microecon principle ch01

7/23/2019 microecon principle ch01

http://slidepdf.com/reader/full/microecon-principle-ch01 1/31

Ten Principles of Economics (Ch. 1)

ECON 103 – Principles of Microeconomic

Junjie Liu – Econ 103



Topics Covered

• Scarcity and Trade-Off

• Opportunity Cost

• Marginal Reasoning

• Incentives

• Market and Government




Suppose one of your friends rents a booth in Crystal Mall and

bubble tea there. In the past few months, your friend was actumoney. Here is the accounting: she pays a monthly rent of $2,0

booth, materials and labour cost $2,800 per month, and mont

revenues are $4,500.

Your friend does not think the sale will pick up in the near futu

decides to close her business. The only problem is that she stil

month lease remaining.

What suggestions do you have for her?

A Scenario…




Fundamental economic problem: resources are scarce.

Scarcity: the limited nature of society’s resources.

Economics: the study of how society manages its scarce resou

For example:

• how people decide what to buy, how much to work, save, a

• how firms decide how much to produce, how many worker

• how society decides how to divide its resources between n

defense, consumer goods, protecting the environment, and

needs.

What Economics Is All About




Making decisions requires trading off one goal against another

Trade-off = To get more of one thing, we have to give up anoth

All decisions involve trade-offs. Examples:

• Going to a party the night before your exam leaves less time

studying.

• Having more money to buy stuff requires working longer ho

leaves less time for leisure.

• Protecting the environment requires resources that could ot

be used to produce consumer goods.

“There is no such thing as a free lunch”

Principle #1: People Face Trade-Offs




Society faces an important trade-off: efficiency vs. equity

• Efficiency = getting the most from scarce resources• Equity = distributing the benefits of those resources fairly am

members of society

There is a trade-off between efficiency and equity, which mean

increase in equity is associated with in a decrease in efficiency.

The reasons are …

Efficiency vs. Equity




To achieve greater equity, the government needs to redistribut

from the rich to the poor. But this reduces incentive to work haa result, people would work less and less output will be produc

Efficiency refers to the size of economic pie, and equity refers t

pie is divided. How the pie is divided eventually affects the size

in the sense that when the government tries to cut the econom

more equal slices, the pie gets smaller.

Efficiency vs. Equity




Opportunity cost: whatever must be given up to obtain some

Word of caution: Economists refer to cost as opportunity cost.

not expenditure or accounting costs, or historical cost, or “wha

for something”.

Opportunity cost is related to scarcity and trade-off. Because o

limited nature of resources, if you want to get more of one thihave to give up another. Whatever you must give up to get the

the opportunity cost of this item. If you have more than one a

the opportunity cost is the value of the best alternative.

Principle #2: The Cost of Something Is What Youto Get It




• The opportunity cost of seeing a movie is not just the price

ticket, but also the value of the time you spend in the movtheatre.

• The opportunity cost of going to college or university inclu

tuition fees plus foregone income.

Food and rent are not cost of going to college or universit

Application: College dropout billionaires

Examples


http://www.google.ca/search?q=college+dropout+billionaires&ie=utf-8&oe=utf-8&aq=t&rls=org.mozilla:en-US:official&client=firefox-a





Rational people systematically and purposefully do the best th

achieve their objectives, given the opportunities available.

Rational people make decisions by comparing marginal benef

marginal costs.

Marginal benefit (MB) is the increase in total benefit that aris

additional unit of good, and marginal cost (MC) is the increasecost from an extra unit of good.

Rational people take an action if and only if the marginal bene

action exceeds the marginal cost.

Principle #3: Rational People Think at the Ma




Notation: ∆ (delta) = “change in…”

Examples:

∆TB = change in total benefits

∆TC = change in total costs

∆ = change in quantity

MB =∆TB

∆

MC =∆TC

∆

Principle #3: Rational People Think at the Ma




The company that you manage has invested $5 million in deve

new product, but the development is not quite finished. At a rmeeting, your salespeople report that the introduction of com

products has reduced the expected sales of your new product

million. If it would cost $1 million to finish development and m

product, should you complete this project or give up?

Exercise




You should complete the project. The fact that you've already

million isn't relevant to your decision anymore, since that is a What matters now is the chance to earn profits at the margin.

spend another $1 million (MC = $1 million) and can generate s

million (MB = $3 million) , you'll earn $2 million in marginal pr

you should do so.

Alternatively, you can compare the profit or loss. If you spend additional $1 million, the project has lost a total of $3 million

in total costs and only $3 million in revenue). But if you don't s

additional $1 million, you won't have any sales and your losse

million. You should complete the project by minimizing the los

Answer




Back to the question on slide 12. Now that you have already s

million in developing the product and you know you will expeanyway. What is the most amount that you should pay to com

project?

Answer: $3 million

A Follow-Up Question




Diamond Water

Q

$

MV

Q

$

MV

10

$3,000

$0Q D

• Price = MV (marginal value)

• Importance to people’s life = TV (total value)

Example: The Water-Diamond Paradox




Incentive = something that induces a person to act, such as th

prospect of a reward or punishment.Because people make decisions by comparing marginal costs

marginal benefits, and incentives change their calculation of b

and costs, so they respond to incentives.

Examples:• In response to higher gas prices, sales of hybrid cars rise.

• In response to higher cigarette taxes, the incidence of smok

Principle #4: People Respond to Incentive




How does a seat belt law affect the number of deaths?

Total number of deaths = number of accidents X number of deaaccident

Seat belts change a driver’s cost-benefit calculation. Seat belts

accidents less costly because the number of deaths per acciden

decreases. As a result, drivers tend to drive faster than before, number of accidents to increase.

The net result is little change in the number of driver deaths an

increase in the number of pedestrian deaths.

Application: Seat Belt Laws




The purpose of rent control is to help the poor by making ho

affordable. Can rent control really reduce homelessness?In the short run, rent control causes the quantity of rental ho

demanded to rise and the quantity supplied to fall. There is a

of rental housing. Over time, housing shortages caused by re

increases because the demand for and supply of housing are

elastic in the long run.

One economist argued that rent control is "the best way to d

city, other than bombing."

Application: Rent Control




Rather than being self-sufficient, people can specialize in pro

things they are better at and exchange for other goods. Throspecialization and trade, people have more of all goods to co

To be covered in Chapter 3.

Principle #5: Trade Can Make Everyone Bette


Principle #6: Markets Are Usually a Good Way to



Market = a group of buyers and sellers of a particular good or

“Organize economic activity” means determining

• what to produce

• how to produce

• how much of each good to produce

• who receives which good

A market economy allocates resources through the decentraliz

decisions of many households and firms as they interact in ma

To be covered in Chapter 4.

Principle #6: Markets Are Usually a Good Way to Economic Activity




Adam Smith and the invisible hand (1776)

•

Although individuals are motivated by self-interest, an invisibguides this self-interest into promoting society’s economic w

The invisible hand works through the price system:

• The interaction of buyers and sellers determines prices.

•

Each price reflects the good’s value to buyers and the cost ofthe good.

• Prices guide self-interested households and firms to make de

that, in many cases, maximize society’s economic well-being

Market Economy




An economic system is the method that coordinates choices a

production with choices about consumption, and distributes gservices to the people who want them.

• Market Economy = Production and consumption are the re

decentralized decisions by firms and individuals.

• Command Economy = The central government makes all de

about the production and consumption of goods and servic

• Mixed Economy = Economic system that combines the free

with limited government intervention.

More on Economic Systems


Principle #7: Governments Can Sometimes Im



Important role for government: enforce property rights (with p

courts, etc.)

Property rights = the ability of an individual to own and exercis

over scarce resources.

• Market works only if property rights are enforced.

• We rely on the government to enforce our rights over the th

produce.

Principle #7: Governments Can Sometimes ImMarket Outcomes




Government may alter market outcome to promote efficiency w

is market failure.

Market failure = the market fails to allocate society’s resources

• Externalities = the impact of one person’s actions on the we

bystander (e.g. pollution).

• Market power = the ability of a single person (or a small num

sellers) to have a substantial influence on the market prices

monopoly).

More on Government




Government may also alter market outcome to promote equity

If the market’s distribution of economic well-being is not desira

tax or welfare policies can change how the economic pie is divi

More on Government


Principle #8: A Country’s Standard of Living Dep



The standard of living in an economy depends on the economy

to produce goods and services. Productivity measures the abilproduce goods and services.

Productivity = the amount of goods and services produced fro

unit of a worker’s time

Principle #8: A Country s Standard of Living DepIts Ability to Produce Goods & Services


P i i l #9 P i Ri Wh T M h M



Inflation = an increases in the overall level of prices in the eco

In the long run, inflation is almost always caused by excessive

the quantity of money, which causes the value of money to fa

Principle #9: Prices Rise When Too Much Money


Principle #10: Society Faces a Short-Run Trad



The short-run effects of monetary injection:

•

Increasing the amount of money in the economy stimulates level of spending and thus the demand for goods and servic

• Higher demand may over time cause firms to raise their pric

encourages them to increase the quantity of goods and serv

produce and to hire more workers to produce those goods a

services.• More hiring means lower unemployment.

Principle #10: Society Faces a Short Run Tradbetween Inflation and Unemployment


E i



Assume you are selling your 10-year old car. You have already

$1,000 on repairs.At the last minute, the transmission fails. You can pay $600 to

repaired, or sell the car “as is.”

In each of the following scenarios, should you have the transm

repaired?1) Blue book value is $6,500 if transmission works, $5,700 if it

2) Blue book value is $6,000 if transmission works, $5,500 if it

Exercise


A



1) The benefits of repairing the transmission are $6,500 − $5

$800, whereas the costs of repairing the transmission are $

should repair it.

2) The benefits of repairing the transmission are $6,000 − $5

$500, whereas the costs of repairing the transmission are $

shouldn’t repair it.

Answer


S



• Economics is about the allocation of scarce resources.

• Individuals face trade-offs.• Opportunity cost is whatever must be given up to obtain so

• Rational people think at the margin.

• People make decisions by comparing costs and benefits; th

respond to incentives.

• Markets are a good, but not perfect, way to allocate resou

Governments can sometimes improve market outcomes.

Summary


Documents

microecon principle ch01