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Chapter 1-3

MIcroeconomics Chapter 1-3 notes

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University of Ottawa
Suren Phansalker

Chapter 1 Economics: the study of how human beings coordinate their wants and desires, given the decision- making mechanisms, social customs, and political realities of society Two defining principles:  Our society has limited resources  Our society has unlimited wants and desires How can we as efficiently as possible utilize our scarce resources in order to satisfy as many wants and desires as possible? Opportunity cost: In economics, it is the cost of the choice we make in a decision making process over another choice.  Basis of cost/benefit reasoning  What must be given up in order to get something else  They are often hidden, and all must be taken into consideration before making a decision Economic theory is divided in two broad categories – microeconomics and macroeconomics. Microeconomic theory: considers economic reasoning and behavior of individuals and firms Macroeconomics: studies the economy as whole and broad economic aggregates such as inflation, unemployment, business cycles, and economic growth. Three central coordination problems any economy must solve are: 1. What to produce 2. How to produce it 3. For whom to produce it *Most economic coordination problems involve scarcity. Economic decision rule: If the marginal benefits of doing something exceed the marginal costs, do it. If the marginal costs of doing something exceed the marginal benefits, don’t do it. Marginal or “extra” benefits (MB) Marginal or “extra” costs (MC) of a course of action If MB > MC  do more of it, because it’s worth it If MB < MC  do less of it, because it’s not worth it Economic reality is controlled by economic forces, social forces and political forces.  Economic forces (the invisible hand); these are the market forces of demand, supply, and prices, etc.  Social and cultural forces; social forces can prevent economic forces from becoming market forces  Political and legal forces; political and legal forces affect decisions too Positive economics: is the study of what is, and how the economy works (Objective analyses) Normative economics: is the study of what the goals of the economy should be (Subjective analyses) Art of economics: the application of the knowledge learned in positive economics to the achievement of the goals determined in normative economics.  Sometimes referred to “policy economics”  “good” policy tries to be objective, tries to weigh all the benefits and costs associated with all policy options and chooses that option in which the benefits outweigh the costs to the greatest degree 2 types of relationships: 1. Direct (positive) relationship: expressed as an upward sloping curve 2. Inverse (negative) relationship: expressed as a downward sloping curve Chapter 2: the economic organization of society Central problems: 1. What and how much to produce 2. How to produce it 3. For whom to produce it How these economic problems are dealt with depends on the type of economic system that has been adopted by each society Two of the most important economic systems are capitalism and socialism. Capitalism: (“market oriented economy”) is an economic system based on private property and the market. It gives property rights to individuals, and relies on market forces to coordinate economic activity.  Characterized by mainly private ownership of resources  And market system solves the what? How? And For whom? Problems. Capitalism’s solutions to the central economic problems:  What to produce: what businesses believe people want, and what is profitable  How to produce: businesses decide how to produce efficiently, guided by their desire to make a profit  For whom to produce: distribution according to individuals’ ability and/or inherited wealth Socialism: (“government-controlled economy”) is an economic system that tries to organize society in the same way as most families are organized – all people should contribute what they can, and get what they need.  Characterized by government control over resources  Government solves the what? How? And for whom? Problems. Soviet-style socialism’s solutions to the three problems:  What to produce: what central planners believe is socially beneficial  How to produce: central planners decide, based on what they think is good for the country  For whom to produce: central planners distribute goods based on what they determine are individuals’ needs. Capitalism and socialism haven’t existed forever.  In the 8 century, feudalism – an economic system based upon tradition – dominated.  In the 15 century, feudalism gave way to mercantilism – an economic system in which government doles out the right to undertake certain economic activities.  In the 18 century, mercantilism gave way to capitalism The production possibilities curve is useful in illustrating many important economic concepts such as opportunity cost, scarcity, choice, and the principle of increasing marginal opportunity cost. It shows the trade off (or opportunity cost) between two things. The slope tells you the opportunity cost of good X in terms of good Y. (how much Y do you give up to get how much X or vice versa) The principle of increasing marginal opportunity cost
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