july02

Outline for Wed, July 2

� Syllabus

� Homework due Monday

� Quiz next Friday

� What is Microeconomics?� What is Microeconomics?

� How is Microeconomics used?

Syllabus

� Book: Jeffrey M. Perloff’s Microeconomics with Mark McLeod’s workbook

� Website: http://fperickson.googlepages.com

How it’ll work

� You’ll get preparation for 400-level courses and some economic intuition

� My part

� Answer questions clearly� Answer questions clearly

� Present material at an appropriate pace

� Your part

� Ask me questions in the first place

� Provide feedback on the course

� Holding back questions and criticism won’t help your grade or my lectures

How it’ll work even better

� Make the most of the lectures

� Arrive on time (and I’ll try to end on time)

� If leaving, don’t disrupt class and get notes from others

� If missing a quiz or test, study the official policy, warn � If missing a quiz or test, study the official policy, warn me and get notes

� Save chatting, reading newspaper, etc. for another time

� Review using the extra materials on the website

� Study together

Outline for Wed, July 2

� Syllabus




What is the subject matter of microeconomics?

� Macroeconomics studies…

� Microeconomics studies…

What is the subject matter of microeconomics?

� Macroeconomics studies the behavior of the whole economy: growth, international trade, money

� Microeconomics studies…

What is microeconomics?

� Macroeconomics studies the whole economy

� Microeconomics studies the decisions of consumers and firms, usually in a market



� Microeconomics studies market decisions

� A market is simply ‘where’ goods and services are tradedtraded





� Anything that can be priced has a market

� iPods, education, time…?

� For this reason micro is sometimes called a price theory





� Anything that can be priced has a market

� We’ll now go over four key micro concepts:

� Scarcity

� Opportunity cost

� Decisions at the margin

� Rationality

Scarcity

� A resource is something that is used to make something else: human labor, oil, water

Scarcity

� A resource is something that is used to make something else

� A resource is scarce if, when you give it away for free, there is too little to go around. It doesn’t have free, there is too little to go around. It doesn’t have to run out

Scarcity


� A resource is scarce if, when you give it away for free, there is too little to go aroundfree, there is too little to go around

� Are cell-phones a scarce resource? No, they are not used to make any other product

Scarcity




� How about trash? No. It’s finite, but (almost) no one wants it. It might be called a bad

Scarcity




� How about trash? No. It’s finite, but (almost) no one wants it. It might be called a bad

� Is fresh air a scarce resource? Maybe, though it might instead be an abundant resource

An aside

� But doesn’t microeconomics study the allocation of scarce resources?

An aside

� But doesn’t microeconomics study the allocation of scarce resources? Other allocation mechanisms include:

� LotteriesLotteries

� Auctions

� Queuing

� Central planning

� Voting

� Gifts

An aside

� Markets are not the only way scarce resources are allocated

An aside

� Let’s consider the allocation of team prizes at a track meet. Teams A, B and C perform as follows:

First Place Second Place Third Place

One mile A C B

Two mile B A C

� Who did better: A or B?Two mile B A C

An aside



One mile A C B

Two mile B A C

BAC

� Who did better: A or B?Two mile B A C

An aside



One mile A C B

Two mile B A C

BAC

� Suppose we put values on each individual prize…Two mile B A C

5 3 1

An aside



One mile A C B

Two mile B A C

BAC

� Suppose we put values on each individual prize…Two mile B A C

5 3 1

� And add another team…

D A C B

B D A C

An aside

� So, the positions of have been switched simply because a new competitor was added

BAC

BDA

An aside

� So, the positions of have been switched

� This depended on the numbers, but is a general problem with prizes, elections, etc.

BAC

BDA

An aside

� So, the positions of have been switched

� This depended on the numbers, but is a general problem with prizes, elections, etc.

� Other non-market mechanisms are similarly

BDA

BAC

complicated

� For the next few weeks micro means markets

Scarcity

� A productive resource is something that is used to make something else


Scarcity



� Markets and prices would not exist without scarcity. Why?

Scarcity



� Markets and prices would not exist without scarcity

� Scarcity means that you have to consider the alternative uses of your limited personal resources

Scarcity



� Markets and prices would not exist without scarcity


� By resources here, I mean wealth, talent, time, personal connections and such

Opportunity costs


� By choosing to come to class, you are passing up the next best use of your time

� By paying for PowerPoint, I would have forgone saving or otherwise spending those $200+

� And the opportunity cost of that money is the time it took to earn it

Opportunity costs


� The opportunity cost of something is the best alternative use of the resources involved in alternative use of the resources involved in acquiring it

Opportunity costs



� All costs can be interpreted as opportunity costs

Opportunity costs



� All costs can be interpreted as opportunity costs

� Is the opportunity cost of the first eight hours of daily school the same as eight more hours?

Decisions at the margin


� People choose not only whether to buy something, but also how much. Why should we care?but also how much. Why should we care?



� People choose not only whether to buy something, but also how much. Why should we care?but also how much. Why should we care?

� The “How much?” decision dominates when goods are broadly defined: food, vacation, education

� It also dominates when people respond to small changes in price



� People choose not only whether to buy something, but also how muchbut also how much

� “How much more or less?” is called a marginal decision

� The marginal effect of a small change is how it affects our “How much?” decisions



� When thinking about marginal effects

� We hold everything else constant. The phrase ceteris � We hold everything else constant. The phrase ceteris paribus, Latin for all else equal, is often invoked




� We hold everything else constant� We hold everything else constant

� If I ask “How will the increasing price of gas affect your food purchases?”, what should or shouldn’t I hold constant?






� Likewise for “How will cheaper train fares affect airline ticket sales”?






� Likewise for “How will cheaper train fares affect airline ticket sales”?

� It’s a matter of judgment. We’ll justify the standard answer soon





� We give a quantitative description of the effect with an elasticity. The elasticity of A with respect to B is how much a small change in B will affect A





� We give a quantitative description of the effect with an elasticity

� A higher elasticity implies a larger effect or a greater sensitivity

?

� So far we have that

� People must make trade-offs because resources are scarce

� The cost of any decision is the best missed opportunity

� Most decisions of economic interest are made at the margin

� The last tenet of micro is: …?

Rationality

� So far we have that

� People must make trade-offs because resources are scarce

� The cost of any decision is the best missed opportunity

� Most decisions of economic interest are made at the margin

� The last tenet of micro is: People will take advantage of opportunities

Rationality


� If you would rather be elsewhere, you will be

� If I can build and sell a better mousetrap, I will� If I can build and sell a better mousetrap, I will

� If the government raises taxes, I will work less

Rationality


� Another common way of saying this is: People will respond to incentives

� Incentives are defined as anything that people will respond to. It’s a useful shorthand

Rationality


� People are rational if they act in their own self-interestinterest

� We will assume throughout that everyone is rational:

� People and governments do as they please

� Firms maximize profits

Today’s outline

� Syllabus




� Markets and prices

� Scarcity

� Opportunity costs

� Decisions at the margin

� Rationality


How is Microeconomics used?

� Recall that we study markets and prices. Besides prices, what other data might economists collect?


� Besides prices, we can also observe

� What is produced

� How it is produced

� Who gets it, and in what quantities� Who gets it, and in what quantities






� Using polls, historical market data and knowledge of the legal structure and political climate might give us even richer answers






� What can be said about these observations?




If the price of oil reaches $10, GM will quit making Hummers

� How it is producedHow it is produced

At current prices, the cheapest way to make SPAM is…

� Who gets it, and in what quantities

Australia will become a net importer of grain

� What can be said about these observations?

� Positive statements: how it is, cause-and-effect, testable



� What is producedIf the price of oil reaches $10, GM will quit making Hummers

Cars are a vice, so gas should be taxed until the price is $10

� How it is produced� How it is producedAt current prices, the cheapest way to make SPAM is…

SPAM isn’t healthy enough; it should be 100% tofu

� Who gets it, and in what quantitiesAustralia will become a net importer of grain

Australia should block imports to protect its currency

� What can be said about these observations?� Positive statements: how it is, cause-and-effect, testable

� Normative statements: how it should be, untestable


� In this course, we’ll try to explain how the market works; making positive statements instead of normative ‘value judgments’



� Normative talk may give us goals or questions. Only � Normative talk may give us goals or questions. Only positive analysis can give us answers. For example,



� Normative talk may give us goals or questions. Only � Normative talk may give us goals or questions. Only positive analysis can give us answers. For example,

� GM is a bastion of Americanism; it must stay in business. The only hope is selling to Honda.

� How can the federal government maximize tax revenue? With a progressive income tax and no sales tax.



� Normative talk may give us goals or questions. Only � Normative talk may give us goals or questions. Only positive analysis can give us answers

� Positive statements can be used to

� Explain markets

� Predict market outcomes

� Choose a best course, given a normative goal


� In this course, we’ll make positive statements

� To test our statements, recall from before that we have …?



� To test our statements, we have data:

� Prices

� What is produced� What is produced


� Who gets it, and in what quantities



� To test our statements, we have data

� To make the statements in the first place…?



� To test our statements, we have data

� To make the statements in the first place, we must make assumptions. The assumptions we choose make make assumptions. The assumptions we choose make up our model of the market


� The assumptions we choose make up our model of the market. Last time, we assumed that…?


� The assumptions we choose make up our model of the market. Last time, we assumed that

� Resources are scarce

� People are rational� People are rational





� When modeling the market for a particular good, we must make additional assumptions





� When modeling the market for a particular good, we must make additional assumptions

� Our assumptions tell us where the model applies: some resources are not scarce, some people are not rational

Ex. #1: Income threshold model

� Anyone earning more than $50,000 will buy a car; the rest will not

� How do we graph it?

Ex. #1: Income threshold model

� Anyone earning more than $50,000 will buy a car; the rest will not

� How do we graph it?

� What do we want to leave out of this model? What � What do we want to leave out of this model? What can we use this model for?

� What goods should this model not be used for?

Ex. 2: Robinson Crusoe’s dilemma

� Robinson has 10 hours to collect food: fish and coconuts

� The marginal cost, in time, of catching fish is higher the more he has already caught. For example,the more he has already caught. For example,

� The first 20 fish take 3 hours, while the next 20 take up 7 more hours

� He can collect 3 coconuts each hour


� Robinson has 10 hours to collect food: fish and coconuts

� The marginal cost, in time, of catching fish is higher the more he has already caught. For example,the more he has already caught. For example,

� The first 20 fish take 3 hours, while the next 20 take up 7 more hours

� He can collect 3 coconuts each hour

� What is the opportunity cost of a coconut? How can we graph Robinson’s dilemma?


� This gives us the Production Possibilities Frontier, which we wont talk about again

� What is good and bad about this model?this model?

Ex. #3: Queues in Wal-mart

� There are 20 check-out lanes in Wal-mart and 200 customers , each waiting to pay for the same number of goods

� What do we expect to happen? What if another � What do we expect to happen? What if another 10 aisles open?



� What do we expect to happen? What if another � What do we expect to happen? What if another 10 aisles open?

� What about the long run

effect of 10 more aisles?



� Is this really a market for anything? Can our model � Is this really a market for anything? Can our model be graphed, or even written down?

Other models

� Children and engineers build model airplanes

� Political strategists model the political climate

� Copernicus modeled planetary movement

Judging models

� What do we expect from a good model?

Judging models

� What do we expect from a good model?

� Answers to interesting questions

� Correct answers

� Realism� Realism

� Logical consistency

� Parsimony:

“As simple as possible, but not simpler” – Albert Einstein

Review

� Remember





� Positive vs. normative

� Models

� Next time: The Supply & Demand Model

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