Microeconomics: Markets, Methods & Models - ASUE catalog

Microeconomics: Markets, Methods & Models

Douglas Curtis and Ian Irvine Version 2014 -- Revision A

The content in this version is differentiated from the 2013 version solely by minor editorial adjustments.

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Contents

Part One: The Building Blocks

3

1 Introduction to key ideas

5

1.1 What's it all about? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

1.2 Understanding through the use of models . . . . . . . . . . . . . . . . . . . . . . 10

1.3 Opportunity cost and the market . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1.4 A model of exchange and specialization . . . . . . . . . . . . . . . . . . . . . . . 12

1.5 Economy-wide production possibilities . . . . . . . . . . . . . . . . . . . . . . . 15

1.6 Aggregate output, growth and business cycles . . . . . . . . . . . . . . . . . . . . 18

2 Theories, models and data

27

2.1 Observations, theories and models . . . . . . . . . . . . . . . . . . . . . . . . . . 28

2.2 Variables, data and index numbers . . . . . . . . . . . . . . . . . . . . . . . . . . 29

2.3 Testing economic models & analysis . . . . . . . . . . . . . . . . . . . . . . . . . 39

2.4 Diagrams and economic analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

2.5 Ethics, efficiency and beliefs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

3 The classical marketplace ? demand and supply

55

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3.1 Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 3.2 The market's building blocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 3.3 Demand and supply curves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 3.4 Other influences on demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 3.5 Other influences on supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 3.6 Simultaneous supply and demand impacts . . . . . . . . . . . . . . . . . . . . . . 71 3.7 Market interventions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 3.8 Individual and market functions . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

Part Two: Responsiveness and the Value of Markets

83

4 Measures of response: elasticities

85

4.1 Price responsiveness of demand . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

4.2 Price elasticity and expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

4.3 The time horizon and inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

4.4 Cross-price elasticities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

4.5 The income elasticity of demand . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

4.6 Elasticity of supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

4.7 Elasticities and tax incidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

4.8 Identifying demand and supply elasticities . . . . . . . . . . . . . . . . . . . . . . 104

5 Welfare economics and externalities

111

5.1 Equity and efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

5.2 Consumer and producer surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . 112

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5.3 Efficient market outcomes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 5.4 Taxation, surplus and efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 5.5 Market failures ? externalities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122 5.6 Other market failures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126 5.7 Environmental policy and climate change . . . . . . . . . . . . . . . . . . . . . . 126 5.8 Equity, justice, and efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

Part Three: Decision Making by Consumer and Producers

143

6 Individual choice

145

6.1 Rationality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145

6.2 Choice with measurable utility . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147

6.3 Choice with ordinal utility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

6.4 Applications of indifference analysis . . . . . . . . . . . . . . . . . . . . . . . . . 163

7 Firms, investors and capital markets

175

7.1 Business organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175

7.2 Profit, ownership and corporate goals . . . . . . . . . . . . . . . . . . . . . . . . . 179

7.3 Risk and the investor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180

7.4 Diminishing marginal utility and risk . . . . . . . . . . . . . . . . . . . . . . . . . 183

7.5 Real returns to investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186

7.6 Financing the risky firm: diversification . . . . . . . . . . . . . . . . . . . . . . . 187

8 Production and cost

197

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8.1 Efficient production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 8.2 The time frame . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 8.3 Production in the short run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 8.4 Costs in the short run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 8.5 Fixed costs and sunk costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 8.6 Long run production and costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 8.7 Technological change and globalization . . . . . . . . . . . . . . . . . . . . . . . 215 8.8 Clusters, learning by doing, scope economies . . . . . . . . . . . . . . . . . . . . 216

Part Four: Market Structures

223

9 Perfect competition

225

9.1 The perfect competition paradigm . . . . . . . . . . . . . . . . . . . . . . . . . . 225

9.2 Market characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227

9.3 The firm's supply decision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228

9.4 Dynamics: entry and exit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234

9.5 Long run industry supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

9.6 Globalization and technological change . . . . . . . . . . . . . . . . . . . . . . . 239

9.7 Efficient resource allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240

10 Monopoly

247

10.1 Monopolies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

10.2 Profit maximizing behaviour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251

10.3 Long run choices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257

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