Modern Microeconomics Lecture Notes

Modern Microeconomics Notes

Preface

• Modern Microeconomics approaches are designed for intermediate levels of economics education.

• The text aims to fill gaps in existing literature, such as the outdated tools used to analyze cost curves and demand.

• The book highlights the importance of oligopoly as a primary market structure in modern economies, a focus that many textbooks underplay.

• The structure is divided into two parts: tools of analysis and theories of the firm.

PART ONE: BASIC TOOLS OF ANALYSIS

I. Economic Models

• Definition: A model represents simplified assumptions of reality to analyze economic phenomena.

• Abstraction: Models must balance realism and generality, as the real economic world is complex.

• Purpose: Models serve for analysis or prediction, requiring different structures based on their intended function.

• Validity Criteria: Predictive power, consistency, realism, generality, and simplicity are vital attributes of a model.

II. Classification of Markets

• Market Structures:

  • Perfect Competition: Many firms, homogeneous products, price elastic demand.

  • Monopoly: One firm, unique product, price elasticity finite.

  • Monopolistic Competition: Many firms, differentiated products, high price elasticity.

  • Oligopoly: Few firms, interdependent pricing, varied product degree.

• Criteria for Classification:

  • Substitutability of products.

  • Interdependence of sellers.

  • Condition of entry into the market.

III. Theory of Demand

• Purpose: To explore factors influencing demand beyond price.

• Traditional Focus: Price, income, tastes, and other factors that can shift the demand curve.

A. Theory of Consumer Behavior

• Cardinal Utility Theory: Utility is quantitatively measurable and follows the law of diminishing marginal utility.

• Indifference Curve Theory: Consumers can rank preferences without precise measures.

• Revealed Preference Hypothesis: Considers consumer choices as indicators of their preferences without reliance on utility measures.

B. Market Demand

• Derivation: Sum of individual demands at varied prices; can show Giffen goods under specific circumstances.

• Determinants: Price, income, tastes, along with changes in population and distribution of income can shift demand.

• Elasticities of Demand:

  • Price elasticity varies based on the availability of substitutes and the nature of the good (necessity vs. luxury).

  • Income Elasticity: Determines how demand changes with income changes.

  • Cross-Elasticity: Determines how demand shifts regarding competing products.

IV. Theory of Production

• Production Function: Relation between quantity of inputs and outputs; represented by isoquants indicating different output levels.

• Types of Isoquants:

  • Linear: Perfect substitution.

  • Input-Output: Complementarity.

  • Smooth: Convex to the origin.

• Laws of Production:

  • Long-Run Analysis: All factors variable with two forms of returns:

  • Constant: Output increases in fixed ratio to inputs increase.

  • Increasing: Output increases more than the proportion of inputs.

  • Decreasing: Output increases less than the proportion of inputs.

  • Short-Run Analysis: Focuses on variable factors leading to diminishing returns as input increases.

A. Equilibrium of the Firm

• Constrained Profit Maximization: The firm aims to maximize output or minimize costs under predefined constraints.

• Isocost and Isoquant Analysis: Graphically represents the optimal combination of inputs for desired output levels, depending on the cost factors.

Conclusion

• The text discusses microeconomic theory emphasizing contemporary applications and practices, particularly focusing on oligopoly and newer developments.