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ECON 1B03 (520)


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McMaster University
Hannah Holmes

ECON 1B03 PowerPoint Lecture NotesChapter 1Introduction to MicroeconomicsWhat is Economics Economics is the study of how society allocates its scarce resources to satisfy peoples unlimited wants Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have Microeconomics focuses on the individual parts of the economy How households and firms make decisions and how they interact in specific markets Macroeconomics looks at the economy as a whole Economywide phenomena including inflation unemployment and economic growth A market economy is one that allocates resources through the decentralized decisions of firms and households Households decide what to buy and who to work for Firms decide who to hire and how much to produce A command or centrally planned economy is one where all production and distribution decisions are made by a central authority like a government Most economies are mixed economiesa combination of both Canada is a mixed economy Basic Principles of Economics A household and an economy face many decisions Who will work What goods and how much will be produced What resources should be used in production At what price should goods be sold Every economic issue involves individual choiceResources are Scarce A resource is anything that can be used to produce something else EXAMPLES land labour physical capital buildings machinery etc To get one thing we usually have to give up something else Fulltime schooling v fulltime employment Food v clothing Leisure time v workMaking decisions requires trading off one goal against anotherOpportunity Costs The opportunity cost of something is what you have to give up getting it It is the cost of the best forgone alternativeEXAMPLE You decide to attend Mac Your tuition costs 8000 books cost 1000 and your apartment costs 6000 Your total explicit costs are 15000 You could have spent that money on something elsesay a car That car is a foregone alternativethe opportunity cost of coming to Mac is the car you chose not to buy But there are other things you give up when you come to Mac Instead of coming to Mac you could have lived at home for free and held a fulltime job that earned you 28000 You gave up the 28000 incomethis is an opportunity cost So what is the opportunity cost of coming to Mac Its the value of the best foregone alternative the lost wages value of 28000 versus the 15000 carMarginal Thinking Marginal changes are small incremental adjustments to an existing plan of action For example a firm will wonder What will happen to my profit if I decide to produce one more good People make decisions by comparing marginal benefits to marginal costs Marginal changes in costs or benefits motivate people to respond The decision to choose one alternative over another occurs when that alternatives marginal benefits exceed its marginal costs For example if producing one more good adds more to a firms revenue than to its costs the firm will produce that good Adam Smith observed that households and firms act as if guided by an invisible hand If each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it the market will settle on a product distribution and prices that are beneficial to all the individual members of a community and hence to the community as a whole The reason for this is that greed will drive economic actors to beneficial behaviour Efficient methods of production will be adopted in order to maximize profits Low prices will be charged in order to undercut competitors Investors will invest in those industries that are most urgently needed to maximize returns and withdraw capital from those that are less efficient in creating value Students will be guided to prepare for the most needed and therefore most remunerative careers And all these effects will take place dynamically and automaticallyMarkets Move Toward Equilibrium An economic situation is in equilibrium when there is no incentive for any economic actorshouseholds firms governments etcto change their behaviour No individual would be better off doing something different Markets usually reach equilibrium through changes in prices Prices guide decision makers to reach outcomes that maximize the welfare of society as a wholeGains from Trade In a market economy people engage in trade with each other Not every family or nation can produce everything it needs efficiently We specialize in tasks we do best and trade with others for the things we need that they can provide In this way we have gains from tradeEfficiency An economys resources are used efficiently when they are used as best as possible to meet societys goals The welfare of society is maximized Markets that are left to operate freely usually lead to efficiency Market failure occurs when the market fails to allocate resources efficiently When the market fails breaks down government can intervene to promote efficiency and equity Efficiency means society makes the best use of its resources economic decisions Equity involves the fair distribution of resources political decisionsMarket failure may be caused by An externalitywhich is the impact of one person or firms actions on the wellbeing ofa bystander Market power which is the ability of a single person or firm to unduly influence market prices Some goods just arent suited to the marketfor example donor organsThe Economists Roles When economists are trying to explain the world they are scientists When economists are trying to change the world they are policy advisorsPositive Versus Normative Statements Positive statements are statements that attempt to describe the world as it is Called descriptive analysis Normative statements are statements about how the world should be Called prescriptive analysisPositive or Normative Statements An increase in the minimum wage will cause a decrease in employment among the leastskilledPOSITIVE The income gains from a higher minimum wage are worth more than any slight reductions in employmentNORMATIVE Why Economists Disagree They may disagree about the validity of alternative positive theories about how the world works They may have different values and therefore different normative views about what policy should try to accomplish
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