The Power of Markets

Scope of Microeconomic Theory

The Nature and Role of Theory
Positive Versus Normative Analysis
Real Versus Nominal Prices

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 1

CPI for 2013

for 1983 (base year)

= 224
= 100

General price level between 1983 and 2013

rose by:
(224 100)/100 = 124 percent

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 2

Medical Care for 2013

= 425

In real terms, between 1983 and 2013, the

price of medical care rose by:
(425 224)/224 = 90 percent

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 3

The Power of Markets

Basic Assumptions About Market Participants
Goal-Oriented Behavior
Rational Behavior
Scarce Resources

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 4

The Power of Markets

Opportunity Cost
-- Implicit versus explicit costs
-- Accounting versus economic costs
Example:

Should one pursue an MBA and, if so,

when?

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 5

Explicit
Benefits
(1)

Explicit
Costs
(2)

Explicit/
Accounting Profits
(1) (2)

Pursue MBA
Now

2,000,000

1,000,000

$1,000,000

Pursue MBA
in 5 Years

2,000,000

1,200,000

800,000

1,000,000

800,000

200,000

900,000

800,000

100,000

You
Keep Working,
Never Pursue
MBA
Travel, Then Work,
No MBA

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 6

The Power of Markets

Sunk Costs
-- Example: Why was it profitable to demolish the
profitable Hong Kong Hilton?

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 7

The Power of Markets

Production Possibility Frontier (PPF)
-- How it depicts basic assumptions
-- How it shows opportunity costs
-- The typical, increasing-cost case

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 8

Figure 1.1 - A Production Possibility Frontier (PPF)

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 9

Figure1.2 - The Typical-Case PPF: Concave to the Origin

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 10

The Power of Markets

Demand and Supply Curves

The Demand Curve
The Law of Demand
Determinants of Demand Other Than Price
-- Income (normal versus inferior goods)
-- Prices of related goods (substitutes/complements)
-- Tastes/preferences
-- Government taxes/subsidies

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 11

Figure 2.1 -The Demand Curve

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 12

Figure 2.2 - An Increase in Demand

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 13

The Power of Markets

Shifts in Versus Movements Along a Demand Curve

The Supply Curve
The Law of Supply
Determinants of Supply Other Than Price
-- Technology
-- Input prices
-- Government taxes/subsidies

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 14

Figure 2.3 - Supply Curve

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 15

Figure 2.4 - An Increase in Supply

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 16

The Power of Markets

Shifts In Versus Movements Along a Supply Curve
Determination of Market Equilibrium
-- Why equilibrium price (P*) will be where Qs = Qd
-- Surplus if P > P*
-- Shortage if P < P*

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 17

Figure 2.5 - Determination of Equilibrium Price and Quantity

Mark Zupan, Olin Professor of Economics & Public Policy and Dean
Simon School of Business, University of Rochester

Page 18