Microeconomic Theory

461 Pages·2018·12.607 MB·English

by  Susheng Wang

Springer Texts in Business and Economics
Susheng Wang
Microeconomic
Theory
Fourth Edition
Springer Texts in Business and Economics
More information about this series at http://www.springer.com/series/10099
Susheng Wang
Microeconomic Theory
Fourth Edition
123
SushengWang
Department ofEconomics
Hong KongUniversity of Science
andTechnology
ClearWater Bay,Hong Kong
China
ISSN 2192-4333 ISSN 2192-4341 (electronic)
SpringerTexts inBusiness andEconomics
ISBN978-981-13-0040-0 ISBN978-981-13-0041-7 (eBook)
https://doi.org/10.1007/978-981-13-0041-7
LibraryofCongressControlNumber:2018940428
1stedition:©WangSusheng,ChinaRenminUniversityPress2006
2ndedition:©WangSusheng,McGill-Hill2012
3rdedition:©WangSusheng,freeonline2016
4thedition:©SpringerNatureSingaporePteLtd.2018
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Preface
This book covers microeconomic theory at the master’s and Ph.D. levels for stu-
dents in business schools and economics departments. It concisely covers major
mainstreammicroeconomictheoriestoday,includingneoclassicalmicroeconomics,
game theory, information economics, and contract theory.
The coverage. Microeconomics is a required subject for all students in a
business school, especially for students in economics, accounting, finance, man-
agement,andmarketing.ItisastandardpracticenowadaysthataPh.D.programin
a business school requires a one-year course in microeconomic theory. This
one-year course is generally divided into two one-semester courses. Chapters 1–4
are the core subjects for the first semester. These chapters cover neoclassical eco-
nomics, which includes demand and supply theories, risk theory, and general
equilibrium.Itisthefoundationofmodernmicroeconomics.Chapters7–11arethe
coresubjectsforthesecondsemester.Chapters7–9covergametheory.Chapters7
and 8 cover noncooperative games, dealing respectively with imperfect and
incomplete information games. Chapter 9 covers cooperative games, which is
useful for advanced topics in information economics and organization theory.
Chapters 10–12 cover information economics, including asymmetric information
and incentive contracts. Chapters 5 and 6 are optional; these chapters are the
foundationsofsomefieldcourses,whichmayormaynotbecovereddependingon
the emphasis of the instructor. Chapter 5 covers some basic theories in financial
economics, especially asset pricing. Chapter 6 contains the basic theory of indus-
trial organizations, which can be covered in either semester.
Specialfeaturesofthisbook.Mas-Colelletal.(1995)isthestandardtextbook
for Ph.D. microeconomics today. In terms of its contents, our book covers all the
important materials in Mas-Colell et al. (1995). However, we do not include
materials that we consider to be out of the mainstream. Those materials that we
think should belong to field courses (such as social choice and public finance) are
also left out. On the other hand, we strengthen many topics that we think are
important, particularly in Chaps. 3, 5, 6, 10, 11, and 12. Roughly half of the
materialsinthisbookcanbefoundinMas-Colelletal.(1995)andtherestarefrom
manydifferentsources.Someadvancedmaterialsexistonlyinpapers.Ourbookis
intended to be a more focused and complete coverage on mainstream topics in
v
vi Preface
microeconomictheory.Inparticular,thisbookisintendedforpostgraduatestudents
in business schools, rather than just for students in economics departments.
This book is intended as a handbook for graduate students and professors. It is
concise with many of detailed explanations deliberately left out. Such a book is
goodforstudentswhowilllearnmostofthedetailsandexplanationsfromlecture.
Itisalsogoodforinstructorswhowouldwanttofillinthedetailsbythemselvesin
their own words. Teachers generally do not like a textbook to have too many
details. With a detailed textbook, some students may skip class and the instructor
may even feel like reading the book aloud in class. This book can also serve as a
reference book for those who have already learned all the materials. When such a
person wants to refresh some materials, he or she can quickly find the key points
of the material in the book without going through all the details.
The main enhancement of this edition over the second edition published by
McGraw-Hill in 2012 is the addition of one chapter, Chap. 8, on incomplete
informationgames.Suchgamesareessentialforinformationeconomics,butarenot
included in Mas-Colell et al. (1995). There are also many minor revisions in all
chapters.
Supporting materials. Exercises and their solutions are available in a PDF file
at www.bm.ust.hk/*sswang/; click the link in Part VI to download. Errors are
inevitableinsuchabookwithsomanydiversematerials.Wewilloffercorrections
at the site. We may also provide more materials such as more exercises, new
sections, and chapters on that site.
Acknowledgement. I would like to thank Dr. Virginia A. Unkefer for profes-
sional English editing.
Hong Kong, China Susheng Wang
December 2017
Contents
Part I Neoclassical Economics
1 Producer Theory... .... ..... .... .... .... .... .... ..... .... 3
1 Technology .... .... ..... .... .... .... .... .... ..... .... 3
2 The Firm’s Problem.. ..... .... .... .... .... .... ..... .... 14
3 Short-Run and Long-Run Cost Functions .. .... .... ..... .... 24
3.1 Definitions.... ..... .... .... .... .... .... ..... .... 24
3.2 Relationship Between AC and MC Curves.... ..... .... 26
3.3 Relationship Between SR and LR Cost Functions.... .... 27
4 Properties.. .... .... ..... .... .... .... .... .... ..... .... 29
5 Aggregation.... .... ..... .... .... .... .... .... ..... .... 35
2 Consumer Theory.. .... ..... .... .... .... .... .... ..... .... 37
1 Existence of the Utility Function. .... .... .... .... ..... .... 37
2 The Consumer’s Problem .. .... .... .... .... .... ..... .... 43
3 Properties.. .... .... ..... .... .... .... .... .... ..... .... 47
4 Aggregation.... .... ..... .... .... .... .... .... ..... .... 56
5 Integrability.... .... ..... .... .... .... .... .... ..... .... 57
6 Revealed Preferences. ..... .... .... .... .... .... ..... .... 58
7 Intertemporal Analysis..... .... .... .... .... .... ..... .... 61
3 Risk Theory... .... .... ..... .... .... .... .... .... ..... .... 69
1 Introduction.... .... ..... .... .... .... .... .... ..... .... 69
2 Expected Utility Theory.... .... .... .... .... .... ..... .... 70
3 Mean-Variance Utility..... .... .... .... .... .... ..... .... 77
4 Measurement of Risk Aversion.. .... .... .... .... ..... .... 79
5 Stochastic Dominance ..... .... .... .... .... .... ..... .... 81
6 Demand for Insurance..... .... .... .... .... .... ..... .... 86
7 Demand for Risky Assets .. .... .... .... .... .... ..... .... 88
8 Portfolio Analysis ... ..... .... .... .... .... .... ..... .... 91
4 General Equilibrium Theory .. .... .... .... .... .... ..... .... 95
1 The General Equilibrium Concept.... .... .... .... ..... .... 95
2 GE in a Pure Exchange Economy.... .... .... .... ..... .... 96
vii
viii Contents
3 Pareto Optimality.... ..... .... .... .... .... .... ..... .... 103
4 Welfare Theorems... ..... .... .... .... .... .... ..... .... 109
5 General Equilibrium with Production.. .... .... .... ..... .... 114
5.1 General Equilibrium with Production .... .... ..... .... 114
5.2 Efficiency of General Equilibrium... .... .... ..... .... 118
6 General Equilibrium with Uncertainty. .... .... .... ..... .... 123
Part II Micro-Foundation of Markets
5 Micro-foundation of Finance .. .... .... .... .... .... ..... .... 129
1 Security Markets .... ..... .... .... .... .... .... ..... .... 129
1.1 Contingent Markets.. .... .... .... .... .... ..... .... 129
1.2 Security Markets.... .... .... .... .... .... ..... .... 130
2 Static Asset Pricing.. ..... .... .... .... .... .... ..... .... 134
3 Representative Agent Pricing.... .... .... .... .... ..... .... 136
4 The Capital Asset Pricing Model. .... .... .... .... ..... .... 138
5 Dynamic Asset Pricing .... .... .... .... .... .... ..... .... 140
5.1 The Euler Equation.. .... .... .... .... .... ..... .... 140
5.2 Dynamic CAPM.... .... .... .... .... .... ..... .... 143
6 Continuous-Time Stochastic Programming . .... .... ..... .... 144
6.1 Continuous-Time Random Variables. .... .... ..... .... 144
6.2 Continuous-Time Stochastic Programming .... ..... .... 146
7 The Black-Scholes Pricing Formula... .... .... .... ..... .... 149
6 Micro-foundation of Industry.. .... .... .... .... .... ..... .... 153
1 A Competitive Output Market... .... .... .... .... ..... .... 153
2 A Monopoly ... .... ..... .... .... .... .... .... ..... .... 161
2.1 A Single-Price Monopoly. .... .... .... .... ..... .... 161
2.2 A Price-Discriminating Monopoly... .... .... ..... .... 163
2.3 Monopoly Pricing Under Asymmetric Information... .... 164
3 Allocative Efficiency . ..... .... .... .... .... .... ..... .... 166
4 Monopolistic Competition.. .... .... .... .... .... ..... .... 170
5 Oligopoly.. .... .... ..... .... .... .... .... .... ..... .... 172
5.1 Bertrand Equilibrium. .... .... .... .... .... ..... .... 173
5.2 Cournot Equilibrium. .... .... .... .... .... ..... .... 175
5.3 Stackelberg Equilibrium .. .... .... .... .... ..... .... 178
5.4 Cooperative Equilibrium.. .... .... .... .... ..... .... 178
5.5 Competition Versus Cooperation.... .... .... ..... .... 180
5.6 Cooperation in a Repeated Game ... .... .... ..... .... 181
6 Production Differentiation .. .... .... .... .... .... ..... .... 182
7 Location Equilibrium. ..... .... .... .... .... .... ..... .... 183
8 Entry Barriers .. .... ..... .... .... .... .... .... ..... .... 186
9 Strategic Deterrence Against Potential Entrants.. .... ..... .... 189
Contents ix
10 Competitive Input Markets . .... .... .... .... .... ..... .... 191
10.1 Demand and Supply . .... .... .... .... .... ..... .... 192
10.2 Equilibrium and Welfare.. .... .... .... .... ..... .... 193
11 A Monopsony .. .... ..... .... .... .... .... .... ..... .... 197
12 Vertical Relationships ..... .... .... .... .... .... ..... .... 200
12.1 Independent Firms... .... .... .... .... .... ..... .... 200
12.2 An Integrated Firm.. .... .... .... .... .... ..... .... 201
12.3 Explanation... ..... .... .... .... .... .... ..... .... 202
Part III Game Theory
7 Imperfect Information Games . .... .... .... .... .... ..... .... 209
1 Two Game Forms ... ..... .... .... .... .... .... ..... .... 209
1.1 The Extensive Form . .... .... .... .... .... ..... .... 209
1.2 The Normal Form... .... .... .... .... .... ..... .... 212
1.3 Mixed Strategy ..... .... .... .... .... .... ..... .... 214
2 Equilibria in Normal-Form Games.... .... .... .... ..... .... 217
2.1 Nash Equilibrium ... .... .... .... .... .... ..... .... 217
2.2 Dominant-Strategy Equilibrium. .... .... .... ..... .... 220
2.3 Trembling-Hand Perfect Nash Equilibrium.... ..... .... 223
2.4 Reactive Equilibrium. .... .... .... .... .... ..... .... 225
3 Equilibria in Extensive-Form Games.. .... .... .... ..... .... 227
3.1 Nash Equilibrium ... .... .... .... .... .... ..... .... 227
3.2 Subgame Perfect Nash Equilibrium.. .... .... ..... .... 230
3.3 Bayesian Equilibrium .... .... .... .... .... ..... .... 235
4 Refinements of Bayesian Equilibrium . .... .... .... ..... .... 248
4.1 Perfect Bayesian Equilibrium .. .... .... .... ..... .... 248
4.2 Sequential Equilibrium ... .... .... .... .... ..... .... 254
4.3 BE Under Complete Dominance: CDBE.. .... ..... .... 261
4.4 BE Under Equilibrium Dominance: EDBE.... ..... .... 264
4.5 Alternative Versions of PBE... .... .... .... ..... .... 268
8 Incomplete Information Games .... .... .... .... .... ..... .... 271
1 Bayesian Nash Equilibrium. .... .... .... .... .... ..... .... 272
2 Signalling Games.... ..... .... .... .... .... .... ..... .... 279
2.1 Pure Strategies in Signalling... .... .... .... ..... .... 279
2.2 Mixed Strategies in Signalling . .... .... .... ..... .... 280
2.3 Cheap Talk... ..... .... .... .... .... .... ..... .... 286
9 Cooperative Games. .... ..... .... .... .... .... .... ..... .... 299
1 The Nash Bargaining Solution... .... .... .... .... ..... .... 299
1.1 The Nash Solution .. .... .... .... .... .... ..... .... 300
1.2 Implementation of the Nash Solution .... .... ..... .... 302