Chapter 1

Introduction to Microeconomics

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.

Main Topics

What is microeconomics?Tools of microeconomicsThemes of microeconomicsUses of microeconomics

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Economics – DefinitionEconomics is the social science that deals with

the production, distribution, and consumption of goods and services and with the theory and management of economies or economic systems. (American Heritage Dictionary)

Economics: the study of how society manages its scarce resources.

What is one of the overriding factors that drive economics….especially microeconomics?

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The Focus of Economics

Scarcity forces societies to confront three critical issues:What to produceHow to produce goodsWho gets what

Economics examines how societies address these three issues: allocation of scarce resources

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What is Microeconomics?Microeconomics: concerns individual decision

making and its collective effect on allocation of a society’s resources

Macroeconomics: concerns aggregate phenomenaMuch of modern macroeconomics involves

applications of microeconomics

Our class will provide a deeper study into the field of microeconomics than what was covered in your principles course.

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What is Microeconomics?

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Which headline talks about (a) economics and if so, (b) micro / macroeconomics

Institutions for Allocation Resources

Micoecon analysis begins with an understanding of institutions, including laws and customs, that define a society’s procedures for allocating resources

In a capitalist economy:Means of production are owned and

controlled by and for the benefit of private individuals

Resources are allocated by voluntary trading among businesses and consumers

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Institutions for Allocation of Resources

In a communist economy:Economic decisions are highly centralizedThe state owns and controls the means of

production and distributionNo economy is completely centralized or

decentralized; all economies are a combination of both.

Examine statistics on the size of government for a rough measure of centralization. P4.Compare Korea and Sweden. Why are there

differences?

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Markets

Markets are the most common form of economic decentralization

Markets are economic institutions that provide people with opportunities and procedures for buying and selling goods and services

May be governed by explicit rules (e.g., NYSE) or by custom (e.g., open bazaar)

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What is a Market?

In microeconomics, a market is:Associated with a single group of closely

related productsOffered for sale within particular geographic

boundaries

Products belong to the same market when they are highly interchangeable

Some markets may be worldwide 1-10

Characteristics of MarketsMarkets include buyers and sellersOften, but not always, sellers are

companies and buyers are individualsB2C / B2B / C2C

Trade in modern markets is usually governed by price, the rate at which someone can swap money for a good

Markets can function only if a system of transferable property rights is established and enforced

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Economic Motives

Need to understand individual motives to determine what choices they will make

Assume people are motivated by self-interest:Desire for goods and servicesCan include possibility that someone might care

about someone else’s well-being

Same motivation even if acting as consumer, firm, or employee

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Positive Economic Analysis

One of the main objectives of microeconomics is to answer questions.

Positive economic analysis: addresses factual questions, typically about economic choices or market outcomesWhat did happen? What will happen? What would

happen?Historical fact-findingForecastingCause-and-effect analysis of actions and their

consequencesStick to objective facts and avoid value

judgments 1-13

Normative Economic Analysis

Normative economic analysis: addresses questions that involve value judgments concerning the allocation of resourcesWhat ought to happen?

Turn normative questions into positive questions using the principle of individual sovereignty

Or….Each person knows what’s best for him or her.

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Normative Economic Analysis

Which music is better? Music A Music B

Which shall our class listen to?How can we weigh the person’s gain who

likes the music we play vs. the loss of the one who hates it? Is this a Normative or Positive value?

How could we turn this into the other argument?

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Scope of Microeconomics

Broad definition of “resources”, not just about money (time, for example)

Range of topics is extremely wide:MarriageCrimeAddictionEnvironment

In many ways, decisions by many individuals combine to produce social outcomes

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Tools of Microeconomics

To uncover the “truth”, economists use the 5-step scientific method.Initial observationTheorizingIdentification of additional implicationsFurther observation and testingRefinement of the theory

A useful theory must have broad application but also specific implications

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Models and Mathematics

Model: a simplified representation of a complex phenomenon

Economists use models to provide an account of cause and effect, to help us understand how the world works

Some economic models are quantitative (mathematical) so that they are more precise

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Simplifying Assumptions

All scientists build models based on assumptions, so do economists

This allows the model to focus on the most important explanations for a particular phenomenon

No economic model is literally trueSome assumptions are easy to criticizeThe test of a model is its usefulness

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Data Analysis

Scientific method requires models to be tested with data, e.g., from:Records (financial accounts, customer databases)Surveys (Consumer Expenditure Survey, other

government or private sources)Experiments

Econometrics: application of statistical methods to empirical questions in economics

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Why Economists DisagreeEven with scientific method, still room to

disagreeDifferences in scientific judgment lead to

disagreements on positive questionse.g. Look at the same data but come to a different

conclusionLikely began from different assumptions; may be

able to resolve by empirically testing assumptionsCan’t resolve normative disputes that arise

from differences in values

Economists from the US vs. USSR

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Themes of Microeconomics: Decisions

Theme 1: Trade-offs are unavoidableThere’s no such thing as a free lunch

Theme 2: Good choices are made at the marginMost decisions are a matter of degree

Theme 3: People respond to incentivesTheme 4: Prices provide incentives

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Themes of Microeconomics: Markets

Theme 5: Trade can benefit everyoneTheme 6: The competitive market price

reflects both value to consumers and cost to producers

Theme 7: Markets have advantagesTheme 8: Sometimes governments can

improve on free-market resource allocations

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Uses of Microeconomics

Why study microeconomics? It’s useful!Tools for understanding and evaluating

the effect of public policiesHelp make important personal and

business decisionsStresses thinking at the margin,

importance of trade-offs

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Uses of Microeconomics

Applications of microeconomics:Business investmentsPortfolio managementReplacing an old carEnvironmental policy….and many others

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