INTRODUCTION

1. INTRODUCTION Review of Key Topics from Micro Principles

2. Topics of Discussion • Microeconomics: The Allocation of Scarce Resources • Models • Use of Microeconomic Models • Ten Principles

3. 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

4. Microeconomics: The Allocation of Scarce Resources • Individuals and firms allocate their limited resources to make themselves as well off as possible • Consumers • Firms • Government

5. TRADE-OFFS • A society faces three key trade-offs: • Which goods and services to produce? • How to produce? • Who gets the goods and services?

6. Who makes the decision?

7. How prices determine allocations • Prices link the decisions about which goods and services to produce, how to produce them and who gets them

8. 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

9. Use of Microeconomic Models?

10. Review of Key Microeconomic Principles: Ten principles

11. 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.

12. Principle #1: People Face Tradeoffs. “There is no such thing as a free lunch!”

13. 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.

14. 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?

15. 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)

16. 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!

17. 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?

18. 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.

19. 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

20. 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)

21. 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

22. 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.

23. 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.

24. 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

26. 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

27. 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)

28. 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.

29. 7. Government can sometime improve market outcomes: • Examples: • Pollution : from production • Market power: government regulates monopoly

30. 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.

31. New Topic: Thinking Like an Economist • “Assumptions” • Assumptions are statements to make world simpler and easier to understand.

32. “Assumptions” • We would like to have assumptions that are generally close to reality • Menus and sticky prices in short run • Rational consumers (lowest price)

33. “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.

34. 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

35. Competitive market: • large number of buyers • large number of sellers • homogenous product • free entry/exit • perfect information

36. 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?