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Chapter 1-6

Microeconomics 103 Chapt 1-6 Notes

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ECON 103
Ryan Allen

MICROECONOMICS 103 NOTES With Doug Allen Chapter 1 – Introduction Economics is a particular way of thinking about behavior  They are unable to predict the future, they can speculate but they aren’t prophets  Are not limited to financial items Economics used “models” to function in life  People are fundamentally the same o Fundamentally same in our preferences and motivations 1. Maximization (Chapter 2) a. All individuals are always motivated by greed. 2. Substitution (Chapter 3) a. Everyone is willing to trade some amount of one good for some amount of another 3. Diminishing Marginal Value – The Law of Demand (Chapter 4) a. The maximum one is willing to sacrifice at the margin for a good, per unit time, declines the more one has of that good, all things held constant i. Margin - a set of constraints conceptualized as a border Chapter 5 – Techy issues of demand Chapter 6 – Exchange without production Chapter 7 – Cost and comparative advantage 4. Opportunity Cost a. The cost of an action is the value of the highest forsaken alternative 5. Diminishing marginal products (Chapter 8) a. Increases in one input, other puts held constant, lead to increases in output at a diminishing rate 6. Rate of time preference a. Other things equal, people always prefer a good today, rather than in the future 7. Optimal organization a. All economic organization is designed to maximize the gains from trade net of transaction costs (Not for midterm) Chapter 2 – Maximization  All individuals are always motivated by greed. 1 Greed doesn’t mean more is always preferred to less, it just means people are never satisfied Ex a man who jumps of a bridge is maximizing, the gains from jumping were greater than the costs Scarcity  For something to be scarce, means people want more of a good than is available if the good were to be free  Scarcity doesn’t equal to rarity o Ex Anthrax is rare, but because no one wants it, it isn’t scarce Scarcity is a result of greed, as everyone always wants more – always trying to improve themselves and their lives it is inevitable  Since the world is full of scarcity, there isn’t enough nor will there ever be enough to go around There’s no such thing as a “free lunch” Equilibrium A situation where no one wants to change their behavior, this happens when people finish trading and producing and all potential gains from doing so are exploited ie no money is left on the table  Equilibrium example, traffic where it doesn’t matter which lane you take, fast or slow lane because of the switching in lanes and people trying to maximize. Indifference – Letting someone else choose for you.  Someone who is indifferent between two options is neither better nor worse off with either option Why believe in maximization? Economists believe in maximization because it works, because it is the only type of behavior that survives – greed will live on and is part of nature/natural selection When a firm or government asks an economist to help them make more money, the economist is confident that the firm/whatever is maximizing profit the best they can in their current situation/circumstances  Consumers maximize utility, firms maximize profit 1. Every economic model assumes people are maximizing 2. We live in equilibrium – as in economic knowledge can only earn a normal rate or return ie there is no secret formula Chapter 3 – Substitution  Everyone is willing to trade some amount of one good for some amount of another o If a good doesn’t provide a person with utility, it is a bad good o “Everyone has their price” 2  If I want something from you, you’ll trade it if I give you enough of something, everyone’s price is different but everyone has their price Substitution is an act of the will; one is willing to substitute one for the other, it isn’t forced consumption  Will people give up their life for a certain amount? o We trade parts of our life for certain substitutes, ex smoking may be enjoyable but we exchange that time for a portion of our life, or eating McDonalds or heavy drinking o Or the case of hospitals in Seattle charging by the day and women were waiting till midnight before they allowed themselves to be admitted to have a child – quite dangerous for the child…all to save maybe 100 bucks Trade offs are everywhere We constantly make trade offs in our lives, one thing for another, one sacrifice to get something else Everyone has different preferences and these manifest in different amounts of goods we’re willing to trade off. The fallacy of priority in consumption Most often people governments etc make statements containing the notion of necessity without considering substitution  Ex we NEED new hospitals, but no one considers how schools will be shut down as a result of hospital funding Trade offs – trait of human behavior, we all simply desire more and its all substitutable (at the margin) Marginal Value Marginal value – the maximum amount of one good an individual is willing to sacrifice to obtain one more unit of another good  This exists because people are willing to substitute one good for another, it provides a measure for the value of goods o Not limited to nominal value (ie dollars) but this is to make it easier; it simply represents other goods and are not valued in and of themselves. Value is based on sacrifices of real goods Exchange  Trade does not occur just because someone has a surplus  Trade occurs when individuals have different marginal values  Mutual voluntary trade makes both parties better off Both parties are made better off because they value the same goods at different values 3 Summary  Nothing is sacred, everyone and everything has its price  Trade takes place when the marginal values are different Chapter 4 – The Law of Demand Diminishing Marginal Value The maximum one is willing to sacrifice at the margin of a good per unit time declines the more one has of those good – other things held constant  Ex at first you value all of your time with a girl, then when you’ve been married for 20 years you just can’t wait to get away from your wife o MV falls the more you have o Per unit time, rate of consumption Real income and relative prices Real income is a measure of how many actual goods once can consume and is given by the nominal income and individual has divided by type of price level  Assume people have fixed incomes and there are only two goods, 1 and 2 -> the prices for them are 1 and p2 Real income = o M is the number of dollars consumer has ie nominal income o Real income is a measure of consumer purchasing power in terms of goods  Inflation, increase in the money supply relative to the amount of goods and services available in the market economy Relative Price =  We measure the price of good 1 in terms of how much of good 2 must be given up o A physical exchange of one good for another, prices denoted in dollars Behavior depends on real income and relative prices not nominal income and nominal price The Law of demand There is an inverse relationship between a good’s price and the quantity demanded  Demand curve must always be downward sloping  The height of a demand curve is equal to its marginal value  The price quantiy combination is an equilibrium for the consumer, the consumer has maximized his utility by choosing Q 1t price P1 A consumer is in equilibrium when Relative Price = Marginal Value 4 To find equilibrium quantity, draw a horizontal line at a given price until it reaches the demand curve that will be the quantity demanded Law of Demand is Everywhere See book for all the examples etc A fixed charge applied to a high and low quantity good lowers the relative price of the high quality good and results in a higher relative consumption of the high quality good Total value vs Marginal Value Total value: the maximum amount one is willing to pay for a given quantity rather than have none at all There is an inverse relationship between total value and marginal value Total value is the sum of all the marginal values and is graphically represented as the area under the demand curve Total expenditure and consumer surplus The area under t
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