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Chapter 1: Preliminaries. What is microeconomic theory? Micro theory is about the allocation of scarce resources with a focus on individual economic units like consumers and firms. It focuses on trade-offs or opportunity costs.

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chapter 1 preliminaries
Chapter 1: Preliminaries
  • What is microeconomic theory?
  • Micro theory is about the allocation of scarce resources with a focus on individual economic units like consumers and firms.
  • It focuses on trade-offs or opportunity costs.
  • Using economic jargon: individuals maximize utility subject to a budget constraint.
economics as a social science
Economics as a Social Science
  • Tries to explain observed behavior and make predictions about the future.
  • Develops theories to explain observed phenomena.
  • A model is a mathematical representation of a theory; no theory is perfect.
  • Models are simplifications of the real world.
positive versus normative
Positive versus Normative
  • Positive: explanation and prediction (deals with actual observed phenomena); can be proven right or wrong.
  • Normative: what ought to be (deals with opinions and recommendations); reflects value judgements.
  • The two can be hard to disentangle.
describing markets
Describing Markets
  • Identify who is the supplier and who is the demander
  • Define the extent of the market
  • Describe units in which the output is measured.
  • How competitive is the market?
real versus nominal prices
Real versus Nominal Prices
  • KEY: Real prices reflect influence of inflation so can make meaningful comparison of real prices across time.
  • Real price: price of a good relative to an aggregate measure of prices (adjusts for inflation); must pick a base year.
  • Nominal price: actual dollar price, not adjusted for inflation (price actually see)
  • Aggregate measure of prices: CPI—Consumer Price Index
formula to calculate real price in year x
Formula to Calculate Real Price in Year X
  • Real Price in Year X =
  • (Nom.P in Year X) * (CPI base year/CPI Year X).
  • Real PX =
  • NomPX (CPIB/CPIX)
  • Homework: Exercises #2 and # 3 on page 18 in textbook.
examples
Examples
  • Information given:

Nominal price of college education = $15,212 in 1993.

CPI values:

1985:107.6

1990: 130.7

1993: 144.0

  • Calculate the real price of a college education in 1993 in terms of 1985 dollars:

Use: Nom P ’93 * (CPI85/CPI93)

$15,212 * (107.6/144.0) = $11.366.74.

exercise cont
Exercise(cont.)
  • Calculate the real price of gasoline for 1977 and 1989 using 1970 dollars.
  • How did gasoline prices changed from from 1977 to 1989?
exercise solution
Exercise Solution
  • 1. Real price in 1977, expressed in terms of 1970 dollars:

1977 nomP * (CPI70 / CPI77) =

$0.58 * (38.8 / 60.6) =

$0.37.

  • 2. Real price in 1989, expressed in terms of 1970 dollars:

1989 nomP * (CPI70 / CPI89) =

$1.10 * (38.8/124.0) =

$0.34.