Fundamentals of Microeconomics

Introduction to Economics

a. Economics consists of the analysis of choice within a framework of constraints.

• i. The economic perspective assumes that resources are scarce relative to human wants, that these resources have alternative uses, and that people have diverse wants, not all of which can be satisfied.

• ii. It follows that the basic economic problem of every society, and of every individual, is to allocate resources so as to best satisfy wants.

b. explains behavior in diverse settings

• Much of the power of economics is rooted in the fact that a single set of assumptions and a single set of analytical concepts (demand, supply, price, and quantity) have proven useful in explaining behavior in such diverse settings as commodity markets, labor markets, and even non-market phenomena (ex. marriage, education and crime).

c. The central features of the economic paradigm are as follows:

• i. People are constantly confronted with the necessity of making choices in a variety of settings as consumers, workers, parents, etc.

• ii. In making those choices, they try to do the best that they can given the constraints they face such as money, time, energy and information.

• iii. The choices are influences by relative “prices” using this term in its broadest sense to include not only money costs but time and psychic costs.

• iv. Their choices may also be influenced by a host of other factors, such as religion, social class, physical and psychological needs, and external pressures.

d. prices

• When we observe large scale, systematic changes in behavior, however, a sensible approach consists of looking first to see if there have been changes in the constraints or in relative prices.

e. We can use this framework to develop a set of principles that we will be considering during the term.

i. Principle #1: People face trade offs(1) This is one of the reasons why economics is the “dismal science”: if you want more of one thing, then you have to have less of something else.(2) Sure free health care would be great as would be a pollution free environment, but what do we have to give up to get them?

ii. Principle #2: The cost of something is what you give up to get it.

(1) Costs exceed just money outlays. (2) A cost of getting married in a monogamous society is the sacrificed opportunity to have married someone else--at that time.

iii. Principle #3: Rational people think incrementally.

(1) Every time that you see the word marginal--and you will see it a lot in this course--insert “incremental” if you find that an easier concept to grasp.(2) This leads to the important conclusion that choices are desirable if the marginal (incremental) benefits exceed the marginal (incremental) costs.

iv. Principle #4: People respond to incentives.

(1) Implied in this is that people make decisions based on their self interest.(2) Essentially, economics has no place for altruism.(3) Still, there is a big difference between egocentric behavior and self-interest.(a) For example, the most important thing that many people do every day based on their self interest is to keep others happy--such as their spouse.(4) In a business setting, these incentives are not exclusively monetary.

v. Principle #5: Trade can make everyone better off.

• (1) Because of opportunities for greater specialization.

• (2) This is true at many different levels: families, businesses and countries.

vi. Principle #6: Markets are usually a good way to organize economic activity.

(1) Decentralized markets coupled with the self interest of participants tend to create and use information more efficiently.(2) This is constrained by the next Principle.

vii. Principle #7: Governments can sometimes improve market outcomes.

(1) Market failure is a situation in which a market left on its own fails to allocate resources efficiently.(a) An externality is the impact of one person actions on the well-being of a bystander(b) Market power is the ability of a single economic actor to have a substantial influence on market prices.(2) Correcting a market failure can result in government failure as elected officials and government employee respond to incentives.(3) Because domestic producers have a narrower focus than domestic consumers of foreign produced goods, there often are attempts to use the political process to protect the producers to the detriment of the consumers.

Contours of Economics:

Economics Defined:• Economic wants exceed productive capacity• Social science concerned with making optimal choices

under conditions of scarcity

Thinking like an economist• Key features:

–Scarcity and choice–Purposeful behavior–Marginal analysis

Scarcity and Choice

• Resources are scarce• Choices must be made• There is no free lunch• Opportunity cost

Purposeful Behavior

• Rational self-interest• Individuals and utility• Firms and profit• Desired outcomes

Marginal Analysis

• Marginal benefit• Marginal cost• Marginal means extra• Comparison of marginal benefit and marginal

cost

Economic Models

• The scientific method• Cause and effect• Economic principles• Simplification of reality• Other-things-equal assumption• Graphical expression

Macro vs. Micro

• Macroeconomics–Aggregate

• Microeconomics–Individual Units

• Positive Economics• Normative Economics

Individual’s Economizing Problem

• Limited income• Unlimited wants• A budget line• Tradeoffs & opportunity costs• Make best choice possible• Change in income

A Budget Line

6543210

02468

1012

DVDs$20

Books$10

12

10

8

6

4

2

02 4 6 8 10 12 14

$120 Budget

Income = $120

Pdvd = $20= 6

Income = $120

Pb = $10= 12

Attainable

Unattainable

Quantity of Paperback Books

Qu

anti

ty o

f D

VD

s

1-20

Production Possibilities Table

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Production Possibilities Curve

Pizzas

Ind

ust

rial

Ro

bo

ts

Under or Unemployment

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

A’

B’

C’

D’

E’

U

1-22

Society’s Economizing Problem• Scarce resources

–Land–Labor–Capital–Entrepreneurial Ability

• Factors of production

1-23

Production Possibilities Model

• Illustrate production choices• Assumptions:

–Full employment–Fixed resources–Fixed technology–Two goods

1-24

Economic growth

–More resources –Better quality resources–Technological advances