1. Preface

2. Objectives of the course
To learn how to learn analytic and theoretical tools to address microeconomic questions.
To promote critical thinking about
To move on to more advanced economics courses.
There are two reasons for the first objective. Efficiency and biased public view.

3. Materials Required Text: Price Theory, Steven E. Landsburg, 9th ed.
Better stick to this edition.
Other reading materials:
Additional references, specified as required or recommended, will be occasionally linked to the course web page.
Powerpoint slides, practice questions, answers, and other reading materials will be available online.

4. About me
Elliott Fan
Assistant Professor
Economics Department
National Taiwan University
Office hour: Wednesday 11:00-12:00
Venue: Graduate Building R502
Australian accent.

5. Course evaluation Part B: Tasks Weighting (%) Practice questions
Group presentation
Quizzes (2)
Midterm examination
Final examination 10 30
TOTAL
100
Note: Except for emergency cases, no special consideration on grading will be granted.

6. Quizzes and exams
The scope is focused on but not limited to lecture notes, textbook, required reading materials.
Presentation topics and discussion are also included.
Numerical questions are not the only form.

7. Group presentation
You should select a topic, form interesting questions, develop analysis and possible answers, design and deliver the presentation.
In general, all kinds of micro-economics related topics can be considered. Available sources of topic can be found online, in pubic media, books, documentaries, academic journal articles etc.
The length of the presentation is 20-minute long, followed by comments, discussion, and Q and A for 5-10 mins.
After each presentation, the presenter should submits the slides to the teacher.

8. Group presentation
You are required to submit a proposal (via or in class) 2 weeks before the presentation date. The proposal should be clearly written, with reading materials, questions, and issues to be discussed specified in it. The proposal will be approved or required to be modified if necessary.
I myself will demonstrate how to present a talk, maybe next week.

9. Regarding math
I am assuming that all students have learned fundamental calculus.
This course will involve applications of various mathematic tools.
If you have any difficulty in following math, please let me know.
Note that intuition is by any means more important than using math.

10. How to get a great mark Get involved. Be active.
Make use of study group.
Complete everything by yourself.
Develop skills as well as intuition

11. Why economists like to blog?
Economists seems more inclined than people in other fields to become a blogger
Some argue that because they feel being ignored by the government
Recommended blogs:
1. Econtalk
2. Foundation of Economic Education
3. gregmankiw

12. Knowledge and Information Chapter 9 (one of the best chaps)

13. Introduction How can all suppliers know how to supply goods
Prices convey information
Enable complex social activities to be organized and implemented
Act to allocate resources efficiently by ensuring appropriate quantities get produced
Contribute to efficient production and distribution because embodies knowledge not available to any one individual

14. Food banks in the US

15. Food banks in the US

16. Food banks in the US
Feeding America is a United States-based nonprofit organization that is a nationwide network of more than 200 food banks that feed more than 46 million people through food pantries, soup kitchens, shelters, and other community-based agencies.
Before 2005, the system relies on a centralized system.
In 2005, a bidding system was introduced using ‘share’ – fake money.
Price of food can be negative
Large amount of food was saved from being rotten.

17. The informational content of prices
Section 9.1
The informational content of prices

18. Information How can suppliers know what to supply? Prices:
Contribute to efficient production and distribution of quantities of goods.
Embody vast knowledge not available to any one individual.
Effects work together with the invisible hand:
Leads to social outcomes that account for producers’ costs and consumers’ preferences.

19. Prices and Information
Price of a good under competition is equal to the marginal cost of supplying the good.
Prices convey free information and provide incentives to act on that information.
Freidrich Hayek: Social role of prices as information allows specialized knowledge of individuals to be incorporated into resource allocation decisions.
Greed enables you to offer incentives to others to act as you want.

20. The Costs of Misallocation
When allocation decisions are not made on basis of price, traditional methods of:
Social gain overstate actual gains to society.
Deadweight loss underestimate actual losses.
Example: A Military Draft:
Social costs associated with a draft are not captured in computed deadweight cost.
Social loss is avoided under a voluntary system where only those with the lowest cost will volunteer.

24. Military draft Why is the conclusion misleading?
There is no guarantee that only individuals left of Qd will be drafted given the random selection.

27. Military draft How about a market for drafts?
There is a concern for “fairness”
Exploitation argument – only the poor would risk their lives for economic benefits
Michael Sandel has some discussion on this issue
Non-scientific questions are beyond the reach of this course

28. The Social Role of Rent Henry George: Land quantity is fixed.
Rent payments serve no economic purpose and landlords are enriched at no social end.
Rent is payments in excess of required minimum.
When Jennifer Lopez earns more for a movie than the minimum she would work for, the excess is rent.
When a factor is in fixed supply, revenue earned consists entirely of rent.

31. The Social Role of Rent
An efficient allocation of land demands an incentive for land owners to distribute lands to those with highest values.
This is something often ignored by careless policy makers.

32. Asymmetric information
Section 9.2
Asymmetric information

33. 4 important topics Signaling Adverse selection (Lemon cars market)
Moral hazard (insurance programs)
Principal-agent problems

34. Signaling Should Colleges be Outlawed?
Going to college is a signal.
Produces nothing of value, but provides information.
Prevents dull students from misrepresenting themselves and provides bright students with better paying jobs.
Dressing for success is a signal.
Tails are a signal in the animal kingdom.
Signals are socially costly and improvement could benefit everyone.

35. Signaling
Suppose we have two types of workers, able and unable. Able workers have MPL of a2 while unable a1 and a2 > a1.
The fraction of able workers is b.
If firms can distinguish two types of workers, then they will offer wage a2 to able and to a1 unable. However, if they cannot, they can only offer ba2+(1-b) a1. Now if under this wage, both types will work, then there is no problem of efficiency loss.

36. Signaling
Suppose now workers can acquire education to signal his type.
Let e2 be the education acquired by able and e1 by unable. Let c2e2 be the cost for able and c1e1 for unable.
Now workers acquire education first and then firms decide how much to pay after observing the choice of education by workers. Assume the education does not affect the productivity at all to simplify. Suppose further that c2<c1.

37. Signaling
Let e* satisfy (a2-a1)/c1 < e*< (a2-a1)/c2. Then we have an equilibrium where able workers get education e* and unable 0. Firms pay a2 when they see e*and pay a1 when they see 0.
Does anyone have an incentive to deviate? Would unable mimic able? If he did, then the gain is a2-a1 while the cost is c1 e*. The first inequality guarantees that this is not profitable.

38. Signaling
What about able workers? Would he deviate to acquire education of 0? If he did, the loss is a2-a1 while the gain is c2e*. The second inequality guarantees that loss is bigger than gain and so it is not profitable to do so. Hence it is indeed an equilibrium.
In this setup it is a pure waste to signal. However, when the competitive equilibrium is not efficient, though signaling has cost, it might have some benefit and may improve efficiency.

39. Adverse Selection
People know more about their own risk characteristics than others do.
The Market for Lemons:
If sellers were truthful about cars, social welfare would be improved and good cars would be sold.
If there is any market for good cars, lemon-owners want to deceptively sell their cars at a higher price.
Insurance Markets:
No incentive for sickly people to identify themselves so that insurance companies can set rates accordingly.

41. Market for lemons
In reality, it is often the case that one of the transacting party has less information than the other.
Consider a market with 100 people who want to sell their used cars and 100 people who want to buy a used car. Everyone knows that 50 cars are lemons and 50 are plums. The current owner knows the quality of his car, but the potential purchasers do not.

42. Market for lemons
The owner of a lemon is happy to part with his car for 1,000 and that of a plum for 2,000. The buyers are willing to pay 2,400 for a plum and 1,200 for a lemon.
If information is fully shared by the seller and buyer, then the plum will sell at some price between 2,000 and 2,400 while the lemon between 1,000 and 1,200.
However, if buyers do not know how much each car is worth, then they are willing to pay the expected value.

43. Market for lemons
Since there are 50 lemons and 50 plums, thus buyers are willing to pay up to 0.5x1, x2,400=1,800.
Yet at 1,800, only the owners of lemons are willing to sell their cars. However, in equilibrium, buyers cannot have wrong expectation, so they expect to see only lemons in the market. When this happens, they are willing to pay only 1,200. Thus only lemons get sold while none of the plums do. This differs from the case when information is symmetric.

44. Financial Crisis of 2008 Borrowers unable to find willing lenders.
Much economic activity stopped.
Problem began with home mortgages.
Home prices fell dramatically resulting in default.
Mortgages became less valuable.
Possibly adverse selection issue.
Some banks may have had better information about riskier loans that others.
Based on this, other banks refused to buy the loans.
Watch this movie “Margin Call”:

45. Adverse selection -- solutions
Compulsory purchase plan (such as the National Health Insurance in Taiwan)
Reputation and standardization (such as Costco)
Warranty
Safety examination (required for car and estate trade)

46. Adverse selection -- evidence
Whilst adverse selection in theory seems an obvious and inevitable consequence of economic incentives, empirical evidence is mixed. Several studies investigating correlations between risk and insurance purchase have failed to show the predicted positive correlation for life insurance,[3] auto insurance,[4][5] and health insurance.[6]
On the other hand, "positive" test results for adverse selection have been reported in health insurance,[7] long-term care insurance[8] and annuity markets.[9]
These "positive" results tend to be based on demonstrating more subtle relationships between risk and purchasing behavior (such as between mortality and whether the customer chooses a life annuity which is fixed or inflation-linked), rather than simple correlations of risk and quantity purchased.

47. Moral Hazard
It is a tendency to be more willing to take a risk, knowing that the potential costs or burdens of taking such risk will be borne, in whole or in part, by others.
Insurance companies
Adjust rates accordingly
Gives insured incentive to behave appropriately
Unable to verify valid claim

48. Moral Hazard – example 1
In Taiwan, Labor Insurance, Government Employee Insurance and Farmers’ Insurance offer disability benefits to uterus failing for women aged under 45, inducing hysterectomy (the surgical removal of an uterus).

49. Moral Hazard – example 1 Hazard by quarter age - Total and partial hysterectomies

50. Moral Hazard – example 2

51. Moral Hazard – solutions
Insurance policy often includes a deductible and co- payment
Increased insurance premium after car accident
Life insurance does not cover suicide in the first 2 years

52. Principal-Agent Problem
Inability of principal to verify the behavior of agent

53. Principal-Agent Problem
Now the whole problem becomes how can I get someone to do something for me? This naturally leads us to the incentives problems.
Suppose we have a worker (agent) who if exerting effort x can produce output y=f(x). Efforts are not observable but outputs are. Let the cost of x be c(x) and the worker has some outside opportunity which gives him the utility of u. Then the whole problem boils down to choosing the payment s(y)=s(f(x)) to the worker to max the profit of the Principal.

54. Principal-Agent Problem
Now to make the worker participate, we have the participation constraint (individual rationality IR). That is, s(f(x))-c(x)u. So if we can observe x, the principal simply does maxx f(x)-s(f(x)) subject to s(f(x))-c(x)u. This can be solved by maxx f(x)-c(x)-u (**). So FOC is MP(x*)=MC(x*).
But if x is not observable, then we need to worry about whether agents will indeed choose x*.

55. Principal-Agent Problem
This brings us to another constraint, called the incentive compatibility (IC) constraint. It means that s(f(x*))-c(x*) s(f(x))-c(x) for all x.
There is a way to do this, that is, to sell the firm to the agents. So s(f(x))=f(x)-R. If the worker max s(f(x))-c(x)=f(x)-c(x)-R, then it looks just like (**). So x* will be chosen if IR is OK. To make IR OK, we just choose R so that f(x*)-c(x*)-R=u.

56. Principal-Agent Problem
In short, the sell-out contract is to make the agents the residual claimant so that he will take the proper care.
However, this is good because we assume risk neutrality of agents. If agents are risk averse, then this incentive scheme may entail too much risk on agents and for this reason, we do not see that every principal uses this kind of scheme to motivate his agents.

57. PA Problem – example 1
Pension funds managements in Taiwan:

58. Financial Markets Efficient Markets Hypothesis
Prices fully reflect all available information.
Efficient security markets serve an important social function.
Allow firms to make appropriate resource allocation decisions.
Evidence against technical analysis.
All information is already embedded in the current price.

59. Financial Markets
Speculative bubble is a situation in which expectations of rising prices cause prices to rise.
All eventually burst resulting in a sharp price decline.
Could speculative bubbles explain stock market crashes of 1987, 2000 and 2008? Grossman:
Small downturn causes a group to investors to sell to protect assets.
Other investors worry and follow first group and so on.