Microeconomics
A Complete Course Handbook
Prosperity and inequality · Technology and growth · Scarcity, work and choice · Social
interactions and game theory · The firm and its customers · Supply and demand
Rania El Ghalbzouri
Microeconomics — KU Leuven
Compiled from the complete lecture series (Units 1, 2, 3, 4, 7 and 8). This handbook is self-contained: it replaces
the original slide decks in full.
Rania El Ghalbzouri — Microeconomics Page 1
,Contents
Unit 1 — Prosperity, Inequality and Planetary Limits .................................................................. 4
1.1 Measuring income and living standards ............................................................................ 4
1.2 The hockey stick: growth rates and their timing ............................................................... 5
1.3 How unequal is the world? .................................................................................................. 6
1.4 What causes high growth? Productivity ............................................................................ 7
1.5 Will artificial intelligence restart the engine? .................................................................... 8
1.6 Explaining stagnation: the Malthusian model ................................................................. 11
1.7 Capitalism, institutions and government ......................................................................... 14
1.8 Economics and the biosphere........................................................................................... 15
1.9 Why do we need models? .................................................................................................. 16
Unit 2 — Technological Change, Population and Growth ........................................................ 20
2.1 Decision making: opportunity cost and economic rent ................................................. 20
2.2 The gains from specialisation ........................................................................................... 22
2.3 Comparative advantage ..................................................................................................... 22
2.4 Technology, production functions and the choice of technique .................................. 24
2.5 Choosing a technology: dominance and isocost lines .................................................. 25
2.6 Why Britain, and why then? ............................................................................................... 27
2.7 Growth, capitalism and climate change ........................................................................... 29
2.8 Summary and revision ....................................................................................................... 30
Unit 3 — Scarcity, Work and Choice ........................................................................................... 32
3.1 Scarcity and the model of constrained choice ................................................................ 32
3.2 Preferences and indifference curves................................................................................ 33
3.3 The feasible frontier and the marginal rate of transformation....................................... 35
3.4 The optimal choice: MRS = MRT ....................................................................................... 35
3.5 Income and substitution effects........................................................................................ 37
3.6 Application: why working hours fell ................................................................................. 38
3.7 Summary and revision ....................................................................................................... 39
Unit 4 — Social Interactions ......................................................................................................... 41
4.1 Why social interactions change everything..................................................................... 41
4.2 Games: the basic vocabulary ............................................................................................ 42
4.3 Best responses and Nash equilibrium ............................................................................. 42
4.4 Dominant strategies and the prisoners' dilemma ........................................................... 43
4.5 Evaluating outcomes: the Pareto criterion ...................................................................... 45
4.6 Route one: social preferences and altruism .................................................................... 46
4.7 Route two: repeated games, social norms and punishment ......................................... 47
4.8 Route three: changing the rules — sequential games ................................................... 47
4.9 Coordination games and multiple equilibria.................................................................... 48
4.10 Summary and revision ..................................................................................................... 49
Unit 7 — The Firm and Its Customers ......................................................................................... 51
7.1 Cost functions: fixed, variable, average and marginal ................................................... 51
Rania El Ghalbzouri — Microeconomics Page 2
, 7.2 Economies of scale and scope ......................................................................................... 52
7.3 Demand, willingness to pay and elasticity....................................................................... 54
7.4 Marginal revenue ................................................................................................................ 57
7.5 Profit maximisation, method one: isoprofit curves ........................................................ 57
7.6 Profit maximisation, method two: MR = MC .................................................................... 59
7.7 Gains from trade: surplus and deadweight loss ............................................................. 60
7.8 Competition, differentiation and market power ............................................................... 61
7.9 Summary and revision ....................................................................................................... 63
Unit 8 — Supply and Demand: Price-Taking and Competitive Markets .................................. 65
8.1 Demand and supply ............................................................................................................ 65
8.2 The supply decision of a price-taking firm ...................................................................... 66
8.3 Competitive equilibrium ..................................................................................................... 67
8.4 Factors that shift the equilibrium ...................................................................................... 69
8.5 Short-run and long-run equilibrium .................................................................................. 70
8.6 Application: taxes ............................................................................................................... 71
8.7 Perfect competition ............................................................................................................ 73
8.8 Summary and revision ....................................................................................................... 74
Rania El Ghalbzouri — Microeconomics Page 3
, Unit 1 — Prosperity, Inequality and
Planetary Limits
Measuring living standards, the hockey stick of growth, inequality within and between
countries, the Malthusian trap, capitalism, and the biosphere
LEARNING OBJECTIVES — What this unit does
• Measure income and living standards, and understand what GDP per capita does and does not
capture.
• Describe the 'hockey stick' of economic growth and the inequality that accompanies it.
• Explain productivity as the engine of growth, and the technological revolution behind it.
• Build the Malthusian model — diminishing average product of labour — to explain the centuries
of stagnation before 1700.
• Understand capitalism as an economic system, and the environmental limits within which the
economy operates.
1.1 Measuring income and living standards
Until about 1700 there was almost no economic growth anywhere in the world: living standards did
not improve, differences between countries were limited, and differences within a country were
huge. Since 1700 the world has seen enormous growth — and much larger differences between
countries. Before we can explain any of this, we need a yardstick: how do we measure living
standards?
DEFINITION — Gross domestic product
Gross domestic product (GDP) is a measure of the total income and output of an economy in a
given period. It is the sum of all value added generated in the economy, where value added is the
difference between the value of output and the value of the intermediate products and services
used up in producing it. That value added is distributed to the owners of the input factors — labour
and capital goods — in the form of wages and rents or dividends.
To compare countries or periods, GDP is usually expressed in per-capita terms (an average
income), and in constant purchasing-power-parity prices so that inflation and price-level differences
do not distort the comparison.
The long-run figures are startling. World GDP per capita (in 1990 PPP dollars) moved from roughly
600 around the year 1000 to about 1,500 in 1913 and above 8,000 by 2015 — but the increase is
concentrated almost entirely in the last two centuries, and it is spread very unevenly across regions
(Western Europe and the USA pulled far ahead of the world average; Africa and, until recently,
China lagged).
Rania El Ghalbzouri — Microeconomics Page 4
A Complete Course Handbook
Prosperity and inequality · Technology and growth · Scarcity, work and choice · Social
interactions and game theory · The firm and its customers · Supply and demand
Rania El Ghalbzouri
Microeconomics — KU Leuven
Compiled from the complete lecture series (Units 1, 2, 3, 4, 7 and 8). This handbook is self-contained: it replaces
the original slide decks in full.
Rania El Ghalbzouri — Microeconomics Page 1
,Contents
Unit 1 — Prosperity, Inequality and Planetary Limits .................................................................. 4
1.1 Measuring income and living standards ............................................................................ 4
1.2 The hockey stick: growth rates and their timing ............................................................... 5
1.3 How unequal is the world? .................................................................................................. 6
1.4 What causes high growth? Productivity ............................................................................ 7
1.5 Will artificial intelligence restart the engine? .................................................................... 8
1.6 Explaining stagnation: the Malthusian model ................................................................. 11
1.7 Capitalism, institutions and government ......................................................................... 14
1.8 Economics and the biosphere........................................................................................... 15
1.9 Why do we need models? .................................................................................................. 16
Unit 2 — Technological Change, Population and Growth ........................................................ 20
2.1 Decision making: opportunity cost and economic rent ................................................. 20
2.2 The gains from specialisation ........................................................................................... 22
2.3 Comparative advantage ..................................................................................................... 22
2.4 Technology, production functions and the choice of technique .................................. 24
2.5 Choosing a technology: dominance and isocost lines .................................................. 25
2.6 Why Britain, and why then? ............................................................................................... 27
2.7 Growth, capitalism and climate change ........................................................................... 29
2.8 Summary and revision ....................................................................................................... 30
Unit 3 — Scarcity, Work and Choice ........................................................................................... 32
3.1 Scarcity and the model of constrained choice ................................................................ 32
3.2 Preferences and indifference curves................................................................................ 33
3.3 The feasible frontier and the marginal rate of transformation....................................... 35
3.4 The optimal choice: MRS = MRT ....................................................................................... 35
3.5 Income and substitution effects........................................................................................ 37
3.6 Application: why working hours fell ................................................................................. 38
3.7 Summary and revision ....................................................................................................... 39
Unit 4 — Social Interactions ......................................................................................................... 41
4.1 Why social interactions change everything..................................................................... 41
4.2 Games: the basic vocabulary ............................................................................................ 42
4.3 Best responses and Nash equilibrium ............................................................................. 42
4.4 Dominant strategies and the prisoners' dilemma ........................................................... 43
4.5 Evaluating outcomes: the Pareto criterion ...................................................................... 45
4.6 Route one: social preferences and altruism .................................................................... 46
4.7 Route two: repeated games, social norms and punishment ......................................... 47
4.8 Route three: changing the rules — sequential games ................................................... 47
4.9 Coordination games and multiple equilibria.................................................................... 48
4.10 Summary and revision ..................................................................................................... 49
Unit 7 — The Firm and Its Customers ......................................................................................... 51
7.1 Cost functions: fixed, variable, average and marginal ................................................... 51
Rania El Ghalbzouri — Microeconomics Page 2
, 7.2 Economies of scale and scope ......................................................................................... 52
7.3 Demand, willingness to pay and elasticity....................................................................... 54
7.4 Marginal revenue ................................................................................................................ 57
7.5 Profit maximisation, method one: isoprofit curves ........................................................ 57
7.6 Profit maximisation, method two: MR = MC .................................................................... 59
7.7 Gains from trade: surplus and deadweight loss ............................................................. 60
7.8 Competition, differentiation and market power ............................................................... 61
7.9 Summary and revision ....................................................................................................... 63
Unit 8 — Supply and Demand: Price-Taking and Competitive Markets .................................. 65
8.1 Demand and supply ............................................................................................................ 65
8.2 The supply decision of a price-taking firm ...................................................................... 66
8.3 Competitive equilibrium ..................................................................................................... 67
8.4 Factors that shift the equilibrium ...................................................................................... 69
8.5 Short-run and long-run equilibrium .................................................................................. 70
8.6 Application: taxes ............................................................................................................... 71
8.7 Perfect competition ............................................................................................................ 73
8.8 Summary and revision ....................................................................................................... 74
Rania El Ghalbzouri — Microeconomics Page 3
, Unit 1 — Prosperity, Inequality and
Planetary Limits
Measuring living standards, the hockey stick of growth, inequality within and between
countries, the Malthusian trap, capitalism, and the biosphere
LEARNING OBJECTIVES — What this unit does
• Measure income and living standards, and understand what GDP per capita does and does not
capture.
• Describe the 'hockey stick' of economic growth and the inequality that accompanies it.
• Explain productivity as the engine of growth, and the technological revolution behind it.
• Build the Malthusian model — diminishing average product of labour — to explain the centuries
of stagnation before 1700.
• Understand capitalism as an economic system, and the environmental limits within which the
economy operates.
1.1 Measuring income and living standards
Until about 1700 there was almost no economic growth anywhere in the world: living standards did
not improve, differences between countries were limited, and differences within a country were
huge. Since 1700 the world has seen enormous growth — and much larger differences between
countries. Before we can explain any of this, we need a yardstick: how do we measure living
standards?
DEFINITION — Gross domestic product
Gross domestic product (GDP) is a measure of the total income and output of an economy in a
given period. It is the sum of all value added generated in the economy, where value added is the
difference between the value of output and the value of the intermediate products and services
used up in producing it. That value added is distributed to the owners of the input factors — labour
and capital goods — in the form of wages and rents or dividends.
To compare countries or periods, GDP is usually expressed in per-capita terms (an average
income), and in constant purchasing-power-parity prices so that inflation and price-level differences
do not distort the comparison.
The long-run figures are startling. World GDP per capita (in 1990 PPP dollars) moved from roughly
600 around the year 1000 to about 1,500 in 1913 and above 8,000 by 2015 — but the increase is
concentrated almost entirely in the last two centuries, and it is spread very unevenly across regions
(Western Europe and the USA pulled far ahead of the world average; Africa and, until recently,
China lagged).
Rania El Ghalbzouri — Microeconomics Page 4
