Microeconomics & Game Theory (The Art of Agent-Based Modeling) · Microeconomics is a very large field of study such that this introductory course can only serve as an orientation

Microeconomics & Game Theory

(The Art of Agent-Based Modeling)

Florian Rupp

GUtech

Introduction & Scope

Winter Term 2016/ 17

Prof. Dr. Florian H.-H. Rupp

([email protected])

German University of Technology in Oman (GUtech)Department of Mathematics and Science

What is Microeconomics?

… and now?


Economics can be distinguished from other social sciencesby the belief that most (all?) behavior can be explained byassuming that rational agents with stable well definedpreferences interact in markets that (eventually) clear .An empirical result qualifies as an anomaly if it is difficult to“rationalize” or if implausible assumptions are necessary to“rationalize” or if implausible assumptions are necessary toexplain it within the paradigm.

(Thaler, 2001)

desires preferences actions

economyagent

rational choice

Economics is about the actions of optimizing individuals or individually rational agents/ players …

Economics is about the actions of optimizing individuals or individually rational agents/ players …

… and the interactions between them

What is this course all about?

Agenda

Microeconomics – A first Case Study


What is Macroeconomics?

How will the Lecture, Homework Assignments and Tutorials Work?

Let us take the example of water policy

Dance your PhD: Florence Metz (2015)

about 10 minutes

The setting is based on a conflict of interests about the use of a limited common good

veto players

players with similar interests form coalitions

brokers mediate between the

coalitions

To predict the outcome of the “game” what do we need to know?

To predict the outcome and maybe influence it we need to know the answers to the following questions?

• Who are the players?

• What are their preferences and how do they judge possible outcomes?

• What are the possible strategies of the players?

• Do the players act simultaneously or consecutively? • Do the players act simultaneously or consecutively?

• Are the players negotiating with each other or make decisions autonomously?

Recall, we assume that the players are individually rational, i.e. they are only optimizing their own profit.

Can this lead to situations that are good for everyone?


Agenda




How will the Lecture, Homework Assignments and Tutorials Work?

Microeconomics studies the behavior of individuals and small organizations in making decisions on allocating limited resources

Microeconomics (from Greek prefix mikro- meaning “small” and economics) is a branch of economics that studies

• the behavior of individuals and small impacting organizations

• in making decisions

• on the allocation of limited resources.

Typically, it applies to markets where goods or services are bought and sold. Typically, it applies to markets where goods or services are bought and sold. Microeconomics examines

• how these decisions and behaviors affect the supply and demand for goods and services, which determines prices,

• and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services.

This is in contrast to macroeconomics , which involves the “sum total of economic activity, dealing with the issues of growth, inflation, and unemployment” (we will come to that later).

Microeconomics strives to analyze market mechanisms from the point of view of individual agents (bottom-up view)

One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses.

Microeconomics analyzes market failure, where markets fail to produce efficient results, and describes the theoretical conditions needed for perfect competition.

Significant fields of study in microeconomics include

• general equilibrium,

• markets under asymmetric information,

• choice under uncertainty and

• economic applications of game theory.

In particular the economic applications of game theory will be main focus of this course as they allow us to identify lines of behavior on the individual agent level.

As a second influencing factor, we will discuss demand & supply (in a nutshell)

The theory of supply and demand usually assumes that markets are perfectly competitive . This implies that there are many buyers and sellers in the market and none of them have the capacity to significantly influence prices of goods and services.

The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of availability at each price (supply) and the desires of those with purchasing power at each price (demand).

The graph depicts a right-shift in demand from D1 to D2 along with the consequent increase in price and quantity required to reach a new market-clearing equilibrium point on the supply curve (S).

In many real-life transactions , the assumption fails because some individual buyers or sellers have the ability to influence prices.

Quite often, a sophisticated analysis is required to understand the demand-supply equation of a good model. However, the theory works well in situations meeting these assumptions.

A simple situation of an equilibrium between supply and demand

The demand of food is one fish per day and the supply is one fish per day …

… hence an equilibrium is reached each and every day …

… but of course there are more factors that influence an economy

Microeconomics is a very large field of study such that this introductory course can only serve as an orientation

The study of microeconomics involves several “key” areas:

• Demand, supply, and equilibrium

• Measurement of elasticities

• Consumer demand theory

• Theory of production

• Costs of production

Supply and demand is an economic model of price determination in a market.

It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity • Costs of production

• Competition & Monopoly

• Market structure

• Game theory

• Labour economics

• Welfare economics

• Economics of information

consumers will equal the quantity supplied by producers resulting in an economic equilibrium for price and quantity.








Elasticity is the measurement of how responsive an economic variable is to a change in another variable.

Elasticity can be quantified as the ratio of the percentage change in one variable to the percentage change in another variable, when the latter variable has a causal influence on the • Costs of production



• Game theory




variable has a causal influence on the former.

Frequently used elasticities include

• price elasticity of demand,

• price elasticity of supply,

• income elasticity of demand, or

• elasticity of substitution between factors of production.








Consumer demand theory relates preferences for the consumption of both goods and services to the consumption expenditures.

Ultimately, this relationship between preferences and consumption expenditures is used to relate preferences to consumer demand • Costs of production



• Game theory




preferences to consumer demand curves.

The link between personal preferences, consumption and the demand curve is one of the most closely studied relations in economics.

It is a way of analyzing how consum-ers may achieve equilibrium between preferences and expenditures by maximizing utility subject to consumer budget constraints.








Production theory is the study of production, or the economic process of converting inputs into outputs.

Production uses resources to create a good or service that is suitable for use, gift-giving in a gift economy, or exchange in a market economy.

This can include manufacturing, • Costs of production



• Game theory




This can include manufacturing, storing, shipping/ logistics, and packaging.

Some economists define production broadly as all economic activity other than consumption. They see every commercial activity other than the final purchase as some form of production.








The cost-of-production theory of value is the price of an object or condition is determined by the sum of the cost of the resources that went into making it.

The cost can comprise any of the factors of production: labor, capital, land. Technology can be viewed either as a form of fixed capital (like a plant) • Costs of production



• Game theory




as a form of fixed capital (like a plant) or circulating capital (like intermediate goods).








Perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product, like Ebay.

A monopoly (from Greek monosμόνος (alone or single) + polein• Costs of production



• Game theory




μόνος (alone or single) + poleinπωλεῖν (to sell)) exists when a single company is the only supplier of a particular commodity.

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). Oligopolies can result from various forms of coalitions which reduce competition and lead to higher costs for consumers.








The market structure can have several types of interacting market systems, like competitive markets, monopolies, etc. from both the seller as well as from the buyer side.

Examples of markets include but are not limited to:

• commodity markets,• Costs of production



• Game theory




• commodity markets,

• insurance markets,

• bond markets,

• energy markets,

• stock markets,

• online auctions,

• media exchange markets,

• real estate market

• …

Quiz

1. The food market in Oman is a

a) monopoly

b) duopoly (only two major players)

c) oligopoly

d) market with perfect competition

2. A souk like in Mathra is an example for a

a) monopoly

b) a market where all sellers have perfect/ complete information about the purchasing prizes or manufacturing costs

c) a market where all buyers have perfect/ complete information about the purchasing prizes or manufacturing costs

d) a market where prices are dictated by the government








Game theory is a major method used in mathematical economics and business for modeling competing behaviors of interacting agents.

Applications include a wide array of economic phenomena and approaches, such

• as auctions, bargaining, mergers & • Costs of production



• Game theory




• as auctions, bargaining, mergers & acquisitions pricing, fair division, duopolies, oligopolies, social network formation, agent-based computational economics, general equilibrium, mechanism design, and voting systems,

• and across such broad areas as experimental economics, behavioral economics, information economics, industrial organization, and political economy.








Labour economics seeks to understand the functioning and dynamics of the markets for wage labour.

Labour markets function through the interaction of workers and employers.

Labour economics looks at the suppliers of labour services (workers), • Costs of production



• Game theory




suppliers of labour services (workers), the demands of labour services (employers), and attempts to understand the resulting pattern of wages, employment, and income.








Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being from allocation of productive factors as to desirability and economic efficiency within an economy, often relative to competitive general equilibrium.

It analyzes social welfare, however • Costs of production



• Game theory




It analyzes social welfare, however measured, in terms of economic activities of the individuals that compose the theoretical society considered.

Accordingly, individuals, with associated economic activities, are the basic units for aggregating to social welfare, and there is no “social welfare” apart from the “welfare” associated with its individual units.








Information economics or the economics of information is a branch of microeconomic theory that studies how information and information systems affect an economy and economic decisions.

Information has special characteristics:• Costs of production



• Game theory




characteristics:

• it is easy to create but hard to trust,

• it is easy to spread but hard to control, and

• it influences many decisions.

These special characteristics (as compared with other types of goods) complicate many standard economic theories.

Why is microeconomics important?

• It tells us how millions of consumers and produces take decisions about the allocation of productive resources among millions of goods and services

• It explains how through market mechanisms goods and services produced in the community are distributed

• It also explains the determination of the relative prices of the various productive services

• It explains the conditions of efficiency both in consumption and production and • It explains the conditions of efficiency both in consumption and production and departure from the optimum

• Microeconomics helps in the formulation of economic policies calculated to promote efficiency in the production of welfare of the masses


Agenda




How will the Lecture, Homework Assignmentsand Tutorials Work?

Macroeconomics deals with the whole of an economy rather than with individual markets, …

Macroeconomics (from the Greek prefix makro- meaning “large” and economics) is a branch of economics dealing with the

• performance,

• structure,

• behavior, and

• decision-making

• of an economy as a whole, rather than individual markets.• of an economy as a whole, rather than individual markets.

This includes national, regional, and global economies.

… it studies aggregated indicators to explain relationships between key factors of whole economies

Macroeconomists study aggregated indicators such as

• GDP,

• unemployment rates, and

• price indexes

to understand how the whole economy functions.

Macroeconomists develop models that explain the relationship between such Macroeconomists develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance.

Again, in contrast, microeconomics is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and quantities in specific markets.

Let’s discuss an example:What happens if the unemployment goes down?

Microeconomics vs. Macroeconomics: a first simplified comparison

Microeconomics is the study of economic behavior of decision

makers (agents).

Macroeconomics is the study of the behavior of entire

economies.

Unfortunately, macro-economics is currently much more influenced by trends and “schools” than micro-economics


Agenda




How will the Lecture, Homework Assignments and Tuto rials Work?

cf. welcome

letter

The lecture blends classical topics from Game Theory, the Theory of Choice and from the Theory of Supply and Demand

Game Theory Theory of Choice

Management & Game Theory

Preference Relations

Prisoner’s Dilemma & Simulating Societies

Nash Equilibrium

The Theory of Choice

Sequential Form & Subgame Perfectness

Trembling Hand Perfect Equilibrium

Consumer Preferences

Mixed Strategies, Maximin Solutions & Zero-Sum Games

Consumer Choice

Supply & Demand Theory

Market Structures

Demand & Supply

Equilibrium Prices

Changes in the Market Environment

Policy Interventions

You are expected to err and ask “stupid” questions

Note,

An expert is someone who has made all the mistakes which can bemade, in a narrow field. (N. BOHR)

Thus, do your errors early and don’t be afraid to ask seemingly “stupid”questions. During the lectures there is enough time for everyone!questions. During the lectures there is enough time for everyone!

⇒ At the end of the course you’ll be anexpert in Microeconomics

Microeconomics is no spectators sport

I really encourage you to

• actively participate in class , and

• actively prepare for the next class ..

Of course, you are allowed to cooperate with your class mates.

“Slide show” lectures can become rather exhaustive. Taking notes will help you stay alert and grasp the key messages more easily.stay alert and grasp the key messages more easily.

Things you may want to jot down:

• section titles

• definitions, theorems, rules of thumb

• key messages

• classroom exercises

• everything else you find interesting

How the first lectures may feel like

We expect from you that you are responsible for your success, this includes that for each lecture hour you will have to work two hours at home to re-study the lecture, to

do the exercises (incl. pre-learning) and to do the homework assignments.

For communication within the class we will use the Q&A platform piazza (all notes will be placed there as well)

Our course will be interactive focusing on hands-on case studies based on Game TheoryLite

Economics lives by the tangible example. Therefore, wewill dedicate a large amount of our time on such casestudies. The source for them is

Game Theory Lite – A Book Full of Problems

The structure of our course will be such that first thefundamental definitions and tools will be clarified, andwe then jump into one of the example problems andwe then jump into one of the example problems andfollow the outline of the solution.

In particular, this gives you the chance to present veryearly in your academic career and learn to bring yourpoint forward in discussions.

Further reading:

• S. Bowles (2004): Microeconomics – Behavior, Institutions, and Evolution, Princeton University Press

• D.A. Besanko & R.R. Braeutigam (2002): Microeconomics, 4th edition, Wiley

Mandatory and further reading

D.A. Besanko & R.R. Braeutigam (2002): Microeconomics, 4th edition, Wiley

S. Bowles (2004): Microeconomics – Behavior, Institutions, and Evolution, Princeton University Press

P. Krugman, R. Wells & K. Graddy (2011): Essetials of Economics, 2nd edition, Worth Publishers

M. Leroch, N. Maaser & F. Rupp (2013): Game Theory Lite – A Book Full of Problems, Accedo

M.C. Lovell (2004): Economics with Calculus, Word Scientific

A. Rubinstein (2012): Lecture Notes in Microeconomic Theory – The Economic Agent, 2nd edition, Princeton University Press

A.D. Taylor & A.M. Pacelli (2008): Mathematics and Politics – Strategy, Voting, Power and Proof, 2nd edition, SpringerSpringer

Florian Rupp

GUtech

See you next time

Questions or

Florian Rupp

[email protected]

Questions or Comments?

Documents

Microeconomics & Game Theory (The Art of Agent-Based Modeling) · Microeconomics is a very large field of study such that this introductory course can only serve as an orientation