Professor: | Susan Athey, E52-252C, x3-6407, Office hours: Wed. 2:30-4 and by appt. |

TA: | Scott Ashworth. Office Hours: e52-303, Wed. and Thurs. 2:30-3:30. |

Assistant | Kelley Donovan, Cubicle in E52-251/252. |

**Where? When?**

- Lecture: MW1-2:30, E51-151
- Recitation: F1-2:30, E51-151
- Exam: Friday, October 29, in section.
- The class is full, and no new students will be admitted.

**Lecture Notes**

- Axiomatic development of utility functions
- Axiomatic development of expected utility
- Applying expected utility theory
- Introduction to Revealed Preference
- Consumer Theory Handout
- Consumer Theory: Summing Up
- Applied Consumer Theory

**Syllabus**

**Course Overview**

This course is designed to provide an introduction to microeconomic theory for students planning to pursue a PhD in economics. The main topics which will be covered are the theory of the consumer and the theory of the firm, as well as the basics of market equilibrium.

**Prerequisites and Enrollment**

The course will be taught assuming that students have taken an intermediate microeconomics course at the undergraduate level. Further, students should have a working knowledge of multivariate calculus and linear algebra, as well as some exposure to real analysis. These prerequisites are essential for success in this course. Students whose backgrounds are weak in some areas should plan to devote extra time, particularly in the first two weeks, to review the

mathematical prerequisites.

Enrollment in this course is limited, and permission is required for students outside of the economics department. Permission can be obtained by attending the first class meeting and providing information about previous coursework in mathematics and economics. Please be advised that students outside the economics department may be better served

by a variety of other alternative undergraduate or Sloan school classes. Students outside of the economics department have historically had difficulty with this class.

**Course Requirements**

There will be approximately six problem sets, which will be graded on a “check, check-,and no credit” scale. You may work in groups, but please do the “write-ups” individually. Thus, we do not expect to see identical answers to problems from different students. The problem sets will count at the margin towards your grade. There will be a final exam to be given, most likely on Friday, October 29; details to be settled in class. Economics Department students who do not pass

the exam will be required to retake the exam at a later date.

**Reading List**

**Reading List**

Note: The assignments will be updated throughout the term to reflect our pace and any schedule changes. I am including a rough outline to give you an idea where we are going!

**Week 1 (9/8): **Read mathematical appendix of M-W-G or Varian, the following topics: matrix notation for derivatives, homogeneous functions, concave and quasi-concave functions, implicit function theorem, continuous functions, maximization (constrained and unconstrained), envelope theorem.

Also read: Handout on existence of utility functions.

**Week 2 (9/13, 9/15): **Read about existence of utility functions under certainty and uncertainty. Kreps has very chatty and inviting discussions of both of these topics, and if your math background is weak or you like concrete examples, these chapters are excellent. I like using them to prepare lectures too. The only thing to watch out for: he uses slightly different axioms than I do. Studying the differences makes a great exercise! Varian is very concise on the axiomatic developments, and probably doesn’t add much beyond what we do in class, but gives clear treatment of applications. (These are good to study for potential exam questions). MWG gets all of the epsilons right, so if you felt concerned about the verbal arguments in class, this is the place to go. But, as usual, it may be tough going for those without as much math background.

Also: keep working through the mathematical background material if yours is weak, perhaps going to Chiang or another more comprehensive source for more detail.

**Week 3 (9/20, 9/22): **Classical consumer theory. This is treated in all books and you probably know your favorite by now. I especially recommend Kreps as hitting the level at which I expect you to understand the material, and for providing intuition. If you have not seen calculus-based intermediate microeconomics before, you definitely need to do some background reading. Nicholson’s intermediate microeconomics textbook is a good choice. You should also review the mathematical appendices about constrained optimization theory and the envelope theorem.

Handout on consumer theory.

**Week 4 (9/27, 9/29): **Consumer theory, expenditure functions and applications to consumer’s surplus and price indices.

Keep reading in your favorite text. Nicholson has nice background (again). Diamond and McFadden have an excellent article (on the reading list and on reserve in the library) on uses of the expenditure function in public finance that you may wish to read if you are interest in labor or public finance. One of the problems on the problem set helps you work through some of the ideas from that paper.

**Week 5 (10/4, 10/6): **Finish price indices, market demand. Comparative statics and producer theory.

Handout on producer theory and monotone comparative statics.

**Week 6 (10/13): **Producer theory comparative statics.

**Week 7 (10/18, 10/20): **Producer Theory and the LeChatlier principle. Competition and markets.

**Week 8 (10/25): **Monopoly and imperfect competition.

**Reading assignments (updated weekly)**

##### Choosing a Text

For your primary text, you may choose between Kreps, MasCollel-Whinston-Green (M-W-G), and Varian. I would recommend purchasing two of the three, which should serve you through the core micro sequence and after. Kreps is the most intuitive, M-W-G the most comprehensive and mathematically detailed, and Varian is the most concise. Students vary as to which approach works for them; you may find you like different books for different topics. Nicholson is an intermediate undergraduate text, which I use for 14.03; if your economics background is weak, you may find Nicholson easier going for getting the main ideas without as much mathematical detail. However, the level of detail in Nicholson will not be sufficient for this course. Lecture notes will serve as a guide as to which topics are required and which are not; not all topics will be covered in the texts.

Primary Texts: Choose between…

Kreps, D., A Course in Microeconomic Theory, (Princeton: Princeton University Press, 1990).

MasCollel, A., M. Whinston, and J. Green, Microeconomic Theory (New York: Oxford University Press, 1995).

Varian, H., Microeconomic Analysis (3rd edition) (New York: Norton, 1992).

Supplemental Text (at an undergraduate level):

Nicholson, W. Microeconomic Theory: Basic Principles and Extensions, Sixth ed. (New York: Dryden Press, 1995).

Additional Readings

The main references for this course are the texts. Below is a list of topics with some additional readings. The additional articles are intended as a references for the curious, and most of the articles listed below will not be discussed in class. There is no reading packet.

##### Course Outline with Readings

##### 1. Introduction, Overview, and Tools

##### 1.1. Overview of the Course

##### 1.2. Introduction to Microeconomic Models

##### 1.3. Mathematical Tools: Optimization, Lagrangians, and the Envelope Theorem

Varian, Chapters 26 and 27. Concise and comprehensive reference.

M-W-G, Mathematical Appendix. Provides more detail than other sources (and more than is required for this six week course).

Kreps Appendix 1. Intuitive explanation of optimization with multiple constraints.

Nicholson Chapters 1 and 2. Good elementary introduction; includes most important topics.

##### 2. Choice Theory, Preferences, and Utility Functions

Varian Chapter 7, 11.

M-W-G Chapters 1, 6.

Kreps Chapters 2 and 3.

Nicholson Chapters 3 and 9.

Kreps, D., 1988, Notes on the Theory of Choice, Underground classics in economics, Boulder, CO: Westview.

##### 2.1 Rationality Axioms, Utility, and Indifference Curves

Liebenstein, H., “Bandwagon, Snob, and Veblen Effects in the Theory of Consumers’ Demand,” Quarterly Journal of Economics 64 (May 1970): 183-207.

Simon, H., “Theories of Economic Decision-Making in Economics and Behavioral Science,” American Economic Review, XLIV, 3, June 1959.

Simon, H., “Rationality as Process and Product of Thought,” American Economic Review, Papers and Proceedings, (May 1978), p. 1-14.

Stigler, George, “Development of Utility Theory,” Journal of Political Economy 59, pts 1-2 (August-October 1950), pp. 307-327, 373-396.

Tversky, A. and D. Kahneman, “The Forming of Decisions and the Psychology of Choice,” Science 21 (30), January 1981, pp. 453-58.

##### 2.2 Von-Neumann Morgenstern Expected Utility

Machina, M. “‘Expected Utility’ Analysis Without the Independence Axiom,” Econometrica March 1982.

Pollak, R., “Additive von Neumann-Morgenstern Utility Functions,” Econometrica, July-October 1967.

2.2.1 Risks, Measuring Risk Aversion and Certainty Equivalents

McCloskey, Don, “The Open Fields of England: Rent, Risk, and the Rate of Interest, 1300-1815,” in D. Galenson, ed., Markets in History: Economic Studies of the Past (Cambridge University Press, 1989).

##### 2.2.2. Insurance

Arrow, Ken, “Uncertainty and the Welfare Economics of Health Care,” American Economic Review 53 (1963): 941- 973.

##### 3. Choice and the Theory of Demand

Varian, Chapters 7-10.

M-W-G Chapters 1-4.

Kreps Chapters 2.

Nicholson Chapters 3-7.

Deaton, A. and J. Muellbauer, Economics and Consumer Behavior, Cambridge University Press, 1980.

Houthakker, H., “The Present State of Consumer Theory,” Econometrica, October 1961.

Houthakker, H., “Additive Preferences,” Econometrica, April 1960.

Samuelson, P., Foundations of Economic Analysis, Cambridge, Harvard University Press, 1947, Chapter 5.

##### 3.1. Budget Constraints and Utility Maximization

Bloackorby C. et al, “Homothetic Separability and Consumer Budgeting,” Econometrica 38 (3), May 1970, pp. 468-72.

##### 3.2. Individual Demand

##### 3.3. Duality, Indirect Utility, and Expenditure Functions

Dwyer, G.P. and C.M. Lindsey, “Robert Giffen and the Irish Potato,” American Economic Review (March 1984): 188-192.

##### 3.4. Revealed Preference

Koo, A.Y.C. and Georg Haverkamp, “Structure of Revealed Preference: Some Preliminary Evidence,” Journal of Political Economy, July/August 1972, 724-744.

##### 3.5. Taxes and Transfers

Congressional Budget Office, Federal Tax of Tobacco, Alcoholic Beverages, and Motor Fuels, August 1990.

Diamond, Peter and Dan McFadden, “Some Uses of the Expenditure Function in Public Finance,” Journal of Public Economics, 3 (1974): 3-21.

Hausman, Jerry, “Labor Supply,” in Henry Aaron and Joseph A. Pechman, How Taxes Affect Economic Behavior (Washington, DC: Brookings Institution, 1981), p. 54.

##### 3.6. Price Indices

Berndt, Ernst R., Griliches, Zvi, and Rosett, Joshua G., “Auditing the Producer Price Index: Micro Evidence from Prescription Pharamceutical Preparations,” Journal of Business and Economic Statistics, July 1993, 11 (3), 251-64.

Blackorby, C. and P.R. Russell, “Indices and Subindices of the Cost of Living,” International Economic Review 19 (1), February 1978.

Boskin, Michael, et al, “Toward a More Accurate Measure of the Cost of Living,” Interim Report to the Senate Finance Committee from the Advisory Commission to Studythe Consumer Price Index, September 15, 1995.

Braithwait, S.D., “The Substitution Bias of the Laspeyres Price Index: An Analysis Using Estimated Cost of Living Indices,” American Economic Review (March 1980): 70-.

Fisher, F. and K. Shell, Economic Theory of Price Indices, New York: Academic Press, 1972, Essay I.

Lau, L.J., “On Exact Index Numbers,” Review of Economicsand Statistics 61 (1) February 1979, pp. 73-82.

##### 3.7. Market Demand and Elasticities

##### 4. Production and Supply

Nicholson Chapters 11-14.

Varian Chapters 1-6.

M-W-G Chapter 6.

Kreps Chapters 7, 19-20.

##### 4.1. Production Functions and Technology

Machlup, F., “On the Meaning of Marginal Product.” Reprinted in American Economic Association, Reading in the Theory of Income Distribution. Philadelphia: Blakiston Co., 1951. Pp. 158-174.

Zimmerman, Martin B., “Learning Effects and the Commericialization of New Energy Technologies: The Case of Nuclear Power,” Bell Journal of Economics 13 (2), 1982, 297-310.

##### 4.2. Production Costs and Cost Minimization; Duality

McFadden, D., “Cost, Revenue, and Profit Functions,” in M. Fuss and D. McFadden (eds.) Production Economics: A Dual Approach to Theory and Applications.

McFadden, D., and P. Diamond, “Some Uses of the Expenditure Function in Public Finance,” Journal of Public Economics 3 (1974) 3-21.

##### 4.3. Profit Maximization, Short and Long Run Supply

##### 4.4 Comparative Statics in the Theory of the Firm

Athey, Susan, Paul Milgrom, and John Roberts, Monotone Methods for Comparative Statics Analyses, Unpublished research monograph.

##### 4.5. Alternative Models of the Firm

Milgrom, Paul, and John Roberts, “The Economics of Modern Manufacturing: Strategy, Structure, and Organizational Change,” American Economic Review 1990.

Milgrom, Paul, and John Roberts, Economics, Organizations, and Management. Prentice Hall: 1992, Chapter 1.

Stigler, G., “The Division of Labor is Limited by the Extent of the Market.” Journal of Political Economy 59 (June 1951): 185-193.

##### 5. Prices and Markets

Varian Chapters 13-14.

M-W-G Chapters 10, 12.

Kreps Chapters 8-9.

Nicholson Chapters 15-21.

##### 5.1. Partial Equilibrium Price Determination

##### 5.2. Long-Run Equilibrium

##### 5.3. Applied Competitive Analysis

##### 5.4. Imperfect Competition and Market Power

Bishop, R., “The Effects of Specific and ad Valorem Taxes,” Quarterly Journal of Economics, May 1968.

Borenstein, Severin, “The Evolution of U.S. Airline Competition,” Journal of Economic Perspectives (Spring 1992): 45-74.

Fisher, Frank, “Diagnosing Monopoly,” Chp. 1 of Industrial Organization and the Law, Hemel Hempstead: Harverster Wheatsheaf and Cambridge: MIT Press, 1990.

**Problem Sets and Solutions**

- Week 1: No problem set due. Study assigned math and any readings or problems from “Math for Economists” course.
- Week 2: Problem set 1, due Thursday, September 23.
- Week 3: Problem set 2, due Friday, October 1. If you would like to hand in the problems NOT on the handout on Monday, October 4, you may do so.
- Week 4: Problem set 3, due Friday, October 8.
- Week 5: Problem set 4, due Monday, October 18.
- Week 6: Problem set 5, not graded.

**Old Exams**

- Fall 1996 Waiver Exam
- Fall 1996 Final Exam
- Fall 1998 Waiver Exam
- Fall 1998 Final Exam
- Fall 1999 Waiver Exam

**Other Handouts**