1. SL354, Intermediate Microeconomics
Monday
Tuesday
Thursday
Friday
Week 1 :
March 3 – 7
Introduction
Varian, 1
Budget Constraints
Varian, 2
Preferences
Varian, 3
Utility
Varian, 4
Week 2 :
March 10 – 14
Choice
Varian, 5
Consumer Demand
Varian, 6 [7]
S. & I. Effects
Varian, 8
Problem Set 1
Thaler, 1 – 3
Week 3 :
March 17 – 21
Exam 1
Buying & Selling
Varian, 9
Buying & Selling
Varian, 9
Intertemporal Choice
Varian, 10; Thaler, 8 – 9
Week 4 :
March 24 – 28
Market Demand
Varian, 15
Equilibrium
Varian, 16
Problem Set 2
Exam 2
Week 5 :
April 7 – 11
Asset Markets
Varian, 11
Uncertainty (Risk)
Varian, 12
Risky Assets
Varian, 13
Portfolio Theory
TBD
Week 6 :
April 14 – 18
Loss Aversion, etc.
Thaler, 6 – 7
Capital Markets I
Thaler, 10 – 11
Capital Markets II
Thaler, 12 and 14
Problem Set 3
Week 7 :
April 21 – 25
Exam 3
Technology
Varian, 18
Profit Maximization
Varian, 19
Exchange
Varian, 31
Week 8 :
April 28 – May 2
Production
Varian, 32
Welfare
Varian, 33
General Equilibrium
TBD
Problem Set 4
Week 9 :
May 5 – 9
Exam 4
Auctions
Varian, 17
Auctions
Thaler, 5
Externalities
Varian, 34
Week 10 :
May 12 – 16
Information
Varian, 35
Asymmetric Information
Varian, 37
Problem Set 5
Thaler, 15
Exam 5

2. Intertemporal Trades • •
Borrowing
in period 1

3. Intertemporal Trades Patient preferences Impatient preferences
(Negative time preference)
Impatient preferences
(Positive time preference)

4. Asset Markets: Debt

5. Asset Markets: Debt

6. Asset Markets: Equity

7. Asset Markets: Equity GE Average 1982-2005 24% SP500 Average 1982-2005
12.3%
*Calculated from a value-weighted index of all publicly traded stocks using CRSP data.
*Calculated as compounded annual return on average monthly returns from preceding 12 months.

8. Present Valuation Techniques and Asset Valuation
The present value (PV) of an amount to be received at time t (FV) when the per-period discount rate is r:
The present value (PV) of a stream of future values, when the per-period discount rate is r:
Bond pricing. The price of a bond will be the net present value of interest payments and the maturity date and value.
Stock valuation. The current value of a firm (PVFirm) is the present value of the stream of future profits that the firm will generate -- and shareholders are “residual claimants” of those profits:

9. Optimal Holding Period for an Asset
Rate of return from holding asset t*

10. Risk and Uncertainty: “Contingent Consumption Plans”
Case 2:
A person with an endowment of $35,000 faces a 1% probability of losing $10,000. He is considering the purchase of full insurance against the loss for $100.
Case 1:
A person with an endowment of $100 is considering the purchase of a lottery ticket that costs $5. The winning ticket in the lottery gets $200.
$100
Outcome A:
Outcome B: If
Pr(Lucky) = 0.025):
$35,000
Lucky
day
Do not
purchase
Do not
purchase
Unlucky
day
$25,000
Lucky
day
Lucky
day
$295
$34,900
Purchase
Purchase
Unlucky
day
Unlucky
day
$95
$34,900

11. Risk and Uncertainty: “Contingent Consumption Plans”
$35,000
Lucky
day
Do not
purchase
Unlucky
day
$25,000
Lucky
day
$34,900 •
Purchase
Unlucky
day
$34,900 •
K = the “expected loss” ($10,000), and gK is the insurance premium.

12. The Meaning of Risk Aversion
Economic Treatment of Risk
The Meaning of Risk Aversion
1. Risk aversion is defined through peoples’ choices:
2. Non-linearity in the utility of wealth.
Given a choice between two options with equal expected values and
different standard deviations, a risk averse person will choose the option
with the lower standard deviation:
Given a choice between two options with equal standard deviations and
different expected values, a risk-averse person will choose the option
with the higher expected value:

13. Dealing With Risk: Insurance
$100,000
Pr(xA) = .990
E[X] = $99,500
s = $4,975
cv =
Pr(xB) = .010
$50,000

14. Dealing With Risk: Insurance
$100,000
$500
$99,500
Pr(xA) = .990
E[X] = $99,500
s = $0
cv = 0
$100,000
Pr(xB) = .010
$100,000
$500
- $50,000
+ $50,000
$99,500

15. Dealing With Risk: Insurance
For a risk-averse person . . . Is
Preferable to
E[X] = $99,500
s = $0
cv = 0
E[X] = $99,500
s = $4,975
cv =
Can we find another option, keeping s = $0, but with a lower
E[X], that will be considered equal to the original? For example,
suppose that for this risk-averse person . . . Is
Equivalent to
E[X] = $99,415
s = $0
cv = 0
E[X] = $99,500
s = $4,975
cv =

16. Dealing With Risk: Insurance
If, for a risk-averse person . . . Is
Equivalent to
E[X] = $99,500
s = $4,975
cv =
$99,415
Then $99,415 is called a certainty equivalent.
Furthermore, we will be able to sell an insurance policy to this
person for $585.
The $85 difference between the amount the person will pay and
the expected loss is called a risk premium.

17. The Meaning of Risk Aversion
Economic Treatment of Risk
Utility
The Meaning of Risk Aversion A
U($) U3 l U2 l l B D U1 l C
Risk Premium $ $0
$99,415
$99,500
$100,000
$50,000

18. Risk Aversion and Risk Neutrality
Economic Treatment of Risk
Utility
U($)
Risk Aversion and Risk Neutrality
U($)
U($)
Risk Aversion
Risk Neutral
Risk Seeking $

19. Economic Treatment of Risk
Utility
Risk Tolerance
U1($)
U2($)
Risk Premium 1
Risk Premium 2 $
Risk Premium 1 > Risk Premium 2 : Agent 1 is more risk averse than Agent 2
Agent 2 is more risk tolerant than Agent 1

20. Certainty Equivalent:
Modeling Risk and Expected Utility in Insurance Problems
Expected Utility:
Certainty Equivalent:
Risk Premium:

21. Dealing With Risk: Diversification (Portfolio Theory)
Expected Return of a Portfolio (2 investments):
Expected Variance of a Portfolio (2 investments):

22. Dealing With Risk: Diversification (Portfolio Theory)
Portfolio Example

23. Capital Asset Pricing Model
Capital Market Line
Security Market Line 1

24. Capital Asset Pricing Model
3-Year
5-Year
10-Year
Mutual Fund Name
Symbol
Beta
Returns
American Century Heritage A
ATHAX
1.44
20.50
1.17
19.26
0.96
8.42
Fidelity Advisor Equity Growth T
FAEGX
1.18
8.31
1.16
11.20
3.34
Fidelity Magellan
FMAGX
1.33
6.88
1.03
10.42
1.04
3.53
Putnam International Growth & Income
PNGAX
1.07
12.55
20.56
6.90
Fidelity Diversified International
FDIVX
1.08
14.57
1.02
22.18
10.85
Templeton Growth A
TEPLX
0.77
5.78
0.85
14.81
0.80
7.01
Vanguard 500 Index
VFINX
1.00
5.72
11.18
3.43
Vanguard Total Stock Market Index
VTSMX
6.19
12.27
1.01
3.89
Vanguard PRIMECAP
VPMCX
9.63
1.06
15.78
8.50
Janis Growth & Income
JAGIX
1.13
6.69
1.05
11.22
0.98
5.84
Dreyfus Premier Balanced B
PRBBX
4.05
0.90
6.59
0.87
1.43
Dreyfus Founders Balanced A
FRIDX
3.71
0.88
7.21

25. Capital Asset Pricing Model
Name
Symbol
Beta
Aetna
AET
1.08
Anheuser Busch
BUD
0.60
Bank of America
BAC
0.32
Boeing BA
0.88
Cummins Inc.
CMI
1.35
Deere & Co.
DELL
1.23
Dell
1.81
Eli Lilly Co.
LLY
0.43
Family Dollar Stores
FDO
0.82
General Electric GE
0.70
General Motors GM
1.27
Google
GOOG
2.01
Intel
INTC
1.72
J.P. Morgan Chase
JPM
0.68
Microsoft
MSFT
1.61
Nordstrom Inc.
JWN
1.51
Pfizer PF
0.75
Wal-Mart Stores
WMT
-0.18
Wellpoint Inc.
WLP
0.61
Wells Fargo
WFC

26. Economic Analysis of Market Opportunities
Efficient Markets and Economic Profits –
Total Market Returns, Selected Time Periods

27. Loss Aversion
You are offered the following bet: A coin will be tossed. If it is heads you win x; if it is tails, you lose y.
+ (Gain)
+ (Loss)
+ v
- v
+ $30
- $10
Value = V($)
“Most respondents in a sample of undergraduates refused to stake $10 on the toss of a coin if they stood to win less than $30.”