Microeconomics 3

Katarzyna Metelska-Szaniawska
 Agenda for today
• class organization, information & contact
• course requirements
• readings
• introduction – partial equilibrium: demand,
supply, consumer/producer surplus, efficiency
• what will follow…?
 Class organization
• seminar class in an online format – active
participation is expected!
• short theoretical introductions – reading specified
chapters before class is expected!
• problem-solving
• homework – volunteers
• case studies – discussion – if time permits
• 2 unjustified absences allowed during the
semester
 Class information & contact
• 8:00 Group 4, room A203
• 11:30 Group 1, room A104
• in-class mode only
• [Link]
(Micro 3)

• kmetelska@[Link]
• office hours: tba
 Course requirements
• maximum total score = 100 points
• 3 elements:
A) active participation in class (30%)
- problem-solving at the board:
5 points (max) / problem
- problem-solving as homework:
5-8 points (max) / problem
- total: max 30 points
B) written paper (20%)
C) final exam (50%)
details: [Link]
 Written papers
• should tackle an interesting research question
• analysis with direct relation to concepts and
theories discussed in class
• gathering data/information on your own or in pairs
• 10000-15000 characters (including spaces)
• submission deadline: Jan 14, 2021
• best suggest a topic yourselves, if not –
suggestions provided

details: [Link]
 Written papers contd.
• working meetings
– 1 meeting per paper (about 20 minutes)
– organized in November
– send an email by Oct 30 if you want to apply for a
meeting (if 2 authors provide both names)
 Course requirements contd.
• to pass the course it is required to obtain:
at least 50% of the maximum exam score
AND
at least 50% of the maximum total score
• it is only allowed to retake the exam and the
written paper (under certain conditions  see
course website)
• the grades will be given according to this scale:
<90,100> 5 <60,70) 3+
<80,90) 4+ <50,60) 3
<70,80) 4 <0,50) 2
 Readings
• Handbook: Varian Hal R. (2019), Intermediate
Microeconomics: a modern approach, W. W.
Norton (also in ebook format).
• Workouts: Bergstrom T.C., H.R. Varian (2009),
Test bank for Intermediate Microeconomics A
Modern Approach, W. W. Norton.

• Additional handbooks: Borland (2008); Masfield and

Yohe (2003); Mansfield and Peoples (2003); Pindyck and
Rubinfeld (2004)…
• Additional workouts: Bergstrom and Varian (2014)
 Partial equilibrium
• partial equilibrium in the (purely competitive) market for
good x is the point, where at a given price (equilibrium
price) quantity demanded becomes equal to quantity
supplied
⇓
the quantity that consumers are willing to and can buy is
equal to the quantity that producers are willing to and can
supply
• we can find the equilibrium point by equalizing the
demand and supply functions, i.e.:
D(p*) = S(p*) or PD(q*) = PS(q*)

• in the equilibrium point the demand and supply

curves intersect
 Example – graph
Market Market
p
demand supply
q = S(p)

D(p*) = S(p*)
equilibrium
p*
q = D(p)

q* D(p), S(p)
This equilibrium is a partial equilibrium because we omit
relationships between prices and quantities in other
markets.
 Demand and supply
Supply (upward-sloping)
• Changes in supplied quantity – movement along the
supply curve caused by price changes
• Changes of supply – shifts of the supply curve
caused e.g. by changes in production costs
• ↑S (shift to the right) => ↑Q ↓P

Demand (downward-sloping)
• Changes in demanded quantity – movement along the
demand curve caused by price changes
• Changes of demand – shifts of the demand curve
caused e.g. by changes in consumer income or
preferences
• ↑D (shift to the right) => ↑Q ↑P
 Algebraic example
• Assume linear demand and supply curves:
D(p) = a – bp, S(p) = c + dp
Find optimal p* and q*.

• We equalize:
a – bp* = c + dp*

• We obtain: p* = (a – c)/(b + d)
q* = D(p0) = S(p0) = (ad + bc)/(b + d)
 Example – graph contd.

Market Market
p
demand supply
S(p) = c + dp

p* = (a – c)/(b + d)

D(p) = a – bp
q* = (ad + bc)/(b + d)
D(p), S(p)
 Example contd.
• We can do the same for inverted functions:
a−q
q = D( p ) = a − bp ⇔ p = = D −1(q ),
b
(inverted market demand curve)
−c +q −1
q = S( p ) = c + dp ⇔ p = = S (q ),
d
(inverted market supply curve)
⇓
a − q* − c + q*
=
b d
 Example contd.
a − q* − c + q*
=
b d

ad + bc
Solution: q =
*

b+d

−1 −1 a−c
p = D (q ) = S (q ) =
* * *
.
b+d
 Example – graph contd.
D-1(q),
S-1(q)
S-1(q) = (–c+q)/d

p*

D-1(q) = (a – q)/b

q* q

in equilibrium: D-1(q *) = S-1(q *)

 Special cases

• The supply curve is perfectly inelastic (vertical),

i.e. supply is constant and does not depend on
the market price
• The supply curve is perfectly elastic (horizontal),
i.e. supply is extremely sensitive to market price
changes (this is the case of pure competition in
the long run)
 Special case #1
p
S(p) = c + dp,
i.e. d = 0 and S(p) ≡ c.

p*

D-1(q) = (a – q)/b

q* = c q
Market supply is constant and does not depend
on price.
 Special case #2
D-1(q),
S-1(q) Such a supply curve
D-1(q) = (a – q)/b can be found in pure
competition in the long
run
p*
S-1(q) = p *

q * = a – bp* q

Market supply is extermely sensitive to price

changes.
 Excess supply
Market Market
p
demand supply
q = S(p)
D(p ′) < S(p ′); excess
p′ supply in the market
p* (compared to demand)
q = D(p)
D(p ′) q * S(p ′) D(p), S(p)

The market price must decrease to p *.

 Excess demand
(shortage in the market)
p
q = S(p)

D(p ″) > S(p ″)

p*
p″ q = D(p)

S(p ″) q * D(p ″) D(p), S(p)

The market price must increase to p *.

 Surplus
• Since there is no discrimination, all consumers
pay the same price and, simultaneously, all
producers receive the same price for a given
good: P*.
• However, some consumers would be willing and
could buy this good for higher prices: P’ > P*.
Because the market price is lower they obtain
benefits, i.e. consumer surplus.
• Similarly, producers would be willing to and could
supply some units for lower prices: P” < P*. They
also obtain benefits, i.e. producer surplus.
(Consumer) surplus depends on
elasticity (of demand)
P P

S S

D D

Q Q
Relatively high elasticity of Relatively low elasticity of
demand (~elastic demand) demand (~inelastic demand)
 Consumer and producer surplus
• Consumer surplus (CS) – the total benefit for the consumer
from a given good after substracting the costs of buying it.
Represented by the area between the demand curve and the
market price.
• Producer surplus (PS) – the total benefit for the producer
from selling a given good after substracting the costs of
manufacturing it. Represented by the area above the supply
curve and below the market price.
• Economic surplus (ES) – the sum of the consumer surplus
and the producer surplus; the sum of the differences
between reservation prices of buyers and sellers of
consecutive units of a good exchanged in the market; the
difference between total social benefits and total social costs
– a (simplified) measure of welfare
 Reservation price
• Reservation price – the highest price that the
buyer is willing to pay or the lowest price that the
seller is willing to accept
• Having the possibility to buy or sell at the
reservation price we are indifferent.
• Reservation prices determine the shape of
demand and supply curves.
 Optimality criterion
Pareto optimum –
improving the situation of
any economic agent must
necessarily lead to
worsening the situation of
another agent

In the case of simultaneous changes of demand and supply

their effect on market price and quantity is determined by:
• the size and direction of changes of demand and supply
• the shape of demand and supply curves (elasticity)
Deadweight loss resulting from
monopoly
P

Loss of consumer surplus As a result of a

higher
Deadweight loss equilibrium price
MC the consumer
resulting from
monopoly loses A+B, while
Pm the producer
gains A-C.
A
B
PC
C
AR=D

MR

Qm QC Q
 What will follow…?

[Link]