Economics 681 Microeconomic Theory Reading list and Course Outline

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1 Economics 681 Microeconomic Theory Reading list and Course Outline Richard Kihlstrom Fall, 2008 Required Texts (available at the Book Store) Varian, H. R. Microeconomic Analysis, Third Edition. New York: Norton, Mas-Colell, A., M. Whinston and J. Green, Microeconomic Theory, New York: Oxford, 1995 An Intermediate Level Text Suggested for Review and Background (available at the Book Store) Pindyck, R. S., and Rubinfeld, D. L., Microeconomics, 6th ed. New York: Macmillan, The Bulk Pack (available at Wharton Duplicating which is located in the basement of Steinberg Hall-Dietrich Hall) The bulk pack contains the math notes and articles which are listed below as required reading and marked by a }. The bulk pack also contains lecture notes, problem sets and answers and old exams. Lecture Notes (In the bulk pack and also to be distributed in class from time to time) 1

2 Students registered in the class will be billed for notes distributed in class by the University. Other Intermediate Level Texts that Can Also Be Used for Review and Background Reading Varian, H. R., Intermediate Microeconomics: A Modern Approach, 3rd ed. New York: W. W. Norton, Hirshleifer, J., Price Theory and Applications, Englewood Clis, NJ: Prentice- Hall. Manseld, E., Microeconomics: Theory and Applications, 8th ed. New York: Norton, Other Useful Texts Malinvaud, E., Lectures on Microeconomic Theory, New York: North-Holland, Henderson, J. M., and R.E. Quandt, Microeconomic Theory: A Mathematical Approach, 3rd ed. New York: McGraw-Hill, Silberberg, E., The Structure of Economics: A Mathematical Analysis, 2nd ed., New York: McGraw-Hill, Kreps, D. M., A Course in Microeconomic Theory, Princeton, NJ: Princeton University Press, Katzner, D., Static Demand Theory, New York: Macmillan, Arrow, K. and F. Hahn, General Competitive Analysis, San Francisco: Holden-Day, Koopmans, T., Three Essays on the State of Economic Science, Kelley. (A reprint of a 1957 McGraw-Hill publication.) Three Classics: Hicks, J. R., Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory, Oxford, Clarendon Press,

3 Samuelson, P. A., Foundations of Economic Analysis, Cambridge, MA: Harvard University Press, Debreu, G., Theory of Value, New York: Wiley, Problem Sets Problem sets and answer sheets are in the bulk pack. In addition there may be some additional problem sets handed out from time to time. These will neither be handed in nor graded. The questions you will be asked to answer in these problem sets will be very similar to the kinds of questions you will be asked on the exams. Required Reading marked with a } are required (meaning that when I write the exam questions I will assume that you have read these). The math notes, journal articles and segments of nonrequired books marked with a } are available in the course "Bulk Pack." Exams There will be one mid-term and a nal. There will be a review for the midterm on Wednesday October 24 and the midterm will be scheduled for a time outside of class on Thursday or Friday following that day. A review for the nal will be scheduled. The nal will be held during the scheduled nal time. The nal will be cumulative but will emphasize heavily the last part of the course. The midterm will be worth 100 points and the nal will be worth 150 points. 1. INTRODUCTION AND BRIEF REVIEW (9/3) Comparative statics methodology and its relationship to the theories of the rm and consumer { Intermediate consumer theory as an example of how comparative statics methodology is applied the logical structure of the analysis 3

4 : the kinds of mathematics required { Fisher's "consumption-savings model"as another illustration of comparative statics methodology Pindyck and Rubinfeld, Chapters 3 and THE THEORY OF THE FIRM The Output Decision of a Competitive Firm (9/8 and 9/10) { A comparative static problem with one choice variable Using rst and second order conditions, concavity and the implicit function theorem Corner solutions in which the rm chooses not to produce { The rm's prot function: maximum prots as a function of output price A rst encounter with the envelope theorem Convexity { The multiplant rm A problem with two decision variables Decentralization }Math Notes 1 and Notes on the Implicit Function Theorem }Varian, Chapter 27, Section }Mas-Colell, et. al., Appendices M.C, M.E, M.J and M.L. Pindyck and Rubinfeld, Chapter 8 The Output Decision of a Monopolist (9/15) { Monopoly and competition compared { Regulation and monopoly 4

5 { Discriminating monopoly An example of comparative statics with two decision variables Using rst and second order conditions, concavity and the implicit function theorem Corner solutions in which the rm chooses not to supply one market { Two-part taris }Math Notes II and Notes on the Implicit Function Theorem }Varian, Chapters 14 and 27, Section }Mas-Colell, et. al., Appendices M.C, M.E, M.J and M.L. Pindyck and Rubinfeld, Chapters 10 and 11. Oligopoly (9/17 and 9/22) { Cournot oligopoly { Oligopoly and competition compared { Stackelberg equilibrium { Collusion The prisoner's dilemma A rst encounter with an externality { Mergers }Varian, Chapter 16, Sections 16.1 and }Pindyck and Rubinfeld, Chapter 12, Sections 12.2, 12.3, 12.5 and Production Technologies and Production Functions (9/24 and 9/29) { Production sets and their properties 5

6 { Production functions Examples Returns to Scale and concavity Diminishing MRTS and strict quasi-concavity Leontie technologies and their relationship to constant returns to scale production functions The elasticity of substitution and CES productions functions }Mas-Colell, et. al., Chapter 5, Sections 5.A and 5.B. Also Appendix M.M. }Varian, Chapter 1 }Dorfman, R., "Mathematical or 'Linear' Programming: A Non-Mathematical Exposition," American Economic Review (1953) Mas-Colell, et. al., Chapter 5, Appendix A. }Arrow, K. J., H. B. Chenery, B. S. Minhas and R. M. Solow, "Capital-Labor Substitution and Economic Eciency," Review of Economics and Statistics, 43 (1961) }Allen, R. G. D., Macroeconomic Theory: A Mathematical Treatment, New York: St. Martins Press, 1968, The Firm's Cost Function (10/1 and 10/6) { The rm's cost minimization problem as a constrained minimization problem using rst and second order conditions and quasi-concavity corner solutions in which some inputs are not used { Properties of cost functions Shepard's lemma and the envelope theorem Concavity in input prices 6

7 Interpreting the Lagrange multiplier as marginal cost Marginal cost and returns to scale The eect of an increase in input price on the demand for inputs: a comparative static exercise Long run and short run cost functions and the envelope theorem }Varian, Chapters 4, 5, 6 and 27 Sections 27.3, 27.4, 27.5 and }Mas-Colell, et. al., Chapter 5, Section 5.D and Appendices M.C, M.E, M.K and M.L. }Notes on the Constrained Maximization and Notes on the Implicit Function Theorem Fall Break (10/13) The Prot Maximizing Competitive Firm's Supply and Input Demand (10/8, 10/15 and 10/17) { Prot maximization and cost minimization { The rst and second order conditions, concavity, quasi-concavity and returns to scale { The rm's prot function: maximum prots as a function of input and output prices Convexity Shepard's lemma and the envelope theorem A proof that input demand functions slope down: comparative statics again { Producer's surplus { Properties of competitive supply and input demand required in General Equilibrium Theory { A "revealed preference" proof that input demand functions slope down 7

8 }Varian, Chapters 2 and 3. }Notes on Constrained Maximization and Notes on the Implicit Function Theorem }Mas-Colell, et. al., Chapter 5, Sections 5.C, 5.E, 5.F, 5.G and Appendices M.C, M.E, M.K and M.L. Mid-Term Review (10/22) Mid-Term Exam (10/23 or 10/24) Empirical Studies of Production and Cost References Varian, Chapter 12. Walters, A. A., An Introduction to Econometrics, New York: Norton, 1970, Chapter 10, See also the references on Walters, A. A., "Production and Cost Functions: An Econometric Survey," Econometrica, 31 (1963) Nerlove, M., Estimation and Identication of Cobb-Douglas Production Functions, Chicago: Rand McNally, Arrow, Chenery, Minhas and Solow, "Capital-Labor Substitution and Economic Eciency," Review of Economics and Statistics, 43 (1961) Jorgensen, D., "Econometric Methods for Modeling Production Behavior," Chapter 31 in Z. Griliches and M. Intrilligator, Editors, Handbook of Econometrics, Volume 3, New York: North Holland-Elsevier, 1986, (see also the list of references) Fuss, M., and D. McFadden, Editors, Production Economics, 2 Volumes, Amsterdam: North Holland, See especially: Fuss, M., D. McFadden an Y. Mundlak, "A Survey of Functional Forms in the Economic Analysis of Production," in Fuss and McFadden, Editors, Production Economics, Volume 1,

9 3. CONSUMER THEORY AND THE THEORY OF DEMAND (10/27, 10/29 and 11/3) Preference orderings The general model based on utility maximization The utility maximization problem as a constrained maximization problem { Deriving Marshallian demand functions { The indirect utility function: maximum utility as a function of prices and income { Interpreting the Lagrange multiplier as the marginal utility of income { The expenditure function Duality The analogy with the cost function Roy's identity and the envelope theorem Concavity in prices { Income compensated (Hicksian) demand and income and substitution eects The Slutsky equation Properties of Hicksian demand { Consumer's Surplus and Compensating Variation { Income and substitution eects and the elasticity of substitution Revealed preference Properties of consumer demand required in General Equilibrium Theory Aggregation: anything can happen }Varian, Chapters 7, 8, 9 and 10. }Notes on the Constrained Maximization and Notes on the Implicit Function Theorem 9

10 }Mas-Colell, et. al., Chapters 1, 2, 3, 4 and Appendices M.C, M.E, M.K and M.L. }Willig, R., "Consumer's Surplus Without Apology," American Economic Review, 66 (1976) Diamond, P. A., and D. L. McFadden, "Some Uses of the Expenditure Function in Public Finance," Journal of Public Economics, 3 (1974) Mishan, E. J., Cost Benet Analysis, Third Edition (Boston: G. Allen and Unwin, 1982). Samuelson, Chapter 7, Harberger, A. C., "Taxation Resource Allocation and Welfare," in The Role of Direct and Indirect Taxes in the Federal Revenue System (report of a Brookings-NBER Conference), Princeton: Princeton University Press, 1974, Special Functional Forms and Empirical Work in Consumer Theory References Varian, Chapter 12. Houthakker, H. S., "The Present State of Consumption Theory," Econometrica, 29 (1961) Houthakker, H. S., "Additive Preferences," Econometrica, 28 (1960) Walters, A. A., An Introduction to Econometrics, Chapter 9, New York: Norton, 1970, Christensen, L. R., D. W. Jorgenson and L. J. Lau, "Transcendental Logarithmic Utility Functions," American Economic Review, 65 (1975) Pollak, R. A., and T. J. Wales, "Estimation of Complete Demand Systems from Household Budget Data: The Linear and Quadratic Expenditure Systems," American Economic Review, 68 (1978)

11 Pollak, R. A., and T. J. Wales, "Comparison of the Quadratic Expenditure System and Translog Demand Systems with Alternative Specications of Demographic Eects," Econometrica, 48 (1980) }Deaton, A., and J. Muellbauer, Economics and Consumer Behavior, New York: Cambridge University Press, 1980, Chapter 3. Deaton, A., "Demand Analysis," Chapter 30 in Z. Griliches and M. Intrilligator, Editors, Handbook of Econometrics, Volume 3, New York: North Holland-Elsevier, 1986, (see also the list of references) 4. APPLICATIONS, EXTENSIONS AND REINTERPRETA- TIONS OF CONSUMER THEORY (11/5) The multiperiod Fisher model and dynamic programming { The roles of the envelope theorem and the indirect utility function { The Bellman equation The labor-leisure choice model Becker's time allocation model Household production }Hirshleifer, J., "On the Theory of Optimal Investment Decision," Journal of Political Economy, 66 (1958) }Fama, E. F., and M. H. Miller, The Theory of Finance, Chapter 1, Hinsdale, IL: Dryden Press, }Mas-Colell, et. al., Appendix M.N. }Becker, G. S., "A Theory of the Allocation of Time," Economic Journal, 75 (1965) Muth, R. F., "Household Production and Consumer Demand Functions," Econometrica, 34 (1966) Lancaster, K. J., "A New Approach to Consumer Theory," Journal of Political Economy, 74 (1966)

12 Pollak, R. A. and M. L. Wachter, "The Relevance of the Household Production Function and Its Implications for the Allocation of Time," Journal of Political Economy, 83 (1975) DECISION MAKING IN THE FACE OF UNCERTAINTY (11/10 and 11/12) Maximizing expected utility of von Neumann-Morgenstern utility Choosing a portfolio of assets Risk aversion Measures of risk aversion }Varian, Chapter 11. }Mas-Colell, et. al., Chapter 6, Sections 6.A, 6.B, and 6.C. }Pratt, J. W., "Risk Aversion in the Small and in the Large," Econometrica 32 (1964) }Arrow, K. J., Essays in the Theory of Risk Bearing, Chapters 1 and 3 Chicago: Markham, GENERAL COMPETITIVE EQUILIBRIUM AND THE WEL- FARE THEOREMS (11/17, 11/19, 11/24, and 11/26) Competitive (Walrasian) equilibrium dened { An Edgeworth box example { One producer-one consumer case { The two period Fisher interpretation: determining the interest rate { 2-input, 2-output, 2-consumer case: graphical interpretation derived from the calculus equilibrium conditions Pareto Optimality of an allocation dened and the rst welfare theorem illustrated 12

13 { The Edgeworth box Example again { One producer-one consumer case: the two period Fisher interpretation { A constrained maximization problem solved by a Pareto Optimal allocation: The rst and second order conditions { 2-input, 2-output, 2-consumer case: graphical interpretation derived from the calculus rst order conditions The rst welfare theorem proved in general The second welfare theorem The existence of competitive equilibrium }Mas-Colell, et. al., Chapters 15, 16 and 17, Sections 17.A, 17.B, 17.C, 17.E, 17.F, 17.I and Appendices A and B. Also Appendices M.F, M.G, M.H and M.I. }Varian, Chapters 17, 18, 19 and 21 Sections 21.2 and }Bator, F. "The Simple Analytics of Welfare Maximization," American Economic Review, 47 (1957) GENERAL COMPETITIVE EQUILIBRIUM AND UNCER- TAINTY (12/1, 12/3) Arrow-Debreu Contingent Claims The two state case and the Edgeworth Box Arrow's demonstration that repeated trading can replicate contingent claims markets Hart's model of repeated trading and the ineciency of equilibrium }Mas-Colell, et. al., Chapter 19, Sections 19.A, 19.B, 19.C, 19.E, and19.f. Mas-Colell, et. al., Chapter 19, Sections 19.G and 19.H. 13

14 }Arrow, K., "The Role of Securities in the Optimal Allocation of Risk Bearing," Review of Economic Studies, 31 (1964) }Hart, O., "On the Optimality of Equilibrium when the Market Structure is Incomplete," Journal of Economic Theory, 11 (1975)