chapter 1 introduction to microeconomics mcgraw-hill/irwin copyright © 2008 by the mcgraw-hill...
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Chapter 1
Introduction to Microeconomics
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Main Topics
What is microeconomics?Tools of microeconomicsThemes of microeconomicsUses of microeconomics
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Economics – DefinitionEconomics is the social science that deals with
the production, distribution, and consumption of goods and services and with the theory and management of economies or economic systems. (American Heritage Dictionary)
Economics: the study of how society manages its scarce resources.
What is one of the overriding factors that drive economics….especially microeconomics?
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The Focus of Economics
Scarcity forces societies to confront three critical issues:What to produceHow to produce goodsWho gets what
Economics examines how societies address these three issues: allocation of scarce resources
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What is Microeconomics?Microeconomics: concerns individual decision
making and its collective effect on allocation of a society’s resources
Macroeconomics: concerns aggregate phenomenaMuch of modern macroeconomics involves
applications of microeconomics
Our class will provide a deeper study into the field of microeconomics than what was covered in your principles course.
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What is Microeconomics?
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Which headline talks about (a) economics and if so, (b) micro / macroeconomics
Institutions for Allocation Resources
Micoecon analysis begins with an understanding of institutions, including laws and customs, that define a society’s procedures for allocating resources
In a capitalist economy:Means of production are owned and
controlled by and for the benefit of private individuals
Resources are allocated by voluntary trading among businesses and consumers
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Institutions for Allocation of Resources
In a communist economy:Economic decisions are highly centralizedThe state owns and controls the means of
production and distributionNo economy is completely centralized or
decentralized; all economies are a combination of both.
Examine statistics on the size of government for a rough measure of centralization. P4.Compare Korea and Sweden. Why are there
differences?
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Markets
Markets are the most common form of economic decentralization
Markets are economic institutions that provide people with opportunities and procedures for buying and selling goods and services
May be governed by explicit rules (e.g., NYSE) or by custom (e.g., open bazaar)
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What is a Market?
In microeconomics, a market is:Associated with a single group of closely
related productsOffered for sale within particular geographic
boundaries
Products belong to the same market when they are highly interchangeable
Some markets may be worldwide 1-10
Characteristics of MarketsMarkets include buyers and sellersOften, but not always, sellers are
companies and buyers are individualsB2C / B2B / C2C
Trade in modern markets is usually governed by price, the rate at which someone can swap money for a good
Markets can function only if a system of transferable property rights is established and enforced
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Economic Motives
Need to understand individual motives to determine what choices they will make
Assume people are motivated by self-interest:Desire for goods and servicesCan include possibility that someone might care
about someone else’s well-being
Same motivation even if acting as consumer, firm, or employee
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Positive Economic Analysis
One of the main objectives of microeconomics is to answer questions.
Positive economic analysis: addresses factual questions, typically about economic choices or market outcomesWhat did happen? What will happen? What would
happen?Historical fact-findingForecastingCause-and-effect analysis of actions and their
consequencesStick to objective facts and avoid value
judgments 1-13
Normative Economic Analysis
Normative economic analysis: addresses questions that involve value judgments concerning the allocation of resourcesWhat ought to happen?
Turn normative questions into positive questions using the principle of individual sovereignty
Or….Each person knows what’s best for him or her.
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Normative Economic Analysis
Which music is better? Music A Music B
Which shall our class listen to?How can we weigh the person’s gain who
likes the music we play vs. the loss of the one who hates it? Is this a Normative or Positive value?
How could we turn this into the other argument?
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Scope of Microeconomics
Broad definition of “resources”, not just about money (time, for example)
Range of topics is extremely wide:MarriageCrimeAddictionEnvironment
In many ways, decisions by many individuals combine to produce social outcomes
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Tools of Microeconomics
To uncover the “truth”, economists use the 5-step scientific method.Initial observationTheorizingIdentification of additional implicationsFurther observation and testingRefinement of the theory
A useful theory must have broad application but also specific implications
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Models and Mathematics
Model: a simplified representation of a complex phenomenon
Economists use models to provide an account of cause and effect, to help us understand how the world works
Some economic models are quantitative (mathematical) so that they are more precise
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Simplifying Assumptions
All scientists build models based on assumptions, so do economists
This allows the model to focus on the most important explanations for a particular phenomenon
No economic model is literally trueSome assumptions are easy to criticizeThe test of a model is its usefulness
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Data Analysis
Scientific method requires models to be tested with data, e.g., from:Records (financial accounts, customer databases)Surveys (Consumer Expenditure Survey, other
government or private sources)Experiments
Econometrics: application of statistical methods to empirical questions in economics
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Why Economists DisagreeEven with scientific method, still room to
disagreeDifferences in scientific judgment lead to
disagreements on positive questionse.g. Look at the same data but come to a different
conclusionLikely began from different assumptions; may be
able to resolve by empirically testing assumptionsCan’t resolve normative disputes that arise
from differences in values
Economists from the US vs. USSR
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Themes of Microeconomics: Decisions
Theme 1: Trade-offs are unavoidableThere’s no such thing as a free lunch
Theme 2: Good choices are made at the marginMost decisions are a matter of degree
Theme 3: People respond to incentivesTheme 4: Prices provide incentives
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Themes of Microeconomics: Markets
Theme 5: Trade can benefit everyoneTheme 6: The competitive market price
reflects both value to consumers and cost to producers
Theme 7: Markets have advantagesTheme 8: Sometimes governments can
improve on free-market resource allocations
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Uses of Microeconomics
Why study microeconomics? It’s useful!Tools for understanding and evaluating
the effect of public policiesHelp make important personal and
business decisionsStresses thinking at the margin,
importance of trade-offs
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Uses of Microeconomics
Applications of microeconomics:Business investmentsPortfolio managementReplacing an old carEnvironmental policy….and many others
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