COURSE

DESCRIPTION

▪ Course Code: INE2101

▪ Degree: Undergraduate
▪ Language teaching: English
▪ Number of credits: 04
▪ Pre-requisite: Microeconomics

2
 COURSE
OBJECTIVES
▪ Identify and appreciate view on microeconomics isues by
microeconomics tools, such as supply and demand curves,
from fundamental concepts...
▪ Understand standard microeconomics problems and
correctly analyze them
▪ Understand how different kinds of market structures operate:
perfect competition, oligopoly and monopoly
▪ Understand and apply the theory of consumer and producer
to solve some exercises
▪ Set up adn solve economic problems analytically
▪ Analyze the effect of some market structures on consumer
behavior or producer behavior.

3
 COURSE
CONTENTS
▪ Topic 1. Consumer behavior
▪ Topic 2. Optimal choice
▪ Topic 3. Consumer choice
▪ Topic 4. Technology, cost and profit
▪ Topic 5. Pure competition
▪ Topic 6. Monopoly
▪ Topic 7. Oligopoly
▪ Topic 8. General equilibrium

4
LEARNING
MATERIALS
▪ Required textbooks
1. Varian, Hal R. Intermediate microeconomics
with calculus: a modern approach. WW
norton & company, 2014.
2. Perloff, Jeffrey M. "Microeconomics: Theory
and applications with calculus. Global
edition." (2018).
3. Mas-Colell, Andreu. Microeconomics
theory. New York: Oxford university press,
2008.

5
ASSESSMENT
AND GRADING
Content Grade

Attendance; homework 10%

assignments

Group presentation 10%

Midterm 20%

Final 60%

6
TOPIC 1: CONSUMER BEHAVIOR
 Consumption Choice Sets
A consumption choice set is the
collection of all consumption choices
available/feasible to the consumer.
What constrains consumption choice?
– Budgetary, time and other
resource limitations.
 Budget Constraints
A consumption bundle containing x1
units of commodity 1, x2 units of
commodity 2 and so on up to xn units
of commodity n is denoted by the
vector (x1, x2, … , xn)
Commodity prices are p1, p2, … , pn
 Budget Constraints
Q: When is a bundle (x1, … , xn)
affordable at prices p1, … , pn?
A: When
p1x1 + … + pnxn  m
where m is the consumer’s
(disposable) income.
 Budget Constraints
The bundles that are only just
affordable form the consumer’s
budget constraint. This is the set

{ (x1,…,xn) | x1  0, …, xn   and
p1x1 + … + pnxn = m }
 Budget Constraints
The consumer’s budget set is the set
of all affordable bundles;
B(p1, … , pn, m) =
{ (x1, … , xn) | x1  0, … , xn  0 and
p1x1 + … + pnxn  m }
The budget constraint is the upper
boundary of the budget set.
 Budget Constraint for n=2
x2

m /p2
Budget constraint is
p1x1 + p2x2 = m

x1
m /p1
 Budget Constraint for n=2
x2
Budget constraint is
m /p2 p1x1 + p2x2 = m.

Not affordable
Just affordable
More than affordable

x1
m /p1
 Budget Set for n=2
x2
Budget constraint is
m /p2 p1x1 + p2x2 = m

the collection of
all affordable bundles.
Budget
Set
x1
m /p1
 Slope of the Budget Constraint
x2
p1x1 + p2x2 = m is
m /p2
x2 = -(p1/p2)x1 + m/p2
so slope is -p1/p2

Budget
Set
x1
m /p1
 Budget Constraints for n=3
If n = 3 what do the budget constraint
and the budget set look like?
 Budget Constraint for n=3
x2
m /p2
p1x1 + p2x2 + p3x3 = m

x3
m /p3

m /p1
x1
 Budget Set for n=3
x2
{ (x1,x2,x3) | x1  0, x2  0, x3  0 and
m /p2 p1x1 + p2x2 + p3x3  m}

x3
m /p3

m /p1
x1
 Slope
For n = 2 and x1 on the horizontal
axis, the constraint’s slope is -p1/p2.
What does it mean?
p1 m
x2 = − x1 +
p2 p2
Increasing x1 by 1 must reduce x2 by
p1/p2.
Slope of the Budget Constraint
x2
Slope is -p1/p2

-p1/p2

+1

x1
 Budget Constraints
x2
Opportunity cost of an extra unit of
commodity 1 is p1/p2 units
foregone of commodity 2.
-p1/p2
+1

x1
 Budget Constraints
x2
Opportunity cost of an extra
unit of commodity 2 is
p2/p1 units foregone
+1 of commodity 1.

-p2/p1

x1
 Income and Price Changes
The budget constraint and budget
set depend upon prices and income.
What happens as they change?
Higher income gives more choice
x2
New affordable consumption
choices
Original and
new budget
constraints are
parallel (same
Original slope).
budget set
x1
 When income m decreases
x2
Consumption bundles
that are no longer
affordable.

Old and new

constraints
New, smaller are parallel.
budget set
x1
 Budget Constraints - Income
Changes
Increases in income m shift the
constraint outward in a parallel
manner, thereby enlarging the
budget set and improving choice.
Decreases in income m shift the
constraint inward in a parallel
manner, thereby shrinking the
budget set and reducing choice.
 Budget Constraints - Income
Changes
No original choice is lost and new
choices are added when income
increases, so higher income cannot
make a consumer worse off.
An income decrease may (typically
will) make the consumer worse off.
 Budget Constraints - Price
Changes
What happens if only one price
decreases?
Suppose p1 decreases.
How do the budget set and budget constraint change
as p1 decreases from p1’ to p1”?
x2
m/p2 New affordable choices

Budget constraint pivots;

slope flattens from -P1’/p2 to
-p1’/p2 -p1”/p2

Original -p1”/p2
budget set
x1
m/p1’ m/p1”
 Budget Constraints - Price
Changes
Reducing the price of one commodity
pivots the constraint outward. No old
choice is lost, and new choices are
added, so reducing one price cannot
make the consumer worse off.
 Budget Constraints - Price
Changes
Similarly, increasing one price pivots
the constraint inwards, reduces
choice and may (typically will) make
the consumer worse off.
Uniform Ad Valorem Sales Taxes
An ad valorem sales tax levied at a
rate of 5% increases all prices by 5%,
from p to 1.05p.
An ad valorem sales tax levied at a
rate of t increases all prices from p to
(1+t)p.
A uniform sales tax is applied
uniformly to all commodities.
Uniform Ad Valorem Sales Taxes
A uniform sales tax levied at rate t
changes the constraint from
p1x1 + p2x2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
i.e.
p1x1 + p2x2 = m/(1+t)
Uniform Ad Valorem Sales Taxes
x2

m p1x1 + p2x2 = m
p2
m p1x1 + p2x2 = m/(1+t)
(1 + t ) p2

m m
x1
( 1 + t ) p1 p1
Uniform Ad Valorem Sales Taxes
x2

m Equivalent income loss:

p2
m t
m m− = m
(1 + t ) p2 1+ t 1+ t

m m x1
( 1 + t ) p1 p1
Uniform Ad Valorem Sales Taxes
x2
A uniform ad valorem
m sales tax levied at rate t
p2 is equivalent to an income
tax levied at rate: t
m .
( 1 + t ) p2 1+ t

m m x1
( 1 + t ) p1 p1
 The Food Stamp Program
Food stamps are coupons that can be
legally exchanged only for food.
How does a commodity-specific gift,
such as a food stamp, alter a family’s
budget constraint?
 The Food Stamp Program
Suppose m = $100, pF = $1 and the
price of “other goods” (composite
good) is pG = $1.
The budget constraint is then:
F + G =100
 The Food Stamp Program
G

100
F + G = 100 (before stamps)

100 F
 The Food Stamp Program
G

F + G = 100 (before stamps.)

100
Budget set after 40 food
stamps issued.

F
40 100 140
 The Food Stamp Program
G

Budget set after 40 food

100 stamps issued.

The family’s budget

set is enlarged.

40 100 140 F
 Relative Prices
“Numeraire” means “unit of account”.
Suppose prices and income are
measured in dollars. Say p1=$2,
p2=$3, m = $12. Then the constraint
is
2x1 + 3x2 = 12
 Relative Prices
If prices and income are instead
measured in cents, then p1=200,
p2=300, m=1200, and the constraint is
200x1 + 300x2 = 1200,
the same as 2x1 + 3x2 = 12.
Changing the numeraire changes
neither the budget constraint nor the
budget set.
 Relative Prices
The constraint for p1=2, p2=3, m=12
2x1 + 3x2 = 12
is also 1x1 + (3/2)x2 = 6,
the constraint for p1=1, p2=3/2, m=6.
Setting p1=1 makes commodity 1 the
numeraire and defines all prices
relative to p1; e.g., 3/2 is the price of
commodity 2 relative to the price of
commodity 1.
 Relative Prices
Any commodity can be chosen as
the numeraire without changing the
budget set or the budget constraint.
 Relative Prices
If p1=2, p2=3 and p3=6, then:
price of commodity 2 relative to
commodity 1 is 3/2,
price of commodity 3 relative to
commodity 1 is 6/2=3.
Relative prices are the rates of
exchange of commodities 2 and 3 for
units of commodity 1.
Shapes of Budget Constraints
Q: What makes a budget constraint a
straight line?
A: A straight line has a constant
slope and the constraint is
p1x1 + … + pnxn = m
so if prices are constants then a
constraint is a straight line.
Shapes of Budget Constraints
But what if prices are not constants?
E.g. bulk buying discounts, or price
penalties for buying “too much”.
Then constraints will be curved.
Shapes of Budget Constraints -
Quantity Discounts
Suppose p2 is constant at $1 but that
p1=$2 for 0  x1  20 and p1=$1 for
x1>20.
 Quantity Discounts
Suppose p2 is constant at $1 but that
p1=$2 for 0  x1  20 and p1=$1 for
x1>20. Then the constraint’s slope is
- 2, for 0  x1  20
{
-p1/p2 =
- 1, for x1 > 20
 Quantity Discount
x2
100 m = $100
Slope = -2/1 = -2
(p1=2, p2=1)
60
Slope = -1/1 = -1
(p1=1, p2=1)

20 50 80 x1
 Shapes of Budget Constraints
with a Quantity Discount
x2
100

Budget Constraint

Budget Set
20 50 80 x1
Shapes of Budget Constraints
with a Quantity Penalty
x2

Budget
Constraint

Budget Set
x1
Shapes of Budget Constraints –
Negative Price
Commodity 1 is stinky garbage. You
are paid $2 per unit to accept it; i.e.
p1 = - $2. p2 = $1. Income, other than
from accepting commodity 1, is m =
$10.
Then the constraint is
-2x1 + x2 = 10 or x2 = 2x1 + 10.
Shapes of Budget Constraints -
One Price Negative
x2 x2 = 2x1 + 10

Budget constraint slope:

-p1/p2 = -(-2)/1 = +2

10
x1
Shapes of Budget Constraints -
One Price Negative
x2
Budget set is
all bundles for
which x1  0,
x2  0 and
x2  2x1 + 10.
10
x1
 More General Choice Sets
Choices are usually constrained by
more than a budget; e.g. time
constraints and other resources
constraints.
A bundle is available only if it meets
every constraint.
 Choice Set Constraint #1
Other Stuff

At least 10 units of food

must be eaten to survive

Food
10
 Choice Set Constraint #2
Other Stuff

Choice is also budget

constrained.

Budget Set
Food
10
 Choice Set Constraint #3
Other Stuff

Choice is further restricted by

a time constraint.

Food
10
 Choice Set Constraints
Combined
Other Stuff

Food
10
 Choice Set Constraints
Combined
Other Stuff

Food
10
 Exercise 1
You have an income of $40 to spend on two commodities. Commodity 1
costs $10 per unit, and commodity 2 costs $5 per unit.
(a) Write down your budget equation.
(b) If you spent all your income on commodity 1, how much could you
buy?
(c) If you spent all of your income on commodity 2, how much could you
buy?
(d) Suppose that the price of commodity 1 falls to $5 while everything
else stays the same. Write down your new budget equation.
(e) Suppose that the amount you are allowed to spend falls to $30, while
the prices of both commodities remain at $5. Write down your budget
equation.
(f) On your diagram, shade in the area representing commodity bundles
that you can afford with the budget in Part (e) but could not afford to
buy with the budget in Part (a). Shade in the area representing
commodity bundles that you could afford with the budget in Part (a)
but cannot afford with the budget in Part (e)

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 Exercise 2
Draw a budget line for each case
(a) p1 = 1, p2 = 1, m = 15.
(b) p1 = 1, p2 = 2, m = 20.
(c) p1 = 0, p2 = 1, m = 10.
(d) p1 = p2, m = 15p1. (Hint: How much of
good 1 could you afford if you spend
your entire budget on good 1?)

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