Abstract
This chapter starts with the introduction of two of the «protagonists» in the «drama» of economics, consumers, and firms. We elaborate on how they make their decisions and on how these individual decisions are coordinated in the marketplace. Sometimes, most of society is unhappy with the results of private decision making and market coordination; such an example is environmental destruction. We explain environmental problems to be a case of «market failure», the inability of the market system to attain socially satisfactory («optimal») results.
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Notes
- 1.
Describing and explaining constitute the positive, evaluating the normative part of microeconomics. See 7 Sect. 3.4, above.
- 2.
On abstraction, belletristic treatment: The text quoted above is taken from the novel «Beerholms Vorstellung» (Beerholm’s performance) by Daniel Kehlmann, first published at Paul Zsolnay, Vienna, 1997, translated by Annette vom Heede, University of Hagen.
- 3.
The wish to have a new car, and to travel abroad in the vacations are «needs» in the sense of 7 Sect. 2.1, above.
- 4.
These two resources are related to each other, even if the saying «time is money!» somewhat overstates the case.
- 5.
If there are several alternatives forgone, it is the best of these which counts as t he opportunity cost.
- 6.
Various allocation mechanisms have been briefly explained in 7 Sect. 3.5.1, above.
- 7.
An example of coordination by social tradition is the (admittedly somewhat old-fashioned) «ladies first» rule, coordinating the behaviour of two people of opposite gender who are about to pass through the same door. Even though it might be considered to be not completely politically correct, the rule has an impressive success rate in preventing people from bumping into each other.
- 8.
- 9.
Choosing the simplest way to make our point meets the requirement of efficiency , one of the most important concepts in economics, as explained in 7 Sect. 3.1, above: we choose the way in which we achieve our didactical goal such that it confines the time our readers must devote to this issue to its minimum level. You see: we treat your time budget as a scarce resource which has to be allocated efficiently. So the rule for prudent decision making that has been explained in the previous subsection also holds for decisions in the process of economic theory building, and of textbook writing.
- 10.
Not being able to buy a dollar’s worth of Y is the opportunity cost of buying a dollar’s worth of X.
- 11.
There are some basic requirements on the preferences of individual decision makers which somewhat attenuate the generality of the observation made above. However, we do not follow this line of thought here. See, e.g., Varian (2014), pp. 35–36. Moreover, not all individual goals are socially accepted. There are certain constraints on individual goals defined by the law, but also by ethical principles, as well as the customs of a particular society. Notably, microeconomic analysis can also be applied to illegal behaviour. See the groundbreaking (Becker 1968) work of Economics Nobel Prize Laureate Gary Becker (1930–2014) and, for a more recent exposition, 7 Chaps. 11 and 12 in Cooter and Ulen (2004).
- 12.
When we talk about «society», it must be mentioned that it consists of human beings only. Animals and all kinds of vegetation do not «count» as members of society in mainstream economics. This may be heartless but it is not as heartless as it sounds at first hearing. It does not mean that animals and vegetation are not respected and have no value from the point of view of economics. They are and they do have value, but only in so far as respect and value is attributed to them by human individuals. So animals and vegetation play a role in economics but it is a secondary role as granted by human beings in the context of an anthropocentric approach. (See 7 Sects. 3.4 and 3.5, above, on anthropocentrism and ecocentrism .)
- 13.
Additionally, a consumer might operate in money markets, borrowing and lending. However, we do not pay very much attention to this dimension of consumer decisions. In the context of environmental issues it is not as consequential as the activities of consumers in markets for physical resources. The present textbook is designed to present economics as it is most useful to environmental studies.
- 14.
The German philosopher Johann Friedrich Herbart (1776–1841) said: «Boredom is the biggest sin!». This is understandable from the point of view of microeconomics because a lifetime is definitely limited. Interestingly, the economic quest for efficiency , often sneered at to be a low «purely mercantile» issue, can be interpreted as a high moral obligation.
- 15.
Most of our readers know that education is a lot of fun, too – isn’t it? However, we do not deal with this aspect in the above brief exposition.
- 16.
If the wage rate gets «very high», this relationship might be turned upside down. The same holds true for «very low» wage rates. See, e.g., the section on the «backward-bending» labour supply curve in Varian (2014), pp. 174–178.
- 17.
If you inherit a huge fortune you probably won’t worry so much about putting in a lot of work to earn money.
- 18.
Since saving is assumed to be zero in most introductory microeconomic analyses, the terms «budget» and «income» are used as synonyms.
- 19.
There is a third kind of method, in addition to static and comparative static analysis. Here, microeconomics observes the trajectory along which the variable to be explained (e.g., the quantity demanded) changes in the process of moving from one equilibrium to another (or even to no other equilibrium at all). This kind of a method is called dynamic analysis. We do not pay very much attention to it in the microeconomic part of this book. However, dynamic analysis plays an important role in the macroeconomic part, particularly in 7 Sects. 9.2 and 10.1.
- 20.
There are some (well, obviously) extremely smart remarks on the division of labour between economics and other social sciences in the (Becker (1993)) article by Economics Nobel Prize Laureate Gary Becker.
- 21.
Indeed: not wanting to change behaviour given the circumstances is the «heart of the matter» in the microeconomic concept of equilibrium.
- 22.
To imagine different periods here is helpful to get the idea. However, strictly speaking, there is no time at all in the concept of static analysis. Acknowledging the passage of time in economic modelling belongs to the realm of dynamic analysis.
- 23.
The abscissa is the horizontal, the ordinate is the vertical axis.
- 24.
Please remember that the property of being monotonically decreasing is assured by the law of demand.
- 25.
Academic economists sometimes love to show off their high level of education. A well established trick to make an impression is to occasionally intersperse some Latin terminology. So instead of saying «all other determinants assumed to be unchanged», you might say « ceteris paribus ».
- 26.
A positive relationship between the quantity demanded at a predetermined price and income is plausible but might not hold for every good . Think of the market for used shoes. Goods for which demand goes down as income goes up are called inferior goods in economics.
- 27.
Our honourable readers are invited to graphically illustrate the comparative static analysis of demand for X as the price of Y increases. They might proceed analogously to what we have done in . Fig. 6.2 referring to an increase of income. They might also distinguish the case of substitutes from the case of complements.
- 28.
To see why, imagine that the demand curve is U-shaped instead of being monotonically downward sloping. After completing this exercise, you might immediately forget about u-shaped demand curves; they violate the law of demand!
- 29.
The initial demand curve (the one where p is the independent and x the dependent variable) is sometimes called the direct demand curve.
- 30.
In reality you might not be exactly sure what these revenues and these costs are going to be. In this introductory exposition, we ignore problems of uncertainty, to keep things simple.
- 31.
Also, the terms «production» and «supply» are used as synonyms. This is so, because we ignore that the firm may put part of its production into storage (or may throw it away). Everything produced is assumed to be brought to the market. Moreover, nothing brought to the market is taken out of storage.
- 32.
The average productivity of an input is the amount of output produced per unit of this input. If the level of output is denoted x and the level of labour is denoted N, then the labour productivity is x/N. A related concept is the marginal productivity of an input. It indicates by how much output increases as the quantity of this input used in the production process is increased by one (small) unit. Calculus Club mini session: marginal productivity of labour is ∂x/∂N.
- 33.
Calculus Club mini session: the marginal cost function is the first order derivative of the total cost function.
- 34.
Again, we ignore uncertainty.
- 35.
Within the context of the present section («the firm»), we have emphasized above that firms are price takers in a perfectly competitive market . For the sake of the completeness of the definition of a perfectly competitive market , let us add that consumers are also assumed to be price takers in this market structure.
- 36.
Closer inspection (from which we refrain here) reveals that this statement does not hold for other market structures than perfect competition . See, e.g., Varian (2014), pp. 439–444, 457–465.
- 37.
This is an example of the fact that the logical relationships dealt with in microeconomics are often more general than suggested by the graphical illustrations used to visualize these relationships. Another example was mentioned when we discussed the comparative statics of demand as income increases, using . Fig. 6.2. There, we mentioned that the demand curves have been drawn to be parallels for simplicity only. The effects of changes in income on the quantity demanded at a given price also hold for (downward sloping) demand curves not parallel to each other.
- 38.
Not so obvious? To solve the puzzle, you might draw a figure with \( \overline{p} \) as the horizontal price line and add a downward sloping marginal cost curve. Then, denote the quantity for which your marginal cost curve intersects the price line as \( \overline{x} \), as we did in . Fig. 6.3, above. Equipped with these analytical instruments you might find out what happens to the firm’s profit if it increases output a little, going from \( \overline{x} \) to \( \widehat{x} \), or decreases output a little, going from \( \overline{x} \) to \( \overline{\overline{x}} \). You will see that profit goes up for both deviations from \( \overline{x} \). Calculus club mini session: If marginal cost decreases in the region of its intersection with the price line the second order condition for a profit maximum which will be derived in the subsequent calculus club is violated. In fact, the firm’s profit is at a minimum at \( \overline{x} \).
- 39.
In the previous chapter we noted that the monotonicity of the demand curve is a prerequisite for the transformation of the direct demand function into the inverse demand function. Analogously, going from the direct supply function to the inverse supply function requires monotony. This requirement is met since for the constitution of the supply curve we use the monotonically increasing part of the marginal cost curve only.
- 40.
This is a particularly nice one because it is monotonically increasing. Sometimes U-shaped marginal cost curves are used. An example is MC = x 2 − 10x + 30.
- 41.
The generality of this statement is attenuated by the fact that maximal profit might be negative for the firm if the price is too low. At these prices the equilibrium supply is 0 and the marginal cost curve of the firm , even if increasing, is not part of the supply curve in this area. These considerations are relevant for U-shaped marginal cost curves, as the one mentioned in footnote 27, and are further differentiated if you distinguish between «long run» and «short run» analysis. However, we do not deal with these issues here and refer instead to the literature. See, e.g., Varian (2014), pp. 413–427.
- 42.
Microeconomics contributes to a better world by stimulating the dialogue among different generations: ask your grandparents what happened during the world wide « oil crisis » in the year 1973. (A contemporary worry is what might happen to the cost of all kinds of electronic devices if the prices for rare metals go up).
- 43.
At this general level of discussion it is not clear what happens if input prices increase and technology improves, simultaneously. Then, the «new» supply curve will shift to a position somewhere between s ′, and s ″. Whether, compared to the «old» equilibrium quantity, \( \overline{x} \), the «new» quantity increases or decreases depends upon which of the two countervailing effects prevails.
- 44.
In more formal terms we may write i ∈ {1, 2}.
- 45.
It is also one of the «famous figures and diagrams» beautifully explained in Blaug and Lloyd (2010). The authors did the right thing to put the supply and demand diagram referred to above right at the beginning of their gallery of fundamental economic illustrations.
- 46.
In this situation every agent is able to realize his/her plan.
- 47.
Among the ideal conditions mentioned above is the requirement that all agents are fully aware of ruling prices. Moreover, it is a prerequisite that no governmental intervention prevents prices from reacting to divergences between the quantity supplied and the quantity demanded.
- 48.
The economic models presented above have been confined to static and comparative static equilibrium analysis. Therefore, strictly speaking, the speculations about how prices would move starting from a situation of disequilibrium violate the limits of our analysis. Therefore we intentionally use the soft term «plausible» in the passage to which this footnote refers.
- 49.
The question of the stability of market equilibria is a key topic of dynamic economic analysis.
- 50.
We put this expression in quotes because, strictly speaking, there is no time in the model that we use here. To allow for that, we need a dynamic model but the one under consideration is static. So of any two activities it is not possible that one happens «first» and the other happens «second», nor can they happen «at the same time». However, it supports intuitive grasp on what is going on in the model if we talk about it using terms from daily «colloquial» language, even if they are not strictly appropriate.
- 51.
Whether the particular individual is better off in A or B is decided by this very individual. This follows from the principle of consumer sovereignty , referred to above.
- 52.
The assumption underlying this expectation is that each individual votes according to his/her own self interest . This implies that the people who are not affected by the reallocation do not envy the ones who benefit.
- 53.
- 54.
Nicholas Kaldor (1908–1986), British economist; John R. Hicks (1904–1989), British economist, Economics Nobel Prize 1972.
- 55.
Abram Bergson (1914–2003), US-American economist; Paul E. Samuelson (1915–2009), US-American economist, Economics Nobel Prize 1970.
- 56.
The understanding of what fairness (justice) is varies over time and across societies with different cultural backgrounds.
- 57.
Obviously, there would not be a «first» theorem if there were no «second» one (and possibly others). However, to discuss this would lead us astray from the convenient pathways of our introductory exposition. See, e.g., Estrin et al. (2012), pp. 538–555, Perloff (2016), pp. 332–367, Varian (2014), pp. 619–625.
- 58.
The invisible hand is a «crossover word» going right back to the cradle of modern economics, the work of Adam Smith (1776). Adam Smith (1723–1790) is often attributed to be the «founding father» of modern economics.
- 59.
- 60.
In our 2-firms-example, « i » might take the values of 1 or 2. Some highbrows might write i ∈ {1, 2}.
- 61.
If « i » is one of the two firms in our example, « j » is the other one.
- 62.
Nevertheless, every reader is cordially invited to compare his/her own attitudes and thoughts with microeconomic wisdom.
- 63.
However, we remind our cherished readers of our discussion of the caveats of this concept, as presented above.
- 64.
- 65.
Please avoid a notational trap here: do not confuse the points on the demand curve, denoted « d », « d ′ », with the demand curve labelled d 2(x 2).
- 66.
This can be disentangled by an exercise in «geometrical accounting»: by the consumption of the additional unit, consumer 2 gains a consumer surplus illustrated by the area \( {\overline{x}}_2\left({\overline{x}}_2+1\right) ed. \) This is equal to the area \( {\overline{x}}_2\left({\overline{x}}_2+1\right) fd- def. \) Consumer 1, consuming one unit less loses consumer surplus illustrated by the area \( \left({\overline{x}}_1-1\right){\overline{x}}_1 ab. \) This is equal to the area \( \left({\overline{x}}_1-1\right){\overline{x}}_1 ac+ \) the area abc. So the change in total consumer surplus is illustrated by \( {\overline{x}}_2\left({\overline{x}}_2+1\right) fd- def-\left({\overline{x}}_1-1\right){\overline{x}}_1 ac- abc. \) Since the areas \( {\overline{x}}_2\left({\overline{x}}_2+1\right) fd \) and \( \left({\overline{x}}_1-1\right){\overline{x}}_1 ac \)are identical to each other, the total change in consumer surplus is −def − abc.
- 67.
Just one of the advantages of the perfectly competitive market model is that it provides a theoretically sound background against which many real world phenomena can be contrasted and analysed. Specifically, microeconomics investigates how equilibria and their social welfare properties are affected if we deviate from the assumptions underlying perfect competition .
- 68.
In reality, the breather is obviously not a third type of an agent. All individuals have to breathe, consumers and producers alike. So the different types of agents described in the economic model represent different roles that one and the same individual might take on. Of course, one individual playing more than one role, simultaneously, might also apply in the simple model that allows for consumers and firms only. All the individuals that act as producers are also consumers, although the opposite does not necessarily hold.
- 69.
An alternative measure would be the amount of money necessary to compensate the people for a certain loss in air quality. There has been a lot of discussion in the environmental economics literature about the relationship between these two evaluation methods: willingness to pay and the requirement to be compensated. See, e.g., Tisdell (2010). A particularly critical view is taken by Hahnel (2011).
- 70.
We use the terms «emissions» and «pollution» as synonyms.
- 71.
The term marginal environmental damage (MED) is used as a synonym in the literature. The term marginal external cost is taken from economic theory, the term marginal external damage is taken from the applied ecologically-oriented discussion.
- 72.
Please recall that in 7 Sect. 6.2 there are a few paragraphs on reading the demand curve «from the abscissa to the ordinate». There, it has been explained that the marginal willingness to pay can be read from the demand curve. We use this insight here and label the demand curve in . Fig. 6.14 as « D (=MWP)».
- 73.
Externality is the most important cause of a market failure in the context of environmental economics . A related problem is generated by collective (public) goods , as referred to in 7 Sect. 2.2.3 and 7 Chap. 4 . However, please recall that we have pointed to other deviations from the «ideal» conception of a market system , which also lead to market failure, above. The most important ones are market power (particularly in the form of monopoly and oligopoly) as well as imperfect information (particularly in the forms of asymmetric information). These issues are dealt with in intermediate microeconomics textbooks like Varian (2014).
- 74.
Kenneth Arrow and Gérard Debreu (1921–2004) were awarded the Nobel Prize in Economic Sciences in 1972 and 1983, respectively.
- 75.
- 76.
Sometimes, this assumption is called perfect information «or full information» but this somewhat overstates the case. For instance, general equilibrium theory does not assume that one individual knows the preferences of another individual.
- 77.
Readers with a deeper economics background are reminded that in general equilibrium theory technology is assumed to be convex and utility functions are assumed to be concave.
- 78.
- 79.
- 80.
See e.g., the literature mentioned in footnote 75.
- 81.
- 82.
- 83.
See, e.g., Bardsley et al. (2010).
- 84.
See, e.g., Löschel and Rübbelke (2014).
- 85.
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Endres, A., Radke, V. (2018). Fundamental Concepts of Microeconomics. In: Economics for Environmental Studies. Springer Texts in Business and Economics. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-662-54828-8_6
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