Class notes
ECO3020F: Microeconomics
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This is a course document for the first term of ECO3020F, covering Microeconomics
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Micro-EconomicsRevision: Week 1
- How can institutions achieve an efficient and/or “just” world?
- Price mechanism (invisible hand) clears markets through self-regulation to ensure no waste of
resources and maximises benefit
- Assumptions: Everyone is self-interested, market price represents all costs and benefits,
relevant information is known by everyone
- Overuse: Occurs when there are negative external effects
- People don’t pay for the full cost of their own actions on others
- Underuse: Occurs when there are positive external effects
- People don’t pay for the full benefits of actions of other
- Fishermen’s dilemma
- Alfredo & Bob share a lake & catch fish in it, as one catches more fish, the other catches
fewer.
- Each must decide how long to fish for
- Each fisherman has a fallback position of 2
- They both know if they both fished less they could both get some fish
- They can choose to fish 10 hours or 12 hours
- If both fish 10 hours, each gets u^A = u^B = 3
- If A fishes 10 hours & B fishes 12, A gets u^A = 1, B gets u^B = 4
- If B fishes 10 hours & A fishes 12, B gets u^B = 1, A gets u^A = 4
- If both fish 12 hours, each gets u^A = u^B = 2
Page 1 of 105
,- For both players: y > w > z > x and y + x < 2w
- If fish 12 hours, outcome is [z,z]
- If fish 10 hours, outcome is [w,w]
- ECONOMIC RENT
- Benefit of fishing 10 hrs vs 12 hours
- [w-z; w-z] = Economic rent
- Total benefit/joint surplus: 2(w-z)
- Solving the game
- Fish 10 hours is socially optimal i.e. the total payoffs (to society) are maximised
- u^B + u^A = 6
- NE is for both to fish 12 hours, but both do worse. ([2,2])
- Total benefit/joint surplus of fishing 10 hours as opposed to 12 hours = 2(3-2)= 2
- The surplus for each fisher IF they divide the catch equally is called his rent = 1
- Common interest: institutions advance common interest by solving problems
- Conflict: institutions are the ways that one group enforces its claim for larger share
- Assurance Game
- History and institutions will matter!!
- Chance events and historical processes unleash a path dependent process that determines where
we end up
Week 1:
Property and Exchange: Mutual Gains and Conflict
- Classical Constitutional Conundrum
- The problem of finding a set of (laws, policies and social norms (institutions)) (“rules of the
game”) so that people are free to choose their actions, whilst avoiding outcomes that none of
them would have chosen had they been able to co-ordinate (elements of mutual gains towards
co-operations BUT ALSO some element of conflict)
Page 2 of 105
,- Start looking at being constrained by OTHER PEOPLE
- Tioli (Take it or leave it power)
- Want to find a socially optimal allocation of goods, see what distributional issues may arise, and
evaluate the different ways (institutions) in which allocation might occur
- Think: Our society is only populated by two people with only two goods
- Data and Coffee, Ayanda and Biko
- Fixed/limited goods
- Key Aspects
- Data and Coffee: endowments
- Initial endowments: goods each person has before any exchanges ( randomly allocated )
- Final endowments: goods each person has AFTER all exchanges
- INDIFFERENCE CURVES
- Marginal rate of substitution: The willingness to pay for a small (marginal) increase in the
amount of good (x) expressed as how much of good (y) the person would be willing to give up
for this.
- It is also the negative of the slope of the indifference curves
- FEASIBLE FRONTIER
- Marginal rate of transformation: the negative of the slope of the feasible frontier. It measures
the sacrifice of the good y necessary in order to get more of the good x.
- It is therefore the opportunity cost of the x good in terms of the y good.
Edgeworth Box:
- Coffee and data
- Total good x (coffee) = X̅ = 10
- Total good y (data) = ȳ = 15
- Feasible allocation:
- x^A + x^B = X̅
- y^A + y^B = ȳ
Page 3 of 105
,- The Edgeworth Box is a way of representing and visualising the distribution and allocative
efficiency of goods in a society/economy.
z = initial endowment (randomly allocated)
A=1
B = 14
- @ initial endowment of coffee, B has 1 KG of coffee and A has 9 KGS of coffee
- People are always happier when they have more of BOTH goods
- Each individual must move AWAY from their origins to improve their situations
- A’s utility increases as his allocation of goods moves away from the bottom-left corner (B is
losing goods and his utility is decreasing )
- B’s utility increases as his allocation of goods moves away from the top-right corner (A is losing
goods and his utility is decreasing)
- Superscripts = Refers to people you are talking about
- Exponents = α and 1- α
- Cobb-Douglas utility function
- u = kx^ α y^𝛽
- Positive marginal utility
- Diminishing marginal utility
- k > 0; α, 𝛽 > 0
- α + 𝛽 = 1 (constant returns to scale)
- α and 𝛽 = relative intensity of preference for x relative to y
- MRS:
- Ayandas indifference curves
Page 4 of 105
, -U^A3 is greatest
- Biko’s indifference curves
- Biko’s origin is at top
- We have rotated B’s indifference
curves by 180 degrees
-COMBINE THEM
Page 5 of 105
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