Universit Pierre Mendes France

MICROECONOMICS
TEACHING BOOKLET

Professor:

Christophe BRAVARD

Level :

Undergraduate 2nd year

Semester

Semester 4

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I Scope of the Course.

Microeconomics studies the factors that influence the individual choices. It
also examines how the individual decisions merge to determine the working
of the entire economy.
In this course, we are interested in the role played by markets and prices on
the individual choices. Here, market refers to the interplay of all potential
buyers and sellers involved in the production, sale, or purchase of a particular
good or service.
To analyze markets, we must focus on factors which influence the buyers and
the sellers. Prices will play a special role. Indeed, they are the result of
market transactions, but they also influence the behavior of the buyers and
sellers in the market.
In Chapter 2, we deal with the consumer theory. In this chapter we examine
the role played by the price on the buyers choices.
In Chapter 3, we deal with the producer theory. In this chapter we examine
the role played by the price on the sellers choices.
In Chapter 4, we focus on market equilibrium with perfect competition.
In Chapter 5, we provide a method which allows to measure the social welfare. It is useful in order to examine the efficiency of price variation associated
with public policies.
In Chapter 6, we examine situations with imperfect competition.

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II. References.
[1] Intermediate Microeconomics: A Modern Approach, Hal R. Varian, 2010.

[2] Microeconomics, Robert S. Pindyck and Daniel L. Rubinfield,

[3] Microeconomics: Theory and Applications, Edgar K. Browning, Jacquelene M. Browning and Mark Zupan, 2001.

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III. Microeconomics I: Contents.

Chapter 2. Consumer Theory

Summary.

The theory of consumer choice is designed to explain why consumers purchase the combinations of goods they do. The theory emphasizes two factors: the consumer budget line, which shows the market bundles that can
be bought, and the consumers preferences, which indicate the subjective
ranking of dierent market bundles. Consumers preferences are represented
by indierence curves. These curves are decreasing and convex. The slope
of an indierence curve measures the marginal rate of substitution (MRS).
The consumer chooses an equilibrium bundle which maximizes her level of
satisfaction given the bundles that the consumer can purchase. Graphically,
an equilibrium bundle of a consumer is obtained at the point of tangency between her budget line and one of her indierence curve. Finally, we examine
the theory of consumer choice in the labor market where she has to choose
the time she spends to work.

Outcomes

A student:
1. demonstrates understanding of economic terms: preferences, utility
function, budget constraint, marginal utility, MRS, income and income

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and substitution eect, line budget, indierence curve, normal good,
gien good, . . . ;
2. is able to find the optimal bundle of the consumers (using graphics or
calculations);
3. is able to measure the income and substitution eect;
4. is able to find the labor supply of the consumer.

Chapter 3. Production Theory

Summary.

In this chapter, we deal with the relationships between the quantities of

inputs used and the amount of output produces. First, we present several
types of production functions. Then we present the counterpart of the MRS
in the production theory: the technical rate of substitution (TRS). We deal
with two kinds of question.
1. What is the optimal combination of inputs which allows to obtain a
given output?
2. How does the firm determine its optimal output?

Outcomes

A student:

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1. demonstrates understanding of economic terms: production function,
marginal product, TRS, returns to scale, the cost functions, . . . ;
2. is able to find the optimal demand of factors and the supply of the firm
(using graphics or calculations).

Chapter 4. Equilibrium Market Price

Summary.

In this chapter, we first deal with the short run equilibrium. We focus on
its characterization and its stability using the Cobb-Web model. Then, we
illustrate with an example the characterization of long run equilibrium.
Outcomes

A student:

1. demonstrates understanding of economic terms: short run equilibrium,

long run equilibrium, market demand, aggregate supply, . . . ;

2. is able to find the short run equilibrium and the long run equilibrium.

Chapter 5. Welfare
Summary.

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In this chapter, we first present the consumer surplus, that is a method

to estimate the satisfaction that an agent obtains thanks to the consumption
of a good. It is a monetary estimation.
Then we present a method to compute the profit obtained by the firms.
Finally, we combine these measures to estimate the social Welfare obtained
in an economy.
Outcomes.

A student:

1. demonstrates understanding of economic terms: short run equilibrium,

long run equilibrium, market demand, aggregate supply, . . . ;

2. is able to find the short run equilibrium and the long run equilibrium.

Chapter 6. Market Power

Summary.

In this chapter, we present several situations with imperfect competition.

First, we deal with a monopoly. We present the equilibrium in that situation and we study the consequences of such market structure on the social
welfare.
Then we examine several market structures with two competitors:

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1. In the Cournot duopoly, firms choose simultaneously their quantities.
2. In the Bertrand duopoly, firms choose simultaneously their prices.
3. In the Stackelberg duopoly, firms choose sequentially their quantities.

Outcomes.

A student:

1. is able to find the monopolists optimal solution, to show that this solution is not efficient.

2. is able to solve the Cournot and Stackelberg duopolies.

3. is able to prove the Bertrand paradox.

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Contents
1 Introduction

11

2 Consumer Theory

15

2.1

Preference and Utility . . . . . . . . . . . . . . . . . . . . . . 16

2.1.1

Consumer preferences . . . . . . . . . . . . . . . . . . . 16

2.1.2

Utility Function . . . . . . . . . . . . . . . . . . . . . . 17

2.1.3

Marginal Utility . . . . . . . . . . . . . . . . . . . . . . 18

2.1.4

Marginal Rate of Substitution (MRS) . . . . . . . . . . 20

2.1.5

Indierence Curves . . . . . . . . . . . . . . . . . . . . 23

2.1.6

Some Examples of Utility Functions . . . . . . . . . . . 26

2.2

The Budget Constraint

2.3

Optimal Choice of the Consumer . . . . . . . . . . . . . . . . 28

2.4

2.5

. . . . . . . . . . . . . . . . . . . . . 27

2.3.1

Graphical Analysis . . . . . . . . . . . . . . . . . . . . 28

2.3.2

Constraint Maximization . . . . . . . . . . . . . . . . . 30

Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
2.4.1

Income Changes . . . . . . . . . . . . . . . . . . . . . . 34

2.4.2

Price Changes . . . . . . . . . . . . . . . . . . . . . . . 36

Labor Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
2.5.1

Model Setup . . . . . . . . . . . . . . . . . . . . . . . . 42

2.5.2

Opimal Choice . . . . . . . . . . . . . . . . . . . . . . 44
9

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CONTENTS

3 Production Theory
3.1

47

Technology and Production Function . . . . . . . . . . . . . . 48

3.1.1

Technological Constraints . . . . . . . . . . . . . . . . 48

3.1.2

Production Function . . . . . . . . . . . . . . . . . . . 49

3.1.3

Examples of Production Functions . . . . . . . . . . . 50

3.2

The Marginal Product . . . . . . . . . . . . . . . . . . . . . . 51

3.3

The Technical Rate of Substitution . . . . . . . . . . . . . . . 53

3.4

Returns to scale . . . . . . . . . . . . . . . . . . . . . . . . . . 54

3.5

Demand of Production for Factors . . . . . . . . . . . . . . . . 56

3.6

3.5.1

Graphical Analysis . . . . . . . . . . . . . . . . . . . . 56

3.5.2

Algebraic Analysis . . . . . . . . . . . . . . . . . . . . 58

3.5.3

The Cost Functions . . . . . . . . . . . . . . . . . . . . 59

3.5.4

Average Costs . . . . . . . . . . . . . . . . . . . . . . . 60

3.5.5

Marginal Costs . . . . . . . . . . . . . . . . . . . . . . 63

Firm Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
3.6.1

Firm Environment . . . . . . . . . . . . . . . . . . . . 64

3.6.2

The Supply Decision of a Competitive Firm . . . . . . 65

4 Equilibrium Market Price

4.1

4.2

Short Run Equilibrium . . . . . . . . . . . . . . . . . . . . . . 69

4.1.1

Short Run Market Supply . . . . . . . . . . . . . . . . 69

4.1.2

Short Run Market Demand . . . . . . . . . . . . . . . 70

4.1.3

Equilibrium Analysis . . . . . . . . . . . . . . . . . . . 73

4.1.4

Equilibrium Stability . . . . . . . . . . . . . . . . . . . 74

Long Run Equilibrium . . . . . . . . . . . . . . . . . . . . . . 78

5 Welfare
5.1

68

82

Consumer Surplus . . . . . . . . . . . . . . . . . . . . . . . . . 83

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CONTENTS

11

5.1.1

Consumer Surplus for a discrete good . . . . . . . . . . 83

5.1.2

Good Available in Continuous Quantities . . . . . . . . 89

5.1.3

Consumers Surplus and Consumers Surplus . . . . . . 93

5.2

Producers Surplus . . . . . . . . . . . . . . . . . . . . . . . . 93

5.3

Welfare

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

6 Market Power
6.1

6.2

96

Monopoly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
6.1.1

Maximizing Profits . . . . . . . . . . . . . . . . . . . . 97

6.1.2

Graphical Analysis . . . . . . . . . . . . . . . . . . . . 101

6.1.3

Lerner Index

6.1.4

Welfare Analysis . . . . . . . . . . . . . . . . . . . . . 104

6.1.5

Discriminating Monopoly . . . . . . . . . . . . . . . . . 107

. . . . . . . . . . . . . . . . . . . . . . . 102

Duopoly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109
6.2.1

The Cournot Model of Quantity Competition . . . . . 110

6.2.2

The Bertrand Model of Price Competition . . . . . . . 114

6.2.3

Model Setup . . . . . . . . . . . . . . . . . . . . . . . . 115

6.2.4

The Stackelber Model of Quantity Competition . . . . 118

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CONTENTS

IV. Indicative course time

Chapters (60-90 indicative hours)

% of course time Indicative Hours

Chapter 2. Consumer Theory

30

18-27

Chapter 3. Production Theory

20

12-18

Chapter 4. Equilibrium Market Price

15

9-13

Chapter 5. Welfare

15

9-13

Chapter 6. Market Power

20

12-18

V. Examination
The student will obtain an examination mark derived from the final examination.

This examination consists in definitions and questions.

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We assume that all firms are identical: they have the same costs functions.
1. (1 point) Define and find the marginal cost function and the average variable cost function.
2. (1 point) Define and find the shutdown condition.
3. (1 point) Find the individual supply function, f (p), of a firm.
4. (1 point) Consider there are n firms in the industry. Find the market supply, Y (p).
5. (1 point) Consider that there are m identical consumers which have the following individual demand function:
200
.
d(p) =
p
Find the aggregate demand function, D(p).
6. (1 point) Find the market price equilibrium.

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The cost function is given by

C(qi ) = cqi , i {1, 2}.
In the following, we assume a game with two stages. In the first stage, firm 1 chooses the
quantity produced. In the second stage, firm 2 chooses how much to produce after observing
the level of output chosen by firm 1 in the first stage. Then each firm collects its profit given
the levels of output chosen.
1. (1 point) What is the name of this game?
2. (3 points) Find the equilibrium of this game.
3. (2 points) What would be the Cournot game situation.
4. (2 points) Does Firm 1 have an incentive to be the first mover (compare with the
Cournot situation).

II. Duopoly (B)

(3 points) Explain the Bertrand paradox.

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