DEPARTMENT OF ECONOMICS

SECOND YEAR 2003/04 Francis O'Toole

INTERMEDIATE ECONOMICS

COURSE DESCRIPTION

This module is designed to provide a general introduction to, and survey of, microeconomic theory. The material for this course is built around the study of economic agents (e.g. consumers, producers, factor-owners) maximising objectives (e.g. utility, profits, rent) in an environment of economic constraints (e.g. income, costs, time). Students are strongly advised to review their first year notes on microeconomics and mathematics as familiarity with material from these modules is essential (and assumed).

SUGGESTED TEXTBOOKS

Most intermediate microeconomics textbooks cover the material adequately. I tend to follow closely Varian's and Laidler and Estrin's textbooks.

Laidler D. & S.Estrin, "Introduction to Microeconomics", Simon & Schuster, 4th edition, 1995. (Feel free to use earlier editions – chapter references may be slightly different.)

Varian,H. "Intermediate Microeconomics: A Modern Approach", Norton, 6^th edition, 2003 (5th edition, 1999 is very similar).

(In general, feel free to use earlier editions of both books; chapter references will be different.)

LECTURE MATERIAL

Lectures will occasionally include topics not covered by the above books. Basic lecture notes (powerpoint files) can be downloaded from www.tcd.ie/Economics/staff/francis.otoole.htm It will be assumed that students have downloaded the basic lecture notes prior to lectures.

CLASS PROGRAMME

Students must attend their assigned weekly (as opposed to fortnightly) class. A list of microeconomic questions is attached. The Teaching Assistants for the course – Liam Delaney and Padraig Moore - will use these questions as the basis for the weekly class discussion. Students must attempt these questions before classes, as classes will be interactive. These questions may be taken as indicative of the type of question that you will be asked to address in the final examination. (However, these questions should not be interpreted as forming the set of questions from which examination questions are chosen.)

ASSESSMENTS

There is a two hour examination at the end of Hilary Term. It takes place in the week after lectures for the term end. This examination will determine 20 per cent of your final grade in Intermediate Economics. In the final (three hour) examination for Intermediate Economics you must answer three (from five) microeconomic questions.

COURSE OUTLINE

1. Introduction

(Laidler & Estrin: Chapter 1. Varian: Chapter 1.)

Optimization and equilibrium

Demand, supply and market equilibrium

Comparative statics

2. Consumer Theory

(Laidler & Estrin: Chapters 2-6. Varian: Chapters 2-6, 8 & 15; parts of Chapters 7, 10 & 14.)

Budget constraint

Preferences and utility

Optimal choice

Substitution and income effects: Slutsky equation

Applications: Labour-leisure choice, intertemporal choice.

Consumer surplus

3. Producer Theory

(Laidler & Estrin: Chapters 10-12 & 24. Varian: Chapters 18-22; parts of Chapter 16.)

Inputs and outputs

Cost curves and cost minimisation

Short-run and long-run

Profit maximisation

Producer surplus

4. Different Market Structures & Game Theory

(Laidler & Estrin: Chapter 13; parts of Chapters 14-20. Varian: Chapters 23,24,25,27,28&29.)

Perfect competition

Firm supply and industry supply

Equilibrium in perfect competition

Monopoly and monopolistic competition

Allocative and productive efficiency

Oligopoly, Cournot and Bertrand

Game theory and Nash equilibrium

5. Factor Markets

(Laidler & Estrin: Chapter 21 [Essential Reading]. Varian: Chapter 26.)

Factor pricing in perfectly competitive markets and imperfectly competitive markets

Application: Minimum wage legislation.

6. General Equilibrium

(Laidler & Estrin: Chapters 27-30 & 32. Varian: Chapter 30 & 31.)

Pareto efficiency

The Edgeworth box

The exchange economy and the production economy

General equilibrium and the two fundamental theorems of welfare economics

Microeconomic Questions

Classes in Weeks 3 and 4: Consumer Theory Questions

1. Explain why convex preferences means that "averages are preferred to extremes." Can you give some counter-examples? Can indifference curves intersect?

2. Explain the relationship between the income consumption curve and the Engel curve. Suggest examples of goods that have Engel curves with (a) positive; (b) negative; and (c) positive and then negative slopes.

3. Explain, using diagrams where appropriate, the differences between:

(i) Giffen and Inferior goods; and

(ii) Hicksian and Marshallian demand curves.

4. (a) Explain how the concepts of income and substitution effects may be used to analyse the labour supply response of an individual to an increase in the wage rate.

(b) Explain why the Minister for Finance might want to be aware of the extent of the labour supply response to a change in the standard rate of labour income tax.

5. (a) Show, using a two-period indifference curve framework, how an individual may respond to an increase in the interest rate by increasing or decreasing savings.

(b) Explain why the Minister for Finance might want to be aware of the extent of the savings supply response to a change in the deposit interest retention tax (DIRT).

Classes in Week 6 & 7: Producer Theory Questions

6. Explain why a firm, which uses two factors of production, A and B, could not be minimising the costs of production of its current output level if:

Marginal Product of Factor A Marginal Product of Factor B

------------------------------------ > ---------------------------------

Price of Factor A Price of Factor B

7. Why would a producer prefer a general subsidy to an equal-cost subsidy to one factor only?

8. Describe with the aid of a (well-drawn) isoquant map, the relationship between the behaviour of a firm's short-run and long-run costs and its production function for the case of the Cobb-Douglas production function.

9. Describe, using diagrams or algebra where appropriate, the following terms:

(a) output elasticity;

(b) diminishing marginal productivity;

(d) returns to scale;

(ii) homothetic production function; and

(iii) elasticity of substitution.

Classes in Weeks 8 and 9: Different Market Structures & Game Theory Questions

10. What is the relationship between the output of a perfectly competitive industry and the output of a monopoly, when both face the same costs (assume constant marginal cost) and the same linear demand?

11. Under perfect competition and monopolistic competition, excess capacity and supernormal profits are only short-run phenomena. Discuss using appropriate diagrams.

12. (a) Analyse the effect of a firm-specific and an industry-specific production tax on the short-run and long-run equilibria of the firm and the industry in a perfectly competitive framework.

(b) Analyse the effect of a firm-specific and an industry-specific production tax on the short-run and long-run equilibria of the firm and the industry in a monopoly.

13. (a) Explain the difference between first-, second- and third- degree price discrimination. What are the conditions necessary for a monopolist to operate an effective policy of price discrimination in each instance?

(b) Present an example of a market in which price discrimination operates in Ireland and explain how it meets, in whole or part, the conditions necessary to operate effective price discrimination.

14. What is an Nash equilibrium? What is the difference between a Cournot-Nash equilibrium and a Bertrand-Nash equilibrium?

15. True, False or Uncertain? Explain your answer.

(a) A discriminating monopolist will charge a higher price in the relatively elastic market.

(b) Monopolistic competition is socially wasteful as productive efficiency is not attained.

(d) Nash equilibria are always "inefficient".

Classes in Week 2: Factor Markets Questions

16. (a) Explain what is meant by the term "derived demand for labour".

(b) Discuss the relationship between the firm's demand curve for labour in the short-run and the long-run.

17. How would a change in production technology, which increases the elasticity of substitution between capital and labour in production, affect the slope of the firm's demand curve for labour?

Classes in Week 3: General Equilibrium Questions

18. Explain briefly the difference between partial and general equilibrium analyses, and suggest economic issues for which each type of analysis would be appropriate.

19. Explain, using an Edgeworth Bowley Box Diagram, what is meant by a Pareto-efficient equilibrium.

20. Outline the efficiency conditions that must hold in our standard 2 x 2 x 2 general equilibrium model.

21. State the two Fundamental Theorems of Welfare Economics. In terms of public policy are they relevant?

22. Can you suggest how we might incorporate some measure of equity or fairness into the contract curve in the Edgeworth Bowley Box Diagram?

Microeconomics Problem Set: Classes in Week 2

This problem set must be attempted by all students taking this course and returned to the collection box outside of Room 3008 in the Department of Economics before 3.00 p.m. on Monday 12^th January (i.e. the start of week 2). This homework will be reviewed during classes in week 2; as such, please retain a photocopy of your problem set. This homework does not contribute to your course grade but a failure to attempt this homework will send a ‘negative' signal to the lecturer and the teaching assistants. The following questions should be familiar to students of first year maths and provide the fundamental background for SF Intermediate Economics.

1. Differentiate (a) y = x¹⁰⁰, (b) y = 1/x, (c) y = 1/x², (d) y = e^3x, (e) y = ln 3x (x > 0),

(f) y = ax² + bx + c, (g) y = e^x + e^-x, (h) y = x⁴.e^2x, (i) y = (x + 1)/(x - 1).

2. Given the demand function, Q = 100 - P, calculate the price elasticity when the price is

(a) 5, (b) 50, (c) 95. Is the demand inelastic, unit elastic or elastic at these prices? Explain.

3. The demand in a market is Q = 50 – (P/2).

(a) Find the inverse demand function P(Q). Sketch the inverses demand function.

(b) Give the total, marginal and average revenue functions for the market.

(d) Assume that this market is supplied by a monopolist firm with the following cost function,

C(Q) = 10 + 20Q. Write down the profit function of the firm, p(Q). At what level of Q is profit maximised?

4. An individual with a (Cobb-Douglas) utility function U = xy² maximises utility subject to the constraint that all income, M, is spent on the goods x and y.

(a) Set up the lagrangian for this problem.

(b) Find the appropriate first-order conditions for this lagrangian.

(d) Interpret your results economically.

DEPARTMENT OF ECONOMICS: INTERMEDIATE ECONOMICS

LECTURER: DR. FRANCIS O'TOOLE

HILARY TERM TEST 2001/2002

PLEASE ANSWER QUESTION 1

1. An individual firm with the following Cobb-Douglas production function, Y = LK, maximises output subject to the constraint that all expenditure by the firm, C, is spent on the two inputs/factors of productions L (labour) and K (capital).

(a) Set up the lagrangian for this problem. Find the appropriate first-order conditions for this lagrangian.

(b) Solve for L and K, i.e., the demands for the two inputs/factors of production, as functions of C, w (wage rate of labour) and r (rental rate of capital).

(c) In the context of the following Cobb-Douglas production function, Y = LK, derive the two output elasticities (i.e. with respect to labour and capital) and the marginal rate of technical substitution (MRTS or TRS). Interpret your results from an economics perspective in each case.

PLEASE ANSWER THREE OF THE FOLLOWING FOUR QUESTIONS

2. Explain, using the concepts of substitution and income effects, the differences between:

(i) Giffen and inferior goods; and

(ii) Marshallian and Hicksian (i.e. compensated) demand curves.

3. (a) If leisure is a normal good for all individuals, must the slope of an individual's labour supply function necessarily be positive? Explain your answer.

(b) Show, using a two-period indifference map and budget constraint framework, how an individual may respond to an increase in the interest rate (on savings) by increasing or decreasing savings.

4. Explain, using isoquants and isocost lines, why a producer would prefer a general subsidy (on all inputs/factors of production) to an equal-cost subsidy on only one input/factor of production?

5. Describe, using diagrams or algebra where appropriate, four of the following concepts/terms:

(i) Transitivity (of preferences);

(ii) Engel curve;

(iii) Homothetic preferences;

(iv) Returns to scale; and

(v) Elasticity of substitution.

Second Year Intermediate Economics

Professor Frances Ruane

May 2003 Draft Version (Answer three questions)

1. (a) Using appropriate diagrams, derive, in two-product space, the Hicksian and Marshallian demand curves for (i) a normal good, and (ii) an inferior good. Comment on the differences between the two cases.

(b) Show, using the Slutsky decomposition in product space, why the typical consumer with well-behaved preferences would prefer an income tax to a tax on one good only which raised the same revenue.

2. Using a Cobb Douglas production function of the form AK^bL^c, and following the standard notation, show that:

(i) the firm has constant returns to scale when (b+c) = 1;

(ii) the output elasticities for K and L are b and c respectively;

(iii) the marginal rate of technical substitution is cK/bL; and

(iv) Euler's Theorem holds.

3. (a) Analyse the effect of a firm-specific and an industry-specific production subsidy on the short-run and long-run equilibria of the firm and the industry in a perfectly competitive framework.

(b) Analyse the effect of a firm-specific and an industry-specific production subsidy on the short-run and long-run equilibria of the firm and the industry in a monopoly.

4. (a) Explain briefly the difference between partial equilibrium (PE) and general equilibrium (GE) analyses, and suggest economic issues for which each type of analysis would be appropriate and inappropriate. (In your answer make use of both a simple supply-demand framework and an Edgeworth-Bowley Box diagram.)

(b) In a two sector (A,B) framework, where labour (which is fixed in total supply) is the only factor of production which is mobile between the two sectors, show the impact on wages and sectoral labour allocations of

(i) a reduction in the price of output A; and

(ii) a fall in the stock of the other (fixed) factors in sector B.

What determines the impact on the wage of the two changes?

5. What is a Nash equilibrium? What is the difference between a Cournot-Nash equilibrium and a Bertrand-Nash equilibrium in terms of (a) assumptions and (b) the price-quantity outcomes? What factors would influence your decision to choose between either model in analysing a particular market situation?