Micro 3/13

Theory of Utility: theory behind demand curve

  • measure your preferences
  • good “x” gives you some amount of utility (happiness)
  • Goal: maximize utility; subject to prices and income
  • hard to measure because it is very subjective (no scale for happiness)
  • Marginal utility = change in total utility / change in quantity…. how much marginal happiness you gain from one to the next
  • Law of diminishing marginal utility: as consumption of “x” goes up, the marginal utility (MUx) you receive goes down
  • People consume until: (MUx / Px) = (MUy / Py)

Theory of the Firm: theory behind supply curve

  • Goal: maximize profit
  • Profit = Total Revenue – Total Cost
  • Find where marginal Revenue = Marginal cost
  • Marginal revenue is the slope of total revenue (MR = change in total revenue / change in Q)
  • Marginal Cost is the slope of Total Cost (MC = change in Total cost / change in Q)
  • why firm?
    1. minimize transaction costs (people specialize)
    2. Economies of scale
    3. Team production

Principal Agent Problem

  • Goal of the principal is not the goal of the agent
  • when goals aren’t the same, you get outputs that hurt the principal
  • Fix:
    1. monitoring (checks and balances)
    2. monetary (reward or punishment)


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