Intermediate

Microeconomics 1
Syllabus
1
1.Introducing the course
*This course is contained of 4 parts:
1. The theory of consumer behavior
2. The theory of the firm
3. Market equilibrium
4. Monopoly , monopsony, &
monopolistic competition
2
2
1.Introducing the course
*The analyses are highly based on
mathematics.

*The students will be responsible for
problem solving.

*Discussing groups is recommended.


3
3
2.Students Activities

a.Oral exam 15%
b.Mid-term exam 30%
c.Exercises 15%
d.Final exam 40%
4
4
3.References
a. The main text:
1.J.M.Henderson & R.E. Quandt , (1980) ,
Microeconomic Theory
b. Complementary texts:
1. Eaton, B.C,& Eaton, D.F.,(1995), Microeconomics
2. Griffiths,A & S.Wall,(2000),
Intermediate Microeconomics
3. Laidler,D. & E. Saul, (1989) ,
Introduction to Microeconomics
4. Nicholson,W,(2002),
Microeconomic Theory

5
5
3.References
5. Varian,H.,(1993),
Intermediate Microeconomics
6. Varian,H.,(1992),
Microeconomic analysis

6
4.Description of the course
Part #1
Chapters 2 & 3 :The theory of
consumer behavior
1. Utility maximization
2. Demand function
3. The Slutsky equation
4. Duality theorem
5. Risk and uncertainty
6
7
4.Description of the course
Part #2
Chapters 4&5 : The theory of the firm

1. Optimizing behavior
2. Cost functions
3. Input Demand
4. CES production functions
5. Linear programming
7
8
4.Description of the course
Part #3
Chapter 6 : Market equilibrium

1. Demand & supply functions
2. Commodity-Market equilibrium
3. Input-Market equilibrium
4. Stability of equilibrium
8
9
4.Description of the course
Part #4
Chapter 7 : Monopoly , monopsony,
& monopolistic competition
1. Monopoly : price determination &
applications
2. Monopsony
3. Monopolistic competition
9
10
Chapter 2
10
Session One
Session Two
Session Three

11
Session One
*General goal
Utility Maximization

*Detailed goals
1. Basic concepts
2. The first & second order conditions
for Utility maximization
11
12
1.Introduction
Ses.1 Ch.2
a. Utility function: Definition
b. Measuring the Utility
1.Cardinal theory (explanations)
2.Ordinal theory (explanations)
-Rationality axioms

12
13
2. Basic concepts
Ses.1 Ch.2
a. The nature of Utility function (explanation)
b. Indifference curves
1. Definition
2. Characteristics (fig.2-1 & 2-2)
c. The rate of commodity substitution
1. Definition
2. Mathematics
3. Economic interpretation


13
14
3. Utility Maximization
Ses.1 Ch.2
a. First & second order conditions
1. Mathematics: F.O.C & S.O.C
2. Economic interpretation of F.O.C
3. Example
b. The choice of a utility index (explanation)
c. Special cases: corner solution (fig.2-4)
1. Concave utility function
2. Economic bads
3. I.C are flatter than B.L
14
15
Evaluation
Ses.1 Ch.2
1. Questions : 2-1 to 2-6
15
16
Session Two
*General goal
Demand functions

*Detailed goals
1. Ordinary Demand functions
2. Compensated Demand functions
3. Demand curves
4. Price & income elasticities
5. Evaluation
16
17
1. Ordinary Demand Functions Ses.2
Ch.2
a. Definition
b. Mathematics
c. Properties
1. Single valued for prices & income
2. Homogeneous of degree zero
d. Indirect utility function
1. Definition
2. Mathematics
e. Example
17
Back
18
2. Compensated Demand Functions
Ses.2 Ch.2

a. Definition
b. Mathematics
c. Example

19
Back
19
3. Demand curves: Graphical analysis
Ses.2 Ch.2
a. Substitution & income effects (review) of
price change: (fig.5.3 : Nicholson)
b. Ordinary Demand curve :
(fig.5.5:Nich.)
c. Compensated Demand curve :
(fig.5.6:Nich)
d. Comparison of C.D.C and U.C.D.C
(fig.5.7:Nich) & (fig.2.5)
20
Back
20
4. Price and income elasticities
Ses.2 Ch.2
a. Descriptions
1. Own Price elasticity
2. Cross Price elasticity
3. Income elasticity
b. Relationship among elasticities
1. Elasticity and total expenditure
2. Cournot aggregation
3. Engel aggregation
21
Back 21
Evaluation
Ses.2 Ch.2
1. Questions : 2-7, 2-9
2. Questions : 7-6, 7-7 : Nicholson

22
Back
22
Session Three
*General goal
Mathematical analysis of comparative
statics in the demand
*Detailed goals
1.Demand for income, income & leisure
2. Slutsky equation
3. Substitutes & complements 23
23
1.Introduction
Ses.3 Ch.2
a. The inverse of a matrix
1. Definition
2. Calculation
3. Using adjoint matrix to find A
-1

b. Simultaneous equation system
1. Description
2. Solution


24
24
2.Supply of Labor: Income & leisure
Ses.3 Ch.2
a. Time allocation model and utility
maximization
1. Mathematics
2. Graph: (fig. 13.9, 13.10 : Sexton)
b. Comparative statics for Labor Supply
1. Analysis
2. Graph:(fig.22.1 : Nicholson)
3. Example
25
25
3. Substitution & income effects
Ses.3 Ch.2
a. The Slutsky equation
b. Slutsky equation & elasticities
c. Direct effects
d. Cross effects
1. Slutsky equation
2. Compensated demand elasticities
3. Ordinary demand elasticities

26
26
3. Substitution & income effects
Ses.3 Ch.2
e. Substitutes & complements
1. Definition
2. Mathematics
3. Relationship between substitutes
and complements
27
4. Generalization to n-variables
Ses.3 Ch.2
a. Optimization
b. Elasticity relations
27
28
Evaluation
Ses.3 Ch.2
Questions : 2.8 to 2.12

28
29
Fig. 2-1: Quandt, Ch:2
Back
29
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30
Fig.2-2: Quandt, Ch:2
Back
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31
Back to the mane page
Fig.2-4: Quandt Ch:2
31
Back to the explanation
32
Fig.5-3: Nicholson
Explain Back
32
33
Explain 5-3: Nicholson
Back to text Back to fig
33
S.E:

I.E :


2
1
,
,
U
U Y X
p
I
Y X MRS
p
p
x
xy
y
x
| | | |
+ | + +
(AB) , U=cte, (X
*
X
B
)

(BC) , (X
B
X
**
)
P
X

T.E=S.E+I.E=X
*
X
B
+X
B
X
**
=X
**
X

34
Fig.5-5: Nicholson, Ch.2
Explain Back
34
35
Explain 5-5: Nicholson, Ch.2
Back to text Back to fig
35
36
Fig.5-6 : Nicholson, Ch.2
Explain Back
36
37
Explain 5-6: Nicholson, Ch.2
Back to text Back to fig
37
38
Fig. 22-1: Nicholson, Ch.2
Explain Back
38
39
Explain 22-1: Nicholson, Ch.2
Back to text Back to fig
39
40
Fig.13-9: Sexton, Ch.2
Explain Back
40
41
Explain 13-9: Sexton, Ch.2
Back to text Back to fig
41
42
Explain Back
42
Fig.13-10: Sexton, Ch.2
43
Back to text Back to fig
43
Explain 13-10: Sexton, Ch.2
44
-All information pertaining to the
satisfaction that the consumer derives
from various quantities of commodities is
contained in his utility function
- He is going to maximize his satisfaction
derived from consuming commodities.
(he should be aware of the alternatives
and should be able to evaluate them.)
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45
Consider the utility is measurable. e.g. u(s) = log s ,
du/ds=1/s
-The difference between utility numbers could be
compared &the comparison lead to : A P
s
B twice as C P
D. (U
a
=45 , U
b
=15 )
-The law of diminishing marginal utility
p=2
Buying if the lost utility is less than obtained
one. He buys 1 unit. if p=1.6 then he will buy 2.
U
m
=5
Cardinal theory: S.Jevons , L.Walras &
A.Marshal (19th economists)
Unit

Coconut 1
Coconut 2
Coconut 3
Additional U

20
9
7
Back
46
century.
th
20 : Bentham proposed it in the Ordinal theory . 2
- Equivalent conclusions can be deduced from much weaker assumptions
- we can not indicate the amount of U in number , but we can only rank
the goods based on the utility obtained .i.e. if U(A) > U (B) , then A P B
: Rationality axioms
(i) Completeness: A P B , A I B , or B P A .
(ii) Full information about prices , goods, market condition.
(iii) Transitivity : A P B & B P C then A P C ( not choosing self
contradictory preferences )
- Rationality Requires that the consumer can rank his preferences.
- His utility function shows this ranking. i.e. if U (A) = 15 , U (B)=45 one
can only say that B is preferred to A , but it is meaningless to say B is
likely 3 times as strongly as A .
- So a monotonic transformation for utility function is justifiable .
- Max U = x Max U = x Back

47
a.The nature of the utility function
1. Continuity of U.F U=f(q
1
, q
2
) : continuous first &
second order partial derivatives.
2. Regular strictly quasi-concave function. Or
2f
12
f
1
f
2
f
11
f
2
2
- f
22
f
1
2
> 0
f
11
f
2
2
2f
1
f
2
f
12
+ f
22
f
1
2
< 0
[ we will see that using this assumption guarantee the
sufficiency of F.O.C ]
3. Partial derivatives are strictly positive : f
1
> 0 , f
2
> 0 :
q U (The consumer will always desires more of both
commodities.)
4. The consumers U.F is not unique. Any single-valued
increasing function of q
1
& q
2
can serve U.F. Continue
48

5. the U.F is defined with reference to
consumption during a specified period of time.

- Satisfaction depends on the length of time.
- Variety in diets and diversification among the
commodities. U.F must not be defined for a
period so short that the desire for variety
cannot be satisfied.
- Tastes may change for too long a period.
[ Any intermediate period is satisfactory for the
static theory of consumer behavior. ]
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49
Indifference curves
1. Definition
the locus of all commodity combination
from which the consumer derives the
same level of satisfaction form an
indifference curve.



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50
Indifference curves
2. Characteristics
(i) Indifference map: a collection of indifference
curves corresponding to different level of satisfaction.
(ii) The more is better: (fig.2-1)
(iii) No intersection: (fig.2-2)
(iv) Convex to origin :
* U.F is strictly quasi-concave I.C is convex.
In other word
If U
0
= f(q
1
0 ,
q
2
0
) = f(

q
1
(1) ,
q
2
(1)
)
U[q
1
0
+ ( 1- )q
1
(1)
, q
2
0
+ ( 1- )q
2
(1)
] > U
0

So I.C expresses q
2
as a strictly quasi- concave
function of q
1.
(Graph)

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51
1
q
2
q
0
2
q
1
2
q
0
1
q
1
1
q
0
U
1
U
) ) 1 ( , ) 1 ( (
1
2
0
2
1
1
0
1
q q q q C + +
) , (
0
2
0
1
q q A
) , (
1
2
1
1
q q B
U(C)>U(A)=U(B)
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52
c. The rate of commodity
substitution

1. Definition:
The rate of which a consumer
would be willing to substitute Q
1
for Q
2
per unit of Q
1
in order to
maintain a given level of utility.


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53

c. The rate of commodity
substitution
2. Mathematics:
, ,

) (
1 2
q f q = ) , (
2 1 1 1
q q f f = ) , (
2 1 2 2
q q f f =
2 2 1 1
dq f dq f dU + =
2
1
2
1
1
2
2 2 1 1
0 0
q
q
MU
MU
f
f
dq
dq
RCS dq f dq f dU = = = = + =
2
2
2 1 22 21 1 1 2 12 11 2
1
2
2
1
) / ( ) / (
f
f f f f f dq dq f f f
dq
q d +
=
Continue
54
3
2
2
1 22 2 1 21 2 1 12
2
2 11
f
f f f f f f f f f f +
=
2
2
2 1 2 22 1 2 1 12 11 2
) / ( ) / (
f
f f f f f f f f f f
=
) 2 (
1
2
1 22 2 1 12
2
2 11
3
2
2
1
2
2
1
f f f f f f f
f dq
q d
dq
dRCS
+ = =
Since the U.F is regular strictly quasi-concave (by definition)
0 0 (...) < >
dq
dRCS
RCS is diminishing along I.C
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55
1
c. The rate of commodity substitution

3. Economic interpretation:

dU = f
1
dq
1
+ f
2
dq
2
(1)

: Total change in utility caused by
variations in q
1
& q
2
is approximately the change in q
1
multiplied by the change in U resulting from a unit
change in q
1
plus change in q
2
multiplied by the change
in utility resulting from a unit change in q
2
.

f
1
dq
1
resulting loss in U (dq
1
<0)
f
2
dq
2
resulting gain in U (dq
2
>0)
* (1) Is the equation of a plane tangent to the U.F
which is a 3 dimensional space.

Continue
56
* Since ordinal utility:
1. f
1
dq
1
& f
2
dq
2
are not determinate numbers
2.we can not recognize MU
q1
& MU
q2
by numbers.
* f
1
> 0 , f
2
>0 : an increase in q
1
(q
2
) will increase
consumers satisfaction level and move him to
higher indifference curve.
* RCS is the absolute value of the slope of I.C
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57

F.O.C

Max U = f (q
1
. q
2
)
s.t y
0
= p
1
q
1
+ p
2
q
2

F.O.C
V = f (q
1
, q
2
) + (y
0
p
1
q
1
p
2
q
2
)





0
0
0
2 2 1 1
0
2 2
2
1 1
1
= =
c
c
= =
c
c
= =
c
c
q p q p y
V
p f
q
V
p f
q
V

1. Mathematics
RCS
p
p
f
f
= =
2
1
2
1
Psychic rate of trade-off =
Mkt rate of trade-off
Interpretation
58

p
f
p
f
2
2
1
1
= =
2. Economic interpretation
(i) The rate at which satisfaction would increase if an
additional dollar were spent on a particular commodity
(ii) : Marginal utility of income
(iii) If f
1
/p
1
>f
2
/p
2
: More satisfaction gained by spending an
additional dollar on Q
1
No utility maximized. Since it
is possible to increase utility by shifting some
expenditures from Q
2
to Q
1
.
0 >
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F.O.C
59
- (n-m) last leading principle minor of boardered
Hessian should alternate in sign. The first with the
sign
S.O.C
22 21
12 11
2
0
f f p
f f p
p p
H

=
1
) 1 (
+

m
0 2
0
0 ) ( ) ( 0
11
2
2 22
2
1 2 1 12
11
2
2 21 2 1 1 2 12
11 2 21 1 2 12 2 22 1 1 2 2
> =
> + + =
> + + + = >
f p f p p p f
f p f p p p p f f p
f p f p p f p f p p H H
n=2 m=1 n-m=1
Dividing by
2
2
p
Continue 60
- < + = 0 2
22
2
1 2 1 12
2
2 11 2
f f f f f f f H
11 22
2
2
2
1
2
1
12
2 f f
p
p
p
p
f =
0 2
0 2
2
2 11 22
2
1 2 1 12
11 22
2
2
2
1
2
1
12
> =
> =
f f f f f f f
f f
f
f
f
f
f
Since P1/P2=f1/f2
Multiplied by
2
2
f
or
-
Is satisfied by the assumption of regular strictly
quasi-concavity
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61
3. Example
Max U=q
1
q
2
s.T 100-2q
1
-5q
2
=0 (i)
RCS=f
1
/f
2
=q
2
/q
1
F.O.C q
2
/q
1
=p
1
/p
2
2q
1
=5q
2


q
1
=5/2q
2
(ii) (i) , (ii)
S.O.C:

25
10
1
2
=
=
-
-
q
q
0 10 10 ) 0 2 ( 5 ) 5 0 ( 2
0 1 5
1 0 2
5 2 0
2
> + = + + =

= H
Continue
62
3. Example
0
2
1
2
1
< =
c
c
q
q
q
RCS
I.C is convex Rectangular hyperbula

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63
b. The choice of utility index
Ordinal utility:
* No need to have cardinal significance for the numbers
which the utility function assigns to the alternative
commodity combinations i.e.
if U (A) > U (B) A:3
or
A = 400
B:2 B = 2
* If a particular set of numbers associated with
various combinations of Q
1
& Q
2
is a utility
index, any positive monotonic transformation of it is
also a utility index.
Continue
64
*F(U) is a positive monotonic transformation
of U If F (U
1
) > F (U
0
) whenever U
1
> U
0

e.g. U = x F(U) = x
2 ,
U = x F(U) = ln x


[order presenting transformation F

(U) > 0 ]
*If U=f (q
1
,q
2
) then W=F(U)=F [f(q
1
, q
2
)]

Continue
65
Max U = Max W
Proof :
If

max f (q
1
,q
2
)
s.t B.L we find (q
1
0
, q
2
0
)
If (q
1
(1)
, q
2
(1)
) : Another bundle satisfying B.L then by
assumption
f (q
1
0
,q
2
0
) > f (q
1
(1)
, q
2
(1)
)
By definition of monotonicity :
W (q
1
0
, q
2
0
) = F[f(q
1
0
,q
2
0
)] > F[f(q
1
(1)
,q
2
(1)
) = w (q
1
1
,q
2
1
)
W = (q
1
, q
2
) is Max by commodity bundle (q
1
0
, q
2
0
)
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66
1- Concave utility function (I.C) :(fig 2-4a)
U= x
2
+ y
2

-F.O.C shows local minimum since S.O.C is
not satisfied for maximum. RCS is increasing
along I.C. U.F is not quasi-concave.
- y
0
/p
1
or y
0
/p
2
will be chosen depending
on whether f(y
0
/p
1
) >< f(y
0
/p
2
)
- Only one good should be consumed to
have higher U.


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67
2- Economic bads (fig.3-8 Nich,92)
- U = x y , y U then y is an
economic bad


- X is the locus of Max utility
(corner solution)

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68
3- I.C are flatter than B.L
(fig 2-4.b) , ( fig 4-4 : Nicholson )
- Kuhn-tucker condition is valid &
U.F is strictly concave or has a
positive monotonic
transformation Kuhn-Tucker is
sufficient for U.Max.


Continue
69
- Max U= f (q
1
, q
2
)
S.t y
0
p
1
q
1
p
2
q
2
0 , q
1
0 , q
2
0
Solution

> =
c
c
s =
c
c
s =
c
c
0
0
0
2 2 1 1
2
2
1
1
q p q p y
F
p f
q
F
p f
q
F

0 ) ( ,
0 ) ( ,
0 ) ( ,
2 2 1 1
0
2
1
=
=
=
q p q p y
p f q
p f q

Continue
70
If
If
Back to the main page
<
>
p f
p f

U by q
1
U by q
1
71
Definition
It gives the quantity of a commodity
that he will buy as a function of
commodity prices and his income.
They are obtained from utility
maximization.
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72
Marshalian D.C
Or Uncompensated D.C
Mathematics
Max U=f
1
(q
1
,q
2
)
s.t y
0
=p
1
q
1
+p
2
q
2

q
1
*
=f
1
(p
1
,p
2
,y
0
)
q
2
*
=f
2
(p
1
,p
2
,y
0
)
Original
problem
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73
1. Single value for prices and income
-When the utility function is strict quasi-concave,
a single commodity combination corresponds to
a given set of prices and income.
-If the utility function were quasi-concave but not
strictly quasi-concave, the indifference curves would
posses straight-line portions, and maxima would not
need to be unique. In this case more than one value
of the quantity demanded may correspond to a given
price, and the demand relationship is called a
demand correspondence rather than demand
function
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74
2. Homogenous of degree zero in
price and income
f(kp
1
,kp
2
,ky
0
)=kf(p
1
,p
2
,y
0
)=g , k=0
Max U=f(q
1
,q
2
)
s.t ky
0
=kp
1
q
1
+kp
2
q
2

F.O.C: V=f(q
1
,q
2
)+ [ky
0
-kp
1
q
1
-kp
2
q
2
]
0
1 1
1
= =
c
c
kp f
q
V

0
2 2
2
= =
c
c
kp f
q
V

0
2 2 1 1
0
= =
c
c
q kp q kp ky
V

2
1
2
1
p
p
f
f
=
0
2 2 1 1
0
= q p q p y
(II)
(I)
Continue
75
(I) ,(II) Demand function for the price-income
set (kp
1
,kp
2
,ky
0
) is derived from the same
equations as for the price-income set (p
1
,p
2
,y
0
).
It can be shown that S.O.C is also satisfied in
this manner.
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76
1.Definition
The maximum utility which is derived from
original problem and is a function of prices
and income.
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77
2.Mathematics
U
*
=V=U
*
(q
*
1
,q
*
2
)=U
*
[f
1
(p
1
,p
2
,y
0
),f
2
(p
1
,p
2
,y
0
)]=U
*
(p
1
,p
2
,y
0
)
Back to the main page
78
Example
U=q
1
q
2
, y
0
=p
1
q
1
+p
2
q
2
F.O.C:

0
0
0
] [
2 2 1 1
0
2 1
1 2
2 2 1 1
0
2 1
= =
c
c
= =
c
c
= =
c
c
+ =
q p q p y
Z
p q
q
Z
p q
q
Z
q p q p y q q Z

2
1
1
2
p
p
q
q
=

=
=
=
2
0
2
1
0
1
0
1 1
2
2
2
p
y
q
p
y
q
E y q p
79
Example
S.O.C:
|
|
.
|

\
|
> = =

=
2
1
3
2
1
2 1
3
0 2 ) ( ) (
0 1
1 0
0
q
q
E pp p p p p H
p
p
p p
H
is a maximum point
)
2
)(
2
(
2
0
1
0
*
p
y
p
y
U =
2 1
0
*
4
2
p p
y
U =
I.U.F
Back to the main page
80
Definition
It gives the quantities of the commodities
that the consumer will buy as a function of
commodity prices and given utility . i.e it
shows those combinations of consumption
bundles for which his utility is constant
(using some public compensation like taxes
and subsidies). Whit the minimum income
necessary to achieve the initial utility.
Back to the main page
81
Mathematics
Min E=p
1
q
1
+p
2
q
2
s.t U
0
=f(q
1
,q
2
)

q
1
=F(p
1
,p
2
,U
0
)
q
2
=F(p
1
,p
2
,U
0
)
C.D.C
Dual problem
Back to the main page
82
Example
U=q
1
q
2
, E=p
1
q
1
+p
2
q
2

Z=p
1
q
1
+p
2
q
2
+ (U
0
-q
1
q
2
)
F.O.C:

0
0
0
2 1
= =
c
c
= =
c
c
= =
c
c
qq U
Z
q p
q
Z
q p
q
Z

0
2 1
2
1
2
1
2 1
0
2
1
1 2
1
2
2
1
0 U p p q
p
p
q q U
p
p
q q
q
q
p
p
= =
|
|
.
|

\
|

= =
83
Example
2
1
0
2
1
2
0
1
,
p
p U
q
p
p U
q = =
Back to the main page
84
1. Own price elasticity
Proportionate rate of change of q
1
divided by
the proportionate rate of change of its own price
with p
2
and y
0
constant.
( )
( )
1
1
1
1
1
1
11
ln
ln
p
q
q
p
p
q
c
c
=
c
c
= c
0
0
1
1
11
11
11
11
>
<
<
>
c
c
c
c
: luxury goods
: necessities
: giffen
: normal goods
Back to the main page
85
2. Cross price elasticity
It relates the proportionate change in one
quantity to the proportionate change in the
other price.
( )
( )
1
2
2
1
1
2
21
ln
ln
p
q
q
p
p
q
c
c
=
c
c
= c
>0 or <0
Back to the main page
86
Income elasticity
( )
( )
( )
y
y p p Q
q
y
y
q
q
y
y
q
c
c
=
c
c
=
c
c
=
, ,
ln
ln
1 1
1
1
1
1
q < , > or =0
Back to the main page
87
1. Elasticity and total
expenditure
Consumers expenditure on Q
1
is p
1
q
1
.


( ) | |
( )
( )
( )
0 1
0 1
0 1
1 1 1
) (
1
1 1
11
1
1 1
11
1 1 11
11 1 11 1
1
1
1
1
1
1
1
1 1
<
A
A
>
>
A
A
<
= A =
= + =
|
|
.
|

\
|
c
c
+ =
c
c
+ =
c
c
p
q p
p
q p
q p
q q
p
q
q
p
q
p
q
p q
p
pq
c
c
c
c c
Back to the main page
88
2. Cournot aggregation
0
2 2
2
0
1 1
1
0
1 1
2
1
1
2
0
2 2
1
1
1
1
0
1 1
1
1
2
2
1
1
1
1 1 2 2 1 1
2 2 1 1 1 1
,
0
y
q p
y
q p
y
q p
q
p
p
q
y
q p
q
p
p
q
y
q p
q
dp
q
p
dp
q
p
dp q dq p dq p
dq p dp q dq p
= =
=
|
|
.
|

\
|
c
c
+
|
|
.
|

\
|
c
c
=
c
+
c
= +
+ + =
o o
Y=p
1
q
1
+p
2
q
2
if dY
0
=dp
2
=0 then
The proportion of total expenditure for
goods; the share of every commodity
in consumers income.
89
2. Cournot aggregation
1 21 2 11 1
o c o c o = +
Summation of own price elasticity
90
2. Cournot aggregation
Knowing the own price elasticity, we can
evaluate cross price elasticity.
If
If
If 0 1
0 1
0 1
21 11
21 11
21 11
< >
> <
= =
c c
c c
c c
The above conditions hold for O.D.F. For
C.D.F we have :
U=(q
1
,q
2
) , if dU=0 then:
91
2. Cournot aggregation
0
0 0
0
0
2 2
2
1
1
2
0
1 1
1
1
1
1
2 2 1 1 2 1
2
1
2 2 1 1
= +
= + = +
= +
y
q p
q
p
dp
dq
y
q p
q
p
dp
dq
dq p dq p dq dq
p
p
dq f dq f
Since f
1
/f
2
=p
1
/p
2

92
2. Cournot aggregation
0
2 2 1 1
= + o o
2 1
,
: compensated price elasticities
Back to the main page
93
3. Engel aggregation
2
0
0
2
0
2 2
1
0
0
1
0
1 1
0
2
2
0
1
1
2 2 1 1 2 2 1 1
2 1 2 2 1 1
1
1
: ) ( ), ( 0
,
p
y
y
q
y
q p
p
y
y
q
y
q p
y
q
p
y
q
p
y f q y f q dy dq p dq p dy
cte p p q p q p y
c
c
+
c
c
=
c
c
+
c
c
=
= = = + =
= + =
Engle curves
Continue
94
3. Engel aggregation
1
2 2 1 1
= + q o q o
- The sum of income elasticities weighted by total
expenditure proportion equals unity.
- Two commodities in the basket can not be inferior.
- Income elasticities can not be derived for C.D.F .
Since income is not an argument of these functions.
Back to the mane page
95
1. Definition
If A , B are two rectangular matrices
and we have A.B=B.A=I
n
, then B=A
-1
is
called the inverse of A.
Back to the main page
96
2. Calculation
| | | |
=
(

=
(

=
(

=
(

=
=
(

= = =


1 0
0 1
7 5
4 3
.
7 5
4 3
.
t y
z x
B A
t y
z x
B A
I b a B A b B a A
n kj ik
n n
ij
n n
ij
If and then:
We determine b
ij
using n equations.

Example:
97
2. Calculation
(

= =

=
=

= +
= +

=
=

= +
= +

=
(

+ +
+ +

3 5
4 7
3
4
0 7 5
1 4 3
5
7
1 7 5
0 4 3
1 0
0 1
7 5 7 5
4 3 4 3
1
A B
t
z
y x
y x
y
x
t z
t z
t z y x
t z y x
Example:
Back to the main page
98
3. Using adjoint matrix to find A
-1

Assertion : It is symetric.

Calculate co-factor matrix:
Calculate adjoint matrix:
Example:

( ) | |
( ) | |
18
2 1 3
3 2 1
1 3 2
1
1
1
1
=
(
(
(

=
=
=
=
+
+

A A
A adjA
A cof A
adjA
A
A
ji
j i
ij
j i
99
3. Using adjoint matrix to find A
-1
Example:
(
(
(
(

=
(
(
(

=
(
(
(

=
(
(
(

nn n n
n
n
D D D
D D D
D D D
cof A A
adjA cof A

2 1
2 22 21
1 12 11
1
1 7 5
5 1 7
7 5 1
18
1
1 7 5
5 1 7
7 5 1
1 5 7
7 1 5
5 7 1
Back to the main page
100
1. Description
(
(
(
(

=
(
(
(
(

(
(
(
(

= + + +
= + + +
= + + +
m n mn m m
n
n
m n mn m m
n n
n n
b
b
b
x
x
x
a a a
a a a
a a a
or
b x a x a x a
b x a x a x a
b x a x a x a

2
1
2
1
2 1
2 22 21
1 12 11
2 2 1 1
2 2 2 22 1 21
1 1 2 12 1 11
AX=B Back to the main page
101
2. Solution
i- Using the inverse of matrix:
Back to the main page

=
=

=
(

=
(

=
(

= =
(

=
(

=
= +
= = = =
=

2
3
2
3
4
5
1 2
1 1
3
1
1 2
1 1
3
1
1 2
1 1
.
1 1
2 1
. 3
4
5
1 2
1 1
4 2
5
.
y
x
adj cof
y
x
or
y x
y x
g e
n m If
x
1
1 1 1
A
A A A
B A X B A AX A B AX
102
2. Solution
ii- Cramers approach (rule):

=
=

=
(
(
(

=
(

=
(

= =
(

= =

=
= +
= =
(
(
(
(

= =
2
3
2
3
3
6
3
9
6
4 2
5 1
9
1 4
1 5
, 3
4 2
5
.
, ,
2 1
2
2
3 2
2 23 22 2
1 13 12 1
1
1
1
y
x
y
x
A and A A
y x
y x
g e
A
A
x
A
A
x
a a a b
a a a b
a a a b
A
A
A
x
n
n
nn n n n
n
n

Back to the main page

103
1. Mathematics
Consumers satisfaction depends on income
and leisure U=g(L,Y).[where L: leisure and Y:
labor income]
Time constraint : T=L+W [where W: amount of
work]
Income constraint : [where r = wage
rate & W=T-L]
Optimization : Max U(T-W , rW) or
Y=rW
L=T-W
Max g(L,Y)
s.t Y-r(T-L)=0
Methods
104
1. Mathematics
Method 1:
F=g(L,Y)+[Y-r(T-L)]
F.O.C: F
1
=g
1
+r =0
F
2
=g
2
+ =0
F

=Y-r(T-L)=0
[r: opportunity cost of leisure]
Result : W=f(r,T) supply of labor or
(uncompensated) demand for income

g1/g2=-dY/dL=r
=MRS
LY
=MU
L
/MU
Y

Continue
105
1. Mathematics
Method 2:
Max U(T-W , rW)
F.O.C:


S.O.C:
r
g
g
r g g
W
Y
Y
U
L
U
dW
dU
= = + =
c
c

c
c
+
c
c
=
2
1
2 1
0
0 2
2
22 12 11
2
2
< + = r g r g g
dW
U d
Continue
106
1. Mathematics
Back to the main page
0 2 0
0 ) ( ) (
1
1 0
22
2
12 11 11 21 12 22
2
11 21 12 22
22 21
12 11 2
< + > + +
> + = =
g r rg g g rg rg g r
g rg g rg r
g g
g g r
r
H
107
1. Analysis
r
) ( & ) ( , : . U W Y L MRS E S | | + |
) &( : . + | | | W U L Y E I
T.E=S.E+I.E=AB+BC=AC
Graph
Fig.22.1: Nicholson
108
A
r
2
T
Y
2

B
L
U
1

U
2

T
C
L
2
L
1
L
3

Y
1

r
1
T
Y
T-L
2
T-L
1
T-L
3

W
r
r
2
r
1
S
L

S
L

Back to the main page

109
) 1 ( 2
48 ) 2 (
2 2 48
) ( 2 48
2 48
+
+
= = + +
+ =
+

r
r T
W rW rT W T rW
W T rW r
L
L rW
Y=rW
L+W=T
3. Example

Approach 1:
MRS=r
Back to the main page
U=48L+LY-L2 ,
Supply of labor
(Demand for y)
110
3. Example
Approach 2:
U=48(T-W)+(T-W)rW-(T-W)
2

Back to the main page
0 ) 1 ( 2 2 2 : . .
) 1 ( 2
48 ) 2 (
0 2 2 2 48 : . .
2
2
< + = =
+
+
=
= + =
r r
dW
U d
C O S
r
r T
W
T W rW
dW
dU
C O F
Supply of labor
(Demand for y)
111
a. The Slutsky equation
1. Comparative statics : To find
(p and y are exogenous factors)
2. To maximize U=f(q
1
,q
2
) subject to y
0
-p
1
q
1
-p
2
q
2
=0
F.O.C:
V=f(q
1
,q
2
)+(y0-p
1
q
1
-p
2
q
2
)
V
1
=f
1
-p
1

V
2
=f
2
-p
2

V

= y0-p1q1-p2q2=0
(I)
Continue
112
a. The Slutsky equation
Step 1: total differentiation of (I) allowing all
variables vary simultaneously:
f
11
dq
1
+ f
12
dq
2
-p
1
d = dp
1

f
21
dq
1
+ f
22
dq
2
-p
2
d = dp
2

-p
1
dq
1
-p
2
dq
2
= -dy+q
1
dp
1
+q
2
dp
2

A system of 3 equations .
Solution requires that right-hand side be constant

(II)
Step 2
113
a. The Slutsky equation
Step 2: Solution of the system:
D
D
A
A
dq rule s Cramer
dp q dp q dy
dp
dp
d
dq
dq
f f p
f f p
p p
Cof actor D D H matrix t Coef f icien
f f p
f f p
p p
H
1
1
1
0
0
: '
2 2 1 1
2
1
2
1
22 21 2
12 11 1
2 1
11 2
22 21 2
12 11 1
2 1
2
= =
(
(
(

+ +
=
(
(
(

(
(
(

= =
(
(
(

Continue
114
Step 3
a. The Slutsky equation
D
dp q dp q dy D dp D dp D
dq
D
dp q dp q dy D dp D dp D
dq
dp q dp q dy D D dp D dp
f f dp q dp q dy
f f dp
p p dp
D
) (
2
) (
) ( ) ( ) (
2 2 1 1 32 2 22 1 12
2 2 1 1 31 2 21 1 11
1
2 2 1 1 31 21 2 11 1
22 21 2 2 1 1
12 11 2
2 1 1
1
+ + + +
=
+ + + +
=
+ + + +
=
+ +

=

(III)
115
a. The Slutsky equation
Step 3: Calculation of substitution and income
effect.
D
D
y
q
dp dp
y
q
D
D
q
D
D
p
q
dy dp
p
q
ef f ect Total
31 1
2
1
31
1
11
1
1
2
1
1
) 0 1 ( ?
) 0 ( ? :
=
c
c

= = =
c
c
+ =
c
c

= = =
c
c

(i)
(ii)
Continue
116
a. The Slutsky equation
Substitution effect : Price rise is accompanied by
increase in the income : dU=0 f
1
dq
1
+f
2
dq
2
=0
since f
1
/f
2
=p
1
/p
2
p
1
dq
1
+p
2
dq
2
=0 Last
equation of (II) ,-dy+q
1
dp
1
+q
2
dp
2
=0

(iii)

(i):
D
D
p
q
cte u
11
1
1

=
|
|
.
|

\
|
c
c

=
y
q
q
p
q
p
q
U
c
c

|
|
.
|

\
|
c
c
=
c
c
1
1
1
1
1
1
Slope of
O.D.C
S.E (Slope of C.D.C) I.E (slope of Engel curve)
Back to the main page
117
:
:
:
1
11
11
1 1 11 11
1
1 1
1
1
1
1
1
1
1
1
1
q

c
q o c =

c

c
c
=
c
c
y
y
q
p
y
q
q
q
p
p
q
q
p
p
q
U
b. Slutsky equation and elasticities
Price elasticity of O.D.C
Price elasticity of C.D.C
Income elasticity
Continue
118
- is more negative than if >0
- C.D.C is steeper than O.C.D
b. Slutsky equation and elasticities
11
c
1
q
11

Back to the main page 119

c. Direct effects
1. Marginal utility of money:
In F.O.C :


2 2 1 1 2 1
, ) 0 ( p f p f dp dp while
y
U
= = = =
c
c
=
-
=
c
c
+
c
c
=
c
c
+
c
c
=
c
c
) ( ) (
) ( ) (
2
2
1
1
2
2
1
1
m
MU
y
q
p
y
q
p
y
q
f
y
q
f
y
U

2 2 1 1 2 1
, ) , ( dq f dq f du q q f U + = =
We prove that (*) confirms the result of (II)

Continue
120
c. Direct effects
D
dp q dp q dy D dp D dp D
d
) (
2 2 1 1 33 2 23 1 13
+ + +
=

D
f f f
D
D
y
2
12 22 11 33

=

=
c
c

) ( of sign of sign 0
2
12 22 11
f f f
y
D
c
c
>

Assume: dp
1
=dp
2
=0
0 >
c
c
y

0 < >
c
c
or
y

If U.F is strictly concave (MU

y
is increasing whit y )
but since only strictly quasi-concave
2
121
c. Direct effects
2. The sign of S.E:

< =
=
|
|
.
|

\
|
c
c
=
0
.
2
2 11
11
1
1
p D
D
D
p
q
E S
U

-S.E is always negative

-C.D.C is always
downward sloping
3
122
c. Direct effects
3. Inferior, normal and giffen good:

E S E I
y
q
Gif f en
D E T E I E S
y
q
Inf erior
y
q
Normal
. . , 0 :
0 . . . , 0 :
0 :
1
1
1
> <
c
c
+ < > <
c
c
>
c
c
4
123
c. Direct effects
4. Example:
0
0
0
2 2 1 1
0
3
2 1 2
1 2 1
= =
= =
= =
q p q p y F
p q F
p q F

=
=
=

2
2
1
1
2 1
2
2
2
p
y
q
p
y
q
p p
y

U=q
1
q
2
y
0
-p
1
q
1
-p
2
q
2
=0 F=q
1
q
2
+(y
0
-p
1
q
1
-p
2
q
2
)
F.O.C:
Continue
124
c. Direct effects
2 2 1 1 2 2 1 1
2 2 1
1 1 2
dp q dp q dy dq p dq p
dp d p dq
dp d p dq
+ + =
=
=


0
0 1
1 0
2 1
2
1
p p
p
p
D

=
4. Example:
Total differentiation:

=
=
=

2 31
2 1 21
2
2 11
p D
p p D
p D
Continue
125
c. Direct effects
4. Example:
Cramers rule:

D
dp q dp q dy D dp D dp D
dq
) (
2 2 1 1 31 2 21 1 11
+ + + +
=

If y=100, p
1
=2, p
2
=5 =5
1
1
1
2
2 1
2
1
2 1
2
2 31
1
11
1
1
2 2 2 2 p
q
p
p
p p
p
q
p p
p
D
D
q
D
D
p
q
=

= + =
c
c
25 . 6 .
25 . 6 .
5 . 12
1
1
=
=
=
c
c
E I
E S
p
q
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126
d. Cross effects
1.The Slutsky equation:
The Slutsky equation and its elasticity
representation can be extended to account
changes in the demand for one commodity
resulting from changes in the price of the
other.
i j ij ij
cte price
i
j
U
j
i i
j
ji
j
i
y
q
q
q
q
D
D
q
D
D
p
q
q o c

=
|
|
.
|

\
|
c
c

|
|
.
|

\
|
c
c
= + =
c
c
=
3
(2)
(1)
Continue
127
d. Cross effects
The sign of the cross-substitution effects
are not known in general.
Let S
ij
=D
ji
/D and S
ji
=D
ij
/D (cross S.E)
Since D is a symmetric determinant, D
12
=D
21
,
then S
ij
=S
ji

2
Back to the main page
128
d. Cross effects
2. Compensated demand elasticities:
- Assertion:
- Proof:


p
1
D
11
+p
2
D
21
=0
Since the cofactors of the elements of the first
column of the determinant are multiplied by the
negative of the elements in the last column.
12 11 12 11
0 = = + or
0
) (
1
21 2 11 1
1
2 21
1
1 11
12 11
=
+
= + = +
D q
D p D p
q
p D
q
p
D
D

3
Back to the main page
129
d. Cross effects
3. Ordinary demand elasticities:
Assertion:
Proof: By (2):

*The income elasticity of demand for a commodity
equals the negative of the sum of ordinary price
elasticities.
1 2 1 12 11 12 11
1 12 11
) ( ) ( ) (
) (
q o o c c
q c c
= + + + = +
= +
Back to the main page
130
e. Substitutes & complements
1.Definition:
- Substitutes: Two commodities which can satisfy
the same need of the consumer.
- Complements: They are consumed jointly in
order to satisfy some particular need.
2
131
e. Substitutes & complements
2. Mathematics:
- Cross substitutes (If the total cross effect is
positive.):

- Cross complements:

- Net substitutes:

- Net complements:
0 >
c
c
i
j
p
q
0 <
c
c
i
j
p
q
0 , 0
21
2
1
> =
c
c
>
|
|
.
|

\
|
c
c
D
D
p
q
p
q
U
i
j

0 , 0
21
2
1
< =
c
c
<
|
|
.
|

\
|
c
c
D
D
p
q
p
q
U
i
j

Back to the main page
3
132
e. Substitutes & complements
3. Relationship between substitutes and
complements:
(i) All commodities can not be complements for each
other.
Proof:




Summation:

equation Slutsky Cross p
D
D
q
D
D
p
q
y
D
D
y
q
equation Slutsky p
D
D
q
D
D
p
q
2
31
2
21
2
1
31 1
1
31
1
11
1
1
+ =
c
c
=
c
c
+ =
c
c

y
D
D
p
D
D
q p
D
D
p
D
D
q p
D
D
31
2
31
2 2
21
1
31
1 1
11
+ + +

Continue
133
Since it is an equation in terms of alien cofactors
S
11
p
1
+S
12
p
2
=0.
Since S
11
<0 S
12
must be positive Q
1
and Q
2
are necessarily
substitutes.
e. Substitutes & complements
( ) | |
( ) | |
| | 0
) . ( , 0
1
1
31 2 21 1 11
2 2 1 1 31 2 21 1 11
= -
= + =
+ =
E S Cross
D
D
S D p D p D
D
q p q p y D p D p D
D
ji
ij



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(ii)
134
( )
y p
p
p y
p
p
p
p p y
q
p
p y
p
p
q
p
p y
q p y q p
p q p y q p q p y
<

=
+
=
(

|
|
.
|

\
|

+
=
+
= + =
= + =
1
1
1
2
1
1
1 1
2
1
1
2
1
1
1 1 1 1
1 1 1 1 1 1 1
:
2 2
2
1
2
1
,
2
2
0 2 0 1
e. Substitutes & complements
(ii) Gross and net substitutability and complementarity
- Assertion: In the 2-good case it is possible to be substitutes
in terms of S
ij
(net) and at the same time gross complements.
Example:
Max U=q
1
q
2
-q
2

S.T y-p
1
q
1
-p
2
q
2
=0
F.O.C:
F
1
=q
2
-p
1
=0
F
1
=q
1
-1-p
2
=0
F
3
=y-p
1
q
1
-p
2
q
2
=0

( )
2
1 1
2
2
1
1
2
1
1 p
q p
q
p
p
q
q
= =

Continue
135
2
e. Substitutes & complements
0
2 2
:
0
2
1
:
2 1
2 1
2
1
12
21
2
1
2 1
2
> = =
|
|
.
|

\
|
c
c
=
=
|
|
.
|

\
|
c
c
< =
c
c

p p
p p
p
q
S
D
D
p
q
Net
p p
q
Gross
U
U
136
4. Generalization to n-variables
a. Optimization:
n i p f
q
V
q p y q q q f V
q p y
q q q f U
i i
i
n
i
i i n
n
i
i i
n
, , 2 , 1 0
0 ) , , (
0
) , , (
1
2 1
1
2 1

= = =
c
c
= + =
=
=

=
=

Max
s.t
F.O.C:
[n+1 equation (n q
s
and )]
S.O.C
137
4. Generalization to n-variables
S.O.C:
Boardered Hessian determinants must alternate in
sign .
Convexity of indifference curves can be extended
to indifference hypersurfaces in n-dimensions.
The satisfaction of the S.O.C is ensured by the
regular strict quasi-concavity of the U.F

Back to the main page
138
4. Generalization to n-variables
b. Elasticity relations:




:
: 0
: 1
: 0
:
1
1
1
1
1
q c

q o
o
o c o
=
=
=
=
=

=
=
=
=
n
j
ij
n
j
ij
n
j
j i
n
i
ij i
ij
ij i
Cournot aggregation

Compensated price elasticities

Engel aggregation

Sum of compensated demand
elasticities
Sum of ordinary demand elasticities

Back to the main page
139
Fig.2.5: Quant, ch.2
Back
Back
f
i
g
.
5
.
7
:

N
i
c
h
o
l
s
o
n
,

c
h
.
2