Neil Bjorksten

Fall, 1993

Department of Economics

CENTRAL EUROPEAN UNIVERSITY

**Scope of Course**

This course provides the basic theoretical tools that are used in economic analysis. It is designed to quickly bring technically very well prepared non-economists up to speed with the theoretical foundations of microeconomics as they are taught at the graduate level in the United States.

**Course Description**

1. Introduction to the subject. We begin by analyzing scarcity and choices, introducing the basic concepts of production possibilities and opportunity cost.

2. Consumer preference and demand. We discuss axioms of consumer preference and develop the concept of utility functions, graphing them with indifference curves. We show how individual demand curves are derived, and introduce income and substitution effects.

3. Consumption Efficiency. We discuss general equilibrium, the Edgeworth box and show how competitive equilibrium in pure trade is derived. We prove both fundamental welfare theorems for consumption.

4. Market demand and elasticity. Returning to partial equilibrium analysis, we develop a market demand and go over own price elasticity of demand in some detail. Cross price and income elasticities of demand are also introduced.

5. Production costs and supply. We develop the concept of production functions, graphing them with isoquants. We spend some time going over the differences between consumption and production theory; ordinality vs. cardinality, long run and short run analysis, etc. We derive short run production functions and cost functions, long run cost functions and introduce returns to scale. We introduce perfectly competitive markets, derive the supply curve of an individual firm and of the market.

6. Production efficiency. Returning to general equilibrium analysis, we introduce the production Edgeworth box and formally derive the production possibilities frontier.

7. General equilibrium in a competitive economy. Putting consumption efficiency and production efficiency together, we show the welfare theorems in full generality and derive a Pareto frontier.

8. Economics of voting. While competitive equilibrium gives us a point on the Pareto frontier which is consumption, production and allocative efficient, society may prefer a different allocation. We introduce Arrow's work on peaked preferences and the paradox of voting. We formally show that different voting procedures and mechanisms can lead to different outcomes.

9. Monopoly and monopolistic competition. The market failure introduced by monopoly is presented in both partial and general equilibrium analysis. Chamberlinian monopolistic competition is also presented in the standard intermediate textbook way, together with recent theoretical work on the subject by Dixit and Krugman.

10. Oligopoly. Basic game theoretic concepts of cooperative and non-cooperative equilibria are introduced. Shared monopoly theory with cartels are covered, as is the kinked demand theory. Cournot and Bertrand competition and Stackelberg equilibria are formally presented.

11. The Principal-Agent Problem with first and second best solutions is formally presented, based on work by Holmstrom.

12. Externalities and the Coase theorem. We present these market failures in both consumption and production, and formally show how to solve for Pigouvian taxes. We also present Coase's work on defining property rights and thus creating markets that previously were missing.

13. Theory of the Second Best. We formally demonstrate Lipsey's and Lancaster's result showing that in the presence of multiple constraints preventing a first-best solution, removal of only one constraint may decrease welfare.

**Texts:
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The midterm exam will count for 30% of the grade.

The (cumulative) final exam will count for 50% of the grade.

Collected homework problems will count for 20% of the grade.

CEU Budapest, Hungary

Modified: May, 1996

Bjo_MicroeTh.W93Econ.v3

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