Lecture 1 · Weeks 1–2 · Lecture notes & Besanko & Braeutigam ch. 1 · about 35 min

Analyzing Economic Problems

The toolkit microeconomics brings to every decision: scarcity and opportunity cost, marginal analysis, the difference between positive and normative claims, and what makes a market a market.

By the end you can

Name the four factors of production and the income each one earns
Classify goods: free vs economic, substitutes vs complements, durable vs nondurable, consumer vs producer vs intermediate
State the three basic economic questions and define full employment
Distinguish partial from general equilibrium, and static from dynamic analysis
Compute opportunity cost and explain why it, not accounting cost, drives rational decisions
Apply marginal analysis: keep doing something while marginal benefit exceeds marginal cost
Distinguish positive economics from normative economics
Define a market and distinguish perfectly competitive markets from other market structures

Key idea · Exam recipe: microeconomic analysis (memorise this)

Classify variables: Exogenous variables come from outside the model and are taken as given (income, input prices, government taxes); endogenous variables are solved inside the model (quantities bought, equilibrium price).
Constrained optimization: Identify the objective function (maximise utility/profit or minimise cost) and the constraint (budget line, production target). Substitute the constraint into the objective and set the derivative to zero.
Opportunity cost & economic profit: Explicit costs are out-of-pocket accounting expenses. Opportunity costs are the highest values of alternatives sacrificed. $\text{Economic profit} = \text{Revenue} - \text{Explicit costs} - \text{Implicit opportunity costs}$ . Sunk costs must be ignored.
Marginal decision rule: Continue an activity as long as marginal benefit exceeds marginal cost ( $MB \gt MC$ ); stop where $MB = MC$ . Never expand when $MB \lt MC$ .
Equilibrium & comparative statics: Equate quantity demanded and quantity supplied ( $Q^d = Q^s$ ) to solve for $P^*$ and $Q^*$ . When an exogenous variable shifts, resolve the new equilibrium and find $\Delta P^*$ and $\Delta Q^*$ .

How the exam asks it: three core exam templates

In microeconomics exams, questions on economic analysis test your ability to structure problems into formal models, distinguish economic profit from accounting profit, and compute market equilibria with exogenous shifts.

Exam template 1: Opportunity cost and economic profit

Question: A university graduate could earn 40,000 TL a year working for an established firm. Instead, she opens a café: total revenue is 180,000 TL per year, and out-of-pocket operating expenses (rent, ingredients, employee wages) are 130,000 TL per year.
a) Calculate the café’s accounting profit.
b) State the opportunity cost of the owner’s time and calculate the economic profit.
c) From an economic standpoint, is opening the café a rational decision? Explain.

Exam template 2: Constrained optimization (farmer’s fence)

Question: A farmer has 100 metres of fencing material and wants to build a rectangular enclosure with the maximum possible enclosed area.
a) State the objective function, the constraint, the endogenous choice variables, and the exogenous parameter.
b) Solve for the optimal dimensions length $L^*$ and width $W^*$ .
c) Compute the maximum enclosed area.

Exam template 3: Market equilibrium and comparative statics

Question: In a competitive market, demand is given by $Q^d = 50 - 2P + 0.1I$ and supply is given by $Q^s = -10 + 2P$ , where $I$ is consumer income.
a) Determine the equilibrium price $P^*$ and quantity $Q^*$ when $I = 200$ .
b) Determine the new equilibrium price $P^*$ and quantity $Q^*$ when income rises to $I = 400$ .
c) Calculate the comparative statics changes $\Delta P^*$ and $\Delta Q^*$ , and classify the good as normal or inferior.

Cheat-sheet & the 4-step method

· Cheat-sheet: core tools of microeconomic problem analysis

Tool / Concept	Formula or Definition	When to use it	How to write the exam answer
Constrained optimization	$\max_{x} U(x) \text{ s.t. } g(x) \le c$	Solving optimal consumer or producer choices	State objective, constraint, endogenous choice variables and exogenous parameters; differentiate to find optimum
Opportunity cost	Best forgone alternative value	Evaluating economic viability of any choice	Value the highest sacrificed alternative; ignore sunk costs
Economic profit	$\pi_{\text{econ}} = TR - EC - OC$	Comparing business returns to outside options	$\text{Accounting profit} - \text{implicit costs}$ ; positive means venture beats alternative
Marginal decision rule	Expand if $MB \gt MC$ ; stop at $MB = MC$	Deciding how much of an activity to undertake	Compare $MB$ vs $MC$ unit by unit; choose quantity where $MB \ge MC$
Equilibrium condition	$Q^d(P) = Q^s(P)$	Finding market-clearing price and quantity	Set equations equal, isolate $P^$ , substitute into either curve for $Q^$
Comparative statics	$\Delta P^* = P_2^* - P_1^$ , $\Delta Q^ = Q_2^* - Q_1^*$	Analysing impact of a change in an exogenous variable	Find old and new equilibria, compute difference, state economic interpretation

Key idea · The 4-step method for microeconomic analysis problems

Step 1: Identify model type and variables.
- Distinguish endogenous variables (solved inside the model, e.g. $P, Q, L, W$ ) from exogenous parameters (fixed from outside, e.g. $I, \text{costs}, \text{taxes}, \text{weather}$ ).
Step 2: State the formal rule.
- For optimization: write $\max \text{Objective}$ subject to $\text{Constraint}$ .
- For market equilibrium: write $Q^d(P) = Q^s(P)$ .
- For marginal choice: compare $MB$ against $MC$ .
- For profit: state $\text{Economic profit} = TR - \text{Explicit costs} - \text{Opportunity costs}$ .
Step 3: Perform arithmetic step-by-step.
- Substitute exogenous values.
- Solve line-by-line without combining steps.
- For derivatives, write the derivative function explicitly before setting to zero.
Step 4: Check and write the bold conclusion.
- Verify units (TL, units, square metres).
- Sanity check directions (does higher demand raise price?).
- Write the final answer as a complete sentence with numbers and economic reasoning.

What microeconomics studies

Microeconomics studies how individual households, firms and markets make decisions when resources are scarce, and how those decisions interact to determine prices and quantities. Where macroeconomics asks “why is the whole economy growing or shrinking,” microeconomics asks “why does this firm charge this price, and why does this household buy this much.”

The first lecture put it in one line: resources are limited, needs and wants are unlimited. Everything else in the course follows from that gap.

Micro versus macro

Macroeconomics studies the economy as a whole	Microeconomics studies the individual units
inflation	consumers
unemployment	firms
economic growth	individual markets
GDP	prices
interest rates	supply and demand

Resources: the four factors of production

Resources (also called inputs or factors of production) are what an economy uses to produce goods and services. There are four, and each one earns its own kind of income.

Factor	What it is	Its return
Labour	people working or looking for work	wage (or salary)
Land	all natural resources: soil, water, minerals, forests	rent
Capital	man-made assets used in production: machines, buildings, tools	interest
Entrepreneurship	organising production and taking on the risk	profit

Labour is not one thing. Lecture split it two ways:

Qualified vs unqualified labour. Qualified workers have education, training or experience for a specific job; unqualified workers do not.
Blue, white and pink collar. Blue-collar workers do physical work (factory, construction) and are usually paid a wage by the hour or week. White-collar workers do office and professional work and are paid a monthly salary. Pink-collar workers do care and service jobs such as nursing, historically held mostly by women.

Goods and services

Resources are turned into goods and services that satisfy needs.

Goods are physical products you can touch and store.
Services are intangible activities (a haircut, a lesson, a doctor’s visit). A service cannot be stored: it is produced and used at the same moment.

Free goods and economic goods

A free good is so abundant that nobody pays for it and using it costs nobody anything: the air you breathe.
An economic good is limited, so it has a price and somebody has to give something up to get it. Almost everything studied in this course is an economic good.

Types of goods

Type	Meaning	Example
Complements	used together	tea and sugar, phone and charger
Substitutes	used instead of each other	car or motorcycle, tea or coffee
Consumer goods	bought by households for final use	water, bread
Nondurable goods	used up quickly or in one use	fuel, food
Durable goods	last for years	cars, refrigerators
Producer (capital) goods	used to produce other goods, not used up in one go	machines, tools
Intermediate goods	used as inputs and used up inside another good	flour in bread, steel in a car
Cultural goods	goods and activities with cultural value	newspapers, going to a museum

Complements and substitutes come back in Week 3: a rise in the price of a substitute shifts demand right, a rise in the price of a complement shifts it left.

Three types of utility

Production does not only mean making things. It also means making them more useful, and lecture listed three ways:

Form utility: created by changing the form of a good (wood into a table).
Place utility: created by moving a good to where it is needed (bringing fruit from the farm to the city market).
Time utility: created by making a good available when it is needed (storing wheat after harvest and selling it in winter).

The three basic economic questions

Because resources are limited, every economy has to answer three questions:

What to produce? Which goods and how much of each. Firms keep producing a product while there is demand for it.
How to produce? With which combination of labour, land, capital and technology.
For whom to produce? Who receives the goods and services.

Opportunity cost

Every choice has a cost measured not in money alone, but in the best alternative given up.

Opportunity costDefinitionFormula sheet →

\text{Opportunity cost of an action} = \text{value of the best forgone alternative}

Use it when a decision involves giving up one option to take another, even when no money changes hands directly, such as choosing how to spend an afternoon.

Marginal analysis

Rational decision-makers do not usually ask “should I do this activity at all?” — they ask “should I do a little more of it?” This is marginal analysis, and it is the single most-used tool in microeconomics.

The marginal decision ruleKey ruleFormula sheet →

\text{Keep expanding an activity while } MB \gt MC; \text{ stop when } MB = MC

$MB$: marginal benefit of one more unit
$MC$: marginal cost of one more unit

Use it when you are deciding how much of something to do — how many units to produce, how many hours to study, how many workers to hire — rather than a simple yes/no decision.

Positive versus normative economics

A positive statement is testable: it can be checked with data, and it answers “what is?”. A normative statement is based on opinions or values, cannot be proven true or false by data alone, and answers “what should be?”.

Positive vs normativeDistinctionFormula sheet →

\text{Positive: what IS, testable with data} \qquad \text{Normative: what SHOULD BE, a value judgement}

Use it when a statement needs to be classified as a factual claim (positive) or an opinion about policy (normative), a very common first-exam question.

Economic models and ceteris paribus

Economics builds deliberately simplified models of reality — not because reality is simple, but because a model with every detail included would be too complicated to learn anything from. Models isolate the relationship of interest by holding everything else fixed.

Ceteris paribusLatin: 'other things equal'Formula sheet →

\frac{\partial Q^d}{\partial P}\Big|_{\text{income, tastes, other prices fixed}} \lt 0

$Q^d$: quantity demanded, held to a strictly negative response to P only once every other influence is held constant

Use it when a model isolates the effect of one variable — such as price — by assuming every other relevant variable stays fixed.

The three analytical tools

Besanko and Braeutigam build the whole course on three tools: constrained optimization, equilibrium analysis and comparative statics. Every later lesson uses at least one of them. Before using any of them you have to sort the variables of the problem into two groups.

Constrained optimization

A decision-maker chooses the endogenous variables to make an objective function as large (or as small) as possible, subject to a constraint that limits the choice.

Constrained optimizationStructureFormula sheet →

\max_{\text{choice variables}} \ \text{objective function} \quad \text{subject to} \quad \text{constraint}

$objective function$: what is maximised or minimised (utility, profit, area, cost)
$constraint$: the limit on the choice (income, a fixed amount of an input, time)

Use it when a problem asks for the best choice under a limit. Name the objective, the constraint, and which variables are endogenous and exogenous.

The consumer’s problem later in the course has exactly this shape: maximise utility (objective) subject to the budget line (constraint), with income and prices exogenous and the quantities bought endogenous.

Equilibrium analysis and comparative statics

Equilibrium analysis finds the state where nothing tends to change (next section). Comparative statics asks how that equilibrium changes when an exogenous variable changes.

Equilibrium: partial and general

Partial equilibrium analysis studies one market (or one part of the economy) at a time, assuming everything else stays unchanged. The supply and demand diagrams in Week 3 are partial equilibrium.
General equilibrium analysis studies all markets in the economy simultaneously and how they interact with each other. It is closer to the real world, but much harder.

Lecture also named three ways to use equilibrium:

Static analysis looks at one equilibrium at a single point in time.
Comparative statics compares two equilibria, before and after something changes (for example, before and after a tax), without asking how the market gets from one to the other.
Dynamic analysis follows the path the economy takes over time as it moves between equilibria.

What makes a market

MarketDefinitionFormula sheet →

\text{Market} = \text{buyers and sellers whose interactions determine the price of a good or service}

Use it when you need to identify the relevant market for a good before analysing supply, demand, or market power.

A key question in defining a market is substitutability: goods are in the same market if buyers readily switch between them in response to price changes. Markets differ enormously in structure, and this course builds toward comparing two extremes: perfectly competitive markets, where many small buyers and sellers trade an identical (homogeneous) product and no single participant can affect the price, and monopoly, the opposite extreme with a single seller. Most real markets sit somewhere between.

Conditions for a perfectly competitive marketChecklistFormula sheet →

1.\ \text{Many small buyers and sellers} \quad 2.\ \text{Homogeneous (identical) product} \quad 3.\ \text{Free entry and exit} \quad 4.\ \text{Full information}

Use it when you need to check whether a described market can be treated as perfectly competitive, the benchmark model built up over Weeks 9 to 10 of this course.

Exam practice

Summary and review

Three tools: constrained optimization (objective + constraint), equilibrium analysis, comparative statics. Exogenous variables are given, endogenous ones are solved for.
Resources are limited, wants are unlimited: that gap is scarcity.
Four factors of production and their returns: labour (wage), land (rent), capital (interest), entrepreneurship (profit).
Free goods cost nobody anything; economic goods are scarce and have a price. Services cannot be stored.
Producer goods are used again and again; intermediate goods are used up inside the final product.
Form, place and time utility. Three basic questions: what, how, and for whom to produce.
Partial equilibrium looks at one market, general equilibrium at all markets together. Comparative statics compares two equilibria.
Scarcity forces choice; the true cost of any choice is its opportunity cost, the best forgone alternative.
Sunk costs are already spent and irrelevant to forward-looking decisions.
Marginal analysis: expand an activity while MB > MC; stop at MB = MC.
Positive economics describes what is (testable); normative economics prescribes what should be (a value judgement).
Ceteris paribus isolates one relationship by holding everything else fixed — the core simplifying device of economic models.
A perfectly competitive market has many small buyers and sellers, a homogeneous product, free entry/exit, and full information.