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ARCH 131
Colin Stewart

ECON 103: Principles of Microeconomics Iryna Dudnyk [email protected] Lecture 1. INTRODUCTION. (Chapters 1 and 2) Economics is a social science. It studies society. Microeconomics’ subject is individual behavior: it studies decision-making. One useful thing you will learn in this class is how to make a decision – what factors are important and what should be ignored. Economics has a specific set of assumptions –perspective through which an economist looks at the world and what they think is true (assumptions are believed to be true and are not questioned for authenticity). The first principle of microeconomics is MAXIMIZATION - every person is driven by desire to advance their self interest and improve their well being. People can still help other people, but only if they see a net gain for themselves. It also states that people try do their best to make correct decisions / maximize on the basis of the limited knowledge they possess, even if in the end the choice may be not the best. One reason to call economics `a dismal science’ is because of this a depressing view of what drives human behavior. We will focus on the following Economic Agents - an agent is an actor and decision maker in an economic model): Firms - choose what to produce, how much to produce, how much capital and labor to hire. Firms maximize profits. Profits = Revenue - Cost Consumers spend their available income on goods. They choose how much of each good to buy, given the prices in the market. They maximize well being and utility (enjoyment, individual gains, satisfaction from consumption) Consumers’ well being = Satisfaction from consumption – Expenditure This satisfaction from consumption we will formally call `value’ TYPES OF CHOICES WE WILL CONSIDER: 1. `All-or-nothing` choices: or `to do or not to do?’ such as: go to school or not / Go to party or not / Eat or not. Trivially a person will do something if the total benefit is greater than the total cost. 2. Continuous choices involve deciding exactly `how much` to do: how many apples to buy in a market, how many workers to hire, how many hours to study. For this type of decisions the important concept is `the margin’. MARGINAL: associated with a small change in activity. When you see `marginal’ in a definition you can substitute it with `change in’. For example: MARGINAL REVENUE - change in revenue if a firm sells an additional unit of output. MARGINAL COST - change in cost incurred from producing one extra unit. N.B. If you look at both definitions above you can notice one more similarity: they involve `for one additional unit’, so all `marginal’ definitions will have the same `skeleton’: Change in …if one more unit is … To choose optimal level of something (the well-being maximizing number of units) we should compare marginal costs we incur when we do more of it and marginal benefits we derive from it. For example, if at current level of output: marginal revenue > marginal cost, the firm should produce more since that will increase its profits. If the marginal cost is higher than the marginal revenue, the firm should lower the output because at this point the additional revenue does not cover the additional production cost. An activity is at the OPTIMAL (well being maximizing) level when Marginal Benefit = Marginal Cost This brings us to the concept of EQUILIBRIUM: A stable situation where people do not want to change their behavior given the circumstances. This means that in equilibrium everyone is perfectly adjusted to the environment. The reason why they do not want to change the behavior is because they have made their maximizing choice. For example those students who decide to drop the course after the first lecture are not in their equilibrium during the lecture: they find that taking it was not their best choice, they `changed their behavior’. On the other hand the ones who stayed enrolled are in equilibrium: even if sitting in class may not be their point of bliss, but for them the benefits of doing so are higher than the cost. In equilibrium everyone is maximizing their well-being. Another interesting thing that happens in equilibrium is INDIFFERENCE – a person is indifferent between two options if they provide exactly the same level of happiness. For example at equilibrium amount of cookies you consume in one day you are indifferent between eating and not eating the last cookie: at the optimal number of cookie eaten the satisfaction you derived from eating the last cookie (marginal benefit) was exactly equal to its marginal cost (money you paid for it). This means that the net gain on the cookie was zero. Maximizing behavior results in another important concept which is Scarcity: The case when something valuable (desirable) exists in a limited quantity and if it was free (zero price) then people would want more than the quantity that is available.  In a market: All valuable goods / services will have a price greater than zero (≠
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