Chapter 1

1. Chapter 1 Preliminaries

2. Introduction • What are the key themes of microeconomics? • What is a market? • What is the difference between real and nominal prices? • Why study microeconomics? Chapter 1

3. Themes of Microeconomics • Microeconomics deals with limits • Limited budgets • Limited time • Limited ability to produce • How do we make the most of limits? • How do we allocate scarce resources? Chapter 1

4. Themes of Microeconomics • Workers, firms and consumers must make trade-offs • Do I work or go on vacation? • Do I purchase a new car or save my money? • Do we hire more workers or buy new machinery? • How are these trade-offs best made? Chapter 1

5. Themes of Microeconomics • Consumers • Limited incomes • Consumer theory – describes how consumers maximize their well-being, using their preferences, to make decisions about trade-offs • How do consumers make decisions about consumption and savings? Chapter 1

6. Themes of Microeconomics • Workers • Individuals decide when and if to enter the workforce • Trade-offs of working now or obtaining more education/training • What choices do individuals make in terms of jobs or workplaces? • How many hours do individuals choose to work? • Trade-off of labor and leisure Chapter 1

7. Themes of Microeconomics • Firms • What types of products do firms produce? • Constraints on production capacity and financial resources create needs for trade-offs • Theory of the Firm – describes how these trade-offs are best made Chapter 1

8. Themes of Microeconomics • Prices • Trade-offs are often based on prices faced by consumers and producers • Workers make decisions based on prices for labor – wages • Firms make decisions based on wages and prices for inputs and on prices for the goods they produce Chapter 1

9. Themes of Microeconomics • Prices • How are prices determined? • Centrally planned economies – governments control prices • Market economies – prices determined by interaction of market participants • Markets – collection of buyers and sellers whose interaction determines the prices of goods Chapter 1

10. Theories and Models • Economics is concerned with explanation of observed phenomena • Theories are used to explain observed phenomena in terms of a set of basic rules and assumptions: • The Theory of the Firm • The Theory of Consumer Behavior Chapter 1

11. Theories and Models • Theories are used to make predictions • Economic models are created from theories • Models are mathematical representations used to make quantitative predictions Chapter 1

12. Theories and Models • Validating a Theory • The validity of a theory is determined by the quality of its prediction, given the assumptions • Theories must be tested and refined • Theories are invariably imperfect – but gives much insight into observed phenomena Chapter 1

13. Positive & Normative Analysis • Positive Analysis – statements that describe the relationship of cause and effect • Questions that deal with explanation and prediction • What will be the impact of an import quota on foreign cars? • What will be the impact of an increase in the gasoline excise tax? Chapter 1

14. Positive & Normative Analysis • Normative Analysis – analysis examining questions of what ought to be • Often supplemented by value judgments • Should the government impose a larger gasoline tax? • Should the government decrease the tariffs on imported cars? Chapter 1

15. What is a Market? • Markets • Collection of buyers and sellers, through their actual or potential interaction, determine the prices of products • Buyers: consumers purchase goods, companies purchase labor and inputs • Sellers: consumers sell labor, resource owners sell inputs, firms sell goods Chapter 1

16. What is a Market? • Market Definition • Determination of the buyers, sellers, and range of products that should be included in a particular market • Arbitrage • The practice of buying a product at a low price in one location and selling it for more in another location Chapter 1

17. What is a Market? • Defining the Market • Many of the most interesting questions in economics concern the functioning of markets • Why are there a lot of firms in some markets and not in others? • Are consumers better off with many firms? • Should the government intervene in markets? Chapter 1

18. Types of Markets • Perfectly competitive markets • Because of the large number of buyers and sellers, no individual buyer or seller can influence the price • Example: Most agricultural markets • Fierce competition among firms can create a competitive market Chapter 1

19. Types of Markets • Noncompetitive Markets • Markets where individual producers can influence the price • Cartels – groups of producers who act collectively • Example: OPEC dominates with world oil market Chapter 1

20. Market Price • Transactions between buyers and sellers are exchanges of goods for a certain price • Market price – price prevailing in a competitive market • Some markets have one price: price of gold • Some markets have more than one price: price of Tide versus Wisk Chapter 1

21. Market Definition • Market Definition • Which buyers and sellers should be included in a given market? • This depends on the extent of the market – boundaries, geographical and by range of products, to be included in it • Market for housing in New York or Indianapolis • Market for all cameras or digital cameras Chapter 1

22. Market Definition • Importance of market definition • In order to set price, make budgeting decisions, etc., companies must know • Their competitors • Product-characteristic and geographic boundaries of the market • Important for public policy decisions • Should government allow a merger between companies in same market? Chapter 1

23. Real Versus Nominal Prices • Comparing prices across time requires measuring prices relative to some overall price level • Nominal price is the absolute or current dollar price of a good or service when it is sold • Real price is the price relative to an aggregate measure of prices or constant dollar price Chapter 1

24. Real Versus Nominal Prices • Consumer Price Index (CPI) is often used as a measure of aggregate prices • Records the prices of a large market basket of goods purchased by a “typical” consumer over time • Percent changes in CPI measure the rate of inflation Chapter 1

25. Real Versus Nominal Prices • Calculating Real Prices Chapter 1

26. Real Price of College Chapter 1

27. Real Price of Wages • Observations • The minimum wage has been increasing in nominal terms since 1940 • From 1930 at $0.25 to 2003 at $5.15 • The 1999 real minimum wage was no higher in 1999 than 1950 Chapter 1

28. The Minimum Wage: Figure 1.1 Chapter 1

29. Why Study Microeconomics? • Microeconomic concepts are used by everyone to assist them in making choices as consumers and producers • Examples show the numerous levels of microeconomic questions necessary in many decisions Chapter 1

30. Ford SUV’s • Built Ford Explorer in 1991, Ford Expedition in 1997 and Ford Excursion in 1999 • In each of these cases, Ford had to consider many aspects of the economy to ensure their introduction was a sound investment Chapter 1

31. Ford SUV’s • Questions • How strong is demand and how quickly will it grow? • Must understand consumer preferences and trade-offs • What are the costs of manufacturing? • Given all costs of production, how many should be produced each year? Chapter 1

32. Ford SUV’s • Questions (cont.) • Ford had to develop pricing strategy and determine competitors’ reactions • Risk analysis • Uncertainty of future prices: gas, wages • Organizational decisions • Integration of all divisions of production • Government regulation • Emissions standards Chapter 1

33. Emission Standards • 1970 Clean Air Act imposed emissions standards and have become increasingly stringent • Questions: • What are the impacts on consumers? • What are the impacts on producers? • How should the standards be enforced? • What are the benefits and costs? Chapter 1