Lecture 1

Chapter 1
Introductory

Motivation

Understand…analyze…visualize

• What is the economics, and microeconomics (in the link with

macroeconomics and other economic subjects)
• How do firms/consumers/governments make choice and
interact with each other in the economy?
• Do firms behavior differently in markets, such as maket of
cars, vegetables... and ice-cream?

Content

1.1. Microeconomics
1.1.1. Definition of Economics
1.1.2. Subjects and research methods of Microeconomics
1.1.3. Some basic concepts

1.2. The basic economic problems

1.3. Optimal economic choices

1.3.1. The nature of economic choices
1.3.2. Objectives of economic choices
1.3.3. Methods of economic choices
1.3.4. Production possibility frontier

1
 1.1. Microeconomics
1.1.1. Definition of Economics

1.1. Microeconomics
1.1.1. Definition of Economics

The word economy comes from a Greek

word for “one who manages a household.”

Economics is the study of how society

manages its scarce resources.

Scarcity . . .
means that society has limited resources and
therefore cannot produce all the goods and
services people wish to have.

2
 Society and Scarce Resources:

• The management of society’s resources is

important because resources are scarce.
• Scarcity implies choice and choice implies
cost.

Microeconomics vs Macroeconomics

Microeconomics
the study of how households and firms make
decisions and how they interact in markets.

Macroeconomics
the study of economywide phenomena,
including inflation, unemployment, and
economic growth

1.1.2. Subject and Method of Microeconomics

Subjects: study of how households and firms make

decisions and how they interact in markets.
Scientific method:
OBSERVATION,
THEORY, AND MORE OBSERVATION
Role of assumption: Assumptions can simplify the
complex world and make it easier to understand.
Economic model: Economists also use models to
learn about the world. The models are most often
composed of diagrams and equations

3
 Circular-flow diagram:

A visual model of the economy that

shows how money and goods flow
through markets among households
and firms.

10

Circular-flow diagram:
Firms
• Produce and sell goods and services
• Hire and use factors of production

Households
• Buy and consume goods and services
• Own and sell factors of production

11

Our First Model: The

Circular-flow Circular-Flow Diagram
diagram:
Markets for Goods and Services
• Firms sell
• Households buy

Markets for Factors of Production

• Households sell
• Firms buy

12

4
 Our First Model: The
Circular-flow Circular-Flow Diagram
diagram:
Factors of Production
• Inputs used to produce goods and services
• Land, labor, and capital

13

The Circular Flow Diagram

MARKETS
Revenue FOR Spending
GOODS AND SERVICES
Goods •Firms sell Goods and
and services •Households buy services
sold bought

FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of dollars

14

1.2 The basic economic problems

Firms : what goods to produce, for which

customers, and how to produce goods to
maximize profit.

15

5
 1.2. The basic economic problems

Consumers: what goods to consume, for which

purpose of consumption, and how to consume to
maximize benefit.

Government: maximize welfare

16

1.3. Optimal economic choices

1.3.1. The nature and objectives of
economic choices

Members of the economy make choices when

facing resource in scarcity to maximize profit
(firms) or benefit (consumers) or welfare
(goverment).

Government (maximize welfare):

Choosing Fish or Steel?

17

1.3. Optimal economic choices

1.3.3. How to make optimal choices

1. Comparing opportunity cost:

The opportunity cost of an item is what you give
up to get that item.

2. Thinking at margin:
Economists use the term marginal changes to
describe small incremental adjustments to an
existing plan of action.
Rational people often make decisions by
comparing marginal benefits and marginal
costs.

18

6
 Principle
The #2: The cost
opportunity Cost of Something Is What
You Give Up to Get It.
• Decisions require comparing costs and benefits of alternatives.
• Whether to go to college or to work?
• Whether to study or go out on a date?
• Whether to go to class or sleep in?
• The opportunity cost of an item is what you give up to obtain
that item.

19

Think at margin

•Marginal changes are small, incremental

adjustments to an existing plan of action.

People make decisions by comparing

costs and benefits at the margin.

20

Marginal benefit (MB) and Marginal

cost (MC)

21

7
 Does the driver think at Margin?

22

1.3. Optimal economic choices

1.3.4. Production possibility frontier (PPF)

PPF is a graph that shows the various

combinations of output that the economy
can possibly produce given the available
factors of production and the available
production technology that firms use to
turn these factors into output.

23

The production possibility frontier (PPF)

 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.

24

8
 The Production Possibilities Frontier

Quantity of
Computers
Produced

3,000 D

C
2,200
2,000 A
Production
possibilities
frontier
1,000 B

0 300 600 700 1,000 Quantity of

Cars Produced
Copyright©2003 Southwestern/Thomson Learning

25

The production
Our Second Model: possibility frontier
The Production
Possibilities Frontier
(PPF)
Concepts Illustrated by the Production Possibilities Frontier
Tradeoffs
Opportunity Cost
Efficiency
Economic Growth

26

Trade off#1:&People
Principle Opportunity cost
Face Tradeoffs.
To get one thing, we usually have to give
up another thing.
• Guns v. bread
• Food v. clothing
• Leisure time v. work
• Efficiency v. equity

Making decisions requires trading

off one goal against another.

27

9
 Efficiency
Principle #1: People Face Tradeoffs
•Efficiency v. Equity
•Efficiency means society gets the
most that it can from its scarce
resources.
•Equity means the benefits of
those resources are distributed
fairly among the members of
society.

28

PPF1: A is inefficient, B is efficient, C is infeasible

PPF2: explains a growth in production: C is efficient and
attainable (due to New technology)

29

PPF1: A is inefficient, B is efficient, C is infeasible

PPF2: explains a growth in production: C is efficient and
attainable (due to New technology)

X0

30

10
 The Production Possibilities Frontier

Quantity of
Computers
Produced

4,000

3,000

2,100 E
2,000
A

0 700 750 1,000 Quantity of

Cars Produced
Copyright © 2004 South-Western

31

11