Welcome to Econ 1

Introduction to Microeconomics

Week 2.2, Tuesday, February 15

Review: Definitions

• GoodGood : is anything that an individual wants to have more of, at zero price.• Resource: Anything that can be used to produce goods.• Scarcity: A good is scarce if the amount desired at zero price is more than the amount available at zero price. •(Scarce good = Economic Good)

Review:AssumptionsReview:Assumptions

• Humankind has unlimited wants

• Our resources are limited

• ScarcityScarcity : Individually, and as a Society, we do not have enough resources to produce all the things we want.

Review:Implications of ScarcityReview:Implications of Scarcity

• ChoiceChoice: people must choose which goods to acquire.

• Economic CostEconomic Cost: The Cost of any action, is the personal value of the next highest valued alternative given-up.

Costs: Economic vs. Accounting

• Accounting Cost: The explicit expenditure for a given activity.

• Economic CostEconomic Cost: The Cost of any action, is the personal value of the next highest valued alternative given-up.

• Economic Cost includes Explicit & Implicit• Sunk Cost: Past expenditures that no

longer represent an alternative (Not a part of Economic Cost)

Review:Implications of ScarcityReview:Implications of Scarcity

• ChoiceChoice: people must choose which goods to acquire.

• Economic CostEconomic Cost: The Cost of any action, is the personal value of the next highest valued alternative given-up.

• CompetitionCompetition: We are in a state of competition for the use of resources

Forms of Competition in SocietyForms of Competition in Society

• ViolenceViolence, , or Threat of Violence

• Social/PoliticalSocial/Political : competition on the basis of some limited behavior or characteristic

• Economic/MarketEconomic/Market: competition based on offering the highest value in exchange.

Scarcity Society Choices

• What to produce? Goal find the mixture of outputs that maximizes society’s value.

• How to produce? Goal: find the optimal mix of inputs to maximize technical output.

• For whom to produce? Who will get to consume the goods produced.

What Economics Is About

• Microeconomics: decisions of individuals and firms: what to buy and what to produce.

• Macroeconomics: the whole economic system and the role of government.

Mechanisms of Choice

• Political: our representatives make choices

• Economic/market: individuals and firms make choices based on relative prices about what to produce

Ten Principles of Economics

• Individual decision making

• How people interact

• The economy as a whole

Individual Decision Making

• People Face Trade-offs: Choice

• Opportunity Cost

• Rational people think at the margins

• People respond to incentives

How People Interact

• Trade Makes everyone better off

• The market system organizes production efficiently

• Markets outcomes can sometimes be improved upon by Government

The Economy as a Whole

• The standard of living depends on productivity

• Inflation results from too much Money

• The short-run trade-off: inflation vrs. unemployment

The Economic/Market Form of Competition

Product Markets

  FIRMSHOUSEHOLD

 ResourceMarkets

$'s $'s Revenue

$'s Income $'s

Goods &Services

Goods &Services

Resources Inputs

 

Circular Flow Diagram of the Exchange Economy

Economic Agents & Decision-makingEconomic Agents & Decision-making

• HouseholdsHouseholds: Decisions: What to sell? What to buy? Assume Maximize Utility

• FirmsFirms: Decisions: What inputs to use? What to produce? Assume Maximize Profits. ∏ = Total Revenue – Total Cost

• MarketsMarkets: Factor Markets, Product Markets

Role of MoneyRole of Money: The medium of exchange

Definition of Money

• Currency in Circulation: Currency outside of Banks in the hands of households,or firms

• Checkable deposits in Banks, Savings & Loans, Credit Unions

Interdependence & the Gains from Trade

(Chapter 3)

Gains from Specialization &Trade

• Production Possibilities

• Resource Fish Coconuts

• Crusoe: 8 or 8

• Friday: 10 or 20

Opportunity Cost in Production

 

Crusoe: 8 F = 8 C 1 F = 1C and 1C = 1F Friday: 10 F = 20 C 1 F = 2C and 1C = ½ F Thus Crusoe has a comparative advantage in the production of fish ( 1F = 1C) and Friday has a comparative advantage in the production of Coconuts ( 1C = ½ F)

Separate Production Possibilities

Crusoe FridayFish Fish

Coco Coco

8

8

10

20

Pre-Specialization Production

• Resource Fish Coconuts

• Crusoe: 4 and 4

• Friday: 5 and 10

• Total Output: 9 and 14

Output with Specialization

Resource Fish Coconuts

• Crusoe: 8 and 0

• Friday: 1 and 18

• Total Output: 9 and 18

Results of Specialization• No increase in Resources

• No increase in effort

• Increased output by 4 coconuts

• Increased output will be shared by the two people or countries so as to make both better off

Apply Reasoning to more than two Resources

• Analyze production decisions using several resources with different relative abilities

• How to organize production to maximize output

• The graphical technique

Graph: Production Possibilities Function

Assumptions:

1. Fixed resources: 10 acres in rows.

2. Fixed technology: current knowledge of how to produce.

3. Resources vary in relative productive ability.

Resources and Potential Outputs

Row 1 2 3 4 5 6 7 8 9 10

Corn 10 10 10 10 10 10 10 10 10 10

Wheat 10 12 14 16 18 20 22 24 26 28

Resources and Opportunity Cost

Row 1 2 3 4 5 6 7 8 9 10

Corn 10 10 10 10 10 10 10 10 10 10

Wheat 10 12 14 16 18 20 22 24 26 28

Cost of

1 corn

1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8

Cost of

1 wheat

1.0 .83 .71 .63 .56 .50 .45 .42 .38 .36

Graph MechanicsGraph Mechanics

• The curve divides the space: interior points possible; Points beyond impossible

• SlopeSlope: Rise/ Run: The slope reflects the relationship: Negative, more corn means less wheat, more wheat means less corn

• ShapeShape: The concave shape reflects increasing cost of production for either good.

Changing assumptions Shifts the Curve

• An Increase in resources– Shifts the curve outward

• An increase in technology of Wheat production: Effects on Cost– Lowers cost of producing Wheat– Raises the cost of producing corn