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BA201a: Introduction
Welcome to Haas, welcome to core micro. I’m Professor Catherine Wolfram.
This is my sixth year at Haas and my fifth year teaching core micro. Before I
began teaching at Haas, I was a professor for four years in the Harvard
Economics Department, where I mainly taught PhD students. Before that, I got
my PhD from MIT.
The way it works in business school is that we’re training you to be generalist, so
you’ll have courses in microeconomics, OB, stats, finance, etc. For the most
part, all of your professors will be specialists. I have a PhD in economics, your
OB professor has a PhD in Sociology, your finance prof will have a PhD in
Finance, etc.
So, you may be wondering, what does someone with a PhD in economics do,
besides teach other people economics? When I’m not teaching, I spend my time
doing research. My research focuses on firm strategies, and how their
competitive environments and their regulatory environments affect the way they
do business. For the most part, I focus on firms in the energy industries, so, for
instance, I’ve analyzed how electricity industry restructuring has affected firms’
pricing strategies and the way they operate their plants. I’m working on a new
project considering how the electricity industry might respond to carbon
regulation. I’m also part of a team that is studying international productivity
differences, and a large part of the project involves going to power plants, talking
to the engineers, putting on hard hats and walking around, which for me is pretty
much energy geek heaven.
Let’s get into micro. What is this course about?
I will give you the tools to understand positive and normative dimensions of
microeconomics.
Positive: descriptive - what will happen.
Normative: prescriptive - what should happen, what decision should I make?
Some examples to help you think about this distinction:
- Positive: What will happen to the number of goods I sell if I lower my
price? If a competitor comes into my market?
- Normative: Should I lower my price?
- Another example: Positive: you buy gasoline as an input, what will
happen to the price of gasoline in California as hybrids take off?
- Normative: Gasoline prices go down, how much of this should you
pass on in the price of your product?
We will go back and forth between these two different questions, often giving
general descriptions of the positive side and then using that model to answer
some normative questions.
Now, what is microeconomics?
Understanding how groups allocate scarce resources.
Parse this:
Scarce resources: Has a precise definition in economics: something which
if priced at zero would be in short-supply. Can anyone think of a good that is
scarce? Harder—how about a good that is not scarce
Allocation: first let’s think about some non-market allocation mechanisms:
1.
2.
3.
Command and control (family: you want to eat that piece of
candy before dinner, think again. Student-teacher: you want to
skip class on Tuesday, September 5th, think again, you’ve got a
midterm. Communist economies: e.g. Chinese gov’t decides
how much wheat to plant, not individual farmers)
Tradition (command and control rules get codified) (Firm buys
from a certain supplier because they always have.)
Markets.
Understanding what gets produced (e.g. medical equipment vs
pharmaceuticals)
how it gets produced and (whether you use more labor
intensive production process or more capital intensive process)
for whom it is produced, (i.e. sold to whom, this is a function
of how you price your products)?
The Methods of Managerial
Decisionmaking
MODELS, MODELS, MODELS.
– simplify reality so that you can see the forest for the trees
– you’ll later think, wait-a-minute, I am the lemonade seller, I’m Herb Kelleher (or
Gary Kelly).
BACKWARDS INDUCTION (mother-in-law catching airplane example,
this is a key technique and one that informs the overall layout of the
syllabus)
Hand out the syllabus so they can see what I mean.
(Turn to page 4 where the content starts)
- Today an aerial view of markets, go through the most fundamental
model used in economics.
- Next three classes, we’ll talk about costs, with one major detour where
I will teach you about decision analysis. This is a useful tool in itself,
but also a good way to help you think about cost and pricing decisions.
- Fifth class (9/5), midterm first half. Last thing we’ll do before the class
is a case, so you’ll be responsible for all the material up to the case,
and the case will be about that material.
- After the midterm, will spend a couple classes on pricing
- Last topic will be entry and exit.
- Last day of class, I will spend a little time wrapping up the class, but
the rest of the time you will present your projects.
Housekeeping.
Requirements: two exams, although if you blow the first one, I won’t count it
in your final grade. Either way, exams count for 80% of your final grade. The
remaining 20% of the grade will be based on a group pricing project. I will
handout details about that next week. Want to work yourself into groups of 4.
Problem Sets: I will hand out five of them over the course. They won’t be
graded, but I strongly recommend that you do them:
 Best way to keep up with the material.
 Very good way to practice working the problems likely to show up
on an exam.
Feel free to work on these in teams. Often the best way to figure out whether
you really understand something is to explain it to someone else. Be careful
if you find yourself being explained to a lot, though, since for the final you’re
on your own.
Reading: The text for this class is Pindyck & Rubinfeld, basic, good clear
treatment of micro. Specific sections are assigned for specific classes. Other
readings in the course reader. A number of them are equivalent to the text.
Cases: Four of them over the course of the semester. I will hand out
preparation questions the class before we discuss the case. Note that all of
the cases are quantitative.
Timing: 6:05-7:30, 8:15-9:25.
Making the most of this class.
- Problem sets: I strongly recommend that you work through the problem sets. I will
hand out 5of them over the course of the class, and the timing is that we will post
the solutions over the weekend because Rob will hold a section on them.
– Come prepared: readings before class. Case preparation means having thought
about questions enough to write out answers to the case preparation questions,
not just uh-huh I’ve thought of that?
– Text before or after, figure out what works best for you.
– Review your notes: I’ve put thought exercises for each class. You should use
these as a guide to your notes.
If you have to miss a class, make sure it will be videotaped, but that won’t
be enough. You should also ask someone to review their notes.
– Math should not be a problem.
– KEEP UP!!!
Class Reps.
NAMES
Ask them to give their name and one fact that we might not guess looking at
them.
Arbitrage example.
January 11
January 12
January 13
January 14
January 15
Chicago
$1056
$1071
$1069
$1062
$1047
Kansas City
$997
$1006
$998
$1004
$985
$59
$65
$71
$58
$62
+$5
+$11
+$2
Ask: did anyone add an extra column to the table (or, how did you approach the
problem).
Think about what the prices in this market are telling us:
-
For one thing, they’re telling us when it is profitable to move wheat
from KC to Chicago.
-
For another thing, they’re higher in Chicago than in Kansas City, so
this tells us that wheat is more valuable in Chicago than in KC. Buyers
are willing to pay more for wheat here (factoid: there are a whole lot of
industrial bakeries in Chicago)
PRICES: CONVEY INFORMATION
-
A central planner would want to make sure to get a lot of wheat to
Chicago.
The beauty of the market system is that no one person has to make
this decision.
Prices not only provide information, but they make things happen.
Arbitrageurs, seeking profits, are moving wheat from KC to Chicago.
PRICES, ARBITRAGEURS RESPONDING TO THEM ECONOMIC
EFFICIENCY
Handout slides while I get PowerPoint set up.
ASSUMPTIONS BEHIND EFFICIENCY OF PERFECTLY COMPETITIVE
MARKET EQM.:
-
homogenous good
many small buyers and sellers
symmetric & complete information
small transactions costs (e.g. the market for cement is very localized
because it’s expensive to transport)
ANALYZING SHIFTS IN SUPPLY AND DEMAND:
Suppose you are the manager of a CA winery. How would you expect the
following events to affect the price you receive for a bottle of wine?
- the price of comparable French wine decreases (DEMAND SHIFTS
DOWN)
- the price of a glass bottle increases significantly due to gov’t antishatter regulations? (SUPPLY SHIFTS IN)
- could do plastic corks
Market for US, unskilled manufacturing labor:
- Outsourcing  demand shifts down (this is like the price of a substitute
product going down). (Other things shifting demand down include
macroeconomic fluctuations, like an income effect for firms).
- Better service sector jobs supply shifts in.
Have any of your companies or industries experienced shifts in demand one way
or another recently? How about shifts in supply?
IN CLASS EXAMPLE OF A MARKET:
Oakland A’s playoff tickets. There are 60 of us in the parking lot, the game is
sold out and there are a bunch of scalpers milling around trying to sell tickets. To
make this conform to the model we used, let’s assume that all the seats in the
stadium are the same. (Used a supply curve with a capacity constraint). Have
them say what the maximum they’d be willing to pay for a ticket, draw demand
curve on the board and label names.
What does the supply curve look like? (What information would you need to
answer this? Does it matter how much the scalpers paid for the tickets? Let’s
say there are 20 scalpers and the tickets are worthless after they’ve been used.
Point out individual’s consumer surplus.
Definition of consumer surplus: difference between what a consumer is willing to
pay for a good and the amount actually paid.
An alternative to solving for equilibrium prices using this graphical method is to
write supply and demand as functions and then solve simultaneously. An ad hoc
linearization of the pizza example gives:
QD = 7,000 – 1,000 P
(DEMAND CURVE, WHERE I’VE WRITTEN IT IN TERMS OF Q)
Qs = 1000 P
(SUPPLY CURVE)
To solve for the equilibrium, set Qs = QD
7000 – 1000 P = 1000 P
7000 = 2000 P
P = 3.5
Q = 3500
S
P
7
3.5
D
3500
7000
0
Q
Consumer and Producer surplus.
In our example = (3.5*3000)/2 = 5250 = ½ base*height = PS = CS
Additional exercises:
1. (Shifting demand and supply numerically, this will help with the problem
set, too)
-
in the pizza example, half the people now go on the Atkins diet (and
Atkins dieters are evenly distributed along the demand curve).
First do it graphically and show the demand curve shifting in.
So, roughly we have the idea that Q* should be lower as should P*.
QD = .5*(7,000 – 1,000 P )
= 3,500 – 500 P
(Note how for simplicity, I’ve been drawing curves where just the intercept
moves and the slope stays the same, this is different.)
- Solve for new equilibrium:
3500 – 500P = 1000P
3500 = 1500P
P = 2 1/3
Q = (3500 – 500*2.33) = 2333
2. Hint of what we’ll do next time: imagine that you are a copper manufacturer
and you’re debating investing in new technology that will make your mining more
efficient, meaning that at any given q, you can get it out for less. Draw two
demand curves and ask them which they would rather face.