Econ10004 Introductory Microeconomics SUBJECT GUIDE Semester 1, 2012 Prepared by Gareth James Department of Economics Faculty of Economics and Commerce

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Subject Guide Contents A. Key Information………………………………… 3 B. Subject details………………………………........4 C. Subject objectives……………………………….. 5 D. Lecture Outline and Readings…………………... 6 E. Details on Assessment…………………………... 8 F. About Tutorials………………………………….. 9 G. Tutorial Enrolment Information………………… 10 H. How to Study…………………………………….10 I. Resources for Study……………………………… 11 J. Subject Prize……………………………………... 14 K. Plagiarism………………………………………..14 L. About Microeconomic Theory…………………...15 Appendices 1. Sample multiple choice exam questions………… 18 2. 2010 Final examination…………………………..22

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A. Key information Lecturer: Gareth James Rm. 542b Phone: 90358057 Email: gjames@unimelb.edu.au Office hours: Wednesdays 12pm to 2pm Tutorial coordinator: Nahid Khan Rm. 606 Phone: 8344-3621 Email: n.khan@unimelb.edu.au Assessment Dates 1. Tuesday March 27 (12 midday) to Thursday March 29 (12 midday) – Multiple-choice exam (on-line). 2. Tuesday April 3 (4.00pm) – Assignment 1. 3. Tuesday May 8 (4.00pm) – Assignment 2. Web address: http://www.lms.unimelb.edu.au [Use the same username and password that you use to access your University of Melbourne email account.]

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B. Subject details Class times: a) Lectures – 2 x 1 hour each week –

Lecture times: Tuesday - 10.00, 11.00, 2.15, 4.15 - Copland Theatre (Eco and Commerce); and Thursday - 10.00, 11.00, 2.15, 4.15 – Copland Theatre (Eco and Commerce).

b) Tutorials – 1 x 1 hour each week (Timetable via ISIS – See section G of Subject Guide for details.) Begin in Week 1 – from Monday February 27.

Textbooks: • Required - Principles of Microeconomics – Joshua Gans, Stephen King, and N. Gregory Mankiw (GKM), 5th Edition. [Any of the 1st , 2nd , 3rd or 4th editions can be used.] Readings for each lecture from the current edition of the textbook are listed in section D of the Subject Guide. The text is required for the subject. For most lectures they are the only prescribed reading. At some points in the subject however we will move beyond the coverage of the GKM text. For these lectures reading material is provided to you in the ‘Reading hand-outs’ that will be distributed. Microeconomics: Case Studies and Applications – Jeff Borland [Can use either the version with ‘green’ cover or ‘orange’ cover.] This text includes summaries of key concepts and theories; a variety of applications; and key lessons. • Recommended – The Undercover Economist – Tim Harford (330.90511 HARF). Reinventing the Bazaar – John McMillan (330.122 MCMI). The Economic Naturalist – Why economics explains almost everything, Robert H Frank. [These books provide excellent non-technical introductions to many topics that we will study, and include plenty of useful examples. Either one or both could be read at the start of semester as an introduction to the subject, or during the semester to help you review what we are studying. The books should be thought of as an optional supplement to the texts. Reading them is a way to develop your understanding of microeconomics, and to see a range of applications of key concepts. But material from these books will not be directly examined. Suggestions for other readings on microeconomics are in the ‘Ideas for Extra Reading’ section of the LMS subject site.] • Other resources – Principles of Microeconomics: Study Guide – Judy Tennant and David R. Hakes. Assessment: Exercise 1: Multiple choice exam (5%) – On-line - To be completed between Tuesday March 27 (midday) and Thursday March 29 (midday). Exercise 2: Assignment 1 (10%) – Due: Tuesday April 3 by 4.00pm. Exercise 3: Assignment 2 (15%) – Due: Tuesday May 8 by 4.00pm.

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Exercise 4: Tutorial participation and attendance (10%). Exercise 5: Final examination (60%) – Two hour examination. C. Subject objectives Students who complete this subject will be able to: • Describe the main objectives of the study of economics - to seek to understand the operation of the economy, and to guide decision-making by individuals, businesses and government. • Explain the nature and role of theory and models in economic analysis. • Explain the concepts of demand, supply, and market equilibrium; and apply the model of demand and supply in a market to explain the determinants of prices and output of goods and services. • Explain how market and social welfare outcomes are affected by changes in demand/supply and government policy, and explain how and in what circumstances intervention by government in the operation of the economy can improve efficiency and social welfare. • Explain models of firm behaviour in choosing output, price, and how to produce. • Identify ‘strategic situations’ in economic activity, and be able to analyse and predict outcomes of strategic situations. • Identify the main characteristics of different market types such as perfectly competitive and monopoly markets. Describe the nature of competitive behaviour in those markets, analyzing and predicting price and output outcomes in the different markets. • Use examples to illustrate key concepts – such as the role of demand and supply factors in determining market outcomes, the effects of government intervention on market outcomes, the existence of strategic situations in the economy, and different types of markets. • Apply economic models of individual behaviour and markets to describe the main features of actual markets, and to explain outcomes in actual markets, including prices and output levels, and business performance and profitability. • Evaluate and critically analyse government policy, and make an informed contribution to public debate on economic issues. • Proceed to the study of other economics and commerce subjects that have a knowledge of introductory microeconomics as a prerequisite.

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D. Lecture Outline and Readings Lecture Date Topic Textbook references A. Introduction

1 Feb 28 Subject overview

GKM chapters 1 and 2

2 March 1 Introduction to key concepts in microeconomics

GKM chapters 1and 2 Reading hand-out 1 Borland 1.1, 1.2, 1.3, 1.4, 1.5 and 1.7

B. The working of competitive markets

3 March 6 Market forces of supply and demand 1

GKM chapter 4 Reading hand-out 2 Borland 2.1 and 2.2

4 March 8 Market forces of supply and demand 2

GKM chapter 4 Reading hand-out 2 Borland 2.3 and 2.4

5 March 13 Elasticity and its applications

GKM chapter 5 Borland 2.5

6 March 15 Supply, demand and government intervention

GKM chapter 6 Borland 2.8

7 March 20 Review of competitive markets

GKM chapters 4 to 6 Borland 2.4, 2.5 and 2.8

C. Welfare and markets

8 March 22 Welfare and markets

GKM chapter 7 Borland 1.6, 2.6 and 2.7

9 March 27 Welfare application 1: Government intervention

GKM chapter 8 Borland 2.9

10 March 29 Welfare application 2: International trade

GKM chapter 9 Borland 3.2, 3.3 and 3.4

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11 April 3 Market failure 1: Externalities

GKM chapter 10 Borland 4.1, 4.2, 4.3 and 4.4

12 April 5 Market failure 2: Public goods

GKM chapter 11 Borland 4.5 and 4.6

April 6 – April 15

Easter Non-teaching period

D. The firm and markets

13 April 17 Key concepts of production

GKM chapter 13

14 April 19 Costs of production 1: short run analysis

GKM chapter 13 5.1 and 5.2

15 April 24 Costs of production 2: long run analysis

GKM chapter 13 Reading Handout 3

16 April 26 Firms in competitive markets 1

GKM chapter 14

17 May 1 Firms in competitive markets 2

GKM chapter 14 Borland 5.7

18 May 3 Monopoly

GKM chapter 15 Borland 5.5, 5.6 and 5.10

19 May 8 Monopolistic competition

GKM chapter 18 Borland 5.5 and 5.6

20 May 10 Price discrimination

GKM chapter 15 Borland 5.8 and 5.9

E. Game theory

21 May 15 Introduction to oligopoly and game theory

GKM chapter 16

22 May 17 Game theory: Simultaneous games

GKM chapter 16 Reading hand-out 4 Borland 6.1 and 6.2

23 May 22 Game theory: Sequential games

Reading hand-out 4 Borland 6.4 and 6.5

24 May 24 Exam review

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E. Details on Assessment Exercise 1: Multiple choice question exam (5%) The multiple-choice exam will be conducted on-line through the ‘FAT’ program that can be accessed via ‘TLU Tools’ on the LMS subject webpage. The exam will be on material that relates to the first 3 weeks of the course. There will be 10 multiple-choice questions (each worth equal marks). You will have 30 minutes to complete the exam. Each student will receive a different set of questions randomly chosen from a much larger set of questions. A sample of the types of questions that might be asked is included as Appendix 2 to this Subject Guide. Review multiple choice questions are also available on-line from the ‘FAT’ program. Extra pit-stop tutorials will be held in the week prior to the exam. Exercise 2: Assignment 1 – 1000 words (10%) In this assignment you will be required to use economic concepts to answer questions on material that relates to the sections B and C of the subject. There will be extra pit-stop tutorials at the time this assignment is due. As well, if you have questions about completing this assignment, the ‘On-line Tutor’ is available. Exercise 3: Assignment 2 – 1500 words (15%) In this assignment you will be required to use economic concepts to answer questions on material that relates to section D of the subject, and also complete a ‘case study’ exercise. There will be extra pit-stop tutorials at the time this assignment is due, and the ‘On-line Tutor’ will also be available for questions. Exercise 4: Tutorial participation and attendance (10%) At the end of semester your tutor will assign you a mark out of 10 for tutorial participation. Your grade for participation will depend on: evidence of preparation for the tutorial; frequency of participation in discussion; relevance and logic of comments in discussion; and evidence of active listening to other students’ contributions. If you have attended at least 7 tutorials during the semester your final mark for this exercise will be equal to the tutor’s original mark. If you have attended less than 7 tutorials during the semester your final mark for this exercise will be equal to the tutor’s original mark minus 1 for each tutorial less than 7 that you attended. (For example, suppose your tutor gives you 8/10, and that you attended 10 tutorials. Then your final mark is 8. Alternatively, suppose your tutor gives you 8/10, but you only attended 3 tutorials. Then your final mark is 4. That is, you lose 4 marks because you missed 4 tutorials under the threshold of 7, and each of these missed tutorials reduces the mark by 1.) Note that to receive a mark for tutorial participation/attendance, you must have a valid tutorial enrolment. Exercise 5: Final examination (60%) Held at the end of semester. Duration – Two hours. Will involve a mix of multiple choice, short answer, and essay type questions. The final examination paper for 2010 is Appendix 6 to this Subject Guide. More details about the exact format of the 2011 exam will be provided later in the semester.

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Submitting Assignments 1 and 2 Assignments 1 and 2 will be submitted in electronic format using the Assignment Tool. You can access the Assignment Tool by clicking on ‘Assignment Tool’ in the navigation menu from the LMS subject website. A guide to using the Assignment Tool can be downloaded from: http://tlu.ecom.unimelb.edu.au/pdfs/StudentsGuideAssignmentTool.pdf Please note that you are required to keep a copy of your assignment after it has been submitted, as it may be necessary for you to be able to provide a copy of your assignment at some later date. Meeting Deadlines It is very important that you submit Assignments 1 and 2 by the specified times on the due dates. After that time there will be a penalty for late submission. To request an extension for an assignment, you’ll need to submit an ‘Assignment Extension Request Form’. The form must be submitted at Commerce Student Centre (ICT Building, 111 Barry Street, Upper Ground Floor). Information on requesting an extension is available at: http://www.ecom.unimelb.edu.au/students/undergrad/assignment.html Late assignments, where approval for late submission has not been given, will be penalised at the rate of 10% of the total mark per day, for up to 10 days, at which time a mark of zero will be given. Special Consideration If you wish to apply for Special Consideration in relation to any component of assessment in this subject you will need to lodge an application online with the Commerce Student Centre. Application for Special Consideration in relation to a component of assessment must be lodged within 3 working days of the date that component of assessment was due to be submitted/performed. Information on the process for applying for Special Consideration, and on the material you will need to submit is available at: http://www.ecom.unimelb.edu.au/students/special/ F. About tutorials Pre-tutorial work Each week in tutorials a ‘blue sheet’ will be distributed. The blue sheet provides a guide to the subject matter of that week’s lectures and what will be the subject matter of the next week’s tutorial. For example, the blue sheet distributed in week 1 covers material that is the subject of lectures in week 1, and will be reviewed in tutorials in week 2. The blue sheet lists the main concepts and readings, and includes review questions. It is an important part of learning in this subject that you should attempt these questions. Usually solutions to the questions will not be covered in tutorials. Instead, solutions are posted on the LMS subject site. This happens at the end of the week following when the blue sheet is distributed. In-tutorial work Each week in your tutorial a ‘pink sheet’ will be distributed. The pink sheet lists the tasks that will be covered in the tutorial. Generally these tasks will be problem-type questions. Your tutor will break you up into small groups where you will work out solutions to the problems. At the end of the tutorial the tutor will bring everyone back together and review solutions. Often this will involve asking the small groups to take turns in presenting their suggested solutions.

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G. Tutorial enrolment information

There will be weekly tutorials starting in the week beginning Monday February 27. Allocation to tutorials is determined by the student system ISIS. You must enroll in a tutorial via ISIS as soon as possible. You access ISIS through the Student Portal.

If you have any problems regarding tutorials contact Ms. Nahid Khan (Room 606; 8344-3621; n.khan@unimelb.edu.au). Note that tutors are not permitted to authorise a transfer from one tutorial to another, not even from one of their own tutorials to another of their own tutorials. Tutors are only permitted to allow you to attend their tutorial if you are not enrolled in that tutorial: (a) Where because of illness you have missed your allocated tutorial in a particular week. In that case a tutor may permit you to ‘sit in’ for that week only and on no subsequent occasion during the semester; or (b) Where you miss your regular tutorial because of the Good Friday Public Holiday. In either of these cases you may attend any other tutorial in that week. In both these cases you should obtain an attendance form from the tutor to pass on to their regular tutor to be entered into the attendance record. H. How to study • Attend lectures. These will give you a broad understanding of each topic and where it fits into the subject. You should also read the relevant pages of the textbook and the case study reading.

• Work outside class contact hours. Working outside class hours is essential for performing to your full potential in the subject. It is recommended that 5-6 hours per week (on average) should be spent on Introductory Microeconomics – This would consist of about 1 hour per week reading the textbook, 2 hours per week doing the pre-tutorial exercises, 2 hours per week (averaged over the semester) on the assessment tasks, and ½ hour using the on-line revision tools.

• Learn how to apply the main concepts. To do well in this subject it is not enough to be able to remember definitions or to provide a summary of lectures; what is most important is to be able to apply the concepts and approaches that are presented. The best way to develop this skill is through ‘active learning’ – for example, trying to answer problems and questions, and discussing those answers with your fellow students and with your tutor. Of course, you also need to know things like definitions of concepts – but this should be the start rather than the end of your study for the subject.

• Practice writing up answers and doing diagrams. You should attempt to write up answers to each set of pre-tutorial and tutorial exercises, including drawing diagrams that assist with explanations of the answers. This is good practice for the exam.

• Do the assessment exercises. Ensure you attend exams, submit essays, and contribute to tutorials.

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I. Resources for study Subject homepage: You can access the subject homepage at: http://www.lms.unimelb.edu.au To access the homepage you need to use the same username and password that you use to access your University of Melbourne email account. A range of information is available on the subject website: • Subject Guide. • Announcements about the subject. • Lecture overheads, audio lectures, and supplementary notes – ‘Economist’ work-outs; ‘Intro Micro Legend’ profiles. • Tutorial material - Solutions to ‘blue sheet’ questions. • ‘FAT’ – Access to multiple-choice question revision modules, and to Assessment exercise 1 (Multiple choice test) (Via ‘TLU Tools’). • Old exam papers. • Access to ‘On-line tutor’ (Via ‘TLU Tools’). • Access to ‘Assignment Tool’. • Ideas for extra reading about economics, and links to economics-related websites. It is important to check regularly the subject homepage for any new messages about the subject – Usually these messages would be placed under ‘Announcements’. Audio lectures:

An audio recording of lectures delivered in this subject will be made available for review in the days following each lecture. Audio recordings of lectures allow you to revise lectures during the semester, or to review lectures in preparation for the end of semester exam. Audio lectures can be accessed from ‘Audio lectures’ on the LMS subject site. Audio streaming and podcast formats are available.

Extra hand-outs: Copies of missed handouts from tutorials (blue and pink sheets) will be available from the LMS subject site at the end of the week in which those sheets were distributed. Tutor consultation times: Your tutor will have a designated consultation time when you will be able to consult on an individual basis about questions or problems you have with the subject material or about assessment exercises.

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On-line tutor: The Online Tutor (OLT) provides the scope to ask questions of a tutor online. It can be accessed via ‘TLU Tools’ on the LMS subject site. One role is for asking about material covered in lectures or tutorials. The other role is for answering questions about the assessment exercises. Subject material The aim of the OLT is to help you understanding key concepts. It needs to be stressed that the OLT is not intended as a substitute for regular tutorials. It is therefore not a facility for providing solutions to tutorial questions, review questions, past exams or questions from the textbook. What the OLT is intended to for is to assist you in being able to work out solutions to those types of problems themselves. So if you have a query about any one of these questions you need to describe what aspect of the question you do not understand and show that you have made some attempt to resolve the problem yourself. You should also consult the relevant sections of your textbook before asking a question. Definitions, which are readily available in the textbook, will also not be provided by the OLT. It is however appropriate to consult the OLT if you have a question about an aspect of the definition you do not understand. The OLT will inform students directly if a question does not fall within the guidelines for the systems use. Those questions that show some evidence of thinking and work will be given the most thorough response. Each time you access the OLT you will be prompted for keywords that relate to the question you want to ask, and the OLT system will direct you to previously asked questions that relate to these keywords. It is very important to check whether your question has been previously asked – since the OLT will not respond to questions that have already been asked, and are hence already available for viewing. Assessment exercises The OLT is available to help point you in the right direction as far as what is expected in an assessment exercise and to provide clarification on aspects of material, which has been read for the exercise that is not fully understood. Clearly OLT will not give answers to questions that relate too directly to a question set for the assessment. Answers will in general be provided within a 24-hour period although on certain occasions when the system is particularly busy or on weekends a slightly longer period may be taken. The period before the mid-semester and end of semester exams is always particularly busy so it is always best to ask questions early. Whilst there is no limit on the number of questions which can be asked of the OLT by an individual student, the service is, like all resources, limited. If too many questions are asked by a student this would also suggest that that student has not spent sufficient time consulting the textbook and others sources for answers. It should be noted that whilst the use of humour is appropriate in relation to your dealings with the OLT insulting and offensive communications will not be tolerated.

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Faculty Teaching and Learning Unit: The Faculty Teaching and Learning Unit (TLU) offers a wide range of support services to students. If you are having any difficulty in studying for this subject you could arrange a consultation with the Unit’s learning skills specialist. The learning skills specialist can review your current approaches to study and offer advice. If you are a student from a non-English speaking background there is an ‘English as a Second Language’ specialist who is available to help you with your written work. Both of these specialists are available for face-to-face consultations or electronically through email. The TLU is located on Level 6 at 198 Berkeley Street. You can arrange for consultations or contact the TLU on-line through its webpage at: http://tlu.ecom.unimelb.edu.au/. Make use of the TLU. It is there to help. Supplementary texts: A range of alternative textbooks – appropriate for this subject - are available. There is no requirement to read any of these extra texts. However, if you are seeking to improve your understanding by reading alternative explanations of key concepts, or looking for extra examples, those texts may be useful. Copies of three texts have been placed on reserve at the Baillieu Library: Principles of Microeconomics – John Sloman and Keith Norris (2005, Pearson Education) (338.5 SLOM). Microeconomics: A Contemporary Introduction – Michael Swann and William McEachern (2006, 3rd edition, Thomson Learning) (338.5 SWAN). Principles of Microeconomics – Robert Frank, Sarah Jennings and Ben Bernanke (2009, 2nd edition, McGraw Hill) (338.5 FRAN).

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Other texts that could be consulted are: • Microeconomics – Paul Krugman and Robin Wells (2005, 1st edition, Worth Publishers). • Microeconomics – John Jackson and Ron McIver (2004, 7th edition, Irwin McGraw-Hill). • Microeconomics – Douglas McTaggart, Christopher Findlay and Michael Parkin (2006, 5th edition, Addison-Wesley). J. Subject prize The student who receives the highest marks in Introductory Microeconomics is awarded the State Chamber of Commerce Exhibition (University Regulation R6.19). K. Plagiarism It is the policy of the Department of Economics that attention be drawn to the nature and serious consequences of plagiarism and collusion. Plagiarism Plagiarism is the act of representing as one’s own original work the creative works of another, without appropriate acknowledgement of the author or source. (Creative works may include published and unpublished written documents, interpretations, computer software, designs, music, sounds, images, photographs, and ideas or ideological frameworks gained through working with another person or in a group. These works may be in print and/or electronic media.) Collusion Collusion is the presentation by a student of an assignment as his or her own which is in fact the result in whole or in part of unauthorised collaboration with another person or persons. Collusion involves the cooperation of two or more students in plagiarism or other forms of academic misconduct. Both the student presenting the assignment and the student(s) willingly supplying unauthorised material (colluders) are considered participants in the act of academic misconduct. There is no objection to assignments being discussed in a preliminary way among students. What is not permissible is anything in the nature of joint planning and execution of an assignment. Where an allegation of academic misconduct involving either plagiarism or collusion is upheld, significant penalties such as deprivation of credit for a subject or component or assessment can be imposed. The Faculty Teaching and Learning Unit has developed a web-based ‘Academic Honesty Module’ that allows you to learn more about and test your knowledge of plagiarism and collusion. I encourage you strongly to complete this module at: http://tlu.ecom.unimelb.edu.au/AcademicHonestyTest/index.cfm

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L. About microeconomic theory by Professor Jeff Borland. The objective of economics is to understand the operation of the economy, and to guide decision-making by individuals and organisations such as firms or government in the economy. Economists seek to achieve this objective by developing ‘theories’. The structure of an economic theory consists of two components: a model and a set of hypotheses that represent the logical consequences of that model. A model is a simplified representation of an aspect of the economy that is to be the subject of theoretical analysis. Having specified a model to characterise the operation of some aspect of the economy, hypotheses or propositions are derived as logical consequences of the specified model. The degree of consistency between the hypotheses and actual market outcomes provides one test of the value of the theory for understanding the operation of the economy. It is not only economists who use models to seek to understand behaviour and social outcomes. For example, in political science and industrial relations the use of models is also common. A distinction between ‘economic’ and ‘non-economic’ models is generally made on the basis of the specific features of those models. Two types of features identify economic models. First, there is a range of general core assumptions common to most modern economic models. Neoclassical economists, for example, have as basic modelling assumptions that all decision-makers are rational and have well-defined objectives they seek to achieve. The assumption of rationality means that in any environment, a decision-maker is aware of the complete set of actions available, can calculate the consequences of each action, and chooses the action which is best for achieving their objective. Second, in developing theories for studying specific economic situations, most economists would draw on the same general set of models. For example, for modelling strategic situations a common approach would be to apply a ‘game theoretic’ model. An important detail regarding an economic model is that it will necessarily be a simplified and subjective representation of the aspect of the economy it seeks to describe. First, it would never be possible, or indeed useful, to provide a representation of the economy which included every possible detail about the economy. The objective of an economic theory is to identify and highlight the key factors which might explain some economic outcome, and to abstract from inessential details regarding that outcome or the situation from which it arose. In this regard, Keith Whitfield (The Australian Labour Market, 1987, Sydney, Harper and Row, p.7) has noted with reference to labour economists that: "Some labour economists have likened their work to the making of a map - for the objective is not so much to describe reality as to give a representation which will be useful to those having to plot a course through it. Instead of contours or symbols, the labour economist develops theories and concepts, but the aim is much the same, that is, to develop a representation of a complex phenomenon which allows the main features to be highlighted and the superficial to be ignored." A second consideration is that each economist will perceive different aspects of the operation of the economy, and different economic outcomes, in very different ways.

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The historian E.H. Carr (What is History?, 1964, Pelican Books, p.22) has observed that: "...the facts of history never come to us 'pure', since they do not and cannot exist in a pure form: they are always refracted through the mind of the reader." The study of economics is no different. There are no objective facts about the operation of the economy or the nature of economic outcomes - only individual economists' perceptions of economic activity. Hence, any representation of the economy, and any choice of what aspects of the economy should be highlighted in a model, will be subjective. As Keynes wrote (in Essays in Biography, pp.207-208, Macmillan, London) in 1933: "The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions." All this suggests that an economist must have two main skills – first, a ‘tool-kit’ of approaches to modelling the economy; and second, knowledge of how to apply those approaches to develop theories which fit the specific situations in which the economist is interested. The primary objective of this subject is to enhance both types of skills. Specifically the subject will: a) Introduce approaches and concepts fundamental to microeconomics – the

concepts of demand, supply and market equilibrium in perfectly competitive markets; game theory; and firm behaviour in competitive and non-competitive markets; and

b) Present applications of microeconomic theory – using case studies, tutorial problem sets, and assessment exercises.

Saying that economics is about applying particular types of theories to understand the operation of the economy of course begs the question – what is the economy? Or put another way, what types of situations does economics seek to understand? There is no simple answer to this question. One response is to say that economics is concerned with situations involving choices about the allocation of scarce resources – and that microeconomics is about situations where individual units such as households and firms must make choices. This definition, however, still includes a wide range of situations. Amongst these situations there will be some where valuable insights can be obtained using economic modelling, and others where economic models seem of less use. For example, the application of economic models to seek to understand what factors influence consumers’ demand for food seems to provide useful insights; on the other hand, economic models seem much less relevant to understanding decisions about household formation (such as marriage). Economists however will disagree about what situations can and cannot usefully be understood using economic models (for example, some economists would disagree with my opinion on using economic models to study marriage). Therefore the decision about what types of situations can be understood using economic models is also a subjective one.

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One final issue about economic models concerns the use of mathematics. It is important to know that maths is just another language for describing a model of the economy. Any model expressed mathematically can also be expressed in words. There are a number of reasons though why it is often useful to express a model in mathematical form. First, maths provides a common language for communicating the details or structure of a model. And second, a mathematical representation makes it easy to test the logical consistency of hypotheses or propositions derived from a model, and clarifies the relation between the model and conclusions. (For more discussion of this issue, see Krugman, P. (1998), ‘Two cheers for formalism’, Economic Journal, pages 1829-1836.

Appendices 1. Sample multiple choice exam questions 2. 2010 Final examination Appendix 1 Sample multiple choice questions Note: You will be able to attempt these questions and check your answers using the ‘FAT revision tool’ that can be accessed at the LMS Introductory Microeconomics subject web-page. 1. Fred decides to start a flower-growing business. To do this, he works only half-time in his job as a consultant, from which he could earn $100,000 per year as a full-time employee. Hot houses for the flowers cost him $50,000, and if he decides at any time to discontinue his business, he could sell the hot houses for $30,000. Seeds to grow the flowers cost $10,000. There are no other costs. Assume there is a zero rate of interest. Flowers to sell will not be available until one year after the business commences. The opportunity cost to Fred if he ceased to operate his business at the end of the first year would be: a) $50,000 b) $160,000 c) $80,000 d) $130,000 e) $110,000 2. Dan the Developer owns a block of land on which he has been thinking of building a new house. He paid $200,000 for the land, and has already spent another $20,000 on building permits and preliminary work. The cost of building the house would be $200,000. Costs of selling either the house and land, or just re-selling the land, would be $10,000. Dan knows that he could re-sell the land for $160,000. He must decide to either sell the land, or to build a house and sell the land/house. What is the minimum amount for which Dan would need to expect to be able to sell the house and land, in order for him to decide to build the house? a) $430,000 b) $360,000 c) $350,000 d) $210,000 e) $160,000

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3. Tastes of television viewers change towards ‘reality TV’ and away from ‘documentaries’. At the same time there is an increase in consumer income, and watching TV is known to be a normal good. From the information provided, we can say that the following must occur: a) Demand for ‘reality TV’ will increase, and demand for ‘documentaries’ will decrease. b) Demand for ‘reality TV’ will increase, and it is not possible to say what will happen to demand for ‘documentaries’. c) It is not possible to say what will happen to demand for ‘reality TV’, and demand for ‘documentaries’ will decrease. d) Supply of ‘reality TV’ will increase, and it is not possible to say what will happen to supply of ‘documentaries’. e) Demand and supply of ‘reality TV’ will increase, and it is not possible to say what will happen to demand and supply of ‘documentaries’. 4. There is a drought in regions in Australia where oranges are grown. At the same time, there is an increase in the number of mango growers. Finally, an increase in income of Australian consumers occurs. From the information provided, we would expect: a) An increase in demand for mangos and oranges. b) An increase in demand and supply of mangos. c) An increase in demand for mangos, and a decrease in supply of oranges. d) An increase in supply of mangos, and a decrease in supply of oranges. e) An increase in supply of mangos, and a decrease in demand for oranges. 5. Assume the market for CDs is perfectly competitive. There is an improvement in production processes for manufacturing CDs. At the price that was the equilibrium price prior to the improvement in production processes, following the improvement there will be: a) An excess supply of CDs. b) Excess demand for CDs. c) An increase in demand. d) A decrease in supply. e) Both a) and d).

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6. Consider the following perfectly competitive market for a good:

SQ = 2P

DQ = 100 – 2P Which of the following is correct? a) At P = 50 there will be excess demand for the good. b) Only at prices below P = 30 will there be excess demand for the good. c) The equilibrium quantity traded is 25. d) At prices above P = 25 there will be excess supply for the good. e) The equilibrium price is 50. 7. The price of the first-year microeconomics textbook, ‘Micro Made Easy’ by Al Marshall, has increased. Assume the market for first-year microeconomics textbooks is perfectly competitive. Which of the following could not explain the price increase? a) A new first-year microeconomics textbook ‘Micro Matters’ by the world-famous economist Adam Smith has been published. b) The price of other first-year microeconomics textbooks has increased. c) Enrolments in first-year microeconomics subjects have increased. d) The author of ‘Micro Made Easy’, Al Marshall, negotiates a new contract that requires the publisher to pays him a higher royalty per copy sold. e) There has been a decrease in supply of the type of paper used for ‘Micro Made Easy’. 8. In the world market for cocoa beans there have been two main recent phases: Phase 1: Pre-early 2001: Decrease price/Increase quantity traded; and Phase 2: Post-early 2001: Increase price/Decrease quantity traded. Assume the market for cocoa beans is perfectly competitive. Which of the following cannot be correct? a) Supply increased in both phases. b) Only supply changed in both phases. c) Only demand changed in both phases. d) In the first phase there was an increase in supply, and an increase in demand. e) Both a) and c).

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9. Motor vehicles and petrol can be considered to be complements. Crude oil is an input to petrol, and steel is an input to motor vehicles. Assume markets for petrol, motor vehicles, crude oil, and steel, are all perfectly competitive. Suppose that the price of motor vehicles decreases, and the price of petrol increases. Which of the following could explain these changes? a) There is a decrease in supply of crude oil. b) There is an decrease in supply of steel. c) There is an increase in demand for steel. d) There is a decrease in demand for crude oil. e) Either a) or c). 10. Beer is an inferior good, and wine is a normal good. Both goods are traded in perfectly competitive markets. There is a decrease in consumer income. We would expect the direct effect of the change in income to be: a) A decrease in the equilibrium price of beer, and an increase in the equilibrium price of wine. b) An increase in the equilibrium price of beer, and an increase in the equilibrium quantity traded of wine. c) No change in equilibrium price or quantity traded of either good since the decrease in income will have an equal effect on supply and demand of both goods. d) An increase in equilibrium price of beer, and a decrease in equilibrium quantity traded of wine. e) A decrease in demand for both beer and wine.

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Appendix 2

THE UNIVERSITY OF MELBOURNE

DEPARTMENT OF ECONOMICS SEMESTER 1 ASSESSMENT, 2010

316-102 INTRODUCTORY MICROECONOMICS

Time Allowed: TWO hours Reading Time: 15 minutes

This examination paper contributes 60% to the assessment in 316-102. The Response Sheet for the multiple-choice questions should be inserted in the back of the examination script book at the end of the examination. For the multiple-choice questions, you may use the examination script books to make notes or calculations. These notes will NOT be taken into account for your assessment. SECTION A: ANSWER ALL QUESTIONS This section is worth 25% of the total exam marks. Answer all questions. Fill in the small circle in the appropriate place with a 2B pencil on the Response Sheet. An incorrect answer, no answer, or more than one answer, will receive a zero mark. SECTION B: ANSWER ALL QUESTIONS This section is worth 25% of the total exam marks. Answer all questions. Each question is worth equal marks. SECTION C: ANSWER ALL QUESTIONS This section is worth 50% of the total exam marks. Answer all questions. Questions are worth different marks. Other Instructions Foreign/English language dictionaries are allowed into the examination room. No other materials are allowed. This exam paper may be removed from the examination room. A copy of this exam paper will be held in the Baillieu Library. This exam paper has 11 pages.

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SECTION A ANSWER ALL QUESTIONS IN THIS SECTION This section is worth 25% of the total exam marks. All questions in this section are worth the same number of marks. For each question select the one BEST answer. Incorrect answers, multiple answers, or no answer, will receive zero. Mark your answer on the Response Sheet. 1. OzAir has a 7.00am flight from Melbourne to Sydney. Capacity on the flight is 250 passengers. So far 200 tickets are sold. The cost of airport charges, fuel and wages for pilots is $40,000. None of these costs vary with the number of passengers carried. The cost for every extra passenger that Qantas now carries will be $50 for extra flight crew, $10 for food and $5 for cleaning. What is the minimum price at which Qantas should be willing to sell an extra ticket? a) $265 b) $65 c) $225 d) $200 2. You own an ice-cream stall at Sandy Beach. You can sell each ice-cream for $2. With extra opening hours for your stall you believe that you can increase your sales as shown in the table below. For each hour the stall is open the opportunity cost of your time is $15. For how many hours should you open your stall? Hours of opening

Total sales of ice-creams

0 0 1 20 2 35 3 45 4 50 5 50 a) 1 b) 2 c) 3 d) 4

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3. Wheat and barley are substitutes. Both goods are traded in perfectly competitive markets. Poor weather conditions reduce the size of the wheat crop. The effect on the markets for wheat and barley will be: a) An increase in the equilibrium price of wheat, and decrease in equilibrium quantity of barley traded. b) A decrease in equilibrium price of wheat, and an increase in equilibrium price of barley. c) An increase in equilibrium quantity of wheat traded, and an increase in equilibrium quantity of barley traded. d) An increase in equilibrium price of wheat, and an increase in equilibrium quantity of barley traded. 4. The market for CDs is perfectly competitive, and it is known that demand for CDs is price-elastic. Two changes to the market occur: first, an increase in consumer income increases demand for CDs; and second, an increase in the cost of manufacturing CDs decreases supply. The ‘Confederation of CD Producers’ is concerned about the effect of these two changes on total revenue to suppliers. It should conclude that the effect will be: a) Positive provided that the increase in demand is sufficiently large, and the decrease in supply is sufficiently small. b) Negative because demand is price-elastic, and the increase in demand and decrease in supply must cause a price increase for CDs. c) Positive provided that the increase in demand is sufficiently small, and the decrease in supply is sufficiently large. d) Positive if the effect of the changes in demand and supply is to increase quantity traded, and negative if the effects of changes in demand and supply is to decrease quantity traded. 5. There are five potential suppliers of a car wash service. Sally, Simon, Sonia, Stewart and Sam are each willing to provide 1 car wash. Their respective opportunity costs are: $1, $3, $5, $7, and $9. There are five potential consumers of the car wash service. Cate, Colin, Chloe, Chris and Cassie are each willing to purchase 1 car wash. Their respective willingness to pay are: $16, $13, $10, $7 and $4. In a competitive equilibrium the consumer surplus and producer surplus will be: a) The same amount. b) Less than total surplus due to deadweight loss. c) $18 and $12 respectively. d) $12 and $18 respectively.

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6. Consider the information below on costs: Quantity FC MC 1 100 5 2 100 6 3 100 7 4 100 8 5 100 9 Which of the following is not correct for quantities shown in the table? a) The firm will be willing to supply at any price above 5 in the short-run. b) AVC is increasing. c) ATC decreases and then increases. d) AFC is decreasing. 7. Stanley’s Sandwich Take-away has two possible methods of production it can use. The costs for the two production methods are shown below: Production

method 1 Production

method 2

Sandwiches made per hour

FC MC FC MC

1 50 2 10 5 2 50 4 10 10 3 50 6 10 15 4 50 8 10 20 5 50 10 10 25 6 50 12 10 30 In the long-run, when Stanley is able to choose between the production methods, which method should be choose? a) Stanley should always use production method 1. b) Stanley should always use production method 2. c) Stanley should use production method 1 if he expects the quantity sold will be less than or equal to 4 units, and otherwise use production method 2. d) Stanley should use production method 2 if he expects the quantity sold will be less than or equal to 4 units, and otherwise use production method 1.

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8. The market for take-away coffee in Australia is perfectly competitive with many identical suppliers. Initially the market is in long-run equilibrium. Then a decrease in demand for take-away coffee occurs. Which of the following is correct? a) In the short-run all firms will make positive economic profits. b) After the market adjusts to the change in demand, the new long-run equilibrium price must be lower. c) After the market adjusts to the change in demand, in the new long-run equilibrium each firm will make zero economic profits. d) In the new long-run equilibrium, after the market adjusts to the change in demand, there will be more suppliers in the market. 9. Consider the following information on demand for membership of the Melbourne University Sports Union by students and staff Price Qty demanded Students Staff $30 1 0 $25 2 1 $20 3 2 $15 4 3 $10 5 4 $5 6 5 $0 7 6 The FC of supplying Sports Union services is $50, and the MC of supplying a membership is $4. The long-run profit-maximizing prices for the Sports Union to charge for students and staff are: a) Both students and staff should be charged $25. b) The Sports Union cannot cover its total costs in the long-run and therefore should not operate. c) Students should be charged $20, and staff $15. d) Students should be charged $15, and staff $10. 10. What are the set of Nash equilibria of the game described in the matrix below? Bella’s Better

Grow

Low price Medium price High price Freida’s Fertiliser

Low price 2,6 3,8 2,10

Medium price 5,1 3,6 1,5 High price 8,4 6,3 0,2 a) {Low price; Low price}. b) {Medium price; Medium price} and {High price; High price}. c) {High price; Low price} and {Low price; High price}. d) {Medium price; Low price} and {Low price; High price}.

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SECTION B ANSWER ALL QUESTIONS IN THIS SECTION This section is worth 25% of the total exam marks. All questions in this section are worth the same number of marks. For each of the following questions: Consider the statements made by Alan Accountant and Edwina Economist. Say whether you believe each statement is correct or incorrect. Briefly explain your answer. Note that most of the marks will be given for your explanation. Question B1 Alan Accountant and Edwina Economist are discussing the decision by the Durr government in Ozland to increase the tariff on imports of t-shirts from $1 per t-shirt to $5 per t-shirt. T-shirts are traded in a perfectly competitive world market in which Ozland is a small country. The world price is $10. Alan says: ‘This is a big increase in the tariff per t-shirt, so there will be a big decrease in the well-being of society in Ozland.’ Edwina says: ‘I disagree. The effect of the higher tariff mainly depends on the price elasticity of supply of t-shirts from suppliers in Ozland, and on the price elasticity of demand for t-shirts by buyers in Ozland. We need to know this information to understand how much effect the higher tariff will have on well-being in Ozland.’ Question B2 The Durr government has made a law that makes Artslet Co. the monopoly supplier of telephone services in Ozland. Alan Accountant and Edwina Economist are discussing how government intervention may therefore be required to correct for market failure in the market for telephone services in Ozland. Alan says: ‘Because Artslet Co. is a monopolist, it will supply less than the efficient quantity of services. Hence the government could improve well-being of society in Ozland by paying Artslet Co. a subsidy that will induce it to increase its quantity supplied.’ Edwina replies: ‘I agree that a subsidy will increase the quantity of services provided, which will therefore improve society’s well-being. But this policy means most of the surplus from trade goes to Artslet Co. A better policy – which will mean that most of the surplus from trade will go to buyers – is to force Artslet Co. to set a price equal to the competitive equilibrium price.’

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Question B3 Alan Accountant and Edwina Economist are deciding whether to donate to a charity organisation that wants to build a new library in a remote area of Ozland. They also need to decide whether to make their decisions on donations simultaneously or sequentially. They know that only if they both donate can the library be built. For each of them, their payoff depends on whether the project is completed (zero if not completed, and 100 if completed); and whether they donate (zero if no donation, and -50 if donate). Hence the game table for the simultaneous version of the game is: Alan Not donate Donate Edwina Not donate 0,0 0,-50 Donate -50,0 50,50 Alan Accountant says: ‘It doesn’t matter what process we use for making donations. The outcome will always involve us both deciding to ‘Donate’.’ Edwina Economist says: ‘I disagree. If we make our decisions simultaneously a possible outcome is for us both to choose to ‘Not donate’. Whereas if we make our choices sequentially then, regardless of who makes the first and second choices, the outcome should involve us both choosing to ‘Donate’.’

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SECTION C ANSWER ALL QUESTIONS IN THIS SECTION This section is worth 50% of the total exam marks. Question C1 (20% of total marks) Part A (10 marks) “In the dry south-western part of California’s Central Valley, almond-growers are resorting to desperate measures. Some are trimming their trees so they can survive on less water… This [the market for water in California] is no free market. The state [government] sets the price, and since demand even at $500 per acre-foot greatly exceeds supply, water must be rationed… The trouble is there is not enough water to go round. Snow levels in the Sierra Nevada mountains [a major source of water to California] are below normal for the third year in a row… As farmers take land out of production, employment falls, and the price of some crops is likely to rise…” (‘Dust to dust’, The Economist, March 7 2009, p.70) (3 marks) (a) Use the demand/supply model to show how it could happen that ‘the state [government] sets the price’ and ‘demand…greatly exceeds supply’. (3 marks) (b) Compare the consequences for the well-being of society in California of: (i) Government setting the price of water; and (ii) Allowing the price of water to be the competitive equilibrium price where market demand and supply are equal. (2 marks) (c) In the situation where the state [government] sets the price of water, use the demand/supply model to show how a decrease in water from snow in the Nevada mountains would affect the market outcome. (2 marks) (d) Use the demand/supply model to show how ‘…as farmers take land out of production…the price of some crops is likely to rise’. Part B (10 marks) ‘The vaccination program Dr Galvani studied was for influenza in America, a country where people are offered flu jabs once a year to protect them from the most severe form of the disease likely to be in circulation that winter. Dr Galvani asked almost 600 university employees about their attitudes towards flu jabs for themselves and their families. Her survey found that people aged 65 and over were more likely to be vaccinated than other adults…that makes perfect sense, as the elderly are at greatest risk of dying if they contract influenza. However, as the parents of any small child know, it is the young who bring pestilence into the home. Thereafter, adults spread coughs and sneezes into their workplaces. Vaccinating the young would reduce the spread of flu, thus saving lives. The researchers therefore asked whether any children living in the household had been vaccinated and found that immunisation rates for the young were lower than for adults. Again, that makes perfect sense, since children rarely die of seasonal influenza.’ ‘Pricking consciences’, The Economist, March 17 2007, page 86.

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(3 marks) (a) Explain why there is likely to be an external effect associated with the decision an individual member of society makes about whether to have a flu vaccination. (5 marks) (b) What do you think the article is suggesting about the relative size of private marginal benefits to vaccination for older people compared to children? What is the article suggesting about the relative size of the social marginal benefits to vaccination for older people compared to children? What do you think this will imply about the difference between the efficient level of vaccination and actual level of vaccination for (i) older people; and (ii) children? (2 marks) (c) Suggest a policy solution that would assist in ensuring that the socially optimal proportion of the population has flu vaccinations. Question C2 (15% of total marks) Part A (5 marks) ‘There is nothing the computer industry likes better than a new idea…’Cloud computing’ is the latest example…The idea is that computing will increasingly be delivered as a service, over the internet, from vast warehouses of shared machines… There are benefits to companies [from cloud computing]. By switching to cloud-based email, accounting, and customer tracking systems, firms can reduce complexity and maintenance costs…Providers of cloud services, meanwhile, can benefit from economies of scale. Why should every company or university set up its own mail server, when Google or Microsoft can do it more efficiently?’ ‘Battle of the clouds’, The Economist, October 17 2009, p.11 (3 marks) (a) Describe two reasons why the excerpt from the article suggests that firms may lower their computing costs by using ‘cloud computing’. (2 marks) (b) Suggest two potential disadvantages for a firm of using ‘cloud computing’ as a way of obtaining computer services it needs.

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Part B (10 marks) The economic consultant ‘Never Wrong Ltd.’ seeks your advice on what would be a profit-maximizing strategy for their clients. These clients are firms that operate in perfectly competitive markets. Marginal cost of both firms increases with the quantity of output they supply. ATC for both firms is U-shaped with the quantity of output. MC intersects ATC at the minimum point of ATC. Further information regarding the firms’ costs and revenues, at current levels of output, is as follows: Firm 1 Firm 2 Price 10 10 MR 10 10 MC 15 5 ATC 5 10 Would your advice for each firm be to: (i) Increase output; (ii) Decrease output; (iii) Shut down operations in the long-run; or (iv) Seek new cost and price data due to measurement error in the original data? Question C3 (15% of total marks) Part A (9 marks) Two players are involved in a game. In the game each player begins with $10. Each player must simultaneously make a choice of how much of the $10 to allocate between two accounts: a ‘private’ account, and a ‘public’ account. Money allocated to the private account by a player is kept by that player. Money allocated to the public account is multiplied by 1.5, and then distributed back equally to each of the two players. Each player has three possible choices: (i) Allocate $0 to the public account; (ii) Allocate $5 to the public account; and (iii) Allocate $10 to the public account. (5 marks) (a) Draw a game table to represent this game. (1 mark) (b) Do players have a strict dominant strategy in this game? (2 marks) (c) What is the Nash equilibrium of the game? (1 mark) (d) Does the Nash equilibrium outcome maximise the total payoff to players? How can you explain this result?

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Part B (6 marks) Ned Kelly is robbing a bank. The manager of the bank must decide whether to ‘Give’ or ‘Not give’ money to Ned. Ned observes the bank manager’s choice, and if the bank manager chooses to ‘Not give’ the money, Ned must then decide whether to ‘Blow up’ or ‘Not blow up’ the bank. (Ned does not need to make this decision if the bank manager chooses to ‘Give’ the money.) (2 marks) (a) Draw a game tree for this game (excluding payoffs). (4 marks) (b) Make up payoffs for the bank manager and Ned which: (i) Make it a rollback equilibrium for the bank manager to choose to ‘Not give’ the money and for Ned to ‘Not blow up’ the bank; and (ii) Make it a rollback equilibrium for the bank manager to choose to ‘Give’ the money and for Ned to choose to ‘Blow up’ the bank. End of Examination