Intermediate Microeconomics

Lecture 1

Introduction
 Introduction
Intermediate Micro Class 3, taught in English
Small class size, get more involved in discussions!
Lecture time: Wednesdays 6：40-9:30pm
Class location: Chengze （承泽）131

Professor:Jianwei Xing, [email protected]

TA: Yucheng Qiu, [email protected]

 Course website: course.pku.edu.cn (lecture notes,

problem sets etc)

2
 Introduction
 TA session： Saturdays 10:10am-noon, every other
week and TBA
 Location: Lijiao(理教) 203
 TA review and homework Q&A
 Optional but strongly encouraged

 Please join the WeChat group of the class.

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 Introduction

 An intermediate-level course in microeconomics.

 Should have completed introductory
microeconomics course and have basic calculus
ability.
 Study the foundations of the analysis of
microeconomic decision-making, e.g., consumer
behavior and theory of the firm
 How economic models can be applied to explain
real-world phenomena.

4
 Introduction
 What do we cover?
Consumer theory (preferences, utility)
Equilibrium
Firm technology, profit maximization
Firm supply
Market structure
Exchange
Externalities and Public Goods
Game theory
Information
…
5
 Textbook
 Intermediate Microeconomics: A Modern Approach
(9th Edition) by Hal R. Varian.
 The previous editions should also be fine.

6
 Grading
 Problem sets (15%): 5 problem sets, designed to
help you better understand the materials covered in
class

 Group presentation (10%):topics will be announced

 Mid-term Exam (30%): April 10th, 2024 (tentative).

Covers the first 7 week materials.

 Final Exam (45%): scheduled on 6:30-8:30 pm, June

19th, 2024, comprehensive

7
 Presentations
 Group presentation
– groups of 3-4 members(depending on the total
enrollment), about 15-20 minutes
– present analysis on a research topic and the
topics will be announced later in the semester.
– identify a research question, collect information or
data, and apply the tools we learned in class
– will be arranged on the second half of the
semester.
– Examples: electric vehicles in China (policies,
market structure, environmental impacts…), green
consumption (methods, policies, impacts…)

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 Weekly Schedule
 Week 1: Introduction, Budgetary and Other
Constraints on Choice
 Week 2: Preferences and Utility
 Week 3: Choice and Demand
 Week 4: Revealed Preference and Intertemporal
Choice
 Week 5: Uncertainty and Consumer Surplus
 Week 6: Market Demand and Equilibrium
 Week 7: Technology and Profit Maximization

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 Weekly Schedule
 Week 8: Midterm Exam and Cost Minimization
 Week 9: Cost Curves and Firm Supply
 Week 10: Midterm Exam Review, Industry Supply
and Monopoly
 Week 11: Monopoly behavior and Oligopoly
 Week 12: Game Theory and Exchange
 Week 13: Externalities and Public Goods
 Week 14: Information and Asymmetric Information
 Week 15: Auction, Behavior Economics and
Review

10
Everyday Economics

11
Airfare

12
Airfare

Prices for same-day

flights much higher.

In what other situations

would you see a price
surge?

13
 Streaming Media
 The live streaming market is expanding.

14
 Streaming Media
 The streaming platforms provide two pricing
methods:

1. Membership subscriptions: ￥XX per month, ￥XX

per year
2. Individual purchase options: ￥XX per episode,
￥XX per series/season

 Which pricing strategy is better, from the firm’s

perspective?

15
Charity-linked products

For each
transaction, the
seller commits
to donate a XX
yuan to a
charity project.

What are sellers’ motivations of opting-in?

16
 Urban Green

Q: What do urban forests do to us?

17
Electric Vehicles

18
 Electric Vehicles
 Governments around the world promote EVs using
subsidy (￥XX off if you purchase an EV). China is
now the world’s largest EV market.

 Why subsidizing EVs?

 How much should we subsidize EVs?

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 Economic Modeling
 How can we construct insightful models to
answer those questions?
– Who are the participants?
– Some assumptions:
Rational choice: each person chooses
the best alternative available
Equilibrium: market price adjusts until
quantity demanded equals quantity
supplied.

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Consumer Theory

21
 Consumer Choice
 If
you want to buy a new cellphone,
how do you make your choice?

22
 Economic Theory of Consumer
 Consumers are assumed to choose
the best bundle of goods they can
afford.

 What do we mean by “best”?

 What do we mean by “can afford”?

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 Consumption Choice Sets
A consumption choice set is the
collection of all consumption choices
available to the consumer.
 E.g. courses, cars

 What constrains consumption choice?

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 Consumption Choice Sets
A consumption choice set is the
collection of all consumption choices
available to the consumer.
 What constrains consumption choice?
– Budget
– Time
– Other resource limitations.
 Consumption Bundle
A consumption bundle containing x1
units of commodity 1, x2 units of
commodity 2 and so on up to xn units
of commodity n is denoted by the
vector (x1, x2, … , xn).

 Commodity prices are p1, p2, … , pn.

 Budget Constraints
 Q:When is a consumption bundle
(x1, … , xn) affordable at given prices
p1, … , pn?

 Howdo we use mathematics to

describe the bundle is affordable?
 Budget Constraints
 When is a bundle (x1, … , xn) affordable at
prices p1, … , pn?

 When
p1x1 + … + pnxn  m

where m is the consumer’s (disposable)

income.
 Budget Constraints
 The bundles that are only just
affordable form the consumer’s
budget constraint.
 This is the set

{ (x1,…,xn) | x1  0, …, xn  and

p1x1 + … + pnxn = m }.
 Budget Constraints
 The consumer’s budget set is the set
of all affordable bundles;
B(p1, … , pn, m) =
{ (x1, … , xn) | x1  0, … , xn 0 and
p1x1 + … + pnxn  m }

 The
budget constraint (line) is the
upper boundary of the budget set.
 Budget Constraints
 Nowlet’s assume there are only two
goods so that we can depict the
consumer behavior graphically.

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 Two Commodities
x2 Budget constraint is
m /p2 p1x1 + p2x2 = m.

m /p1 x1
 Two Commodities
x2
Budget constraint is
m /p2
p1x1 + p2x2 = m.
What is the slope?

m /p1 x1

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 Two Commodities

x2
Budget constraint is
m /p2
p1x1 + p2x2 = m. (slope is -p1 /p2 )

Which part is just affordable?

m /p1 x1
 Two Commodities
x2
Which region is not affordable?
m /p2

Just affordable

m /p1 x1
 Two Commodities
x2
m /p2

Not affordable
Just affordable

m /p1 x1
 Two Commodities
x2

m /p2

Not affordable
Just affordable
Affordable

m /p1 x1
 Two Commodities
x2
Budget constraint is
m /p2
p1x1 + p2x2 = m.

Budget set is the collection

of all affordable bundles.
Budget
Set
m /p1 x1
 Budget Constraints

 Ifn = 3 what do the budget constraint

and the budget set look like?
 Three Commodities

x2 p1x1 + p2x2 + p3x3 = m

m /p2
How about the budget set?
m /p3
x3

m /p1
x1
 Three Commodities

x2 { (x1,x2,x3) | x1  0, x2  0, x3  0 and
m /p2 p1x1 + p2x2 + p3x3  m}

m /p3
x3

m /p1
x1
 Budget Constraints
 Forn = 2 and x1 on the horizontal axis,
the constraint’s slope is -p1/p2.

 How do we interpret this economically?

p1 m
x 2 =  x1 
p2 p2
 Budget Constraints
 The constraint’s slope is -p1/p2.
p1 m
x2 =  x1 
p2 p2

 Increasingthe consumption of x1 by 1
unit must reduce the consumption of x2
by p1/p2.
 Budget Constraints
x2
Slope is -p1/p2

-p1/p2
+1

x1
 Budget Constraints
x2

-p1/p2
+1

x1
In other words, opportunity cost of an extra unit of
commodity 1 is p1/p2 units foregone of commodity
2.
 Budget Constraints
x2

+1
-p2/p1

x1
The opportunity cost of an extra unit of commodity
2 is p2/p1 units foregone of commodity 1.
Q: what determines the budget
constraint and budget set?

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 Income and Price Changes
 The budget constraint and budget set
depend upon prices and income.

 What happens as prices or income

change?
 How do the budget set and budget
constraint change as income m
x2 increases?

Original
budget set
x1
Higher income gives more choice
x2 New affordable consumption
choices
Original and
new budget
constraints are
Parallel. Why?
Original
budget set
x1
Higher income gives more choice
x2 New affordable consumption
choices
Original and
new budget
constraints are
Parallel.
Since the slope
does not change
Original (prices fixed)
budget set
x1

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 How do the budget set and budget
constraint change as income m
x2 decreases?

Original
budget set
x1
 How do the budget set and budget
constraint change as income m
x2 decreases?
Consumption bundles
that are no longer
affordable.
Old and new
New, smaller constraints
budget set are parallel.
x1
 Budget Constraints - Income Changes

 Increases in income m shift the

constraint outward in a parallel
manner, thereby enlarging the
budget set and improving choice.
 Q: Does this improve consumer
welfare?
 Budget Constraints - Income Changes

 Increasesin income m shift the

constraint outward in a parallel manner,
thereby enlarging the budget set and
improving choice.

 Decreases in income m shift the

constraint inward in a parallel manner,
thereby shrinking the budget set and
reducing choice.
 Budget Constraints - Income Changes

 Nooriginal choice is lost and new

choices are added when income
increases, so higher income cannot
make a consumer worse off.

 Anincome decrease will make the

consumer worse off.
 Budget Constraints - Price
Changes
 Whathappens if just one price
decreases?

 Suppose p1 decreases. X1 becomes

less expensive.
 p1 decreases from p1’ to p1”?
x2
m/p2

-p1’/p2

Original
budget set
m/p1’ m/p1” x1
 p1 decreases from p1’ to p1”
x2
m/p2
New affordable choices:
can buy more x1
-p1’/p2

Original
budget set
m/p1’ m/p1” x1
 p1 decreases from p1’ to p1”
x2
m/p2
New affordable choices

-p1’/p2

Original
-p1”/p2
budget set
x
m/p1” 1
m/p1’
Budget constraint pivots;
Slope flattens from -p1’/p2 to -p1”/p2
 Budget Constraints - Price Changes

 Reducingthe price of one

commodity pivots the constraint
outward.

 No old choice is lost and new

choices are added, so reducing one
price cannot make the consumer
worse off.
 Budget Constraints - Price Changes

 Similarly,increasing one price pivots

the constraint inwards, reduces
choice and will make the consumer
worse off.
Q: If the economy is weak and so is
consumer demand, what should the
policy makers do to stimulate
consumption?

63
 Budget Constraints - Price Changes

 Q：Inwhat situations would you see

price changes?

64
 Ad Valorem Sales Taxes
 Suppose the government imposes an
ad valorem sales tax levied at a rate
of 5%

– Original price: p
– New price: (1+0.05)p = 1.05p.

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Uniform Ad Valorem Sales Taxes
 An ad valorem sales tax levied at a rate
of t increases all prices by tp from p to
(1+t)p.

A uniform sales tax is applied uniformly

to all commodities.
Uniform Ad Valorem Sales Taxes
A uniform sales tax levied at rate t
changes the constraint from
p1x1 + p2x2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
Uniform Ad Valorem Sales Taxes
A uniform sales tax levied at rate t
changes the constraint from
p1x1 + p2x2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
i.e.
p1x1 + p2x2 = m/(1+t).
 The tax essentially discount the
income.
Uniform Ad Valorem Sales Taxes
x2
m p1x1 + p2x2 = m
p2

m x1
p1
Uniform Ad Valorem Sales Taxes
x2
m p1x1 + p2x2 = m
p2
m p1x1 + p2x2 = m/(1+t)
( 1  t ) p2

m m x1
( 1  t ) p1 p1
Uniform Ad Valorem Sales Taxes
x2
m
p2 Equivalent income loss:
m t
m m = m
1 t 1 t
( 1  t ) p2

m m x1
( 1  t ) p1 p1
Uniform Ad Valorem Sales Taxes
x2 A uniform ad valorem
m sales tax levied at rate t
p2 is equivalent to an income
t
m tax levied at rate 1  t .
( 1  t ) p2

m m x1
( 1  t ) p1 p1
 Example: The Food Stamp Program
 Food stamps are coupons that can be
legally exchanged only for food
(cannot be cashed out).
Example: The Food Stamp Program

 How does a commodity-specific gift

such as a food stamp alter a family’s
budget constraint? (10 kilograms of
rice)

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 The Food Stamp Program
 Suppose m = $100, pF = $1 (food)
 The price of “other goods” is pG = $1.
 The budget constraint is then
F + G =100.
 The Food Stamp Program
G
Before stamps: F + G = 100
100

100 F
 The Food Stamp Program
G
F + G = 100: before stamps.
100

100 F
 The Food Stamp Program
G
F + G = 100: before stamps.
100 Budget set after 40 food
stamps issued.
You increase your food
consumption by 40
at any consumption level
of G

40 100 140 F
 The Food Stamp Program
 Whatif the receiver wants to further
expand the consumption on other
goods?

79
 The Food Stamp Program
 What if food stamps can be traded on
a black market for $0.50 each?

 Remember that pF = pG = $1
 The Food Stamp Program
G
120 Budget constraint with
100 black market trading of 40
food stamps.

40 100 140 F
 The Food Stamp Program
G
F + G = 100: before stamps.
120
100 Budget constraint after 40
food stamps issued.
Black market trading
makes the budget
set even larger.

40 100 140 F
 Relative Prices

 What units should we use for prices?

 “Numeraire” means “unit of account”.
 Suppose prices and income are
measured in dollars.
 Say p1=$2, p2=$3, m = $12. Then the
constraint is
2x1 + 3x2 = 12.
 Budget Constraints - Relative Prices
 Ifprices and income are measured in
cents, then p1=200, p2=300, m=1200
and the constraint is
200x1 + 300x2 = 1200,
the same as
2x1 + 3x2 = 12.
 Changing the numeraire changes
neither the budget constraint nor the
budget set.
Budget Constraints - Relative Prices
 The constraint for p1=2, p2=3, m=12
2x1 + 3x2 = 12
is also 1x1 + (3/2)x2 = 6,
the constraint for p1=1, p2=3/2, m=6.
 Setting p1=1 makes commodity 1 the
numeraire and defines all prices
relative to p1;
 3/2 is the price of commodity 2
relative to the price of commodity 1.
Budget Constraints - Relative Prices

 Any commodity can be chosen as

the numeraire without changing the
budget set or the budget constraint.
Budget Constraints - Relative Prices
 p1=2, p2=3 and p3=6 
– price of commodity 2 relative to
commodity 1 is 3/2,
– price of commodity 3 relative to
commodity 1 is 3.
 Relative prices are the rates of
exchange of commodities 2 and 3 for
units of commodity 1 （the amount of
commodity 1 that can be traded）.
 Shapes of Budget Constraints
 For
the figure, we see that the budget
constraint is a straight line.

 Q:What makes a budget constraint a

straight line?
 Shapes of Budget Constraints
 Q:What makes a budget constraint a
straight line?

 A:
A straight line has a constant slope
and the constraint is
p1x1 + … + pnxn = m

so if prices are constants then a constraint

is a straight line.
89
 Shapes of Budget Constraints
 But what if prices are not constants?

90
 Shapes of Budget Constraints
 But what if prices are not constants?

 E.g.bulk buying discounts, or price

penalties for buying “too much”.
 Prices could be a function of the
quantity of purchase.
 Then constraints will be curved.
 Quantity Discounts
 Suppose p2 is constant at $1 but that
p1=$2 for 0  x1  20 and p1=$1 for x1>20.

 Note:For the first 20 units of X1, the price

is still $2.
 Quantity Discounts
 Then the constraint’s slope is
- 2, for 0  x1  20
{
-p1/p2 =
- 1, for x1 > 20
 What does the constraint look like?
 Shapes of Budget Constraints
with a Quantity Discount
x2
100 Slope = - 2
m = $100

Slope = -1

20 50 80 x1
 Shapes of Budget Constraints
with a Quantity Discount
x2
100 Slope = - 2
m = $100

Slope = - 1

20 50 80 x1
 Shapes of Budget Constraints
with a Quantity Discount
x2
100 m = $100
Budget Constraint

Budget Set
20 50 80 x1
Q: Is price always positive?

97
Special Case- One Price Negative
 Commodity 1 is stinky garbage. You
are paid $2 per unit to accept it; i.e.
p1 = - $2. p2 = $1.
 Income, other than from accepting
commodity 1, is m = $10.
 Then the constraint is
- 2x1 + x2 = 10 or x2 = 2x1 + 10.
Shapes of Budget Constraints -
One Price Negative
x2 x2 = 2x1 + 10

Budget constraint’s slope is

-p1/p2 = -(-2)/1 = +2

10
x1
Shapes of Budget Constraints -
One Price Negative
x2
Budget set is
all bundles for
which x1  0,
x2  0 and
x2  2x1 + 10.
10
x1
 Discussion

 Whatare the constraints when you decide

whether to obtain a second degree in
economics?

101
 Multiple Constraints
 Choicesare usually constrained by
more than a budget; e.g. time
constraints and other resources
constraints.

A bundle is available only if it meets

every constraint.
 Multiple Constraints
Other Stuff

At least 10 units of food

must be eaten to survive

10 Food
 Multiple Constraints
Other Stuff

Choice is also budget

constrained.

Budget Set

10 Food
 Multiple Constraints
Other Stuff
Choice is further restricted by
a time constraint.

10 Food
 Multiple Constraints

So what is the choice set?

 Multiple Constraints
Other Stuff

10 Food
 Multiple Constraints
Other Stuff

10 Food
 Multiple Constraints
Other Stuff

The choice set is the

intersection of all of
the constraint sets.

10 Food