ECO601E: Advanced Microeconomics II

Last Updated: August 13


Term / Time: Spring 2nd ses. / Tuesday 10:35-12:05 and 13:20-14:50

Class room: H

Office hours: Wednesday 11:00-13:00 (Room C911)

Syllabus: A word file



0. Announcement

(Released date, gCommentsh)


2008/08/13, gProblem sets 5&6 and the final exam have been graded and returned to your mail-box.h New!

2008/07/11, gProblem set 6, due on July 22, is available now.h

2008/07/08, gProblem set 4 has been graded and returned to your mail-box. The solution keys for problem set 5 are uploaded.h

2008/07/07, gSolution keys for problem set 4 are uploaded.h

2008/07/01, gThere is a problem set due on July 8.h

2008/06/25, gWe have a final exam on July 22 from 10:35-12:05h Important!

2008/06/25, gWe have make up classes on July 2 and 9 from 13:20 to 14:50.h

2008/06/25, gThere is no class on July 15.h

2008/06/18, gThere is a problem set due on June 25.h

2008/06/18, gPlease take a look at the handout about introduction of game theory before the next class.h Important!

2008/05/27, gWe have make up classes on June 11, 18 and 25 from 9 to 10:30.h

2008/05/27, gThere is no afternoon class on May 27. Both morning and afternoon classes will be cancelled on June 3.h


1. Course Description


This is an advanced course in microeconomics, succeeding to Advanced Microeconomics I in which we study individual economic decisions and their aggregate consequences under ideal situations. In this course, we extend our previous analyses to incorporate less than ideal conditions. More specifically, we consider imperfectly competitive market structures, missing markets, uncertainty, and incomplete information.



2. Lecture Schedule and Topics


Lecture 16 (6/10)


7. Uncertainty

 7.1 Lottery and prospect

  7.1.1 Probability and expected value

  7.1.2 St. Petersburg Paradox Class room questionnaire

 7.2 Expected utility theory

  7.2.1 von Neumann and Morgenstern foundation How to construct a vN-M utility function Invariant up to linear transformation

  7.2.2 Allais Paradox Class room questionnaire Violation of independence axiom

  7.2.3 Ellsberg Paradox Class room questionnaire Ambiguity vs. risk


Lecture 17 (6/10)


 7.3 Risk aversion

  7.3.1 Fair games and attitudes to risk

  7.3.2 Certainty equivalence and risk premium

  7.3.3 Absolute risk aversion

  7.3.4 Relative risk aversion

7.4 Insurance market

 7.4.1 Graphical analysis MRS and 45 degree line

 7.4.2 Maximizing expected utility Full insurance under fair prices


Lecture 18 (6/11)


 7.5 Arrow-Debreu security (ADS)

  7.5.1 No aggregate risk Efficient allocations = 45 degree line Full insurance in equilibrium Independence of preferences

  7.5.2 Aggregate risk Efficient allocations = between 45 degree lines ADS for bad scenario is more expensive

 7.6 Markets for lemon

  7.6.1 Asymmetric information between sellers and buyers

  7.6.2 Market failure => adverse selection


Lecture 19 (6/17)


Handout: Machina (1987), gChoice Under Uncertainty: Problems Solved and Unsolvedh Journal of Economic Perspectives, Summer 1987, pp. 121-132, 147-150.


Review on the final exam (Advanced Microeconomics I)


8. Monopoly

 8.1 Basic model

  8.1.1 Monopoly quantity

  8.1.2 Monopoly price

  8.1.3 Optimal pricing


Lecture 20 (6/17)


 8.2 Price discrimination (note)

  8.2.1 First degree (perfect)

  8.2.2 Second degree (nonlinear pricing)

  8.2.3 Third degree

  8.2.4 Limitation


Lecture 21 (6/18)


Handout: Varian (1992), Microeconomic Analysis, Chapter 14 (Monopoly), pp. 244-247.

Handout: Gibbons (1997), gAn Introduction to Applicable Game Theoryh Journal of Economic Perspectives, Winter 1997, pp. 127-137. Please read it before the next lecture!


 8.3 Screening (menu pricing)

  8.3.1 Asymmetric information

  8.3.2 Example: Two type consumers Principal agent model Information rent Consumption distortion for low type Efficiency at the top


Lecture 22 (6/24)


9. Introduction to game theory

 9.1 Motivation

 9.2 Nash equilibrium

 9.3 Simple 2 x 2 games

  9.3.1 Prisonerfs dilemma

  9.3.2 Coordination game

  9.3.3 Battle of the sexes

 9.4 Oligopoly models

  9.4.1 Hotelling model: Location choice Principle of minimum differentiation

  9.4.2 Bertrand model: Price competition Price = marginal cost


Lecture 23 (6/24)


9.4.3 Cournot model: Quantity competition First order conditions Best response function Graphical analysis

 9.5 Mixed strategy

  9.5.1 Matching penny

  9.5.2 Mixed strategy Nash equilibrium

  9.5.3 Kakutanifs fixed point theorem

  9.5.4 Existence of Nash equilibrium


Lecture 24 (6/25)


10. Dynamic games

 10.1 Entry game

  10.1.1 Credible and non-credible equilibria

  10.1.2 Backward induction solution

 10.2 Subgame perfect Nash equilibrium (SPE)

  10.2.1 Existence of SPE

  10.2.2 Example of multiple SPE

 10.3 Stackelberg model

  10.3.1 Non-credible NE

  10.3.2 Unique SPE

  10.3.3 Graphical analysis


Lecture 25 (7/01)


11. Repeated games

 11.1 Motivation and basic set-up

 11.2 Finitely repeated games

  11.2.1 Backward induction and unique SPE

  11.2.2 Example of multiple SPE

 11.3 Infinitely repeated games

  11.3.1 Alternative interpretation

  11.3.2 How to check SPE

  11.3.3 Collusion Trigger strategy


Lecture 26 (7/01)


  11.3.4 Folk theorem Nash-reversion Proof Perfect folk theorem Mini-max payoffs Implication

  11.3.4 Application: Reputation Firm as a going concern


Lecture 27 (7/02)


Handout: Kreps (1990), A Course in Microeconomic Theory, Chapter 15 (Bilateral Bargaining), pp. 556-565.


12. Bargaining

 12.1 Motivation and examples

  12.1.1 Wage negotiation

  12.1.2 Bilateral trade

 12.2 Simultaneous offer game

  12.2.1 Multiple NE

12.3 Ultimatum game

 12.3.1 Take-it-or-leave-it-offer

 12.3.2 Multiple NE

 12.3.3 (Essentially) Unique SPE

 12.3.4 Experimental results

 12.4 Alternating offer game (Rubinstein model)

  12.4.1 Stationary SPE

  12.4.2 Properties of equilibrium The first proposer gets more Patient player gets more (Almost) Fair division when little discount

  12.4.3 Uniqueness (see handout)


Lecture 28 (7/08)


12.5 Nash bargaining solution

  12.5.1 Introduction to cooperative games

  12.5.2 Axiomatic approach

  12.5.3 Graphical analysis

  12.5.4 Nashfs theorem


Lecture 29 (7/08)


Handout: Osborne and Rubinstein (1990), Bargaining and Markets, Chapter 2 (The Axiomatic Approach: Nashfs Solution), pp. 9-15.


12.6 Nash program

 12.6.1 Alternating offer game

 12.6.2 Role of Nash program


13. Bayesian Games

 13.1 Games with incomplete information

 13.2 Bayesian games (Harsanyifs formulation)

 13.3 Bayesian Nash equilibruim

 13.4 Sealed bid first price auction


Lecture 30 (7/09)


Handout: Myerson (1991), Game Theory: Analysis of Conflict, Chapter 2 (Basic Models), pp. 74-83.


Review of problem set 4 and problem set 5



3. Problem Set


There will be three problem sets:

*      First (due on 6/25, pdf, solution)

*      Second (due on 7/08, pdf, solution)

*      Third (due on 7/22, pdf, solution)



4. Grading


Course grade will be determined by combining grades on problem sets (30%) and a final exam (70%).

Problem sets will be distributed in class and will be due a week later. Because solutions are published, late problem sets cannot be accepted. You are encouraged to form study group, but must write up solutions independently.

*      Final exam (pdf, comments, comments on grading)



5. Textbooks


The textbook for the course is:


Walter Nicholson, Microeconomic Theory: basic principles and extensions, 10th edition 2007


A highly readable textbook whose second part contains a lot of intuitive discussion on the topics of our course is:


  David M. Kreps, Microeconomics for Managers, 2004


If you look for some textbooks for contract theory (principal-agent model) or game theory, the followings are recommended.


  Jean-Jacques Laffont and David Martimort, The Theory of Incentives: The Principal-Agent Model, 2002

Robert Gibbons, Game Theory for Applied Economics, 1992




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