microeconomic principles â econ111
MICROECONOMIC PRINCIPLES – ECON111
Assessment Overview Tutorial & participation & attendance – due each week starting week 2 – 10% Online quiz – due 9am Friday weeks 5,9, 13 – 10% Assignment – due 30th April week 7 – 20% • Final exam – 60% • • •
Introduction to Economics • • • • • •
•
All economic questions arise because we want more than we can get Our inability to satisfy all our wants is called scarcity Because we face scarcity, we must make choices The choices we make depend on the incentives we face An incentive is a reward that encourages an action or a penalty that discourages an action Economics is the social science that studies the choices that individuals, businesses, governments and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices Economics divides into two main parts o Microeconomics – how households and firms make choice, how they interact in the markets, how governments attempt to influence their choice o Macroeconomics – the study of the economy as a whole (inflation, unemployment, economic growth, etc – economic issues)
Two Big economic questions 1. How do choices end up determining what, how and for whom goods and services get produced 2. When do choices made in the pursuit of self-‐interest also promote the social interest? What, how and for whom? • Goods and services are the objects that people value and produce to satisfy human wants • Goods and services are produced by using productive resources that economists call factors of production • Factors of production are grouped into four categories o Land – all natural resources, wood, gas, oil, minerals, fish, water o Labour – work time and work effort. Quality of labour depends on human capital (obtained from education or on job training) o Capital – tools, instruments, building, materials, etc o Entrepreneurship – human resources that organise land, labour and capital
•
Who gets the goods and services depends on the incomes that people earn o Land earns rent o Labour earns wages o Capital earns interest o Entrepreneurship earns profit
Can the pursuit of self-‐interest promote the social interest? • Self interest: you make choices that are in your self-‐interest – choices that you think are best for you • Social interest: choices that are best for society as a whole are said to be in the social interest • Social interest has two dimensions o Efficiency is achieved when the available resources are used to produce goods and services at the lowest possible price and in quantities that give the greatest possible benefit o Equity is fairness but economists have a variety of views about what is fair • “By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it” referred to as the ‘invisible hand’ – Adam Smith and the Wealth of Nations • Can choices made in self-‐interest promote the social interest? Social Interest VS self interest • Four topics that generate discussion and that illustrate tension between self-‐ interest and social interest are o Globalisation o The information-‐age economic o Global warming o Economic instability
The Economic Way of Thinking •
Six key ideas define the economic way of thinking o A choice is a trade-‐off o People make rational choices by comparing benefits and costs o Benefit is what you gain from something o Cost is what you must give up to get something o Most choices are ‘how-‐much’ choices made at the margin. o Choices respond to incentives.
A Choice is a Trade-‐off • The economic way of thinking places scarcity and its implication, choice, at centre stage • You can think about every choice as a trade-‐off – an exchange – giving up one thing to get something else • For example, on Saturday night, will you study or have fun?
o o
You can’t study or have fun at the same time, so you must make a choice. Whatever you choose, you could have chosen something else. Your choice is a trade-‐off
Making a rational choice • A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice à the answers turn on benefits and costs • Only the wants of the person making a choice are relevant to determine its rationality. • The idea of rational choice provides an answer to the first question: What goods and services will be produced and in what quantities? • The answer is: Those that people rationally choose to buy! Cost: what you must give up • The opportunity cost of something is the highest-‐valued alternative that must be given up to get it • For example, what is the opportunity cost of going to a music concert? o Opportunity cost has two components § The things you cant afford to buy if you purchase the concert ticket § The things you cant do with your time if you go to the concert How much? Choosing at the margin • You can allocate the next hour between studying and instant message your friends. The choice is not all or nothing, but you must decide how many minutes to allocate to each activity • To make this decision, you compare the benefits of a little bit more study time with its cost – you make your choice at the margin à you evaluate the consequences of making incremental changes in the use of your time • The benefit from pursing an incremental increase in an activity is its marginal benefit (MB) • The opportunity cost of pursing an incremental increase in an activity is its marginal cost (MC) • If MB>MC: your rational choice is to do more of that activity • If MB<MC your rational choice is to do less of that activity • For example: If… o 30 min studying à benefit: a grade of 50% (or 50 units of Happiness) & 30 min texting à benefit: 50 units of Happiness o 45 min studying à Benefit a grade of 60% (or 60 units of Happiness) à MB from studying 15 min more = 10 units of happiness & 15 min texting à benefit: 45 units of happiness à MC from studying 15 min more (or texting 15 min less) = 5 units of happiness o Thus MB>MC à Decision: study 15 min more Choices respond to incentives
• • •
A change in marginal cost or a change in marginal benefit changes the incentives that we face and leads us to change our choice The central idea of economics is that we can predict how choices will change by looking at changes in incentives Incentives are also the key to reconciling self-‐interest and the social interest. For example, studying nursing
Economist as Social Scientists •
• •
Economists distinguish between two types of statement o What is – positive statements o What ought to be – normative statements A positive statement can be tested by checking it against facts o Eg the minimum wage law causes an increase in unemployment rate A normative statement expresses an opinion and cannot be tested o Eg the government should introduce the minimum wage law to protect workers from being exploited by employers
Unscrambling Cause and Effect • The task of economic science is to discover positive statements that are consistent with what we observe in the world and that enable us to understand how the economic world works • Economists create and test economic models • An economic model is a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand • A model is tested by comparing its predictions with the facts • But testing an economic model is difficult, so economics also use o Natural experiments o Statistical investigations o Economics experiments
Economists as Policy Adviser • • • •
Economics is a toolkit for advising governments and businesses and for making personal decisions All the policy questions on which economists provide advice involve a blend of the positive and the normative. Economics can’t help with the normative part—the goal. But for a given goal, economics provides a method of evaluating alternative solutions—comparing marginal benefits and marginal costs
Production Possibilities and Opportunity Cost Production Possibilities Frontier
•
• •
The production possibility frontier (maximum output can be produced from the given resources) (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot To illustrate the PPF, we focus on two goods at a time and hold the quantities of all other goods and services constant. That is, we look at a model economy in which everything remains the same (ceteris paribus) except the two goods we’re considering
Attainable and Unattainable • Any point on the frontier (A,B,C,D,E,F,etc) and any point inside the PPF are attainable because the economy can produce such a combination of two goods from the available resources • Points outside the PPF are unattainable Production efficiency and inefficiency • Points on or within the PPF are attainable. An attainable point can be o Efficient: cannot produce more of one good without producing less of another (on frontier line) o Inefficient: can produce more of one good without producing less of another (inside frontier) – some resources are either unemployed or misallocated Trade-‐of along the PPF • Every choice along the PPF involves a tradeoff, we must give up some cola to get more pizzas or give up some pizzas to et more cola • There is no tradeoff inside the PPF Opportunity cost • Moving down along the PPF o More pizzas, but less cola produced à the opportunity cost of a pizza is the cola forgone o Opportunity cost of pizza = decrease in cola/increase in pizza
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o OC = !!!"#$ !" ! !"#$
Increasing Opportunity cost • Resources are not equally productive in all activities à increasing opportunity cost à the PPF bows outward • The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost • If resources are equally productive in all activities à Constant opportunity cost à PPF is straight
The Economic Problem Using Resources Efficiently •
To determine which of the alternative efficient quantities to produce, we compare costs and benefits
The PPF and Marginal Cost • The PPF determines opportunity cost • The marginal cost of a good or service is the opportunity cost of producing one more unit of it
Preferences and marginal benefit • Preferences are a description of a person’s likes and dislikes. To describe preferences, economists use the concepts of marginal benefit and the marginal benefit curve • Marginal benefit of a good or service is the benefit received from consuming one more unit of it
• •
•
We measure marginal benefit by the amount that a personal is willing to pay for an additional unit of a good or service Typically, the more we have of anything, the smaller is its marginal benefit and the less we are willing to pay for an extra unit of it – this is called the principle of decreasing marginal benefit Marginal benefit curve shows the relationship between the marginal benefit of a good and the quantity of that good consumed
Allocative efficiency • When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency • We are producing at a point on the PPF • When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved allocative efficiency • We are producing at the point on the PPF that we prefer above all other points • At the point of allocative efficiency, marginal costs and marginal benefits are equal
Assessment Overview Tutorial & participation & attendance – due each week starting week 2 – 10% Online quiz – due 9am Friday weeks 5,9, 13 – 10% Assignment – due 30th April week 7 – 20% • Final exam – 60% • • •
Introduction to Economics • • • • • •
•
All economic questions arise because we want more than we can get Our inability to satisfy all our wants is called scarcity Because we face scarcity, we must make choices The choices we make depend on the incentives we face An incentive is a reward that encourages an action or a penalty that discourages an action Economics is the social science that studies the choices that individuals, businesses, governments and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices Economics divides into two main parts o Microeconomics – how households and firms make choice, how they interact in the markets, how governments attempt to influence their choice o Macroeconomics – the study of the economy as a whole (inflation, unemployment, economic growth, etc – economic issues)
Two Big economic questions 1. How do choices end up determining what, how and for whom goods and services get produced 2. When do choices made in the pursuit of self-‐interest also promote the social interest? What, how and for whom? • Goods and services are the objects that people value and produce to satisfy human wants • Goods and services are produced by using productive resources that economists call factors of production • Factors of production are grouped into four categories o Land – all natural resources, wood, gas, oil, minerals, fish, water o Labour – work time and work effort. Quality of labour depends on human capital (obtained from education or on job training) o Capital – tools, instruments, building, materials, etc o Entrepreneurship – human resources that organise land, labour and capital
•
Who gets the goods and services depends on the incomes that people earn o Land earns rent o Labour earns wages o Capital earns interest o Entrepreneurship earns profit
Can the pursuit of self-‐interest promote the social interest? • Self interest: you make choices that are in your self-‐interest – choices that you think are best for you • Social interest: choices that are best for society as a whole are said to be in the social interest • Social interest has two dimensions o Efficiency is achieved when the available resources are used to produce goods and services at the lowest possible price and in quantities that give the greatest possible benefit o Equity is fairness but economists have a variety of views about what is fair • “By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it” referred to as the ‘invisible hand’ – Adam Smith and the Wealth of Nations • Can choices made in self-‐interest promote the social interest? Social Interest VS self interest • Four topics that generate discussion and that illustrate tension between self-‐ interest and social interest are o Globalisation o The information-‐age economic o Global warming o Economic instability
The Economic Way of Thinking •
Six key ideas define the economic way of thinking o A choice is a trade-‐off o People make rational choices by comparing benefits and costs o Benefit is what you gain from something o Cost is what you must give up to get something o Most choices are ‘how-‐much’ choices made at the margin. o Choices respond to incentives.
A Choice is a Trade-‐off • The economic way of thinking places scarcity and its implication, choice, at centre stage • You can think about every choice as a trade-‐off – an exchange – giving up one thing to get something else • For example, on Saturday night, will you study or have fun?
o o
You can’t study or have fun at the same time, so you must make a choice. Whatever you choose, you could have chosen something else. Your choice is a trade-‐off
Making a rational choice • A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice à the answers turn on benefits and costs • Only the wants of the person making a choice are relevant to determine its rationality. • The idea of rational choice provides an answer to the first question: What goods and services will be produced and in what quantities? • The answer is: Those that people rationally choose to buy! Cost: what you must give up • The opportunity cost of something is the highest-‐valued alternative that must be given up to get it • For example, what is the opportunity cost of going to a music concert? o Opportunity cost has two components § The things you cant afford to buy if you purchase the concert ticket § The things you cant do with your time if you go to the concert How much? Choosing at the margin • You can allocate the next hour between studying and instant message your friends. The choice is not all or nothing, but you must decide how many minutes to allocate to each activity • To make this decision, you compare the benefits of a little bit more study time with its cost – you make your choice at the margin à you evaluate the consequences of making incremental changes in the use of your time • The benefit from pursing an incremental increase in an activity is its marginal benefit (MB) • The opportunity cost of pursing an incremental increase in an activity is its marginal cost (MC) • If MB>MC: your rational choice is to do more of that activity • If MB<MC your rational choice is to do less of that activity • For example: If… o 30 min studying à benefit: a grade of 50% (or 50 units of Happiness) & 30 min texting à benefit: 50 units of Happiness o 45 min studying à Benefit a grade of 60% (or 60 units of Happiness) à MB from studying 15 min more = 10 units of happiness & 15 min texting à benefit: 45 units of happiness à MC from studying 15 min more (or texting 15 min less) = 5 units of happiness o Thus MB>MC à Decision: study 15 min more Choices respond to incentives
• • •
A change in marginal cost or a change in marginal benefit changes the incentives that we face and leads us to change our choice The central idea of economics is that we can predict how choices will change by looking at changes in incentives Incentives are also the key to reconciling self-‐interest and the social interest. For example, studying nursing
Economist as Social Scientists •
• •
Economists distinguish between two types of statement o What is – positive statements o What ought to be – normative statements A positive statement can be tested by checking it against facts o Eg the minimum wage law causes an increase in unemployment rate A normative statement expresses an opinion and cannot be tested o Eg the government should introduce the minimum wage law to protect workers from being exploited by employers
Unscrambling Cause and Effect • The task of economic science is to discover positive statements that are consistent with what we observe in the world and that enable us to understand how the economic world works • Economists create and test economic models • An economic model is a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand • A model is tested by comparing its predictions with the facts • But testing an economic model is difficult, so economics also use o Natural experiments o Statistical investigations o Economics experiments
Economists as Policy Adviser • • • •
Economics is a toolkit for advising governments and businesses and for making personal decisions All the policy questions on which economists provide advice involve a blend of the positive and the normative. Economics can’t help with the normative part—the goal. But for a given goal, economics provides a method of evaluating alternative solutions—comparing marginal benefits and marginal costs
Production Possibilities and Opportunity Cost Production Possibilities Frontier
•
• •
The production possibility frontier (maximum output can be produced from the given resources) (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot To illustrate the PPF, we focus on two goods at a time and hold the quantities of all other goods and services constant. That is, we look at a model economy in which everything remains the same (ceteris paribus) except the two goods we’re considering
Attainable and Unattainable • Any point on the frontier (A,B,C,D,E,F,etc) and any point inside the PPF are attainable because the economy can produce such a combination of two goods from the available resources • Points outside the PPF are unattainable Production efficiency and inefficiency • Points on or within the PPF are attainable. An attainable point can be o Efficient: cannot produce more of one good without producing less of another (on frontier line) o Inefficient: can produce more of one good without producing less of another (inside frontier) – some resources are either unemployed or misallocated Trade-‐of along the PPF • Every choice along the PPF involves a tradeoff, we must give up some cola to get more pizzas or give up some pizzas to et more cola • There is no tradeoff inside the PPF Opportunity cost • Moving down along the PPF o More pizzas, but less cola produced à the opportunity cost of a pizza is the cola forgone o Opportunity cost of pizza = decrease in cola/increase in pizza
!!!"#$ !" ! !"#$
o OC = !!!"#$ !" ! !"#$
Increasing Opportunity cost • Resources are not equally productive in all activities à increasing opportunity cost à the PPF bows outward • The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost • If resources are equally productive in all activities à Constant opportunity cost à PPF is straight
The Economic Problem Using Resources Efficiently •
To determine which of the alternative efficient quantities to produce, we compare costs and benefits
The PPF and Marginal Cost • The PPF determines opportunity cost • The marginal cost of a good or service is the opportunity cost of producing one more unit of it
Preferences and marginal benefit • Preferences are a description of a person’s likes and dislikes. To describe preferences, economists use the concepts of marginal benefit and the marginal benefit curve • Marginal benefit of a good or service is the benefit received from consuming one more unit of it
• •
•
We measure marginal benefit by the amount that a personal is willing to pay for an additional unit of a good or service Typically, the more we have of anything, the smaller is its marginal benefit and the less we are willing to pay for an extra unit of it – this is called the principle of decreasing marginal benefit Marginal benefit curve shows the relationship between the marginal benefit of a good and the quantity of that good consumed
Allocative efficiency • When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency • We are producing at a point on the PPF • When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved allocative efficiency • We are producing at the point on the PPF that we prefer above all other points • At the point of allocative efficiency, marginal costs and marginal benefits are equal
