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Course
Objective
The objective of this class is to train students
in the basic concepts and techniques of modern microeconomic theory.
The course covers general equilibrium theory with time and uncertainty
; missing markets ( public goods and externalities ) ; imperfect
competition and simple models of asymmetric information and moral
hazard.
Grading: Weekly problem sets (50% ), midterm (20%), final
exam (30%).
SUMMARY
OUTLINE of COURSE
Preliminary
Concepts
-
Historical Evolution of Economics
- Human
Behavior and Society: Law, Economics and Politics
- Time-uncertainty
setting
General
Equilibrium
- Description
of Exchange Economy
- General
Equilibrium: exchange economy
- General
Equilibrium: financial markets.
- General
Equilibrium: production economy
- Economics
of risk sharing with complete markets
Missing
Markets
- Public
goods
- Incentive
compatible public choice
- Externalities
Imperfect
Competition
- Monopoly
- Oligopoly:
Cournot-Nash equilibrium
Asymmetric
Information
-
Adverse selection: signalling
- Moral
Hazard: principal agent problem
EXTENSIVE
COURSE OUTLINE
(1)
Historical Evolution of Economics
- Mercantilism,
classical economics, Keynes-Simon and the modern era.
(2)
Human Behavior and Society
- Law,
economics and political economy as the framework for studying
human behaviour in society. Basic axioms about human ability and
motivation: bounded rationality and opportunism as a way of understanding
the classification of economic theory. (a):Informal theory: transactions
cost approach. (b): Formal theory: game theory, asymmetric information
and theory of incomplete markets.
(3)
Time, uncertainty and information
-
Idea of event-tree and information partitions on a set of states
of nature as basic approach to modelling time, uncertainty and
information in economics.
(4)
Description of Exchange Economy
- Endowments,
preferences, representation by utility functions, expected utility
preferences.
(5)
General Equilibrium: Exchange Economy
- Feasible
allocations, Pareto optimum, competitive (contingent market) equilibrium,
contingent markets. existence of equilibrium. First and Second
Welfare Theorems. The gradient conditions for Pareto optimality.
(6)
General Equilibrium: Financial Markets
- Spot
markets and financial contracts. Financial market equilibrium.
Special case: Fisher's theory of the rate of interest based on
rate of impatience and productivity of capital. CAPM model and
valuation of financial securities. Complete and incomplete markets.
Nominal versus real securities. Money as a medium of exchange
and how it can influence economic activity. In Arrow-Debreu theory
money has no role to play --- hence its complete absence in conventional
microeconomic theory. Incomplete markets as a way of linking traditional
microeconomic theory to macroeconomics. Extending such models
to intertemporal setting with many periods: informational efficiency
and random behavior of security prices.
(7)
General Equilibrium: Production Economy
-
Firms technology sets, profit max problem, supply functions, ownership
of firms, competitive (contingent market) equilibrium for production
economy (recall modified budget sets for agents from firms' profits).
Existence of equilibrium (idea only). First and Second Welfare
Theorems. The gradient conditions for Pareto optimality.
(8)
Economics of Risk Sharing with Complete Markets
-
Expected utility preferences, Pareto optimum maximizes weighted
sum of utility functions subject to feasibility. Representative
agent analysis, one of the fundamental techniques of modern macroeconomics.
Additive separability permits interchange of summations. Each
agent's equilibrium consumption is an increasing function of aggregate
output .
(9)
Public Goods (Missing Markets I)
- One
public and one private good economy. Provision of indivisible
public good, willingness to pay, Pareto efficient provision of
public good. Provision by subscription and by majority voting.
Provision of perfectly divisible public good. Pareto optimum,
first order conditions for Pareto optimum. Personal prices and
Lindahl equilibrium. Subscription equilibrium. Personal prices
as tax rates: problem of free-riders and revelation of preferences.
The Clarke-Groves and pivot mechanism for truthful revelation
of preferences. Provision by majority voting.
(10)
Incentive Compatible Collective Choice
- Preference
revealing mechanisms for public choice problems: message space,
allocation function. Quasi-linear utility functions: with such
utility functions there exists an allocation function (allocation
rule and transfer functions) such that truthful revelation of
preferences is a dominant strategy equilibrium. Examples: public
good, second price auction.
(11)
Externalities (Missing Markets II)
- Two
outputs, one input economy with production externality: proportional
tax restores optimality of outputs. Consumption externalities.
Property rights and the Coase theorem.
(12)
Monopoly (Imperfect Competition I)
-
Partial equilibrium story: inefficient output. Market separation
and price discrimination: conditions under which leads to welfare
improvement.
(13)
Oligopoly (Imperfect Competition II)
-
Exogenously given demand functions. Cournot equilibrium in quantities:
collusion: Stackelberg equilibrium. Bertrand equilibrium in prices.
Oligopoly as a repeated game.
(14)
Adverse Selection
- Insurance
problem with two states, expected utility preferences. Monopolist
selling insurance: high and low risk agents. Complete information
contracts charge agents maximum risk premium. Incomplete (asymmetric)
information contract design is a principal agent problem for monopolist
(incentive constraints). Competitive insurance market: zero expected
profit: no pooling equilibrium: separating equilibrium if sufficiently
high proportion of high risk agents. Lemons problem and signalling:
when does it pay for agents to invest in a signal indicating their
type.
(15)
Moral Hazard
-
The principal-agent problem: effort, incentives and efficiency.
Finitely many actions and outcomes: incentive constraints and
interpretation of first order conditions. Optimal wage contracts.
Monotone likelihood ratio property. Moral hazard and the limits
of insurance.
REFERENCES
Textbook
for the Course
- MAS-COLLEL,
A., M.D. WHINSTON and J.R. GREEN, Microeconomic Theory, Oxford
University Press, 1996.
Recommended
Texts
- MAGILL,
M. and QUINZII, M., Theory of Incomplete Markets, Volume 1, MIT
Press, 1996.
- KREPS,
D., A Course in Microeconomic Theory, Princeton University Press,
1995.
- VARIAN,
H.R., Microeconomic Analysis, Norton and Company, Third Edition,
1995.
Other
Textbooks
- LAFFONT,
J-J, Fundamentals of Public Economics, MIT Press, 1988.
- LAFFONT,
J-J, Economic of Uncertainty and Information, MIT Press, 1988.
- TIROLE,
J., The Theory of Industrial Organization, MIT Press, 1989.
- FUDENBERG,
D. and TIROLE, J., Game Theory, MIT Press, 1991.
- RASMUSEN,
E., Games and Information, Blackwell, 1989.
- HUANG
and LITZENBERGER, Fundamentals of Finance, North-Holland,1989.
- DEBREU,
G., Theory of Value, New York, Wiley, 1959.
- MILGROM,
P. and J. ROBERTS, Economics, Organizational and Management, Prentice-Hall,
1992.
- HILDENBRAND,
W. and A. KIRMAN, Equilibrium Analysis, Amsterdam, North-Holland,
1988.
- MARSHALL,
A., Principles of Economics, London, MacMillan ,1920.
- WALRAS,
L., Elements of Pure Economics, translation of Elements d'economie
politique pure, 1875.
- SMITH,
A., An Inquiry into the Nature and Causes of the Wealth of Nations,
1776, reprinted by Oxford University Press,1976.
Selected
Classical Papers
- Akerlof,
G. (1970). ``The Market for Lemons: Quality uncertainty and the
market mechanism,'' Quarterly Journal of Economics, 89, 488-500.
- Coase,
R. (1937). ``The Nature of the Firm,'' Economica.
- Coase,
R. (1960). ``The Problem of Social Cost,'' Journal of Law and
Economics, 3, 1-44.
- Hayek,
F.A., ``The Use of Knowledge in Society,'' American Economic Review,
vol. 35, 1945 pp. 519-530.
- Rothschild,
M. and Stiglitz, J. (1976). ``Equilibrium in Competitive Insurance
Markets: An Essay on the Economics of Imperfect Information,''
Quarterly Journal of Economics, 80, 629-649.
- Spence,
M., Job Market Signalling, (1974) Quarterly Journal of Economics,
pp. 355-374.
Students
are expected to be familiar with the following:
MATERIAL
COVERED IN MICROECONOMIC THEORY I ( 503 )
Textbooks for the Course
- MAS-COLLEL,
A., M.D. WHINSTON and J.R. GREEN, Microeconomic Theory, Oxford
University Press, 1996.
- VARIAN,
H.R., Microeconomic Analysis, Norton, 1992.
- NICHOLSON,
W., Microeconomic Theory, Dryden Press, 1989.
BRIEF
SUMMARY OF TOPICS
Theory
of Consumer
- preferences
(hypotheses on …)
- representation
of preferences by utility function
- consumers
choice problem on system of static markets
- expenditure
function and indirect utility function
- consumers
surplus
- Slutsky
equation inverse demand functions
Theory
of Firm technology
- sets
(hypotheses on …)
- firms
choice problem on system of static markets
- average
and marginal costs
- long
and short-run cost curves
- properties
of firms optimal plan as function of prices
Partial
Equilibrium on Single Market
-
assumptions required to validate partial equilibrium analysis
- monopoly
solution
- competitive
solution
Mathematical
Techniques
-
constrained maximum problems ( Kuhn-Tucker Theorem )
- envelope
theorem
- gradients
and tangent hyperplanes
- convexity
- second
order conditions
- elements
of linear algebra (plus Cramer's rule)
- implicit
function theorem
- solving
systems of equations types of functions: additively separable,
homogeneous…
Some Useful Math-Econ Textbooks
-
INTRILIGATOR, M., Mathematics for Economists, Academic Press,1971.
- SIMON,C.P.
and L. BLUME, Mathematics for Economists, Norton,1993.
I
recommend that you all have a good book on Calculus and another
on Linear Algebra: more generally you should be on the lookout for
good books in the many areas of modern mathematics that you will
encounter on your journey through Economics : probability theory,
statistics, differential equations, …
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