ECON 103: Principles of Microeconomics Iryna Dudnyk
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
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
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
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
In a market: All valuable goods / services will have a price greater than zero (≠