Chapter 1

1. Chapter 1

2. What is? • Economics: Economics is the study of the allocation of scarce resources among alternative uses • Microeconomics: The study of the economic choices individuals and firms make and how these choices create markets • Micro theory: Provides the tool box to understand how decisions are made and resources are allocated by individuals and firms

3. An Economic Model • A model is a simple theoretical description that captures the essentials of how the economy works • An abstraction • Makes assumptions

4. An example of a model: The PPF • Suppose an economy produces food and clothing Amount of food per week • Scarce resources • opportunity costs • Opportunity costs increase • Incentives matter • Inefficiency has real costs PPF Amount of clothing per week

5. To build a model • Start with an economic problem • Identify the decision makers • Identify their objectives • Identify the relevant choices • State assumptions • Solve for the equilibrium • Discuss the equilibrium

6. How Economists Verify Theoretical Models • Testing Assumptions: Verifying economic models by examining validity of assumptions upon which models are based • Is it reasonable to assume that people are rational, that firms maximize profits etc. • Testing Predictions: Verifying economic models by asking whether models can accurately predict real-world events • If the model predicts events well, then the theory is useful even if the assumption may not appear to be valid.