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INTRODUCTION. Review of Key Topics from Micro Principles. Topics of Discussion. Microeconomics: The Allocation of Scarce Resources Models Use of Microeconomic Models Ten Principles. Economics is the study of how society manages its scarce resources.

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Introduction

INTRODUCTION

Review of Key Topics from Micro Principles


Topics of discussion
Topics of Discussion

  • Microeconomics: The Allocation of Scarce Resources

  • Models

  • Use of Microeconomic Models

  • Ten Principles


Economics is the study of how society manages its scarce resources
Economics is the study of how society manages its scarce resources.

  • Resources such as natural resources, fertile land, labor etc are limited.

  • Therefore not everyone can have everything they want. That is what we mean by scarcity.

  • Microeconomics is the study of how individuals and firms can make themselves as well off as possible in a world of scarcity, and the consequences of those individual decisions for markets and the entire economy


Microeconomics the allocation of scarce resources
Microeconomics: The Allocation of Scarce Resources

  • Individuals and firms allocate their limited resources to make themselves as well off as possible

  • Consumers

  • Firms

  • Government


Trade offs
TRADE-OFFS

  • A society faces three key trade-offs:

    • Which goods and services to produce?

    • How to produce?

    • Who gets the goods and services?



How prices determine allocations
How prices determine allocations

  • Prices link the decisions about which goods and services to produce, how to produce them and who gets them


Models
Models

  • To explain how individuals and firms allocate resources and how market prices are determined, economists use models: a description of the relationship between two or more economic variables

  • Assumptions

  • Testing Theories

  • Maximizing subject to constraints

  • Positive Vs Normative




First 4 principles how people make decisions
First 4 Principles: How people make decisions

  • People face tradeoffs.

  • The cost of something is what you give up to get it.

  • Rational people think at the margin.

  • People respond to incentives.


Principle 1 people face tradeoffs
Principle #1: People Face Tradeoffs.

“There is no such thing as a free lunch!”


Principle 2 opportunity costs
Principle #2: Opportunity costs:

  • The cost of something is what you give up to get it.

  • The opportunity cost of something is what you would receive in the next best alternative usage.


2 opportunity costs
2. Opportunity costs:

  • Example: Opportunity cost of time spent studying in the university is the money that you have earned if you were working instead.

  • Can you think of any other examples?


Principle 3 rational people think at margin
Principle #3: Rational people think at margin

  • When making decisions people often think of the effects of small or incremental changes in the current course of action.

  • Example: Instead of thinking about cost/benefit of getting a PhD they might consider the effects of one or two more years of school.

  • Can you think of any other examples? (Assignment for next time)


3 rational people think at margin
3. Rational people think at margin:

  • People make decisions by comparing costs and benefits at the margin.

  • The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!


3 rational people think at margin1
3. Rational people think at margin:

  • Airline:

  • 30 seats costs $15,000 AC=$500

  • Suppose the plane is scheduled to take off in an hour. What if, at the last minute, a potential passenger offers $300 for a seat on the plane. Should the airline allow this passenger to board?


3 rational people think at margin2
3. Rational people think at margin:

  • If airplane not full, and willingness to pay $300, then for airline the MC of the passenger is small since the plane is still planning to make trip but MB of passenger is $300.


3 rational people think at margin3
3. Rational people think at margin:

  • Consider staying up an extra hour to study:

  • MB of 1 more hour of studying on grade.

  • MC of losing 1 hour of sleep on grade


3 rational people think at margin4
3. Rational people think at margin:

  • Firm’s hiring decision:

    • MB of 1 more worker (increase production)

    • MC of 1 more worker (wages, health insurance)

  • Employee’s work decision:

    • MB of working 1 more hour (more realistically or a few more hours a week)

    • MC of working 1 more hour (less leisure time, less sleep time, less time with friends and family)


Principle 4 people respond to incentives
Principle # 4: People respond to incentives:

  • Since people make decisions based on benefits and costs, then decisions may change when costs or benefit change.

  • Example: Increase in wage may encourage workers to work more.

  • Increase in wage will most likely cause firm to hire less workers.

  • Decrease in cost of education may encourage people to attain more years of education


Next 3 principles how people interact with each other
Next 3 Principles: How people interact with each other.

5. Trade can make everyone better off.

6. Markets are usually a good way to organize economic activity.

7. Governments can sometimes improve economic outcomes.


Principle 5 trade off can make everyone better off
Principle # 5:Trade off can make everyone better off

  • Without trade each family would grow own food, make clothes and houses.

  • Trade allows specialization.

    • Also applies to international trade. Some countries specialize in oil production growing certain crops, manufacturing.


Principle 6 markets are good way to organize economic activity
Principle # 6: Markets are good way to organize economic activity

  • Market economy vs. command economy (USSR, state makes all decisions)

  • In a market economy, households decide what to buy and who to work for, and firms decide who to hire and what to produce

  • How is there not chaos when everyone making decisions individually?

    • Idea of invisible hand by Adam Smith 1770


6 markets are good way to organize economic activity
6. Markets are good way to organize economic activity:

  • Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions.

  • In most cases p= value to society of a good=cost to society of a good


  • 6 markets are good way to organize economic activity1
    6. Markets are good way to organize economic activity:

    • Competition leads to Efficiency: when there is competition firms have to minimize costs, use the least inputs necessary (use inputs efficiently or else they will go out of business)


    Principle 7 government can sometime improve market outcomes
    Principle # 7: Government can sometime improve market outcomes

    • Market failure occurs when the market fails to allocate resources efficiently.

    • In other words, the interaction of supply and demand don’t lead to best outcome

    • Externality: when an action of one person or firm affects many people but the effects are not internalized.

    • A benefit or cost from production or consumer accruing without compensation to non-buyers and non-sellers of the product.


    7 government can sometime improve market outcomes
    7. Government can sometime improve market outcomes:

    • Examples:

    • Pollution : from production

    • Market power: government regulates monopoly


    Last 3 principles the forces and trends that affect how the economy as a whole works
    Last 3 Principles: The forces and trends that affect how the economy as a whole works.

    8. The standard of living depends on a country’s production.

    9. Prices rise when the government prints too much money.

    10. Society faces a short-run tradeoff between inflation and unemployment.


    New topic thinking like an economist
    New Topic: Thinking Like an Economist

    • “Assumptions”

    • Assumptions are statements to make world simpler and easier to understand.


    Assumptions
    “Assumptions”

    • We would like to have assumptions that are generally close to reality

    • Menus and sticky prices in short run

    • Rational consumers (lowest price)


    Assumptions1
    “Assumptions”

    • Sometimes we will see assumptions that seem unrealistic

      • Either by ‘loosening’ that assumption doesn’t change model/how we solve problem but assumption makes problem easier to think about.

      • Need a jumping off point and in the future basic model helps economist solve more real model.


    Review of supply and demand
    Review of Supply and Demand

    • Market: a group of buyers and sellers of a particular good or service.

      • May be centralized or not: grocery stores, all selling wheat bread

      • Stock market (more centralized)

      • Buyers determine demand

      • Sellers determine supply


    Competitive market
    Competitive market:

    • large number of buyers

    • large number of sellers

    • homogenous product

    • free entry/exit

    • perfect information


    Competitive market1
    Competitive market:

    • For now, the most important thing to remember is that since there are a large # of buyers and sellers, so one individual or firm cannot significantly have an impact on price. In other words, everyone is a price taker.

      • If all stores are selling milk at $2.50 per gallon but one decides to sell at $5, will anyone buy from that store?


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