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Chapter 1

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Northeastern University
ECON 1116
Osborne Jackson

01/08/2014 Chapter 1: Course Introduction Microeconomics: the branch of economics that studies how people make decisions and how these decisions interact. Economy: system for coordinating society’s productive activities. Economics: the social science that studies the production, distribution, and consumption of goods and services. Economic system: a collection of institutions that determines how resources are allocated 1. Traditional 2. Command 3. Market Market Economy: is an economy in which decisions about production and consumption are made by individual producers and consumers. - Alternative to market economy is command economy when there is a central authority making decisions on production and consumption. - Market failure: when individual pursuit of self-interest leads to bad results for society as a whole. (Air/ water pollution). o Recessions: downturn in economy. (workers may be laid off) Scarcity: The inability to satisfy our desire with available resource. The economic problem - How to best allocate scarce resources while trying to satisfy limitless wants? o What to produce? o How to produce? 01/08/2014 Chapter 1: Course Introduction o For whom to produce? - The approach we adopt is to build models of economic decision-making scenarios and draw insights from those models o What makes a good model? (to yield insights of the economy) • How to balance model simplicity with complexity  A model is useful only insofar as it abstracts from reality • The more closely a model corresponds to reality the less useful it becomes o Parsimony: in a model building demands that we make our models sufficiently realistic to capture the phenomenon of interest, but no more realistic. (Sufficiently complex simplicity). • How realistic they prove (how accurate their prediction) than how realistic their assumptions are. - Production Possibilities frontier o Simple model used to demonstrate the effect of scarcity of productive resources o Production: process of transforming factors of production (inputs) into goods and services (outputs) If factors of production are scarce this limits the quantities of various goods and services that can be produced. (Scarce then limits production, limited by number of inputs). o Assume  Two good can be produced (pizza and lasagna)  Production of these goods request at least some common inputs (capital, labor) or chef and oven  Common inputs are limited in supply (ie are scarce) o Production decision reveals a tradeoff (cost0benefit comparison)  If all productive resources are employed then increasing output of one good implies that output of the other good will fall. 01/08/2014 Chapter 1: Course Introduction • If we’re using all chef and ovens and want to produce more pizza, then must allocate more to pizza production than lasagna production. - - Points strictly inside the PPF are wasteful: productive resources remain unused © - We can refer to these interior allocation as inefficient o Produce more macs without producing fewer phones, vice versa. o This corresponds to our notion of Pareto efficiency  Can make somebody better off, without making someone worse off. o Points on boundary of PPF are efficient o All productive resources are used to maximize output. Example: Pizza Production - Chicago deep dish New York Thin crust (make each better) - Given limited resources (chef and oven) restaurant must decide which chefs and ovens to make each type of pizza. o Red line: PPF - Absolute Advantage: - Consider the two PPF’s o NY can produce more thin crust pizza than Chicago o NY can produce more deep dish pizza than Chicago - NY has the absolute advantage in production of both goods. 01/08/2014 Chapter 1: Course Introduction Opportunity Cost - When one choose to devote resources to one task, one neccesariy forgoes the opportunity to use those resource for some other purpose, the opportunity cost is the value of the best opportunity forgone. Marginal Analysis: - Observed here is the process of comparing the value of productive resources at the margin o Comparing a little extra thin crust pizza production with lost deep dish pizza porductino, vice versa. How production should be organized • Let efficiency be our guide • Answer depends on quantities of each good to be produced o If we want as much thin as possible both cities should devote all of their resources to thin crust production.  Suppose we devote all resources to deep dish pizza, consider reallocating resources to thin crust pizza sector Which resource should we transfer? NY or Chicago (NY because it has a lower opportunity cost. How do we think that production will be organized? Comparative Advantage: If produce A has a lower opportunity cost of producing a good than produce B, then produce A has a comparative advantage in production of that good. - Relative comparison vs absolute comparative - NY has a comparative advantage than Chicago in Thin crust cuz lower opportunity cost in producing a good. 01/08/2014 Chapter 1: Course Introduction How will production be organized? (Positive question) - Assume that producers respond to the incentives provided by the market. o Under certain conditions, markets provide exactly the right incentives to ensure efficient allocation of resources. o Explore conditions throughout the term, along with the cases in which they fail. What shape do we think the combined two city PPF has? - Two city PPF, will e downward sloping- cuz both cities have to give up production of one slice of pizza in order to produce more of the other style. Vice versa. o Is it linear? Or how production should be organized across cities, and how it will affect PPF shape. Diminishing marginal returns: Principles that underlie Individual Choice: 1. Choices Are Necessary Because Resources are Scarce a. People must make choices because resources are scarce. i. Resource: anything that can be used to produce something else. ii. Scarce: when there’s not enough resource available to satisfy all the ways society wants to use it. 2. The True Cost of Something Is It’s Opportunity Cost a. The opportunity cost of an item—what you must give up in order to get it—is it’s true cost i. Opportunity Cost: the real cost of an item, what you must give up in
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