Getting Creative in Intermediate Microeconomic Theory

- - posted in economics, groupwork, lecture

Intermediate Micro Theory is a required course for all economics majors. Grades are typically based exclusively on problem sets and exams. I just posted this rather unconventional assignment for my Intermediate Micro students. They will work on it throughout the semester. I have no idea how it will go, but it will be fun to find out!

The Assignment

Most of the work you do in this class involves analyzing and answering questions about models and markets that I give you. In this project, you will work in 4-5 person groups to model and analyze a market of your choice using the theoretical methods you learn here. This is your opportunity to think creatively and choose a market that you care about.

The Market Description (1 page)

You should write three or four prose paragraphs about a market. First provide the basic facts about the market: What is being produced and/or exchanged? Is this a local or global market? Where are the agents? Who is doing the buying and selling?

You should also describe what is interesting about the market. Are there important externalities (positive or negative)? That is, are people outside the market affected by market activity? Do any of the agents involved have less than complete information? Are there relevant regulations that affect the market?

Next year, I’ll be able to use the best of your market descriptions as examples. This year, you can use a few of my ideas as inspiration:

  • Solar panels: Once a system is installed, solar panels provide free, clean electricity. The alternative is electricity from the power grid which has no fixed cost, but substantial variable costs. The government subsidizes these fixed costs (e.g., NY-Sun program) because of the pollution externalities present in most electricity provided from the grid.
  • Health insurance: This is a market plagued by “adverse selection” as individuals often know more about the state of their health than insurance providers. Once insured, people have lower incentives to invest in their health. This is called “moral hazard.” Insurance contracts and many government regulations try to address these two impediments to economic efficiency.
  • Low skill labor: You might choose to think about how US firms decide whether to hire low skill labor locally or outsource production to countries where wages are lower. What is the impact of the minimum wage on such a market? How might other regulations/tariffs affect this market?
  • Country songs: Markets for intellectual property differ in interesting ways from physical markets. In country music, most songs are not written by the artists who record and perform them. Instead, most songwriters live in Nashville and try to sell their work to publishers who in turn sell those songs to the artists.

Be creative! The market you choose is not set in stone–You will be able to modify or change your choice later if you need to.

Part 2: Preferences and Production Description (5-7 pages)

  1. Describe in detail the characteristics of the consumers in the market. What does demand look like? Is it elastic or inelastic? Are there obvious substitute goods available? Are there important complements? Is there decreasing marginal utility of consumption?
  2. Write down a utility function for a typical consumer. Justify the functional form you’ve chosen.
  3. Write down the consumer’s optimization problem including the budget constraint.
  4. If your market has producers:
    1. Describe the production process in detail. Are there high fixed costs? Are there high variable costs? What are the production inputs?
    2. Write down a production function and justify its functional form.
    3. Derive the cost function from the production function and prices of inputs.
    4. Use the cost function and output prices to set up a firm’s profit maximization problem.
  5. If your market involves only buyers and sellers (e.g., the FCC spectrum auction or the residential housing market), describe as precisely as possible the rules of the market.

Part 3: Market Analysis (5-10 pages plus poster)

  1. Describe the distribution of firms and consumers in the market. Are there only a few on one side or both sides? Is there a mix of very different kinds of firms? Or consumers?
  2. Aggregate the consumer demand functions to construct a market demand.
  3. Describe and write down mathematically any important constraints or regulations on the market.
  4. If possible, solve for the equilibrium outcome.
  5. Say something interesting about the market. Some ideas: a. How would changes in input prices affect the market equilibrium? b. Is there a policy that if implemented would improve efficiency? c. What implications would an improvement in production technology have? d. Is the market outcome efficient? e. How is market surplus divided between consumers and producers/sellers?

Posters will contain only the most important pieces of your analysis—You won’t have room to put down everything you do. The poster session will take place on the evening of May 10. Groups will be divided into three “waves.” When one wave is showing their posters, the rest of you will wander around learning about the projects, asking questions, and giving feedback. You’ll also listen to music, eat and drink, and generally have a good time. Posters will be single page PowerPoint or pdf files, and they will be displayed on mobile ClickShare stations. The screens are about four feet diagonally, so don’t make your text too small. You can see what the poster session in my Applied Econometrics class looked like last semester on my blog.

Grades

Part 1 and the poster are required but ungraded. Groups will receive overall grades for the quality of their work on the Preferences and Production Description and the written Market Analysis. Individual student grades on these two parts of the assignment will be the average of the group grade and a composite peer score. After the group submits a part of the assignment, each group member will anonymously rate each of their group peers on their dependability and effort using a scale from 1 to 5. The peer score is composed of the ratings each student gets from their teammates. The goal of including a peer evaluation component in your grade is to reward students who participate in the project and discourage free-riding.

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