analysis attempts to explain how an economic system works and
Normative studies introduce value judgments into the analysis.

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