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. 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)
  2. Tradition (command and control rules get codified) (Firm buys from a certain supplier because they always have.)
  3. 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.

Chicago / Kansas City
January 11 / $1056 / $997 / $59
January 12 / $1071 / $1006 / $65 +$5
January 13 / $1069 / $998 / $71 +$11
January 14 / $1062 / $1004 / $58
January 15 / $1047 / $985 / $62 +$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 anti-shatter 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

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.