Ksg l212 Office Hours: Monday 1: 00 pm to 3: 00 pm Thursday 2: 00 pm to 4: 00 pm Teaching Fellow

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Harvard Kennedy School Fall 2016

Markets and Market Failure
Faculty: Chris Avery


KSG L212
Office Hours: Monday 1:00 pm to 3:00 pm

Thursday 2:00 pm to 4:00 pm

Teaching Fellow: Guthrie Gray-Lobe


Meetings: Monday, Wednesday, 10:15 am – 11:30 am, HKS Land Hall

Review Sections: Friday, 1:15 pm – 2:30 pm, L-280
Important Dates

First Class Meeting: Wednesday, August 31, 2016 10:15 am to 11:30 am.

First Section Meeting: Friday, September 2, 2016 1:15 pm to 2:30 pm.

Midterm Exam: Wednesday, October 19, 2016 10:15 am to 11:30 am.

Final Exam: Monday, December 12, 2016 3:00 pm to 6:30 pm.
API-101 applies microeconomic reasoning to public issues, policies and programs. It considers economic incentives and organizations; models of economic behavior; the operation of markets; the price system and how it works; the consequences of market failure and interventions in markets; and policy objectives and instruments. All sections cover a common set of core topics. Section Z is differentiated from the other sections because it assumes prior knowledge of calculus.
Details about the “Z” Section
The Z-section is aimed at students who feel quite comfortable using math, have a working knowledge of basic calculus, and are motivated to delve more deeply into some topics and also to learn some advanced skills. By using calculus based methods, Section Z is able to cover some topics in more depth than the other sections of API-101. The use of mathematics in Section Z is only a means of communication rather than an end in itself; the common objective of all sections of API-101 is to provide students with a solid economic intuition and an ability to apply economic insights to real-world problems.
If you find that the use of mathematics often fails to clarify things for you, you are probably better off in the non-calculus sections of API-101. If you have had a lot of economics before and are now looking for a much more advanced treatment of the same material; then the Z-section is probably not for you either, and you might consider taking API-111.
To ensure equitable grading across all of the sections, approximately two-thirds of the problems on the midterm and the final exams for the Z section will be identical to problems given on the exams for the other sections. The grading curve for the Z section will be based on the grading curve used for the other sections – which may result in a deviation in course grades from the Dean’s recommended grade curve.

Add/Drop Policy
This course also offers sections (A, B, and D) that will not be using Calculus. We encourage students to try out the Z section if it might be a good fit. You may switch into the other sections up until

October 21, 2016. After October 21, students may not switch into or out of the Z section.

To switch sections, please email Joseph Solomon (joseph_solomon@hks.harvard.edu), with the sections you are switching between and the date you will first attend the new section. You may NOT switch among the B, C and D sections. You may “try out” the other section for one class without sending this email; simply attend that section for one class.
If you do switch sections, grades will transfer from one section to the other. Problem set grades will transfer fully. However, you must submit any problem sets to the section for which you are currently registered (i.e. your original section if you have not yet emailed Joseph Solomon to formally switch). If you switch after the midterm, your midterm in your old section will count only 20% with the remaining

20% weight being transferred to the final exam.

The formal course requirements are: completion of nine problem sets, two discussion questions, a midterm examination, and a final examination. The problem sets and discussion questions will count for 10 percent of the final grade, the midterm will count for 40 percent, and the final for 50 percent. The examinations will be “in-class”; books and notes cannot be consulted during examinations. Note that the midterm will be held on Wednesday, October 19, from 10:15 to 11:30 AM for all sections. The final exam will be held on Monday, December 12 from 3:00 PM to 6:30 PM for all sections. The final exam will be cumulative. Please check your calendars as soon as possible and avoid any scheduling conflicts for the midterm and the final. We WILL NOT schedule makeup exams except for students with documented dire emergencies.
A problem set will be assigned (and due) almost every week. Problem sets will give you hands-on experience with the techniques and concepts taught in the course. It will be extremely difficult to perform well in the midterm and final unless you devote time (about 6 to 8 hours per week) to working out these problems. The problem sets will be graded on the check-plus/check/check-minus basis, which will correspond to 1, 2, or 3 points out of 3 points total per problem set. Each problem set will count for one point of the final grade (for a total of 8 points plus two freebie points that we generously allot to all students). Problem sets are due at the beginning of class on the due date. If a problem set is not turned in by this time, it is considered late and there is no credit for late assignments. Class participation is strongly encouraged, but will not be graded.
Small groups of students (no more than 4) are STRONGLY encouraged to work together on the problem sets. However, problem solutions must be written independently by EACH of the students in your small group. This is to ensure that what you turn in reflects your own understanding of how to do the problems. In addition, you must indicate the name of the students in your group at the top of your solutions. Answer sheets will be posted on the class website shortly after each problem set is turned in.
The letter grade that will appear on your transcript will be determined by the sum of the midterm, final, and problem set numerical grades (minus any adjustments; see section below on tardiness). We will rank all students across all sections from highest to lowest grade, and use the (more generous) Dean’s recommended grade curve to determine the letter grade. The curve is as follows: 15% A's, 25% A-, 35% B+, 20% B, and 5% B- or less.
Across this course, you are expected to abide by the University policies on academic honesty and integrity as given in the Student Handbook. Violations of these policies will not be tolerated and are subject to severe sanctions up to and including expulsion from the university.
Class Logistics:
Our past experience suggests that student use of electronic devices can be very disruptive to the flow of the class (real world example from the past: a student texting while sitting in the front row). As a result, no mobile phones, tablets, PDAs, or laptops may be used in class. We will, of course, make whatever exceptions are necessary if there is a documented need.
Discussion Questions
We provide a list of discussion questions for six of the lectures for the course, starting with Lecture 5 on Wednesday, September 14. Each student is required to provide written answers to two of these questions prior to the relevant lecture over the course of the semester. These questions are designed to prompt detailed reflection about the subject of these lectures as well as to promote incisive conversations during those lectures. We will ask students to sign up for discussion questions during the second week of class.
Each written answer to a discussion question should be on the order of 2 to 3 paragraphs (1-2 written pages) and should be submitted to the course website by 8 pm the day before the relevant lecture. These answers will be graded on a “Check Plus/Check/Check Minus” scale. Especially interesting answers will be referenced in class, typically with attribution – the goal is to stimulate discussion, not to embarrass anyone for expressing an honest viewpoint.
The textbook for this course is Microeconomics: Theory and Applications with Calculus by Jeffrey M. Perloff. The book is on reserve at the HKS library and can be purchased at the Coop.
The exams will be based primarily on the material covered in lectures and on the problem sets. Professor Avery has also written a set of notes for this class to augment the material covered in class; these lecture notes will be available on the course webpage.
Each lecture will be delivered with use of the document camera. Professor Avery will start with partly completed slides and will add additional material to the slides during the course of the lecture. The partly completed slides for each class will be posted (for the entire semester) on the course webpage.
In previous years some students indicated that they did not read the textbook very much while others found it to be helpful. The problems on the problem sets are original, but we also provide a list of “recommended” problems (for most lectures) from the Perloff text for students seeking additional practice problems. You may wish to assess your propensity to rely on a textbook before purchasing one. You may also wish to consider the use of an alternative textbook. Nearly every microeconomics textbook covers the topics we will talk about in class, so you should feel free to use any alternative textbook that uses calculus and seems appropriate to you, such as:

Intermediate Microeconomics with Calculus by Hal Varian.

Introduction to Economic Analysis by Preston McAfee (free online, legally).


UNIT 1: Supply and Demand (Classes 1 to 4)

1. Thinking at the Margin

Optional Reading: Perloff, Calculus Appendix, A1 – A4
Viscusi, W. Kip and Josepah Aldy, “The Statistical Value of a Life,” Journal of Risk and Uncertainty, 2003. http://scholar.harvard.edu/files/jaldy/files/valueofstatisticallife.pdf
2. Supply and Demand, Introduction to Comparative Statics Analysis

Perloff, 2.1–2.5, Lecture Notes Chapter 1

3. Policy Applications of Supply and Demand

Perloff, 2.6–2.8, Lecture Notes Chapter 2

4. Trade: Quotas and Tariffs

Perloff, 9.5-9.6, Lecture Notes Chapter 3

UNIT 2: Theory of the Consumer (Classes 5 to 9)

5. The Consumer Problem

Perloff, 3.1-3.4 (p. 58-81), Lecture Notes Chapter 4

6. Income and Substitution Effects

Perloff 3.4 (p. 81-88), 4.1-4.3, Lecture Notes Chapter 4

7. The Consumer Price Index

Perloff, 4.4, 5.2, Lecture Notes Chapter 6

Optional Readings: Boskin, Michael J., et al. 1998. "Consumer Prices, the Consumer Price Index, and the Cost of Living." Journal of Economic Perspectives, 12(1): 3–26.


Munnell, Alicia and Anqi Chen, 2015, “Do We Need a Consumer Price Index for the Elderly?”


8. The Labor-Leisure Problem and the Earned Income Tax Credit

Perloff, 5.5, Lecture Notes Chapter 7

Optional Readings: Liebman, Jeffrey, 1998. “The Impact of the Earned Income Tax Credit on Incentives and Income Distribution,” http://www.ksg.harvard.edu/jeffreyliebman/tpaeeitc.pdf
Chetty, Raj and Emanuel Saez, 2013. “Teaching the Tax Code: Earnings Responses to an Experiment with EITC Recipients.” American Economic Journal: Applied Economics 5(1): 1–31. http://eml.berkeley.edu/~saez/chetty-saezAEJ13EITC.pdf
9. Introduction to Behavioral Economics

Optional Readings: Schelling, Thomas, 1982. “Ethics, Law and the Exercise of Self-Command,” Tanner Lectures at the University of Michigan, http://tannerlectures.utah.edu/_documents/a-to-z/s/schelling83.pdf
Sunstein, Cass and Richard Thaler, “Libertarian Paternalism is not an Oxymoron”, University of Chicago Law Review, 2003 http://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=1184&context=public_law_and_legal_theory

UNIT 3: Theory of the Firm and Competitive Equilibrium (Classes 10 to 15)
10. Producer Theory

Perloff, chapter 6, Lecture Notes Chapter 8

11. Profit Maximization and Competitive Supply

Perloff, chapter 7, Lecture Notes Chapter 9

12. Pareto Optimality, Equilibrium and Negotiation

Perloff, 10.1-10.3, Lecture Notes Chapter 10 (Chapter 11 very optional)

13. International Trade Revisited

Perloff, Chapter 9.1-9.4, 10.4-10.5, Lecture Notes Chapter 12

14. Introduction to Market Failure. Monopoly.

Perloff, Chapter 11. Lecture Notes Chapter 13

15. Price Discrimination and Regulation.

Perloff, 12.1-12.3 Lecture Notes Chapter 14

Optional Reading: “Pricing the Surge,” The Economist, March 29, 2014


UNIT 4: Market Failures and Policy Responses (Classes 16 – 24)
16. Oligopoly.

Perloff, 14.1-14.5 Lecture Notes Chapter 15

17. Externalities

Perloff, 17.1-17.7

18. Prisoner’s Dilemma; Basics of Game Theory.

Perloff, 13.1-13.2 Lecture Notes Chapter 16

19. Dynamic Games and Negotiation Analysis

Perloff, 13.3 Lecture Notes Chapter 17

Optional Reading: Nason, Jason and Charles Plosser, “Time Consistency and Credible Monetary

Policy After the Crisis,” Philadelphia Federal Reserve Bank Business Review, 2012.

20. Adverse Selection and Lemons

Perloff, Chapter 18.1-18.3 Lecture Notes Chapter 18

21. Signaling

Perloff, 18.4-18.5 Lecture Notes Chapter 19

22. Moral Hazard

Perloff, 19.1-19.4 Lecture Notes Chapter 20

23. Thomas Schelling and Microeconomics Lecture Notes Chapter 21

Optional Readings: Myerson, Roger B., 2009. “Learning from Schelling’s Strategy of Conflict,” http://home.uchicago.edu/rmyerson/research/stratofc.pdf
Schelling, Thomas, 1978. Micromotives and Macrobehavior, ch. 3. (available on reserve)


Fall 2016 Schedule of Lectures and Assignments



Topic of Discussion

Assignment due


Wed., Aug 31

Thinking at the Margin

Mon., Sept. 5



Wed., Sept. 7

Organic Apples: A Market Simulation


Fri., Sept. 9

Policy Applications of Supply and Demand


Mon., Sept. 12

Trade: Quotas and Tariffs

PS #1 due


Wed., Sept. 14

Consumer Theory


Mon., Sept. 19

Income and Substitution Effects

PS #2 due


Wed., Sept. 21

The Consumer Price Index


Mon., Sept. 26

The Labor Leisure Model

PS #3 due


Wed., Sept. 28

Introduction to Behavioral Economics


Mon., Oct. 3

Producer Theory

PS #4 due


Wed., Oct. 5

Profit Maximization and Competitive Supply

Mon., Oct. 10



Wed., Oct. 12

Pareto Optimality, Equilibrium and Negotiation Analysis


Mon., Oct. 17

General Equilibrium and International Trade

PS #5 due

Wed., Oct. 19

MIDTERM EXAM for ALL sections


Mon., Oct. 24

Monopoly Theory


Wed., Oct. 26

Price Discrimination and Regulation


Mon., Oct. 31

Oligopoly Theory

PS #6 due


Wed., Nov. 2



Mon., Nov. 7

Game Theory and the Prisoners’ Dilemma

PS #7 due


Wed., Nov. 9

Dynamic Games and Negotiation Analysis


Mon., Nov. 14

Adverse Selection and the Market for Lemons


Wed., Nov. 16

Signaling Models


Mon., Nov. 21

Moral Hazard

PS #8 due

Wed., Nov. 23



Mon., Nov. 28

Thomas Schelling and Microeconomic Theory

PS #9 due


Wed., Nov. 30

Applying and Extending Microeconomic Models

Note: Problem sets will be handed out a week before and returned a week after they are due.
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