Welcome to Econ 202 Principles of Microeconomics

1. Welcome to Econ 202 Principles of Microeconomics Dr. David Sobiechowski, Instructor www-personal.umd.umich.edu/~davidski www-personal.umd.umich.edu/~davidski

2. Introduction to Economics Scarcity, Opportunity cost, and graphs

3. What is Economics ? (or why does economics exist) Problem 1.Human Beings haveunlimited wants for goods and services. Problem 2.Resources (which are used to produce goods and services) are Limited Example: You have a limited income (your resources), but could always want more goods & services than you do now.

4. The Economic problem is Scarcity • Scarcity is theimbalancebetween: theunlimited wants of humans andthelimited means to satisfy those wants • An Economy is: a mechanism through which the use of land, labor, and capital are organized... ...in an attempt to satisfy the unlimited wants of it's members. • Economics is... ...1. the study of how individuals, groups, and countries use their limited resources in an attempt to satisfy their unlimited wants. 2. Economics is the study of how peoplemake choices in attempting to satisfy their unlimited wants.

5. Why make choices? • You can’t ever get everything you desire because of limited resources... ...(i.e. income, wealth, time, etc.)this implies that one mustchooseamong many different possible alternatives. …which means that we could have donesomething elsewith our time or with our income… …in other wordswe must give up some other alternativeto get something else.

6. This is called: Opportunity cost... ... is the cost of making a choice... …it is measured as the sacrifice of the next best alternative given up by a person, group, or nation. Opportunity cost is, for the most part, subjective (by the person making the choice). But italways existsregardless of person or nation. This leads to the saying: There is no such thing as a free lunch.

7. Decision Making The question that is fundamental to economics is: How should we use our resources and capabilities? This applies to an individual, a business firm, and a nation as a whole… …because all face the universal problem of scarcity • Economists use the concept of opportunity cost as a way to make decisions: 1. There is an opportunity cost to everything we do 2. There must also be a benefit (the opposite of cost) to everything we do… …it is measured by what we are willing to give up.

8. Marginal Analysis • Economists assume that people haveobjectives they want to reach, such as getting as much profit as possible from producing goods or services. • How can a firm or a person make sure they do this? • By comparing the benefits and costs of an action!... …moreover, you will only be concerned with the additional benefits and additional costs from your current situation… …because there is nothing you can do about past costs and benefits(Sunk Costs)… …the decision rule is simple: pursue an action where the additional benefitsare greater or equal to the additional costs of an action. It is called marginal analysis because this is the name economists give to the words: additional, next, extra.

9. Example: The choice of going to college. • All of you decided themarginal benefit of going to collegewas higherthan themarginal costof going to college. • I assume you are a rational self-interested person • Rational means you have anobjectiveand will choose that action that will give you thegreatest satisfaction • Choosing the alternative where the marginal benefit >= marginal costwill do this. • In fact you will choose the amount of that alternative until themarginal benefit = marginal cost(get the most satisfaction from your action).

10. How do we study Economics? A look at a Theories (Models) To explain economic behavior

11. Microeconomics • Looks closely at how individuals, business firms, and societiesmake choices. • It attempts to show how themarket-capitalist system answersthe following three fundamental questions (every economy faces these because of Scarcity) : 1. What to Produce? 2. How to Produce? 3. For whom to Produce?

12. Macroeconomics • The study of how the choices individuals, businesses and governments affect the aggregate or total economy. • Three large issues of Macroeconomics: • 1. Standard of Living - level of consumption of goods and services people enjoy. • Economic growth and Unemployment. • Productivity - Total Production / Number employed • 2. The cost of Living - number of dollars it takes to buy goods and services for a given standard of living. • Inflation and Price Stability : Quantity of Money • 3. Economic Fluctuations - the periodic rise and fall of total production in the economy, the business cycle • Recessions and Expansions affecting Unemployment & Inflation : Fluctuations in total spending

13. Begins with observing the economy • All Scientific inquiry starts with observations about what is happening in the world. • Economists gather information and describe the economy by organizing the data. • This data can be shown with tables of numbers which we can translate into a picture(graph). • A discussion of how to read and interpret these observations will be done later in the lecture. • However, this is only the start: Descriptions are not explanations… …this is why economic models or theories are needed: To explain the data that is collected

14. Two types of Scientific inquiry • Positive Economics...makingobjective statements about economic phenomena that can be tested andproved right or wrong. a. Explaining why events occur b. Predicting under what circumstances economic events will occur in the future Example: An increase in income taxes will cause consumer spending to go down • Normative Economics...a way of determining thedesirability of outcomes based on somevalue judgments (opinions) a. Recommending appropriate courses of actions to take. Example: Taxes should be lowered in order to increase consumer spending. b. Criteria:1. Efficiency 2. Equity

15. Theories or Models • Used to explain how something works. • An Economic model is asimplified wayof expressing how the economy or parts of that economy function. • It’s main purpose is toexplain how the economy (or parts of it) workand tomake predictionsaboutwhat could happenwhensomething changesin the economy.

16. Theories or models include four steps 1. Identify what you want to study (variables) Example: You may want to study how a congressperson will vote on bill. Some variables that may be relevant to that vote are: Party affiliation Congressional district (Constituents) Conscience Money received for political campaigns 2. Make assumptions on variable behavior Example: What is the objective of the Congressperson? 1. Reflect constituent views, 2.Vote with Party, 3. Get Re-elected

17. Theories or models include four steps 3. Make hypothesis or Predictions (In the form of IF... THEN..) • Example: If a Congressman receives money from the UAWhe will vote Yes on raising the minimum wage... ....Ceteris Paribus:All other things held constant. (This is an implicit assumption made with all predictions) It means that we only usetwo variables at a time when making predictions(in order to isolate how one variable affect one other variable)... ...Everything else is assumed not to change. 4. Test your predictions • If wrong you may have to adjust theory

18. Problems in theory building: 1. Fallacy of Composition...what is true for the individual is true of the group 2. Post hoc, ergo Propter Hoc(Post Hoc fallacy) Association does not imply causation

19. 1. The Fallacy of Composition:The often mistaken belief that what is true for a part is necessarily true for the whole. • When I stand up at a ballgame, I can see better. Therefore, if everyone stands up, everyone will be able to see better? • If Farmer Jones produces more corn, her revenues will rise. If all farmers produce more corn, their revenues will all rise?

20. 2. Post Hoc Fallacy:If event A happens beforeevent B, it is notnecessarily truethat event A causedevent B. • Many, many examples exist... • I went to the beach and it began to rain. It must have rained because I went to the beach? • We increased our advertising budget and people stopped buying our product. Our advertising must be discouraging consumers?

21. Correlation vs. Causation • Two variables are correlatedif one variable changes when the other variable changes. • This does NOT mean that changes in one variableCAUSE changes in the other.

22. APPLICATION: Correlation vs. Causation • Cities with high crime rates also have many automobiles. Does this mean that automobiles cause crime? • President Bush took office in 2001 and soon after the economy began to get worse. Does this mean that the Bush inauguration caused the worsening economy?

23. An Introduction in reading and using Graphs

24. Graphs • Graphs are pictures that show the relationship between two variables • A variable is something that can take on more than one value. • There are two ways that variables can be related: 1) Positive relationship: variables move in the same direction 2) Negative relationship: variables move in the opposite direction

25. Example: Positive or Direct relationship Miles driven in a car and the total amount of gasoline used As youdrive moreyou will use upmore gasoline. Miles Driven Gasoline used (gallons) 200 10 400 20 600 30 800 40

26. A graph always starts with labeling the vertical and horizontal axis with the variables (numbering is usually optional) Miles Driven 800 600 400 200 10 20 30 40 Gallons of gasoline used Next, we plot the points from our table... Miles Gasoline used Driven (gallons) 200 10 400 20 600 30 800 40 0 Then we connect the dots to represent other possible observations and to describe the relationship The graph is read by moving to the right on the horizontal axis..... ...and then moving vertically until you hit the relationship line.

27. If we want more detailed information about this relationship we can calculate theslopeof the line Miles Driven Slope = Change in vertical distance Change in horizontal distance 800 = Rise Run 600 = 200 miles 200 miles 10 gallons 400 10 gallons = 20 miles 200 gallon 10 20 30 40 Gallons of gasoline used 0 Miles Gasoline used Driven (gallons) 200 10 400 20 600 30 800 40

28. This relationship line is constructed ceteris paribus • Are thereother variables could affect the amount of gasoline a car would use for the same amount of miles driven? Tire inflation Weather conditions a well tuned engine amount of weight in car or towing • If a car is driven is cold weather it will use more gas for same miles driven • How will this affect the relationship line we have drawn?

29. Use more gas more same amount of miles driven... Miles Driven Adding the variable driving in cold weather has caused the curve to Shift Position! 800 When a third(or more) variable is included in a model it causes the entire curve to shift. 600 400 200 10 20 30 40 Gallons of gasoline used 0 Miles Gasoline used Gasoline used Driven (gallons) (gallons) 200 10 20 400 20 30 600 30 40 800 40 50

30. Cost of Next car Dealing with curves Interpretation: As production gets larger the same increase in production leads to greater increases in costs than before. Any time a line gets steeper, the slope is getting larger This curve also shows a positive relationship, except it is a not a straight line... ...The slope of a curved line changes at every point on that curve... ...you should be able to tell how the slope of the line changes as we move away from the origin....... Production of Cars

31. Production of Autos Dealing with curves Interpretation: As more workers are added the same increase in workers leads to smaller increases in production. Here is a positive relationship where Y increases but at a smaller rate as X increases. Amount of Workers

32. The Difference Between a Line and a Curve Equal increments in X lead to constant increases in Y. Equal increments in X lead to diminished increases in Y.

33. Negative or Inverse relationship • Two Variables move in theopposite direction • Example:Birthrate and Family income • As Family income increases the Birthrate tends to decline

34. A negative relationship shows a downward sloping line (moving to the southeast) Birthrate (average per family) A c B d 0 e f Family Income (average per family) When we move to the right on the horizontal axis, the relationship line tells us we must move down the vertical axis.

35. Dealing with curves Y Interpretation: As X gets larger the same increase in X leads to Y decreasing in greater amounts than when X was smaller Here is a case of a negative relationship that is not a straight line X

36. A Graph that shows no relationship between the two variables... Y 20 X …as X increases,Y does not change This means that Y is independent of X and vice versa. A straight horizontal or vertical line indicate no relationship between the two variables.

37. This is a time series graph. It shows how a variable performs over time. This graph shows Mortgage rates 1978-2008