Below is a single, consolidated set of Standard Operating Procedures (SOPs) for the most common microeconomics exercises, combining the major points from both SOP documents (“Different exercises SOPs” and “NLM SOPs”), while removing duplicated content. These SOPs are organized by exercise type, highlighting each topic’s typical problems and the step-by-step approach to solve them.
COMPREHENSIVE SOPs FOR SOLVING MICROECONOMICS EXERCISES
CONSUMER THEORY: PREFERENCES, UTILITY, AND CHOICE Typical Problems • Understanding Preferences and Utility Functions (e.g., Cobb-Douglas, Perfect Substitutes, Perfect Complements). • Calculating Marginal Utility (MU) and deriving the Marginal Rate of Substitution (MRS). • Utility Maximization under a Budget Constraint. • Identifying corner vs. interior solutions.
Steps to Solve
Identify the Utility Function Determine the form: Cobb-Douglas (e.g., U = xᵃy^(1−ᵃ)), Perfect Substitutes (U = ax + by), Perfect Complements (U = min(ax, by)), Quasilinear, or other forms. Set Up the Budget Constraint Typically of the form: I = pₓx + pᵧy. For multi-good cases, generalize to Σ pᵢxᵢ = I. Compute Marginal Utilities and MRS MUₓ = ∂U/∂x; MUᵧ = ∂U/∂y. MRS = MUₓ / MUᵧ (or ratio of partial derivatives). The typical interior-solution condition is MRS = pₓ / pᵧ. Solve the Utility Maximization Problem Either use the Lagrangian: L=U(x,y)+λ[I−pxx−pyy] \mathcal{L} = U(x, y) + \lambda [I - p_x x - p_y y] and derive the first-order conditions. Or check for special forms (e.g., corner solutions for perfect substitutes, or balanced bundles for perfect complements). Determine optimal consumption (x*, y*) given pₓ, pᵧ, and I. Check for corner vs. interior solution. For corner solutions, the MRS condition might not hold because the optimum occurs at a boundary. Perform Comparative Statics Examine how x* and y* change with income (I) or prices (pₓ, pᵧ). Relate changes to normal vs. inferior goods, or to income/substitution effects. Compute and interpret results (optimal bundle, total utility, possible corner solutions, etc.). DEMAND THEORY: MARSHALLIAN AND HICKSIAN DEMANDS Typical Problems • Deriving demand functions (Marshallian) from the utility maximization problem. • Substitution and income effects (Slutsky decomposition). • Hicksian (compensated) demand functions. • Consumer surplus, Compensating Variation (CV), Equivalent Variation (EV).
Steps to Solve
Obtain Marshallian Demand Functions From the consumer’s utility maximization under budget constraint. Express x* and y* in terms of pₓ, pᵧ, and income I. Distinguish Income vs. Substitution Effects Use Slutsky decomposition: total effect of a price change = substitution effect + income effect. For large price changes, depict graphically or use formulas for Slutsky/ Hicks decomposition. Derive the Hicksian (Compensated) Demands
a) Indirect Utility Function: plug the Marshallian demands back into U(x, y) to get V(p, I).
b) Expenditure Function: solve the expenditure minimization problem min? pxx+pyysubject toU(x,y)=Uˉ. \min \, p_x x + p_y y \quad \text{subject to} \quad U(x, y) = \bar{U}. The minimal expenditure E = E(pₓ, pᵧ, Ū).
c) Hicksian Demands: differentiate E with respect to pₓ or pᵧ (Shepard’s Lemma). Consumer Surplus (if approximating changes for small price variations). For larger changes, use Compensating Variation (CV) or Equivalent Variation (EV): CV: income adjustment needed before price change to reach new utility. EV: income adjustment needed after price change to preserve original utility. Summarize Key Elasticities Price elasticity of demand, income elasticity, cross-price elasticity. Interpret normal, inferior, and Giffen goods from sign and magnitude of effects. PRODUCTION AND COST FUNCTIONS Typical Problems • Identifying the production function type (Cobb-Douglas, CES, Leontief). • Deriving marginal products, returns to scale, and the marginal rate of technical substitution (MRTS). • Cost minimization: short-run vs. long-run costs. • Deriving the cost function and analyzing cost curves (e.g., AC, MC).
Steps to Solve
Identify Production Function E.g., Cobb-Douglas: q = A Kᵅ Lᵝ, or CES: q = [αK^ρ + βL^ρ]^(1/ρ), etc. Compute Marginal Products MPᴷ = ∂q/∂K, MPᴸ = ∂q/∂L. Check for diminishing marginal returns, returns to scale, or special forms. For cost minimization, set MRTS = w/r (the ratio of input prices, e.g., wages w and rental rate r). For a given output level q̄, minimize total cost C = wL + rK subject to q(K, L) ≥ q̄. Use the Lagrangian: L=wL+rK+λ[qˉ−f(K,L)]. \mathcal{L} = wL + rK + \lambda [q̄ - f(K,L)]. Solve for conditional input demands (K*(q̄,w,r), L*(q̄,w,r)). Plug K*(q̄,w,r), L*(q̄,w,r) back into C = wL + rK → C(q̄, w, r). Analyze shapes: AC(q), MC(q), the presence of economies of scale, etc. Check Short-Run vs. Long-Run In short run, some factors are fixed. In long run, all factors are variable and you can re-optimize capital. Interpret Returns to Scale Increasing: doubling inputs > doubles output. Constant: doubling inputs doubles output. Decreasing: doubling inputs < doubles output. PROFIT MAXIMIZATION AND SUPPLY Typical Problems • Profit maximization for a price-taking firm. • Short-run vs. long-run production decisions. • Deriving supply curves from marginal cost (MC). • Producer surplus.
Steps to Solve
Set Up the Profit Function π(q)=p⋅q−C(q). \pi(q) = p \cdot q - C(q). If multiple inputs, π=p⋅f(K,L)−wL−rK. \pi = p \cdot f(K, L) - wL - rK. Find First-Order Condition For a single-output firm, profit max typically satisfies p = MC if interior solution. For multiple inputs, partial derivatives w.r.t. each input = 0. Short-Run vs. Long-Run Decisions Short run: keep fixed inputs, only optimize variable inputs. Long run: all inputs variable, can exit or enter. In a perfectly competitive market, the firm’s supply curve is MC above the average variable cost (AVC) in the short run, and above average total cost (ATC) in the long run. Sum across identical firms for the industry supply. Producer Surplus (PS) = Revenue − Variable Cost. In the short run, fixed cost does not affect the decision to produce but does affect profit. Examine how optimal q* changes with changes in p, w, r, or technology. Example: pass-through of taxes or shifts in supply curves. MARKET EQUILIBRIUM AND WELFARE ANALYSIS Typical Problems • Determining market-clearing price and quantity under perfect competition. • Measuring changes in consumer surplus (CS) and producer surplus (PS) from policy changes. • Effects of price controls, quotas, or taxes. • Understanding deadweight loss (DWL) and efficiency.
Steps to Solve
Set Up the Market Demand and Supply Equilibrium: Qᴰ = Qˢ → p* and q*. For linear demand and supply, set D(p) = S(p) to find p*. Then q* = D(p*). Introduce a tax, quota, or price ceiling/floor. Derive the new equilibrium. Compare old vs. new price, quantity, and welfare. Measure Consumer and Producer Surplus Graphically: area under demand curve above price → CS; area above supply curve below price → PS. For larger changes, might need exact integrals or CV/EV approaches. Calculate Deadweight Loss (DWL) Reduction in total surplus from the policy distortion. Compare new total surplus vs. original total surplus. If no externalities or market failures, competitive equilibrium is (Pareto) efficient. Government interventions can create DWL unless justified by externalities or other distortions. MARKET POWER: MONOPOLY, PRICE DISCRIMINATION, OLIGOPOLY Typical Problems • Profit maximization under monopoly; optimal price and quantity. • Welfare loss from monopoly power. • Types of price discrimination (1st, 2nd, 3rd degree). • Basic oligopoly models (Cournot, Bertrand, Stackelberg).
Steps to Solve (A) Monopoly
Set Up the Demand Function p = D⁻¹(Q), total revenue TR(Q) = p(Q)·Q. π(Q)=p(Q)⋅Q−C(Q). \pi(Q) = p(Q)\cdot Q - C(Q). Solve MR = MC for Q*. Then p* = p(Q*). MR = ∂[p(Q)·Q]/∂Q = p(Q) + Q·p′(Q). 1st degree: perfect discrimination, each unit sold at highest willingness to pay. 2nd degree: quantity discounts or block pricing. 3rd degree: separate markets or segments, distinct prices for each. Compare competitive vs. monopoly output to identify deadweight loss. (B) Oligopoly
Cournot: Firms choose quantities Qᵢ. Bertrand: Firms choose prices pᵢ. Stackelberg: Sequential move quantity-setting. Write Down Payoff Functions Each firm’s profit = (Price - Cost) × Quantity for that model. For Cournot: each firm sets Qᵢ to maximize its profit given the other firms’ Qⱼ, leading to best response functions Qᵢ = BRᵢ(Qⱼ). Solve simultaneously. For Bertrand: each firm sets pᵢ to maximize profit, typically undercut the rival if homogeneous product. Compare equilibrium quantity, price, and profit to those under perfect competition or monopoly. UNCERTAINTY, RISK, AND GAME-THEORETIC APPROACHES Typical Problems • Expected utility maximization and risk aversion. • Insurance choice, diversification. • Game theory with strategic interactions, normal-form and extensive-form solutions.
Steps to Solve
Expected Utility Framework For uncertain outcomes x₁ with probability p, x₂ with probability 1−p: E[U]=pU(x1)+(1−p)U(x2). E[U] = pU(x_1) + (1-p)U(x_2). Evaluate risk preferences: risk-averse (concave utility), risk-neutral (linear), risk-loving (convex). Analyze Insurance or Investment Decisions Evaluate expected payoffs, certainty equivalents, or risk premia. Possibly incorporate the Arrow-Pratt measure of risk aversion RA(x) = −U″(x)/U′(x). Identify players, strategies, and payoffs. Solve for equilibrium using appropriate solution concept (Nash equilibrium, subgame perfect equilibrium for sequential moves, Bayesian Nash for incomplete info). Where relevant, incorporate repeated-game or dynamic considerations (trigger strategies, collusion, etc.). EXTERNALITIES AND PUBLIC GOODS Typical Problems • Negative externalities (pollution) or positive externalities. • Pigouvian taxes, quotas, or permits. • Under-provision of public goods; free-riding. • Lindahl pricing or other mechanisms.
Steps to Solve
E.g., a polluting firm imposes costs on others. Social cost differs from private cost. Analyze Unregulated Equilibrium Competitive outcome ignoring the externality. Show the difference between private MC and social MC for a negative externality. Identify the Social Optimum Marginal Social Benefit = Marginal Social Cost. Solve for Qᵒ or other key variables to minimize deadweight loss from the externality. Examine Possible Policies Pigouvian tax: Set tax = external marginal damage. Compare efficiency outcomes and distributional effects. Nonrival and nonexcludable goods. Summation of marginal benefits across consumers to find social demand. Voluntary contribution typically leads to under-provision. Check solutions such as Lindahl pricing, or incentive-compatible mechanisms. COMPARATIVE STATICS AND NUMERICAL SPREADSHEET MODELING Typical Problems • Changing exogenous variables (prices, income, etc.) and assessing new equilibrium. • Using Excel or other software to solve, especially if an analytic solution is hard to find.
Steps to Solve
Define the Model in Equations E.g., a system:
D(p) = S(p), or utility max, or cost min, etc. Use Analytical vs. Numerical Tools