Advanced Microeconomics II

Advanced Microeconomics II
(Mikroökonomik für Fortgeschrittene II)

Lecturer: Prof. Fabian Herweg

Course material: eLearning plattform https://elearning.uni-bayreuth.de/

Target audience

This course is addressed to students who aim to obtain a Master (or PhD) degree in Economics, Internationale Wirtschaft & Governance, or Philosophy & Economics. Students who are currently completing a Bachelor program are welcome; they may take this course as preparation for international PhD programs. 

The analysis of the presented topics will be on a highly abstract and theoretical level. Therefore, students who take part in this course should have a profound knowledge of Microeconomic Theory (Game Theory) and good mathematical skills. 

The course is going to be a reading class. The participants and the lecturer will jointly discuss the book "Microeconomics of Banking" by Xavier Freixas and Jean-Charles Rochet. (https://mitpress.mit.edu/books/microeconomics-banking-second-edition) In alternating order, all participants (and the lecturer) will present parts of the book (at the black board - without slides). It is planned to cover chapter 1-5. Due to the structure of the course, there will be no distinction between Lecture and Exercise class. 

The course Advanced Microeconomics II gives 6 credit points: 

•  Economics M.Sc.: “Mikroökonomik für Fortgeschrittene II”
•  IWG M.A.: „Theorie und Empirie der Geld- und Währungspolitik“ or „Probleme der Wettbewerbs- und Wirtschaftspolitik“
•  P&E M.A.: “Modul C2 - Economics Electives”. 

Graded evidence of achievement 

Short term paper (research idea or replication of a part of the book) and active participation in class. The term paper should have a length of 7-8 pages (A4 paper, standard margins, 12pt, at most 1,5 line spacing). After a short introduction, which motivates the topic, you should present one model in detail. You can defer lengthy mathematical derivations to an appendix that does not count to the page limit. The model can be either (i) one presented in the book by Freixas/Rochet (ideally a topic that we did not discuss), (ii) based on a journal publication related to topics discussed, or (iii) based on own ideas. Instead of presenting the model in the most general way, you can make simplifying assumptions and use specific functional forms (if this is helpful to convey your main message). The deadline for submission of the term paper is February 28, 2022. The term paper should be submitted as a pdf file via e-mail. 

Course description (Lecture 2 SWS + exercise class 1 SWS) 

The course “Advanced Microeconomics II” is a course in “Microeconomics of Banking”. First, the course defines banks and discusses what banks do (differently from other economic agents). We will understand why there is no scope for a banking sector in a classic Arrow-Debreu type general equilibrium model. Thereafter, we will discuss the role of banks as financial intermediaries: in the presence of transaction costs, coalitions of depositors, coalitions of borrowers. We will also deal with topics like the choice between market and bank debt, the role of monitoring, and more broadly with issues of moral hazard on credit markets. An important part of the course is the so-called industrial organization approach to banking. In this part, we will understand how competition between banks affects the behavior of banks and the efficiency of the banking sector.

Course outline 

1. Introduction 

   a. What is a bank, and what do banks do?
   b. Banking in the Arrow-Debreu model 

2. The role of financial intermediation 
   a. Transaction costs
   b. Coalitions of depositors
   c. Coalitions of borrowers
   d. The choice between market debt and bank debt 

3. The industrial organization approach to banking 
   a. A perfectly competitive banking sector
   b. A monopolistic bank (Monti-Klein model)
   c. Monopolistic competition
   d. Beyond price competition
   e. Relationship banking
   f. Two-sided markets 

4. The lender-borrower relationship 
   a. Costly state verification
   b. Incentives to repay
   c. Moral hazard
   d. Incomplete contracts 

5. Credit market equilibrium and macroeconomic implications 

Textbooks and further readings 

• Freixas, X. and J.-C. Rochet: “Microeconomics of Banking”, 2nd edition, MIT Press 2008.
• Allen, F. and D. Gale: “Comparing Financial Systems”, MIT Press, 2001.
• Tirole, J.: “The Theory of Corporate Finance”, Princeton University Press, 2006. 

Further readings – in particular journal articles – will be mentioned in class