Summary Microeconomics by Robert S. Pindyck & Daniel L. Rubinfeld
Table of Contents
Chapter 1 – Preliminaries................................................................................................................ 2
Chapter 2 - The Basics of Supply and Demand ............................................................................... 5
Chapter 3 – Consumer Behavior ................................................................................................... 10
Chapter 4 – Individual and Market Demand ................................................................................ 15
Chapter 5 – Uncertainty and Consumer Behavior ........................................................................ 20
Chapter 6 – Production ................................................................................................................. 22
Chapter 7 – The Cost of Production .............................................................................................. 26
Chapter 8 – Profit Maximization and Competitive Supply ........................................................... 31
Chapter 9 – The Analysis of Competitive Markets ....................................................................... 37
Chapter 10 – Market Power: Monopoly and Monopsony ............................................................ 41
Chapter 11 – Pricing with Market Power...................................................................................... 46
Chapter 12 – Monopolistic Competition and Oligopoly ............................................................... 49
Chapter 13 – Game Theory and Competitive Strategy ................................................................. 54
Chapter 17 – Markets with Asymmetric Information ................................................................... 59
Chapter 18 – Externalities and Public Goods ................................................................................ 61
1 Bart van Rosmalen
,Part One Introduction: Market and Prices
Chapter 1 – Preliminaries
1.1 The Themes of Microeconomics
Microeconomics deals with the behavior of individual economic units. Microeconomics explains
how and why these units make economic decisions. By studying the behavior and interaction of
individual firms and consumers, microeconomics reveals how industries and markets operate
and evolve, why they differ from one another, and how they are effected by the government
policies and global economic conditions. By contrast, macroeconomics deals with aggregate
economic quantities, such as the level and growth rate of national output, interest rates,
unemployment, and inflation.
Trade-Offs
Microeconomics describes the trade-offs that consumers, workers and firms face and shows
how these trade-offs are best made.
Prices and Markets
A second important theme of microeconomics is the role of prices. All of the trade-offs
described above are based on the prices faced by consumers, workers or firms.
Theories and Models
In economics, as in the other sciences, explanation and prediction are based on theories.
Theories are developed to explain observed phenomena in terms of a set of basic rules and
assumptions. A model is a mathematical representation, based on economic theory, of a firm, a
market, or some other entity.
Positive versus Conditional Normative versus Purely Normative Analysis
Microeconomics is concerned with both positive and normative (conditionally and purely
normative) questions.
- Positive analysis deals with explanation and prediction. It is about what is. It’s an
analysis of cause and effect. An example is: “For non-Giffen goods an increase in price
will decrease demand” or “A firm that sets MR=MC is maximizing its profit.”
- Normative analysis without value judgements is called conditional-normative analysis.
Conditional-normative analysis has an “if …., then one should” structure. No value
judgements are involved, but without the condition (“if ….”) there would. An example is
“If a firm strives for maximizing profits, then it should set MR equal to MC.”
- Finally, there is purely normative analysis, which includes value judgements. An example
is: “Firms should not strive for maximizing profits, but for maximizing social welfare.”
1.2 What Is a market?
A market is the collection of buyers and sellers that, though their actual or potential
interactions, determine the price of a product or set of products. When defining a market,
potential interactions of buyers and sellers can be just as important as actual ones.
2 Bart van Rosmalen
, Competitive versus Noncompetitive Markets
A perfectly competitive market has many buyers and sellers, so that no single buyer or seller
has any impact on price. Most agricultural markets are close to being perfectly competitive.
Market Price
In a perfectly competitive market, a single price – the market price – will usually prevail.
Market Definition – the extent of a market
To determine which buyers and sellers to include, we must first determine the extent of a
market – its boundaries, both geographically and in terms of the range of products to be
included in it.
Market definition is important for two reasons:
- A company must understand who its actual and potential competitors are for the
various products that it sells or might sell in the future. It must also know product
boundaries and geographical boundaries of its market in order to set price, determine
advertising budgets, and make capital investment decisions.
- Market definition can be important for public policy decisions. Should the government
allow a merger or acquisition involving companies that produce similar products, or
should it challenge it? The answer depends on the impact of that M&A on future
competition and prices; often this can be evaluated only by defining a market.
1.5 Notes added by Jacques Siegers (prof)
Methodological individualism
Economics (i.e. both macroeconomics and microeconomics) tries to explain phenomena on a
collective level, e.g. on the level of a market, a country, or the world. Microeconomics is
characterized by an approach that is called methodological individualism: For methodological
reasons we descend to the level of the relevant individual actor. Then we try to explain the
behavior of this individual actor; to do this we apply rational choice theory (see below).
Eventually, we aggregate, because the problem to explain is on the collective level.
In macroeconomics we do not apply methodological individualism, but try to explain
phenomena on a collective level by directly relating them to other variables on that level.
So, although several textbooks (including Pindyck & Rubinfeld) may suggest otherwise, it is
applying or not methodological individualism that provides the dividing line between
macroeconomics and microeconomics, not whether they analyze phenomena on a collective
level or not. With respect to the latter, they both do.
Rational choice theory
Economics is a special branch of rational choice theory. In rational choice theory people are
assumed to strive for the attainment of certain goals. In their attempt, they are confronted
with restrictions, so they have to make choices. The result of this choice process is their
behavior.
Method of decreasing abstraction
3 Bart van Rosmalen
Table of Contents
Chapter 1 – Preliminaries................................................................................................................ 2
Chapter 2 - The Basics of Supply and Demand ............................................................................... 5
Chapter 3 – Consumer Behavior ................................................................................................... 10
Chapter 4 – Individual and Market Demand ................................................................................ 15
Chapter 5 – Uncertainty and Consumer Behavior ........................................................................ 20
Chapter 6 – Production ................................................................................................................. 22
Chapter 7 – The Cost of Production .............................................................................................. 26
Chapter 8 – Profit Maximization and Competitive Supply ........................................................... 31
Chapter 9 – The Analysis of Competitive Markets ....................................................................... 37
Chapter 10 – Market Power: Monopoly and Monopsony ............................................................ 41
Chapter 11 – Pricing with Market Power...................................................................................... 46
Chapter 12 – Monopolistic Competition and Oligopoly ............................................................... 49
Chapter 13 – Game Theory and Competitive Strategy ................................................................. 54
Chapter 17 – Markets with Asymmetric Information ................................................................... 59
Chapter 18 – Externalities and Public Goods ................................................................................ 61
1 Bart van Rosmalen
,Part One Introduction: Market and Prices
Chapter 1 – Preliminaries
1.1 The Themes of Microeconomics
Microeconomics deals with the behavior of individual economic units. Microeconomics explains
how and why these units make economic decisions. By studying the behavior and interaction of
individual firms and consumers, microeconomics reveals how industries and markets operate
and evolve, why they differ from one another, and how they are effected by the government
policies and global economic conditions. By contrast, macroeconomics deals with aggregate
economic quantities, such as the level and growth rate of national output, interest rates,
unemployment, and inflation.
Trade-Offs
Microeconomics describes the trade-offs that consumers, workers and firms face and shows
how these trade-offs are best made.
Prices and Markets
A second important theme of microeconomics is the role of prices. All of the trade-offs
described above are based on the prices faced by consumers, workers or firms.
Theories and Models
In economics, as in the other sciences, explanation and prediction are based on theories.
Theories are developed to explain observed phenomena in terms of a set of basic rules and
assumptions. A model is a mathematical representation, based on economic theory, of a firm, a
market, or some other entity.
Positive versus Conditional Normative versus Purely Normative Analysis
Microeconomics is concerned with both positive and normative (conditionally and purely
normative) questions.
- Positive analysis deals with explanation and prediction. It is about what is. It’s an
analysis of cause and effect. An example is: “For non-Giffen goods an increase in price
will decrease demand” or “A firm that sets MR=MC is maximizing its profit.”
- Normative analysis without value judgements is called conditional-normative analysis.
Conditional-normative analysis has an “if …., then one should” structure. No value
judgements are involved, but without the condition (“if ….”) there would. An example is
“If a firm strives for maximizing profits, then it should set MR equal to MC.”
- Finally, there is purely normative analysis, which includes value judgements. An example
is: “Firms should not strive for maximizing profits, but for maximizing social welfare.”
1.2 What Is a market?
A market is the collection of buyers and sellers that, though their actual or potential
interactions, determine the price of a product or set of products. When defining a market,
potential interactions of buyers and sellers can be just as important as actual ones.
2 Bart van Rosmalen
, Competitive versus Noncompetitive Markets
A perfectly competitive market has many buyers and sellers, so that no single buyer or seller
has any impact on price. Most agricultural markets are close to being perfectly competitive.
Market Price
In a perfectly competitive market, a single price – the market price – will usually prevail.
Market Definition – the extent of a market
To determine which buyers and sellers to include, we must first determine the extent of a
market – its boundaries, both geographically and in terms of the range of products to be
included in it.
Market definition is important for two reasons:
- A company must understand who its actual and potential competitors are for the
various products that it sells or might sell in the future. It must also know product
boundaries and geographical boundaries of its market in order to set price, determine
advertising budgets, and make capital investment decisions.
- Market definition can be important for public policy decisions. Should the government
allow a merger or acquisition involving companies that produce similar products, or
should it challenge it? The answer depends on the impact of that M&A on future
competition and prices; often this can be evaluated only by defining a market.
1.5 Notes added by Jacques Siegers (prof)
Methodological individualism
Economics (i.e. both macroeconomics and microeconomics) tries to explain phenomena on a
collective level, e.g. on the level of a market, a country, or the world. Microeconomics is
characterized by an approach that is called methodological individualism: For methodological
reasons we descend to the level of the relevant individual actor. Then we try to explain the
behavior of this individual actor; to do this we apply rational choice theory (see below).
Eventually, we aggregate, because the problem to explain is on the collective level.
In macroeconomics we do not apply methodological individualism, but try to explain
phenomena on a collective level by directly relating them to other variables on that level.
So, although several textbooks (including Pindyck & Rubinfeld) may suggest otherwise, it is
applying or not methodological individualism that provides the dividing line between
macroeconomics and microeconomics, not whether they analyze phenomena on a collective
level or not. With respect to the latter, they both do.
Rational choice theory
Economics is a special branch of rational choice theory. In rational choice theory people are
assumed to strive for the attainment of certain goals. In their attempt, they are confronted
with restrictions, so they have to make choices. The result of this choice process is their
behavior.
Method of decreasing abstraction
3 Bart van Rosmalen
