Microeconomic Analysis - VUuosis.mif.vu.lt/~celov/dest/Mikro/Lecture 1 Intro.pdf · Slide 2/23-Dmitrij CELOV-Microeconomic Analysis - Lecture 1. ... Silberberg E., Suen W. (2001)

V I L N I U S U N I V E R S I T Y F A C U L T Y O F M A T H E M A T I C S A N D I N F O R M A T I C S

DEPARTMENT OF ECONOMETRIC ANALYSIS

Microeconomic AnalysisMicroeconomics as the social science

Dmitrij CELOV

September 5, 2017· Lecture 1


Expectations• Your priors to this course?

• Mathematical skills: mathematical analysis, algebra, operationresearch; mathematical economics

• Read/recall essential material in Mas-Colell et al. MathematicalAppendix or in Varian Chapters 26 Mathematics and 27 Optimizationor Useful Maths from the course companion page

• Intermediate (Introductory) course in Microeconomics• Recall key microeconomic concepts and the principles of Economic

Thinking – ask if some of them are still unclear• You may follow recommended readings at the companion page for

bachelor level Microeconomics

• Current course emphasis is on methods and tools, their application(do you really need these methods and tools?)

• Experiences of microeconomic data analysis?Micro-econometric research?

• With what data types you dealt with?• What issues/problems did you have to address?• What methods were used to solve them?

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Administrative Matters

• Lecturer: Dmitrij Celov

• Contact: [email protected], [email protected]

• Companion page: http://mif.vu.lt/∼celovCheck it approximately once per week or two

• Office hours: II 15:00-18:00, by appointment via e-mail.Questions by e-mail, to be discussed during office hours,practicals or immediately after class

• Lectures: II 15:00-18:00, room 105.



Readings and Problems• Required readings:

[V] Varian H.R. (1992) Microeconomic Analysis[MWG] Mas-Colell A., Winston D.W. and Green J.R. (2004)

Microeconomic Theory[K] Kreps D.M. (1990) A course in microeconomic theory

[LN] These Lecture Notes

• Additional readings:[S] Silberberg E., Suen W. (2001) The Structure of Economics: a

mathematical analysis[R] Rasimavicius J. (2008) Makro-ekonometrinis modeliavimas (In

Lith.)• Frank R.H. (2008) Microeconomics and Behaviour• Any advanced level lecture notes (for instance Luke Stein’s)

• Problems are selected after chapter problems (70% of the examcontent)



Assessment• The general assessment framework. 10-point grade system.

The final grade is passed iff a final exam is passed – a studentmust score more than 4 points

• The final grade is a weighted average of all activities:10% Seminar presentation – microeconomics application, experiment,

case study10% Homework presentation during recitation hours40% Mid-term exam (test and problems)40% Final exam (test and problems)• Exam IS NOT a memory test. It is important to understand the

concepts and their application issues, that are tested. And beable to solve the problems.

• Nota bene: re-takes are organized for the final exam only!• Additional points may be collected for participation at

experiments, workshops, organization of debates, presentations,original solutions to the homework assignments.

P.S. Try to score additional points, they may happen to be crucialSlide 5/23 - Dmitrij CELOV - Microeconomic Analysis - Lecture 1


How to score 10 points in MIKEA?• Do many problems (more than it is suggested for homeworks)• Pose correct questions, dig dipper into the concepts – the devil is

in details• Attend lectures – discussions outside the book and lecture notes• Read/browse the content of recommended readings before

lectures and a several days after (at least [V])• Make your own lecture notes – the most elegant get extra points• Go to bed by 11pm (including me), get up at 7am – sleep at least

8 hours per day• Do not memorize the material• Do not copy the solutions to the problem sets• ... and do not just give your solutions to the group-mates• A better option is to explain the solution loudly step-by-step• ... do it to your friends, little brother, dog, Teddy Bear• Avoid solution of the "typical" problem in the mechanical way –

do economics, not just mathematicsSlide 6/23 - Dmitrij CELOV - Microeconomic Analysis - Lecture 1


At the completion of the course



Why study Microeconomic Analysis?• General tools for all economics, including empirical economics

• Microeconomics theory itself is just a bunch of facts

• ... but tools make it alive:• organize your thinking, make it economic• dig dipper into theory’s assertions (general) and assumptions

(particular), understand the outcomes (conclusions)• predict the changes and drive conclusions followed from the theory• test it on the empirical grounds (econometrics enters here)• general – applicable to similar decision making problems in other

fields of studies• useful to build (micro)economic models• provide (with concepts) microeconomic foundations of

macroeconomic theory

• Be a professional researcher, not just get acquainted with thestatistical/mathematical part of the story



Why economic way of thinking is so special?Starting exampleHow to provide an economic explanation to• the increase in the rate of participation of women in competitive

labor market• especially in engineering, law, medicine• increasing prominence of the "two-earner" family• increase in age of first marriage, baby, etc.

• What do you expect to hear?• What the phrase "economic explanation" means? What one

means by the term "explanation"?• Is it different from sociological or political explanation?• A list of facts (empirical observations) IS NOT an explanation• Facts are just the data points, but there is no story in just

observing them• The data could be interesting but it does not speak for itself



Let facts speak for themselvesWhy active labor force is emigrating from Lithuania?• Lithuania has joined EU labor market• Lithuanian salaries are almost five times lower when the EU

average• Lithuanian labor force is relatively highly skilled and educated• 2008 global recession resulted in 10% inflation• The government introduced higher taxes with reductions in

social programs• New construction orders dropped by 50%• Lithuanian basketball team lost the first match in Eurobasket

2013• "Samsono" sausages price in 2011 increased by 30%• ...

• What facts help to explain the issue? What are irrelevant? Why?• Do we have to vote to decide on the true migration reasons?



Explain like an economist

• Explanation – there exists a more general proposition than theobserved data (a special case), a conclusion from the theory

• General laws and rules drive the facts (events), interpretation ofthem in the framework of systematic human behavior

• General – want to apply the framework to other set of facts

• Standard definition of economics – a social science that studyhuman behavior as the interaction between ends under scarce(restricted) resources – content

• . . . but it is not the conceptual framework – methodology

N.B. Content and methodology ARE interrelated



Interdependence of content and tools

• Methodology is the positive common feature of all economists,but the economists may and do disagree on the content ofeconomics

• The content evolves: from classical political economy (trade,wealth, specialization gains, growth of the productive capacity) –A.Smith, D.Ricardo, K.Marx – through marginal analysis (Walras,Marshall, Pareto) to institutionalism and social choice theories

• the set of tools grows: old remain, new are developed

Ex. Individual choice, preferences, production costs, etc.

• Elegant mathematical solution to the decision problems

• Weak points – too restrictive assumptions

⇒ The growth in tools aims to weaken restrictive assumptions, thatis in line with the evolution of the content



Marginalist paradigm• Economics (neoclassical view) is an empirical science• Positive economics studies the facts as they are (true or false),

while normative – ought to be, subjective judgement• Two economists may disagree in the (subjective) view on social

transfers to young mothers could still come to the sameconclusions regarding the effects of these decisions

• Positive economics – refutable facts – empirically testable• Social science – the study of human behavior – theory of

(individual) choice – homo economicus vs. homo reciprocans• Physical objects (atoms, molecular structures) do not choose,

they adopt the laws of nature – homo sociologicus• Decision, choices, trade-offs – the consequences of scarcity of

goods and services (even fresh air is a scarce resource, time,energy, stomach size)

• Scarcity is not observable, depends on individual preferencesand individual preferences assumptions (more to less, no freelunch, etc.)



Choice under neoclassical paradigm• Individual choice for the most of problems (neoclassical view) is

determined by the interaction of two things1 Tastes, or preferences – like scarcity, unobservable2 Opportunities, or constraints – like choices, observable

• Constraints:• on the demand (and exchange) side – money in the pocket, prices

of goods and services, system of laws and property rights• on the supply side – technology, law of diminishing returns, the

production possibility frontier limits the total consumption

• Even if we have complete info on all constraints – unmeasured,unobserved data is still present→ tastes, or preferences

• Hypothetical exchange process (what bundle to select)• Each individual has its own preferences – heterogeneity• Conclusion: assertions, or postulates about unobservables

(tastes), and this alone makes economics more an art thansimply a social science



How to proceed• Additional assumption – ceteris paribus – assume that

unobservables remain constant (or do not change significantly)• Certain decisions (choices) are made with tastes remaining

constant when one faces different observables – constraints, oropportunities

• Choices observable and they change to the changes inconstraints or opportunities

Definition 1.1. Neoclassical content of economicsEconomics is the discipline within social science that seeks refutableexplanation in human events on the basis of changes in observableconstraints, utilizing universal postulates of behavior and technology,and the simplifying assumption of unmeasured variables ("tastes")remain constant

• 1.1 does not asserted that tastes are irrelevant or constant ∀ time• Marginal change, short-run (even static) impacts• Theory that allows sudden changes in tastes explains everything



Discussion of the starting example

• WWII "baby boom" effect

• more or less equally divided in sex

• Women traditionally prefer to marry men slightly older

• When the baby boomers reached young adulthood – differentconstraint, less (about 20%) potential husbands of the preferredage

• The old scheme (arithmetically) is ruined – career alternativebecame relatively more attractive than wait for a husband choice

• Increase in labor force supply lowed the wage rate – two-earnerfamilies became more common

• After the baby boomers wave drops down – return to the oldscheme with traditional marriage patterns (tastes remainedconstant assumption)



Theories and refutable propositions• Closer look at concepts: theory, proposition, confirm• Recall that facts do not speak for themselves• Without set of axioms, propositions and other elements of theory

describing the nature of the phenomenon there is no way to sortthe relevant facts from the irrelevant ones

• A theory, in an empirical science, is a set of explanations(predictions) about the objects in the real world, and consists ofthree parts:

1 A set of assertions, or postulates A = {A1, . . . ,An} abouttheoretical constructs (objects)

• "All x have property P" – "firms maximize profits", "consumersmaximize utility"

• Firm, consumer, profit, utility are constructs2 Assumptions, or test conditions C = {C1, . . . ,Cn} – link assertions

(general) to real world observations (concrete)• Assumptions must be realistic and observable• Careful treatment – gasoline price example

3 Events E = {E1, . . . ,En} that are predicted by the theoryA→ (C → E)



Refutable propositions• Karl Raimund Popper – Austro-British philosopher, professor at

London School of Economics, pioneered in• criticism of the classical observationalist/inductivist form of

scientific method in favor of empirical falsification(refutability)• opposition to the classical justificationist account of knowledge

which he replaced with critical rationalism• Theories are abstract in nature• How to test them? Which are useful?• Falsification, refutability ; the statement of the theory is false• ... it states the principle possibility for the statement to be false

Firm’s Aloyzas&Ko 2016 profits were 1 mln. EUR• What could we conclude about it’s behavior?

• Is it profits maximizing? Or may be output maximizing?

• Or may be it is costs minimizing?

• ... not optimizing behavior at all?



What theories are useful• We observed the event, and even could add the context –

assumptions• However A→ (C → E) is not the same as (C → E)→ A• The theories ARE NOT provable on the empirical grounds• Useful theories are the ones that could be refuted, but are not

refuted yetEx. Statement Economy after tax reduction will grow if does not fall is

not refutable

• Refutability points out the inconsistencies in the analysed theoryand is the source for the evolution of the economics content

• The refuted theory is not abandoned, but is rather modified andimproved

• The Newtonian mechanics is still useful in everyday life,predicting outcomes, constructing mechanism, even if Einstein’srelativism is more suitable on empirical grounds



Theories versus models

• Theory is a formal abstract description of the process, reality,that could be applied to real situations exampled by the set ofassumptions

• Model is logically complete and purified theoretical object• is based on the theory’s assertions and concepts• . . . , becomes the useful theory if the data (assumptions) is

supplemented• could not be tested without the second bullet-point

• There are two ways to conclude that theory is inconsistent:1 The model is logically inconsistent2 The theory is refuted on empirical grounds

• One way to test the theories is to apply the method ofcomparative statics (C.S.)



Comparative statics• Logical, qualitative simulation• Compares two pictures that describes the same content under

different, but related set of assumptions• Static means transition dynamics is not important• Qualitative – the direction of change, not the quantity• What is changeable:

1 Endogenous (decision) variables x2 Parameters and exogenous variables α

• Test conditions – decision rule f : C → E

x = f (α)

• almost never directly observable relationship• Do it in marginal terms

dxdα

= f ′(α)

• the sign of change is actually important• C.S. is the first general tool to test refutable hypothesis



Conclusions• We will study general tools of microeconomic analysis –

conceptual framework to provide economic explanation to theobserved human behavior

• Marginalism paradigm, positive economics are the way toempirically test the refutable theoretical hypothesis

• A theory is a set of assertions (general), test conditions(particular set of assumptions), and events – the observedoutcome, consequences that follows from the theory

• Different theories might produce the same outcomes under thesame set of assumptions

• Refutability is the principal opportunity to find the empirical testconditions that could contradict the general assertions

• Useful theories are refutable• Comparative statics is the qualitative general tool to test

refutable hypothesis



Key concepts

• economic explanation

• conceptual framework

• marginalism paradigm

• positive economics

• normative economics

• choice theory

• scarcity

• tastes, or preferences

• constraints, or opportunities

• theory

• assertion

• assumption

• event

• refutable proposition

• hypothesis

• model

• comparative statics


Documents

Microeconomic Analysis - VUuosis.mif.vu.lt/~celov/dest/Mikro/Lecture 1 Intro.pdf · Slide 2/23-Dmitrij CELOV-Microeconomic Analysis - Lecture 1. ... Silberberg E., Suen W. (2001)