Lecture 1

Intermediate Microeconomic Theory
Lecture I:
Analyzing Economic Problems
Fall 2024
Instructor: SHI, Ce Matthew
The Chinese University of Hong Kong
1
Class Logistics
• Syllabus
• …Syllabus as a contract…
We need your inputs with…

1. Timeslots that you will NOT be available for
tutorials;
2. (Optional) names of 4 students who are
willing to form a group for homework
assignments.
Chapter One 2
Economics Defined
Economics is the study of how human beings
coordinate their wants and desires under various
constraints;
- Decision-making under constraints.
Constraints can be:

1. Monetary (e.g., budget)
2. Social/political
3. Biological/behavioral
Chapter One 3
Microeconomics Defined
• Microeconomics is the study of individual
choice, and how that choice is influenced by
economic forces
- Individual: consumers, workers,
firms, policy-makers…
• Macroeconomics is the study of the

economy as a whole
Chapter One 4
(Micro)Economic Thinking
1. Economic agents respond to incentives.

• Economic agents can be:
• Individuals (consumers, workers, etc.)
• Firms (sellers, producers, etc.)
• Policy-makers, politicians, governments
• Incentives may be:

• Pecuniary ($$)
• Non-pecuniary
2. Correlation is not causation.

• Example I (silly): wet shoes and fallen leaves.
• Example II (not-so-silly): hospitalization and death rate.
• Example III (serious): returns to education

E.g., To what extend more schooling leads to higher wages?
Confounding factors like parenting, family background, inherent ability, etc
are hard to observed;
Therefore, we often need economic theories for guidance.

3. Modeling
• Math = economic intuitions (= graphical representation);
• Modeling involves abstraction & simplification;
• Not all assumptions are 100% realistic;
• Models are benchmarks - start points for deeper thinking;
E.g., rationality assumption

Analogy: the (frictionless) Newtonian world of physics.
The Objective Function
Dependent on How the Objective Function is Specified
The Objective Function specifies what the

agent cares about.
In the standard economic theory,
• Consumers -
• Firms/producers -
Chapter One 8
The Constraints
Constraints are whatever limits is placed

on the resources available to the agent.
 Time
 Budget
 Other Resources
 Technical Capabilities
 The Marketplace
 Rules, Regulations, and Laws
Chapter One 9
The Constraint Optimization
Behavior can be modeled as

optimizing the objective function,
subject to various constraints.
Chapter One 10
Exogenous & Endogenous Variables
Variables that have values taken as given in

the analysis are exogenous variables.
Variables that have values determined as a
result of the model’s workings are
endogenous variables.
Chapter One 11
Equilibrium
Equilibrium is defined as the point where demand

just equals supply in this market (i.e., the point
where the demand and supply curves cross).
Equilibrium analysis is an analysis of a system in

a state that will continue indefinitely as long as the
exogenous factors remain unchanged.
Chapter One 12
Example
Suppose
Supposewe
wehave…
have…
Demand
Demand P_d
P_d==100
100––QQ
Supply
Supply P_s
P_s==20
20++QQ
In
Inequilibrium,
equilibrium,
P_s
P_s==P_d
P_d
Solving
Solvingfor
forP_d,
P_d,P_S,
P_S,and
andQ:
Q:
QQ==40
40
P_s
P_s==P_d
P_d==60
60
Chapter Two 13
Comparative Statics Analysis
A Comparative Statics Analysis compares the

equilibrium state of a system before a change in
the exogenous variables to the equilibrium state
after the change.
Chapter One
Example: Excise Tax
We
Weused
usedan
anexample…
example…
Demand
Demand P_d
P_d==100
100––QQ
Supply
Supply P_s
P_s==20
20++QQ
When
Whenthethegovernment
governmentimposes
imposesan
anexcise
excisetax
tax
T>0,
T>0,
Equilibrium
Equilibrium P_s
P_s++TT==P_d
P_d
Solving
Solvingfor
forP_d,
P_d,P_S,
P_S,and
andQ:
Q:
QQ==40
40––T/2
T/2
P_s
P_s==60
60––T/2
T/2
P_d
P_d==6060++T/2
T/2
Chapter Two 15
Comparative Statics Analysis
A Comparative Statics Analysis compares the

equilibrium state of a system before a change in
the exogenous variables to the equilibrium state
after the change.
Chapter One
Example: Excise Tax
Comparative
Comparative Statics
Statics Analysis
Analysis
•• What
What are
are the
the effects
effects of
of TT on
on P_d,
P_d,
P_S,
P_S, and
and Q:Q:
dQ/dT
dQ/dT == -1/2
-1/2 << 00
dP_s/dT=
dP_s/dT= -1/2-1/2 << 00
dP_d
dP_d /dT=
/dT= 1/2
1/2 >> 00
Chapter Two 17
An Exercise
Part 1: What is the size of the government
tax revenues for any T?
Tax Revenue (R) = TQ
= (T) * (40 – T/2)
= 40T – T2/2
Chapter Two 18
An Exercise
Part 2: Suppose the government is interested in
choosing the level of its tax receipts. For what value
of T will the government maximize tax receipts?
Goal: Maximize R with respect to T.

FOC: dR/dT = 0
=> 40 – T* = 0
=> T* = 40
Verify the Second-Order Condition (SOC).
Chapter Two 19
An Exercise
Part 3: What will the maximum tax revenues be?
When T* = 40,
Q = 20
=> R* = TQ = 800
Chapter Two 20
An Exercise
Part 1&2 revisited: What is the effect of T on
R? Can you explain in words?
Tax Revenue (R) = TQ
dR/dT= Q + T*(dQ/dT)
What if Q + T*(dQ/dT) not = 0?
Chapter Two 21
Competitive Markets
Perfect Competitive Markets are

those with sellers and buyers that
are small and numerous enough that
they take the market price as given
when they decide how much to buy
and sell.
Copyright (c)2014 John Wiley & Sons, Inc.

Chapter Two 22

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Intermediate Microeconomic Theory

The Chinese University of Hong Kong

We need your inputs with…

Constraints can be:

• Macroeconomics is the study of the

1. Economic agents respond to incentives.

• Incentives may be:

2. Correlation is not causation.

• Example II (not-so-silly): hospitalization and death rate.

• Example III (serious): returns to education

Therefore, we often need economic theories for guidance.

• Modeling involves abstraction & simplification;

• Not all assumptions are 100% realistic;

• Models are benchmarks - start points for deeper thinking;

E.g., rationality assumption

The Objective Function specifies what the

In the standard economic theory,

Constraints are whatever limits is placed

Behavior can be modeled as

Variables that have values taken as given in

Equilibrium is defined as the point where demand

Equilibrium analysis is an analysis of a system in

A Comparative Statics Analysis compares the

A Comparative Statics Analysis compares the

Tax Revenue (R) = TQ

= (T) * (40 – T/2)

Goal: Maximize R with respect to T.

Tax Revenue (R) = TQ

What if Q + T*(dQ/dT) not = 0?

Perfect Competitive Markets are

Copyright (c)2014 John Wiley & Sons, Inc.

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