Week 1- #1 9/12/2012 7:32:00 AM
Microeconimcs deals with individual househholds and firms
Equilibrium and particular markets
Macroecomincs deals with the study of economic aggregates such as:
inflation, unemployment, and economic growth
Scarcity: refers to the limited nature of society’s resources
Economics: Is the study of how society manages its scarce resources
including: how peoples decide how much to work, save, and spend, and
what to buy. How firms decide how much to produce, how many workers to
hire. How society decides how to divide its resources between national
defense consumers goods, protecting the environment and other needs
In microeconomics we are mainly interested in: the study of the allocation of
scare resources which are: resources with alternative uses
Scarcity arises from a combination of large human wants or desires and
limited resources to attain them.
Principle 1: all decisions involve trade offs. Examples:
Going to a party the night before midterms leaves less time for studying.
Society faces and important tradeoff: efficiency vs. equity
Efficiency: getting the most out of scares resources
Equity: the distributing prosperity fairly among society’s members
Tradeoff: to increase equity, can redistribute income from the well-off to the
poor. But this reduces the incentive to work and produce and shrinks the
size of the economic pie.
Principle 2: The cost of something is what you give up to get it Making decisions requires comparing the cost and benefits of alternative
The opportunity cost of any item is whatever me be given up to obtain it.
The opportunity cost is the difference from the next best alternative not all
of the other alternatives.
Opportunity cost includes explicit (out of pocket expenses) and implicit costs
(such as foregone earnings)
Opportunity cost does not include sunk costs (unrecoverable costs)… costs
that must be incurred regardless of which course of action is taken.
A firms/person should engage in activity A if the benefits of A exceed the
opportunity cost of A.
Principle 3: Rational people think at the margin
A person is rational if she systematically and purposefully does the best she
can to achieve her objectives.
Many decisions are not “all or nothing”
Principle 4: People respond to incentives
incentive: something that includes a person to act, i.e. the prospect of a
reward or punishment.
Principle 5: Trade can make everyone better off
- Rather than being self-sufficient, people can specialize in producing one
good or service and exchange it for other goods.
Principle 6: Markets are usually a good way to organize Economic activity
A market is a group of buyers and sellers (they need not be in a single
Organize economic activity mrans determining: what goods to produce, how
to produce them, how much of each to produce, who gets them.
Markets failure can come from: lack of competition (monopoly), externalities
(pollution), lack of info, public goods
Principle 7: Governments can sometimes improve market outcomes
- Important role for govt: enforce property rights (with police, courts) - People are less inclined to work, produce, invest or purchase if large risk of
their property being stolen.
- Governemnt may alter market outcome to promote effieciency
Market failure: when the market fails to allocate soceitys resources
externalities: when the production or consumption of a good affects
bystanders (eg. Pollution)
market power: a single buyer or seller has substantial influence on market
price (eg. Monopoly)
Principle 8: A countrys standard of living depends on its ability to produce
goods and services
- Huge variation in living standards across countries and over time:
-Average income in rich countries is more than ten times average income in
- The most important determinant of living standards: productivity, the
amount of goods and services produced per unit of labor
- productivity depends on the equipment, skills, and technology available to
- Other factors (eg. Labor unioins, competition from abroad) have far less
impact on living standards. Week 1 - #2 9/12/2012 7:32:00 AM
- Economist play two roles:
Scientists: try to explain the world.
Policy advisors: try to improve it
- In the first role, economists employ the scientific method: the
dispassionate development and testing of theories about how the world
Assumptions & Models
- Assumptions simplify the complex world, make it easier to understand.
Example: When studying international trade, we might assume the world
consists of two countries and two goods.
- Economists use models to study economic issues.
The production possibilities frontier: Our second model
- The PPF is a graph that shows the combinations of two goods the economy
can possibly produce given the available production technology.
Fixed inputs, (labour capital)
We produce technology
Points on the PPF (like A and E ) are
- efficient: all resources are fully utilized
Points under the PPF (like F) are
- not efficient
Points above the PPF (Like G) are
- not possible
Moving along the PPF involves shifting resources. The slope of the PPFtells
you the opportunity cost of one good in terms of the other. - Economic growth shifts the PPF outwards and economic.
The Shape of the PPF
- The PPF could be a straight line, or bow-shaped. Depends on what happens
to the opportunity cost as the economy shifts resources from one industry to
- If the opportunity cost remains constant, the PPF is a straight line.
If opportunity cost of a good rises as the economy produces more of the
good, which is more likely the case, then the PPF is bow-shaped.
Why the PPF might be Bow-Shaped
- when different workers have different skills, which result s in different
opportunity costs of producing one good in terms of the other.
- the PPF would also be bow-shaped when there is some other resource, or
mix of resources with varying opportunity costs. Eg. Different types of land
suited for different uses.
Social scientists make positive statements which attempt to describe the
world as it is
Policy advisors make normative statements, which attempt to describe the
world how it should be. Week 2- #1 9/12/2012 7:32:00 AM
Exports: Goods produced domestically and sold abroad
Imports: Goods produced abroad and sold domestically
Absolute advantage: the ability to produce a good using fewer inputs than
another producer. If each country has an absolute advantage in one good
and specializes in that good, then both countries can gain from trade.
Absolute advantage measures the cost of a good in terms of the inputs
required to produce it
Recall: Another measure of cost is opportunity cost
Comparative advantage: The ability to produce a good at a lower
opportunity cost than another producer.
Differences in opportunity cost and comparative advantage create the gains
When each country specializes in good(s) in which it has a comparative
advantage, total production in all countries is higher, the worlds “economic
pie” is bigger, and all countries gain from trade.
Interdependence and trade allow everyone to enjoy a greater quantity and
variety of goods and services. Week 2- #2 9/12/2012 7:32:00 AM
Market: a group of buyers and sellers of particular good or service.
Competitive market: is one in which there are so many buyers and so many
sellers that each has a negligible impact on the market price.
Perfectly competitive market:all goods are exactly the same. Buyers and
sellers so numerous that no one can affect the market price- each is a “price
In this chapter we assume markets are perfectly competitive
Quantity demanded: the amount of any good that buyers are willing and
able to purchase at any price.
Law of demand: the claim that, other things equal the quantity demanded of
a good falls when the price of the good rises.
Demand schedule: a table that shows the relationship between the price of a
good and the quantity demanded.
The demand curve shows how price affects quantity demanded, other things
being equal. These “other things” are non-price det