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Chapter 1: Preliminaries

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  1. 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.

  2. 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.

  3. 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.

  4. 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?

  5. 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

  6. 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.

  7. 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.

  8. Exercise

  9. 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?

  10. 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.