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Week 1 chapter notes

Economics for Management Studies
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Chapter 1 Preliminaries Notes
x microeconomics Æ branch of economics that deals with the behaviour of individual economic units—consumers, firms, workers,
and investors—as well as the markets that these units comprise
x it explains how consumers make purchasing decisions and how their choices are affected by changing prices and incomes, and
also explains how firms decide how many workers to hire and how workers decide where to work and how much work to do
x another important concern of microeconomics is how economic units interact to form larger units—markets and industries
x by studying the behaviour and interaction of individual firms and consumers, it reveals how industries and markets operate and
evolve, why they differ from one another, and how they are affected by government policies and global economic conditions
x macroeconomics Æ branch of economics that deals with aggregate economic variables, such as the level and growth rate of
national output, interest rates, unemployment, and inflation
x macroeconomists have become increasingly concerned with the microeconomic foundations of aggregate economic phenomena,
and much of microeconomics is actually an extension of microeconomic analysis
1.1 The Themes of Microeconomics
x much of microeconomics is about limits—the limited incomes that consumers can spend on goods and services, the limited
budgets and technical know-how that firms can use to produce things, and the limited number of hours in a week that workers
can allocate to labour or leisure—but it is also about ways to make the most of these limits
x more precisely, it is about the allocation of scarce resources
x in modern market economies, consumers, workers, and firms have much more flexibility and choice when it comes to allocating
scarce resources; unlike in planned economies such as that of Cuba, North Korea, or the former Soviet Union
x microeconomics describes the trade-offs that consumers, workers, and firms face, and shows how these are best made
x consumers have limited incomes, which can be spent on a wide variety of goods and services, or saved for the future
x consumer theory describes how consumers, based on their preferences, maximize their well-being by trading off the purchase of
more of some goods for the purchase of less of others
x workers also face constraints and make trade-offs—(1) they must decide whether and when to enter the workforce, which means
they face trade-offs between working now and continued education; (2) they face trade-offs in their choice of employment; and
(3) they must sometimes decide how many hours per week they wish to work, thereby trading off labour for leisure
x firms also face limits in terms of the kinds of products that they can produce, and the resources available to produce them
x the theory of the firm describes how these trade-offs can best be made
Prices and Markets
x a second important theme of microeconomics is the role of prices
x all of the trade-offs described above are based on the prices faced by consumers, workers, or firms
x microeconomics also describes how prices are determined—in a centrally planned economy, prices are set by the government; in
a market economy, prices are determined by the interactions of consumers, workers, and firms
x these interactions occur in markets—collections of buyers and sellers that together determine the price of a good
x the central role of the market is the third important theme of microeconomics
Theories and Models
x economic theories are to explain observed phenomena in terms of a set of basic rules and assumptions, and to make predictions
x the theory of the firm begins with a simple assumption—firms try to maximize their profits
x the theory uses this assumption to explain how firms choose the amounts of labour, capital, and raw materials that they use for
production and the amount of output they produce; and it also explains how these choices depend on the prices of inputs, such as
labour, capital, and raw materials, and the prices that firms can receive for their outputs
x this theory tells economists whether a firm’s output level will increase or decrease in response to an increase in wage rates or a
decrease in the price of raw materials, and other such predictions
x with application of statistical and econometric techniques, theories can be used to construct models (mathematical representation
based on economic theory, of a firm, a market, or some other entity) from which quantitative predictions can be made
x statistics and econometrics also let economists measure the accuracy of their predictions
x quantifying the accuracy of a prediction can be as important as the prediction itself
x no theory, whether in economics, physics, or any other science is perfectly correct
x the usefulness and validity of a theory depend on whether it succeeds in explaining and predicting the set of phenomena that it is
intended to explain and predict; therefore, theories are continually tested against observation
x as a result of this testing, they are often modified or refined and occasionally even discarded
x the process of testing and refining theories is central to the development of economics as a science
Positive versus Normative Analysis
x positive questions deal with explanation and prediction, normative questions with what ought to be
x positive analysis Æ analysis describing relationships of cause and effect; central to microeconomics
x theories are developed to explain events, tested against observations, and used to construct models from which guesses are made
x the use of economic theory for prediction is important both for the managers of firms and for public policy
x normative analysis Æ analysis examining questions of what ought to be
x normative analysis is not only concerned with alternative policy options; it also involves the design of particular policy choices
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