Nicholson Ch01 New

8/8/2019 Nicholson Ch01 New

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Intermediate MicroeconomicsIntermediate Microeconomicsand Its Applicationand Its Application

10 th Editionby

Walter Nicholson, Amherst CollegeWalter Nicholson, Amherst CollegeChristopher Snyder, Dartmouth CollegeChristopher Snyder, Dartmouth College

P ower P oint Slide P resentationbyMark KarscigCentral Missouri State University

2006 Thomson Learning/South-Western


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Chapter 1Chapter 1

Economic Models

2004 Thomson Learning/South-Western


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Economics

E conomicsHow societies allocate scarce resourcesamong alternative usesthreequestions:

What to produce

How much to produceWho gets the physical and monetaryproceeds


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MICRO

ECONO

MICS

How individuals and firms makeeconomic choices among scarceresources

How these choices create markets


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Economic

Models

Simple theoretical descriptions--captureessentials of how economies work

Real economies too complex to describe inuseful detailM odels are unrealistic, but useful

M aps unrealistic--do not show every house,parking lot, etc. Despite lack of realism, mapsshow overall picture; help us get where we want togo; form mental image


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Production

Possibility Frontier

Graph showing all possible combinationsof goods produced with fixed resources

Figure 1-1 shows production possibilityfrontier--food and clothing produced per

week At point A, society can produce 10 units of food and 3 units of clothing


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Amount of food

per weeklbs.

4

10A

B

Amount of clothingper weekarticles of clothing

0 3 12

F IGUR E 1-1: P roduction

P ossibility Frontier


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Production


At B, society can choose to produce 4 lbs.of food and 12 articles of clothing.Without more resources, points outsideproduction possibilities frontier areunattainable

Resources are scarce; we must chooseamong what we have to work with.


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Production


Simple model illustrates five principlescommon to microeconomic situations:

Scarce ResourcesScarcity expressed as Opportunity costsRising Opportunity Costs

Importance of IncentivesInefficiency costs real resources


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Scarcity And Opportunity Costs

Opportunity cost:Cost of a good as measured bygoods or services that couldhave been produced using thosescarce resources


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Opportunity CostE

xampleFigure 1-1: if economy produces one morearticle of clothing beyond 10 at point A,economy can only produce 9.5 lbs. of food, given scarce resources.

Tradeoff (or OPP ORTUNITY COST ) at pt. A: lb food for each article of clothing.


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Amount of food per week (lbs.)

9.510 A

Opportunity cost of clothing = pound of food

Amount of clothing per week (articles)

0 3 4

FIGUR

E1-1:

Production



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Rising Opportunity Costs

Fig.1-1 also shows that opportunity costof clothing rises so that it is much higher at point B (1 unit of clothing costs 2 lbs.of food ).

Opportunity costs of economic actionnot constant, but vary along PP F


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Amount of food per week(lbs.)

4 B

Opportunity cost of clothing = 2 poundsof food

2

Amount of clothing per week (articles)0 1213

F IGUR E 1-1: P roduction P ossibility Frontier


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Amountof food

per week

4

9.5

10A

B

Opportunity cost of clothing = pound of food

Opportunity cost of clothing = 2 poundsof food

2

Amountof clothing

per week0 3 4 1213

F IGUR E 1-1: P roduction P ossibility Frontier


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Uses of M icroeconomics

Uses of microeconomic analysis vary. Oneuseful way to categorize: by user type:

Individuals making decisions regarding jobs,purchases, and finances;Businesses making decisions regarding productdemand or production costs, or

Governments making policy decisions abouteconomic effects of various proposed or existinglaws and regulations.


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Basic Supply-Demand M odel

M odel describes how sellers and buyersbehavior determines goods priceE conomists hold that market behavior generally explained by relationshipbetween buyers preferences for a good

(demand ) and firms costs involved inbringing that good to market ( supply ).


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Adam Smith--The Invisible Hand

Adam Smith (1 723 -179 0) saw prices asforce that directed resources into activities

where resources were most valuable.P rices told both consumers and firms theworth of goods.

Smiths somewhat incomplete explanationfor prices: determined by the costs toproduce the goods.


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Adam Smith--the Invisible Hand

In 1 8 th century, labor was primary resource.Thus Smith embraced labor-based theory of prices:

If catching a deer took twice as long as catching abeaver, one deer should trade for two beaver (therelative price of a deer is two beavers ).

Figure 1-2(a ), horizontal line at P* shows that anynumber of deer can be produced without affectingrelative cost


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P rice(hrs)

P*

Q uantity deer per week

F IGUR E 1-2(a ): Smiths M odel


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David Ricardo--Diminishing Returns

David Ricardo (1 77 2-1 823 ) believed thatlabor and other costs would rise withproduction level

As new, less fertile, land was cultivated,farming would require more labor for sameyield

Increasing cost argument: now referred toas the Law of Diminishing Returns


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David Ricardo--Diminishing Returns

Relative price of good could be practicallyany amount, depending upon how much

was produced.P roduction level represented quantity thecountry needed to survive.Figure 1-2(b ): as countrys needsincrease from Q 1 to Q 2, prices increasefrom P 1 to P 2


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P rice

P 1

Q uantity per weekQ 1

F IGUR E 1-2(b ): Ricardos M odel


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P rice

P 2

P 1

Q uantity per weekQ 1 Q 2

F IGUR E 1-2(b ): Ricardos M odel


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P rice

P*

Q uantity per week

(a) Smith model (b) Ricardo model

P rice

P 2

P 1

Q uantity per weekQ 1 Q 2

F IGUR E 1-2: E arly Views of P riceDetermination


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M arshalls M odel of Supply and Demand

Ricardos model could not explain fall inrelative good prices during nineteenthcentury (industrialization ), so economistsneeded a more general model.E conomists argued that peoples

willingness to pay for a good will declineas they have more of that goodthebeginnings of thinking at the margin .


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M arshall, Supply and Demand, and the M argin

P eople willing to consume more of goodonly if price drops.Focus of model: on value of last, or marginal , unit purchased

Alfred M arshall (1 84 2-1 924 ) showed howforces of demand and supplys imultaneou s ly determined price.


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Figure 1- 3 : amount of good purchased per period shown on the horizontal axis; priceof good appears on vertical axis.

Demand curve shows amount of goodpeople want to buy at each price. Negativeslope reflects marginalist principle.


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Upward-sloping supply curve reflectsincreasing cost of making one more unit of a good as total amount producedincreases.Supply reflects increa s ing marginal costs

and demand reflects decrea s ing marginalutility.


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P rice

Demand

Supply

Q uantityper week0

F IGUR E 1-3 : The M arshallSupply-Demand Cross


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M arket E quilibrium

Figure 1- 3 : demand and supply curvesintersect at the market equilibrium pointP* , Q *P* is equilibrium price: price at which

the quantity demanded by a goodsbuyers precisely equals quantity of thatgood supplied by sellers


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P rice Demand Supply

Equilibrium pointP*

Q uantityper week0 Q*

F IGUR E 1-3 : The M arshallSupply-Demand Cross

.


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M arket E quilibrium

Both buyers and sellers are satisfied atthis price--no incentive for either to alter their behavior unless something elsechangesM arshall compared roles of supply and

demand in establishing market equilibriumto two scissor blades working together inorder to make a cut


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Non-equilibrium Outcomes

If an event causes the price to be setabove P* , demanders would wish to buyless than Q, * while suppliers wouldproduce more than Q *.If something causes the price to be set

below P* , demanders would wish to buymore than Q * while suppliers wouldproduce less than Q *.


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Change in M arket E quilibrium: IncreasedDemand

Figure 1- 4 peoples demand for goodincreases, as represented by shift of demand curve from D to DNew equilibrium established where

equilibrium price increases to P**


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P riceD S

P*

Q uantityper week0 Q*

F IGUR E 1- 4 : An increase in Demand Alters E quilibrium P rice and Quantity


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P riceD

DS

P*

P**

Q uantityper week0 Q* Q**

F IGUR E 1- 4 : An increase in Demand Alters E quilibrium P rice and Quantity


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Change in M arket E quilibrium:decrease in Supply

Figure 1- 5 : supply curve shifts leftward(towards origin )--reflects decrease insupply because of increased supplier costs (increase in fuel costs )

At new equilibrium price P** , consumers

respond by reducing quantity demandedalong Demand curve D


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P rice

D

S

P*

Q uantityper week

0 Q*

F IGUR E 1- 5 : A shift in Supply AltersE quilibrium P rice and Quantity


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4 0

P rice

D

SS

P*

P**

Q uantityper week0

Q** Q*

F IGUR E 1- 5 : Shift in Supply AltersE quilibrium P rice and Quantity


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4 1

How E conomists Verify Theoretical M odels

Two methods used:

Testing Assumptions : Verifying economicmodels by examining validity of assumptionsupon which models are based

Testing P redictions : Verifying economicmodels by asking whether models canaccurately predict real-world events


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Testing Assumptions

One approach: determine whether underlying assumptions are reasonable

Obvious problem: people differ in opinion of what is reasonable

E mpirical evidence

Results have problems similar to those foundin opinion polls:interpretation


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Testing P redictions

E conomists such as M ilton Friedmanargue that all theories require unrealisticassumptions.Theory is only useful if it can be used topredict real-world events.

E ven if firms state they dont maximize profits,if their behavior can be predicted by usingtheory, it is useful.


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M odels of M any M arkets

M arshall's supply and demand model ispartial equilibrium model: E conomic modelof a single marketTo show effects of change in one marketon others requires a general equilibrium

model: An economic model of completesystem of markets


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P ositive-Normative Distinction

Distinguish between theories that seek toexplain the world as it is and theories that

postulate the way the world should beTo many economists, the correct role for theory is to explain the way the world is(positive ) rather than the way it should be

(normative ).Text takes approach based on positiveeconomics.

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