Microeconomics & Game Theory

Christian Thöni

UNIL-Centre de droit public

University of Lausanne, Fall 2022

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 1 / 24
 Lecture 0: Preamble Objectives

Objectives

This course provides an introduction to microeconomics, game theory, and

industrial organization. Economics is a social science, offering a coherent theory
with the aim to explain human behavior. Students learn to ‘think like an
economist’ and to apply the theory to real world problems. The course contains
both a graphical and intuitive approach and introduces the students to the basic
analytical tools necessary to solve microeconomics optimization problems.

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 2 / 24
 Lecture 0: Preamble Contents

Contents
The course will cover the following topics
Microeconomics
I Consumer behavior
I Firm behavior
I Supply and demand in competitive markets
I Welfare theorems
I Externalities
Game theory
I Strategic interaction
I Normal form games
I Extensive form games
I Repeated games
I Solution concepts
Industrial organization
I Imperfect competition, monopoly, oligopoly
I Price discrimination
I Cartel formation

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 3 / 24
 Lecture 0: Preamble Procedures

Procedures

Style Lectures and exercises

Literature Slides, articles, and textbook:

Robert H Frank. Microeconomics and Behavior.
8th ed. McGraw-Hill, 2009

Requirements (a) Students hand in & present problem sets in class.

(b) Economic naturalist exercise: Short presentation
(5 min) and paper (1 page).

Exam Written, 2h, closed book. (4 function calculator ac-

cording to HEC directive)

Payoff 6 credits, grade: 20 percent problem sets; 80 percent

final exam.

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 4 / 24
 Lecture 0: Preamble Plan

Schedule (preliminary)

Week Date Material Date Material

1 21.09 F1 23.09
2 28.09 F2 30.09 F3
3 05.10 F4 07.10 F5
4 12.10 F9 14.10 F10
5 19.10 F11 21.10 F12
6 26.10 F16 28.10 F17
7 02.11 GT1 04.11
8 09.11 11.11
9 16.11 18.11
10 21.11 25.11
11 30.11 02.12
12 07.12 09.12
13 14.12 16.12
14 21.12 23.12

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 5 / 24
 Lecture 0: Preamble Plan

Further literature
Main textbook, microeconomics with a pinch of behavioral economics: Frank,
Microeconomics and Behavior
Introductory textbook in game theory: Martin J Osborne. An introduction to
game theory. Oxford University Press, 2003
Playing for Real: Kenneth G Binmore. Playing for Real—A Text on Game
Theory. New York: Oxford University Press, 2007
Game theory and the law: Douglas G Baird, Robert H Gertner, and
Randal C Picker. Game Theory and the Law. Harvard University Press, 1994
Standard textbook in Microeconomics: Hal R Varian. Intermediate
Microeconomics: A Modern Approach. Norton, 2010
Microeconomics, more advanced, very interesting: Samuel Bowles.
Microeconomics: Behavior, Institutions, and Evolution. Princeton University
Press, 2004
Classical textbook on industrial organization, advanced: Jean Tirole. The
Theory of Industrial Organization. Vol. 56. 223. The MIT Press, 1994, p. 401

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 6 / 24
 Lecture 1: Thinking Like an Economist

Lecture 1:

Thinking Like an Economist

Contents

Lecture 1: Thinking Like an Economist

What is economics?
Explaining choices
Thinking like an economist
Deviations from rational choice
Economic Naturalist
Readings
Frank (2009), chapter 1

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 7 / 24
 Lecture 1: Thinking Like an Economist What is economics?

What is economics?

Subject
‘economic’ relations (con- non-economic relations
sume, work) (friends, relatives)
economic traditional economics non-market economics,
Method
environmental economics,
public choice
other Organizational behavior Sociology, Psychology . . .

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 8 / 24
 Lecture 1: Thinking Like an Economist What is economics?

Economics as subject

Microeconomics
Utility maximization of consumers
Profit maximization of firms
Interactions in markets and strategic settings
Macroeconomics
Aggregation across all markets
Business cycles
Exchange rates
Economic growth

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 9 / 24
 Lecture 1: Thinking Like an Economist Explaining choices

Theories and predictive success

Why do we need a theory about human behavior?

Policymaker: How will the firms react to fiscal stimuli?
Lawmaker: How will people react to the introduction of a new law?
Business people: How will customers react to changes in product prices or
advertising
Private: How will friends react to gifts or insults?
In everyday life we constantly ‘theorize’ about others behavior and unconsciously
use our model of human behavior to predict behavior.

A good model is a model with

Precise predictions
High predictive success (i.e., often predicts behavior correctly)
Relation between these two aims?

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 10 / 24
 Lecture 1: Thinking Like an Economist Explaining choices

Explaining choices

How do we explain human behavior. Economics offers a widely applicable model

of human behavior. The model has several names. Gintis1 calls it the BPC model.

Ingredients
B. Beliefs. What will others do?

P. Preferences. Well defined and stable.

C. Constraints. Given by the scarcity of money, time, abilities.

1 Herbert Gintis. “A framework for the unification of the behavioral sciences.” In: Behavioral and Brain Sciences 30.1 (2007), pp. 1–61. doi:
10.1017/S0140525X07000581.
Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 11 / 24
 Lecture 1: Thinking Like an Economist Explaining choices

Preferences

Without restrictions on preferences the model is not of much use. Traditionally

economists take a very extreme position and assume that actors are homo
economicus. The model is also called the ‘rational choice approach’.

A homo economicus is
Rational
Selfish
Utility maximizer
Has stable preferences

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 12 / 24
 Lecture 1: Thinking Like an Economist Explaining choices

Restrictive assumptions on preferences?

What is a good model?

There is a trade-off between predictive success and usefulness of a model.

Assumptions with regard to preferences

Restrictive No restrictions on preferences

Example: Actors maximize their own Example: Actors donate anonymously
material wealth because they like to donate
Ô Exact predictions Ô Unclear predictions, anything goes
Ô Falsifiable Ô Non-falsifiable

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 13 / 24
 Lecture 1: Thinking Like an Economist Thinking like an economist

Thinking like an economist: Cost benefit analysis

Which alternative yields the highest net utility?

Price Utility Net-utility

Ferrari 300’000
Fiat 30’000

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 14 / 24
 Lecture 1: Thinking Like an Economist Thinking like an economist

Thinking like an Economist: The scarcity principle

Wants are unlimited, but means are limited. Resources are scarce for most of
us, time is scarce for all
For every decision we face a trade-off: spending money or time on one
activity means that we have less to spend on other activities

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 15 / 24
 Lecture 1: Thinking Like an Economist Thinking like an economist

Thinking like an economist: Opportunity cost

“There’s No Such Thing as a Free Lunch”

Every decision has opportunity costs, because deciding for X means to forgo Y .

Example: Going out

Assume you plan to go out at Saturday night.

Utiliy Price Net-utility Opportunity Net utility

(isolation) cost total
Cinema 20 15
Theater 45 30
Opera 90 88

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 16 / 24
 Lecture 1: Thinking Like an Economist Thinking like an economist

Thinking like an economist: Comparative Analysis

Situations are not evaluated in isolation, but relative to other feasible states of the
world.

Example. Compare Swiss style democracy to other, existing representative

democracies (and not to the ideal state)

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 17 / 24
 Lecture 1: Thinking Like an Economist Thinking like an economist

Application

Choice of transportation: Car or bike?

The decision depends on

Preferences: car lover, sport lover
Constraints: income, prices of fuel, price of bike usage, value of time
(Beliefs: what do others do? only important if strategic interactions)

How to influence the choice between bike and car?

Change preferences: moral suasion, education (6= economics approach)
Change constraints: subsidies for bikers, fuel tax, parking fees

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 18 / 24
 Lecture 1: Thinking Like an Economist Thinking like an economist

Normative vs. positive

Positive economics. What is?

I What happens to gasoline prices if crude oil becomes cheaper?
I How changes employment when the government lowers unemployment
benefits?
I Development of income inequality over time?

Normative economics. What should be?

I Is the tax burden too high?
I Should Switzerland spend more on development aid?
I Are salaries of top managers too high?

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 19 / 24
 Lecture 1: Thinking Like an Economist Thinking like an economist

Other examples

Terrorism
Chances for survival of war prisoners
Unethical behavior of managers
...

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 20 / 24
 Lecture 1: Thinking Like an Economist Deviations from rational choice

Are ordinary people homo economicus?

How do we find out whether a theory produces correct predictions?

Ô Confront the predictions with data
How? See parallel class “Empirical methods for Lawyers”

Good theories produce testable predictions. Empirical observations either

confirm or refute the predictions. The latter case should motivate researchers to
improve the theory.

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 21 / 24
 Lecture 1: Thinking Like an Economist Deviations from rational choice

Deviations from rational choice

The field of behavioral economics has identified a number of areas where people
systematically deviate from the predictions of the traditional choice model:

. . . three important ways in which humans deviate from the standard eco-
nomic model. Bounded rationality reflects the limited cognitive abilities
that constrain human problem solving. Bounded willpower captures the
fact that people sometimes make choices that are not in their long-run
interest. Bounded self-interest incorporates the comforting fact that
humans are often willing to sacrifice their own interests to help others.
Mullainathan and Thaler2

2 Sendhil Mullainathan and Richard H Thaler. Behavioral Economics. Ed. by Neil J Smelser and Paul B Baltes. 2001.

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 22 / 24
 Lecture 1: Thinking Like an Economist Deviations from rational choice

Bounded rationality: Common pitfalls

Frank (2009) discusses four common pitfalls in decision making.

Ignoring implicit costs
Failing to ignore sunk costs
Measuring costs and benefits in proportions rather than absolute amounts
Fail to understand the average-marginal distinction

Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 23 / 24
 Lecture 1: Thinking Like an Economist Economic Naturalist

Exercise: Become an Economic Naturalist

Your task. Use an economic principle discussed in class to explain some pattern
of events or behavior that you have personally observed. Write it up (about 1
page). Present your observation and explanation in class (about 5min).

Examples (source: Frank3 )

Why do brides spend so much money on wedding dresses, while grooms often rent
cheap tuxedos, even though grooms could potentially wear their tuxedos on many
other occasions and brides will never wear their dresses again?
Why do top female models earn so much more than top male models?
Why are child safety seats required in cars but not in airplanes?
Why are round-trip fares from Hawaii to the mainland higher than the
corresponding fares from the mainland to Hawaii?
Why do many people buy larger houses when they retire and their own children
leave home?
Why do airlines charge much more for tickets purchased at the last minute, while
Broadway theaters follow exactly the opposite practice?
3 Robert H Frank. “The Economic Naturalist: Teaching Introductory Students How to Speak Economics.” In: American Economic Review 92.2 (2002),
pp. 459–462. doi: 10.1257/000282802320191804.
Christian Thöni (UNIL-Centre de droit public) Microeconomics & Game Theory University of Lausanne, Fall 2022 24 / 24