microeconomics slides - chapter 1

Chapter 1 - Microeconomics, Curtis & Irvine, 2013

CHAPTER 1

INTRODUCTION THE BIG IDEAS

Microeconomics

Curtis & Irvine, 2013

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Learning outcomes

By the end of this chapter you should understand

The nature and objective of economics

The role of theory, models, hypotheses and data

The centrality of government

How microeconomics differs from macroeconomics

Opportunity cost, productivity advantage and efficiency

Specialization, exchange and markets

The production possibility frontier

Full employment, booms, recessions and economic growth

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A Working Definition of Economics

Economics, at its best, is a set of ideas and methods for the improvement of society. It is not, as so often seems the

case today, a set of ideological rules for asserting why we

cannot face the challenges of stagnation, job loss and

widening inequality.

Christopher Sims,

Nobel Laureate in Economics, 2011

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Ideas and Methods

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Economics is a social science

It is concerned with ideas that may improve society

It is scientific in its approach

Use of mathematics Use of models Use of data and statistical methods

Translation of ideas into formal models through mathematics, and

testing of the ideas/models through the use of statistical methods

(more in chapter 2)


Challenges for todays society

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Unemployment rates among young people are at historic highs

Government balance sheets are in disarray

Inequality is on the rise.

In addition, the world simultaneously faces

structural upheaval:

overpopulation climate change political instability globalization

These issues challenge us to understand and

formulate policies


But there is Good News too

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Literacy rates rising dramatically in the developing world

Child mortality has plummeted

Family size is a fraction of what it was 50 years ago

Prosperity is on the rise in much of Asia

Life expectancy is increasing universally

Deaths through wars are in a state of long term decline.


Microeconomics and Macroeconomics

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Macroeconomics studies the economy as a system in which feedbacks among sectors

determine national output, employment and prices

Microeconomics is the study of individual behavior in the context of scarcity

In a mixed economy goods and services are supplied both by private suppliers and government


Government

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Government is not an add-on to our economy.

It plays an integral role in regulating, redistributing and enforcing contracts.

Without this legal structure the private sector could decline into a state of Hobbesian anarchy

Example: Congo in the modern era


Understanding Economics through the Use of Models

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A model is a formalization of theory that facilitates scientific enquiry

A theory is a logical view of how things work, and is frequently formulated on the basis of observation

Frequently we transform theories into models and test the theories in this way by confronting them with data and statistical analysis .

Examples below


Markets, Trading and Opportunity Cost

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Markets are central to our economic lives

they permit us to trade, work efficiently and improve our living standards

Example of Gardner and Plummer who are neighbors:

Trading skills == market place

Let us take a numerical example that we can develop into a

model of production and exchange.


Each producer has a time allocation of 36 hours

By allocating total time to one activity, Amanda can produce 12F or 18V

Zoe can produce 18F or 9V

By splitting their time each person can also produce a combination of the two

Table 1.1 Production Possibilities in a Two-Person Economy

Hours/fish Hours/vegetable Fish production Vegetable production

Amanda 3 2 12 18

Zoe 2 4 18 9

A Model of Exchange and Specialization

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Opportunity Cost

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The opportunity cost of a choice is what must be

sacrificed when a choice is made

Zoes opportunity cost is 1:2 (1 unit of V for 2 units of F)

Amandas opportunity cost is 3:2 (18 units of V for 12 units of F)


Specialization

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Amanda specializes in Vegetable Zoe specializes in Fish

We are about to develop our first graphical model

Lets now see what can happen as a result of each individual specializing in the production of the good

where their opportunity cost dictates:


Absolute Advantage - Production

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18

9

12 18

* 6,9

9,4.5 *

Vegetable

Fish

Zoes PPF

Amandas PPF

Amandas initial consumption is {6, 9} and

Zoes is {9, 4.5}. With specialization they can

produce a greater total

{18, 18} than when

operating individually.

Hence, if they trade, after

specializing, they each

have the potential to

consume more.

Amanda

specializes

Zoe specializes

Amandas assumed initial

consumption

Zoes assumed initial consumption


From Production to Consumption

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Let us see how specialization, that produces more output can

translate into more consumption. It is consumption rather than

production which is of ultimate interest

First they must decide upon a rate at which to exchange the

two goods:

If each individual is to benefit this rate should lie between their individual rates of transformation.

To illustrate: suppose they exchange at a rate of 1:1


Absolute Advantage - Consumption

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18

18

8,10

10,8

Vegetable

Fish

Zoes initial consumption = {9, 4.5}

Amandas initial consumption = {6, 9}

If Amanda trades 8V to Zoe in return for

8F Amanda moves to

the point {8, 10} and

Zoe to {10, 8}.

Both consume more

after specialization,

relative to pre-

specialization

Amanda

specializes

Zoe

specializes

Amandas assumed final

consumption

Zoes final consumption

With specialization, and trade at 1:1, they consume

along the line joining the specialization points


From Individuals to the Economy

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Can we represent the production possibilities of the

whole economy by aggregating the production capabilities of each individual?

The economy-wide PPF

is the set of products combinations that can be

produced in the economy when all available productive

resources are in use.


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9

18 12

Vegetable

Fish

Zoes PPF

Amandas PPF

c 18,18

PPF for whole economy

a 0, 27

e 30, 0

With complete specialization this

economy can produce 27V or 30 F

From a, to produce Fish it is more efficient

to use Zoe because

her opportunity cost is

less (segment ac).

When Zoe is completely specialized

Amanda is used

(section ce)

Economy-wide PPF

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Vegetable

Fish

a

b

c

d

e

The PPF for the whole economy abcde, is obtained

by allocating productive resources most efficiently.

The opportunity cost in the economy of

producing more fish is the amount of

vegetable that must be foregone.

Opportunity cost depends upon how

much of the economys productive resources (individuals) are already

producing F and V. The opportunity

cost along bc differs from along cd

With many individuals

the PPF is the concave

envelope of the

individual capabilities

A Multi-person PPF

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Services

Goods

a

B b

Economic growth or an

increase in the available

resources can be

envisioned as an outward

shift in the PPF from

PPF0 to PPF1. With PPF1

the economy can

produce more in both

sectors than with PPF0.

A

Gmax Gmax

Smax

Smax

S0

G0

X0

X1 S1

G1

PPF1

PPF0

Growth and the PPF

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Recessions and Booms

In an economic recession output

falls below the economys capacity output

A boom is a period of high growth

that raises output above normal

capacity output.

illustrate through the PPF

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Services

Goods

a

b

Economic recessions leave the

economy below its normal

capacity; the economy might be

driven to a point such as Z.

Gmax

Smax

S0

G0

X

W

PPF Z

Economic expansions, or

booms, may drive capacity

above its normal level, to a

point such as W.

Booms and Recessions

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Productivity of the Economy

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The productivity of labour, defined as output per worker,

depends on:

the skill, knowledge and experience of the labour force

the capital stock: buildings, machinery, equipment, and

software the labour force has to work with

the current technology embodied in the labour force and

the capital stock.


Full Employment and the PPF

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When everyone who is willing to work at current wage rates and normal hours of work is actually working, the economy is a full employment

In this state the economys actual output is also termed its capacity output or full employment output

In 2012 the actual unemployment was 7.3% in Canada. Economists believe that full employment corresponds to approximately 6%

unemployment

Hence the PPF in Canada has an associated unemployment rate of 6%!


Chapter Summary

Economics: methods and ideas for the improvement of society

Economists use models to test theories with data

Markets improve the economys efficiency

Opportunity cost reflects the alternative possibilities

Production possibility frontier represents the capabilities of the

economy when functioning efficiently

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Chapter Summary

Absolute advantage refers to greater absolute efficiency

Specialization increases consumption possibilities

With many individuals the PPF may be concave

Economic growth shifts the PPF

Booms and recessions see increases and decreases in output

beyond what is normal

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microeconomics slides - chapter 1

Documents

government chapter

prices microeconomics

policies chapter

modern era chapter

use of statistical methods

understanding economics

objective of economics

set of ideas