Micro Economics- The Economic Perspective

8/3/2019 Micro Economics- The Economic Perspective

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MICROECONOMICS

P R O F . R U S H E N C H A H A L

The Economic Perspective

Prof. Rushen Chahal


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Learning Objectives

y 1. Describe how scarce resources and unlimited wants leadto the study of economics

y 2. Know the difference between micro and macroeconomics

y 3. Know the 3 basic questions that any economy mustanswer

y 4. Recognize strengths and weaknesses of the marketplaceand reasons for government involvement

y

5. Understand what a model is and why models are bestwhen they are simple

y 6. Explain what a model is and why models are best whenthey are simple

Prof. Rushen Chahal


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In Chapter 1

y Definitions

y Micro vs. Macro

y The 3 Basic Questions

y Equity vs. Efficiency and Redistribution

y Prices as Signals

y Modeling

Prof. Rushen Chahal


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y Economics studies the allocation of scarce (scarce= limited) resources in response to unlimited wants.

y In other words: We have a limited resources, but we would all like have more.

Economics studies how we use and consume these resources tosatisfy our wants (and our wants are never-ending).

Prof. Rushen Chahal


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y Scarcity a situation in which there are too few resourcesto meet all human wants.

y In other words: limited resources which do not satisfy all wants and needs.

y Examples wed all like more, but there is not enough Oil

Water Food

Housing

Prof. Rushen Chahal


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y the Margin the cutoff point; decision making at themargi

n refers to deciding on one more or one less ofsomething.

y In other words: Making a decision about ONE MORE UNIT of something. Cost benefit analysis: which is greater, the cost or the

benefit? Find out, then decide what to do.y Examples: Ive studied for 3 hours. Should I study one more hour? Ive played basketball for 4 hours. Should I play for one

more hour? I made 7 dumplings. Should I make another one? I plan to buy 5 dvds. Should I only buy 4? Should our business hire one more person?

Prof. Rushen Chahal


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Micro vs. Macro

y Microeconomics (small) analyzes theINDIVIDUAL COMPONENTS of the economy, suchas the choices made by people, firms, and industries.

y In other words:

Analyze one small part of the economy. Understand how thatone part functions.

Prof. Rushen Chahal


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Micro vs. Macro

y Macroeconomics (big) analyzes economicaggregates (aggregates = sums = totals), such asaggregate (total) employment, growth, and inflation.

y In other words: Analyze the big picture. Put all of the small parts together and

understand what happens.

Prof. Rushen Chahal


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y Markets make possible the voluntary exchange of

resources, goods, and services; can take physical,electronic, and other forms.

y Examples:

Stock exchange, food market, job market, real estate office,internet

Where/how people exchange goods and services

Prof. Rushen Chahal


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y Market prices serve as signals that guide theallocation of resources.

y In other words: Prices provide incentives to consumers and producers

that affect how resources are used.

y Example:

A job for an advertising graduate pays $90,000 per yearand a job for a management graduate pays $30,000 peryear. What will happen?

Prof. Rushen Chahal


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The 3 Basic Questions

y 1. What is produced? What goods are services are produced?

y2. How are those goods produced? What production methods are used?

y 3. For whom?

Who gets which goods?

Prof. Rushen Chahal


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An Economic System

y Command and control economy governmentdecisions control all economic activity. The 3questions are answered by the government. All production and consumption must be decided on by a

central planner. Can a central planner gather all the information necessary to

make efficient choices?

Characterized by poverty and inefficiency. Why?

In large part due to lack of information and INCENTIVES.

Prof. Rushen Chahal


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An Economic System

y Free market economy the collective decisions ofindividual buyers and sellers that, taken together,determine what outputs are produced, and whoreceives the outputs; free markets depend on

private property and free choice.

People are free to buy and sell what they want. Consumer preferences determine what is produced.

Firms determine how things are produced. Labor value and resources (income) determines whoconsumes what.

Prof. Rushen Chahal


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An Economic System

y Free markets

Also known as laissez-faire leave it alone; let it be; dontintervene; let it do what it does.

There are some rich and some poor, usually a large middleclass; generally far less poverty than in a command and controleconomy and an enormous amount more of wealth

Prof. Rushen Chahal


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An Economic System

y Mixed economies the mixture of free-market andcommand-and-control methods of resourceallocation that characterize modern economies.

Most modern economies include both laissez-faire andgovernment control in the economy which allowscreation of wealth and efficiency but provides some safety

net. People must decide what mixture to use.

Prof. Rushen Chahal


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y Equity fairness.

How does the idea of fairness influence your views on what

kind of economic system should be used?

Prof. Rushen Chahal


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y Efficiency means that resources are used inways that provide the most value; implies that no

one can be made better off without someone elsebecoming worse off.

y Examples:

With no additional cost, a farmer can load his producein a new way so that half as much produce is damagedon the way to the market. Is it efficient for the farmeruse the new way? YES

John can be made better off if we take 100 RMB from

Fang and give it to John. Is it efficient to take the 100RMB from Fang and give it to John? NO

Prof. Rushen Chahal


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2 Types of Efficiency

y Technological Efficiency the greatest quantity ofoutput for given inputs; likewise, for any givenoutput, requires the least-cost productiontechnique.

y Example: You can produce cars using technique A or B. Technique

A takes 300 workers and B takes 200 workers. In allother ways A and B are the same. Is A or B moretechnologically efficient?

Prof. Rushen Chahal


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y Technological Efficiency

y Another example: You can produce cars using technique A or B. Technique A

produces 500 cars per month and B produces 600 cars permonth. A and B are the same in all other ways. Which is moretechnologically efficient?

Prof. Rushen Chahal


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yAllocative Efficiency involves choosing the mostvaluable mix of outputs to produce.

y In other words: Choosing what we have to consume. What is the most

efficient amount of each good?

y Example:

Why is it allocatively inefficient to produce as many shoesas possible and no other goods.

Prof. Rushen Chahal


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.Redistribution

y Sometimes we much choose between what is fair(equity) and what is efficient, and it can be difficultto have both. Why?

Prof. Rushen Chahal


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Equity vs. Efficiency and RedistributionWhat happens when you change incentives?

MonthlyMonthlyStudyStudyHoursHours

GradeGrade

4040 AA

3030 BB

2020 CC

1010 DD

00 FF

WeeklyWeeklyHoursHours

WorkedWorked

WeeklyWeeklySalarySalary

4040 400 RMB400 RMB

3030 300 RMB300 RMB

2020 200 RMB200 RMB

1010 100 RMB100 RMB

00 0 RMB0 RMBProf. Rushen Chahal


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y The attractiveness of command and control

economics (central planning): It seems like it isfair (equity).

yA central planner decides what is produced and

who gets to consume what, but the centralplanner cannot possibly make all the decisionsnecessary for an efficient economy; it is notpossible to gather all of the necessary

information. Necessary information includes the preferences of all

people of all goods, costs of production, changes inpreferences and costs, etc.

Prof. Rushen Chahal


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.

y Invisible hand the idea that self-interest andcompetition promote economic efficiency withoutany need for action by government.

People working in their own interest creates efficiencyand prosperity.

To earn money, you must provide a good or service thatsomeone wants to buy.

Competition for buyers motivates producers to improve

quality and decrease cost.Why are property rights important?

Prof. Rushen Chahal


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Prices as Signals

y Prices provide information about scarcity

If the price of a good increases, this is a signal of more

scarcity consumers should consume less and producersshould produce more. Why?

If the price of a good decreases, this is a signal of moreabundance consumers should consume more andproducers should produce less.

Prof. Rushen Chahal


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Why choose a mixed economy?y Market failure situation in which a market is

inefficient.

Some causes: public goods, common property

resources, externalities, monopoly.

y The inability of some people to produce goodsand services leads people to allow theirgovernments to redistribute income tax the

wealthy and give to the poor; when there isextreme inequity.

Often this type of policy backfires and creates morepoverty. Why?

Prof. Rushen Chahal


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Positive vs. Normative Economics

y Normative having to do with behavioral norms,which are judgments as to what is good or bad(what is fair; equity).

y Examples:What someone thinks SHOULD happen.

The country should increase exports.

The country should decrease oil imports. The poor should get free housing.

Prof. Rushen Chahal


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Positive vs. Normative Economics

y Positive having to do with what is, was, or will be.

y Examples:

Facts. Last year GDP per capita in China was about12,800 RMB.

Unemployment in the U.S. is 4.5%.

Prof. Rushen Chahal


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Modeling

y Models simplified versions of reality thatemphasize features central to answering thequestions we ask of them.

Only important features are kept. Unimportant details are notused.

Prof. Rushen Chahal


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When is a model good?

yWhether or not a model is good depends upon itslogical consistency and its ability tot accuratelypredict behavior.

The validity of a model does not depend on thecorrectness of the assumptions the model makes.

The assumptions used in models are never absolutely

correct because of the need to simplify to understand theimportant features.

Prof. Rushen Chahal


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Ceteris Paribus

y Ceteris Paribus Latin for holding all elseconstant.A very common assumption in economics.

y In other words: If nothing else changes.

y Example: If we feed the pigs more food, then they will grow

larger, ceteris paribus.

Since nothing else changes, we exclude the possibiltythat the pigs are also given a vaccine that causes them

to lose weight.Prof. Rushen Chahal

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Micro Economics- The Economic Perspective