CH 1 micro 1. ders normative positive.ppt

1. Microeconomics lecture 1
Lecturer: Assoc Prof Akalpler Ergin

2. 2
1. Microeconomic Modeling
• Elements of models
• Solving the models
2. The Limits of Microeconomic Analysis

3. All microeconomic models rely on three analytical tools:
 Constrained optimisation
 Equilibrium analysis
 Comparative statics
3

4. EXOGENOUS ENDOGENOUS VARIABLES
Any model, whether it is used to study chemistry,
physics, or economics, must specify what
variables will be taken as given in the analysis
and what variables are
to be determined by the model
exogenous variable
A variable whose value is taken as given in the
analysis
of an economic system.
endogenous variable
A variable whose value is determined within the
economic system being studied.
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5. Constrained optimisation problems usually have two
parts:
Objective function
A set of constrains
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6. CONSTRAINED OPTIMISATION
EXAMPLE Suppose a farmer plans to build a rectangular fence as a pen for
his sheep. He has F feet of fence and cannot afford to purchase more.
However, he can choose the dimensions of the pen, which will have a
length of L feet and a width of W feet. He wants to choose the
dimensions L and W that will maximize the area of the pen. He must also
make sure that the total amount of fencing he uses (the perimeter of the
pen) does not exceed F feet.
Problem
(a) What is the objective function for this problem?
(b) What is the constraint?
(c) Which of the variables in this model (L, W, and F )
are exogenous? Which are endogenous? Explain.
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7. SOLUTION
(a) The objective function is the relationship that the farmer is
trying to maximize—in this case, the area LW.
In other words, the farmer will choose L and W to maximize
the objective function LW.
(b) The constraint will describe the restriction imposed on the
farmer. We are told that the farmer has only F feet of fence
available for the rectangular pen. The
constraint will describe the restriction that the perimeter of the
pen 2L+ 2W must not exceed the amount of fence
available, F.
Therefore, the constraint can be written as
2L+ 2W < F.
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8. (c) The farmer is given only F feet of fence to work
with.
Thus, the perimeter F is an exogenous variable, since
it
is taken as given in the analysis. The endogenous
variables are L and W, since their values can be
chosen by
the farmer (determined within the model).
SUMMARY
what max : LW
endogenous : (L,W )
Exogenous : (F) 8

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Definition: The Objective Function specifies what the
agent cares about and wants to optimize
Examples:
• A consumer cares about maximizing his satisfaction
• The manager cares about:
• Raising profits
• Reducing costs
• Increasing “power”

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Definition: Limits placed on the resources available to the
agent
Examples:
• The manager’s budget is €1M
• The consumer’s income is €3000

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The behavior of an agent can be modeled as
optimizing the objective function, subject to his
various constraints.

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Example: Consumer purchases
• The consumer
• Chooses Food (F) and Clothing (C)
• Take as given his Income (I), the Price of food (PF)
and the Price of clothing (PC)
• Satisfaction from purchases: S = (FC)1/2
• Objective function:
Max S = (FC)1/2 subject to: PFF + PCC < I
(F,C)

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Example: Consumer Purchases
PFF + PCC = I
F
C
0

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Example: Consumer Purchases
(FC)1/2 = S1
PFF + PCC = I
F
C
0

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Example: Consumer Purchases
(FC)1/2 = S1
(FC)1/2 = S0
PFF + PCC = I
F
C
0

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Example: Consumer Purchases
(FC)1/2 = S1
(FC)1/2 = S2
PFF + PCC = I
F
C
0
S2 > S1 > S0
(FC)1/2 = S0

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Another Example: Advertising Spots
Suppose the manager of a beer company wants to decide the
firm’s advertising spots.
Budget = €1m to allocate between TV ( T ) and radio ( R )
Problem: Max B(T,R)
(T,R)
subject to: pTT + pRR < €1m
where: B is "barrels“ and pT, pR are the prices of TV and radio
advertising, respectively.

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Total Spent New Beer Sales Generated
TV Radio
$ 0 0 0
$100,000 4,750 950
$200,000 9,000 1,800
$300,000 12,750 2,550
$400,000 16,000 3,200
$500,000 18,750 3,750
$600,000 21,000 4,200
$700,000 22,750 4,550
$800,000 24,000 4,800
$900,000 24,750 4,950
$1,000,000 25,000 5,000

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Definition: Equilibrium is a state that will
continue indefinitely as long as the
exogenous factors remain unchanged.

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Example: The Market for Coffee Beans
Price per pound
Quantity, pounds
Supply (P,W)
Q*

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Example: The Market for Coffee Beans
Price per pound
Quantity, pounds
Supply (P,W)
Demand (P,I)
•
Q*

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Example: The Market for Coffee Beans
Price per pound
Quantity, pounds
Supply (P,W)
Demand (P,I)
•
Q*
P*

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Definition: In this example, Equilibrium is defined as the
point where demand equals supply in this
market
(i.e., the point where the demand and supply
curves cross)

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Definition: A comparative statics analysis compares
the equilibrium state of a system
before a change in the exogenous variables
to the equilibrium state after the change.
comparative statics
Analysis used to examine how a change in some
exogenous variable will affect the level of some
endogenous variable in an economic system.

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Price per pound
Quantity, pounds
Supply (P,W)
Demand (P,I)
•
Example: Coffee Beans, revisited

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Example: Coffee Beans, revisited
Price per pound
Quantity, pounds
Supply (P,W)
Demand (P,I)
•
New Supply (P,W)
•

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Price per pound
Quantity, pounds
Supply (P,W)
Demand (P,I)
•
Q*
P*
New Supply (P,W)
•
Q**
P**
Example: Coffee Beans, revisited

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Example: Consumer choice, revisited
PFF + PCC = I0
F
C
0

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(FC)1/2 = S0
PFF + PCC = I0
F
C
0
•
C** C*
Example: Consumer choice, revisited

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(FC)1/2 = S0
PFF + PCC = I0
F
C
0
•
•
PFF + PCC = I1
Example: Consumer choice, revisited

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(FC)1/2 = S0
(FC)1/2 = S1
PFF + PCC = I0
F
C
0
•
•
PFF + PCC = I1
Example: Consumer choice, revisited

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(FC)1/2 = S0
(FC)1/2 = S1
PFF + PCC = I0
F
C
0
S0 > S1
•
•
C** C*
F*
F**
PFF + PCC = I1
I0 > I1
Example: Consumer choice, revisited

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Definition: Positive Analysis
• Can explain what has happened due to an
economic policy, or
• Can predict what might happen due to an
economic policy.
Definition: Normative analysis is an analysis of
what should be done

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positive analysis
Analysis that attempts to explain how an economic system works or to
predict how it will change over time.
Positive economics is a stream of economics that focuses on the
description, quantification, and explanation of economic developments,
expectations, and associated phenomena.
normative analysis
Analysis that typically focuses on issues of social welfare, examining what
will enhance or detract from the common good
Normative economics focuses on the ideological, opinion-oriented,
prescriptive, value judgments, and "what should be" statements aimed
toward economic development, investment projects, and scenarios

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Positive statements (and positive reasoning more generally)
are objective. As such, they can be tested. These fall into two
categories. One is a hypothesis, like “unemployment is caused
by a decrease in GDP.”
A normative statement is one that makes a value judgment.
Such a judgment is the opinion of the speaker; no one can
“prove” that the statement is or is not correct. Here are some
examples of normative statements in economics:
•We ought to do more to help the poor.
•People in the United States should save more for retirement.
•Corporate profits are too high.

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Positive statements deal with assumptions about the state of the world
and some conclusions.
• The validity of a positive statement is verifiable or testable in principle,
no matter how difficult it might be.
Example 1: The weight of the earth is 6 septillion (6 × 1024) metric tons.
Example: An increase in the minimum wage increases unemployment
among teenagers.
Normative statements contain a value judgment.
They contain words such as " have to," "ought to," "must," "should" or
nonquantifiable adjectives such as "important," that cannot be objectively
measured. Accordingly, normative statements cannot be verified by
scientific methods.
Example: At present, unemployment is a more serious problem than
inflation.
The tax rate on the top earners (more than 1 million euros) should be 75%

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Examples:
• “Should we increase income equality rather than focus
on economic efficiency?”
• “Should we impose a progressive income tax or a sales
tax to increase income equality?”
• “Will a progressive income tax reduce aggregate hours
worked?”

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Thank you