Introduction to

Microeconomics
Module: Week 1
Introduction to Microeconomics
Economists generally define
economics as the study of how
individuals and societies use limited
resources to satisfy unlimited wants.

Economists argue that the

fundamental economic problem is
scarcity.
Economic Good, Free Good and Economic Bad

A good is an economic good if people want more of it

than would be available if the good were available for
free.

A good is a free good if there is more than enough

available for everyone even when the good is free.

An item is said to be an economic bad if people are

willing to pay to avoid the item. Examples of economic
bad include things like garbage, pollution, and illness.
Economic Good, Free Good and Economic Bad

Goods that are used to produce other goods or

services are called economic resources and are also
known as inputs or factors of production. These
resources are often categorized into the following
groups: Land, Labor, Capital, and Entrepreneurial
ability.

The category of "land" includes all natural resources.

These natural resources include the land itself, as
well as any minerals, oil deposits, timber, or water
that exists on or below the ground.
Economic Good, Free Good and Economic Bad

This category is sometimes described as the "free gifts of

nature," those resources that exist independent of human
action. The labor input consists of the physical and
intellectual services provided by human beings.

The resource called "capital" consists of the machinery and

equipment used to produce output. Note that the use of the
term "capital" differs from the everyday use of this term.
Stocks, bonds, and other financial assets are not capital
under this definition of the term. Entrepreneurial ability refers
to the ability to organize production and bear risks.
Rational Self-interest
Economists argue that individuals pursue their
rational self-interest when making choices. This
means that individuals are assumed to select the
alternative(s) that they believe will make them
happiest, given the information that they possess
at the time of the decision.
Opportunity Costs
The opportunity cost of any alternative is defined as the cost of
not selecting the "next-best" alternative.

Marginal cost is defined as the additional cost associated with a

one-unit increase in the level of the activity.

If marginal benefit exceeds marginal cost, net benefit will

increase if the level of the activity rises. Therefore, rational
individuals will increase the level of any activity when marginal
benefit exceeds marginal costs.
Opportunity Costs

If marginal cost exceeds marginal benefit, net benefit rises when

the level of the activity is decreased. There is no reason to change
the level of an activity (and net benefit is maximized) at the level of
an activity at which marginal benefit equals marginal cost.
Production Possibilities Curve
• The law of diminishing returns states that output will
ultimately increase by progressively smaller amounts as
additional units of a variable input (time in this case) are
added to a production process in which other inputs are
fixed

• The increase in the marginal opportunity cost of points on

the economics exam as more time is devoted to studying
economics is an example of the law of increasing cost. This
law states that the marginal opportunity cost of any activity
rises as the level of the activity increases.
Specialization and Trade

In The Wealth of Nations, Adam Smith argued that economic growth

occurred as a result of specialization and division of labor.

Adam Smith and David Ricardo argued that similar benefits accrue from
international specialization and trade. If each country specializes in the
types of production at which they are best suited, the total amount of
goods and services produced in the world economy will increase.
Specialization and Trade
There are two measures that are commonly used to determine
whether an individual or a country is "best" at a particular activity:

Absolute
advantage Comparative
advantage
Specialization and Trade
• An individual (or country) possesses an
absolute advantage in the production of
Absolute a good if the individual (or country) can
advantage produce more than the other
individuals

• An individual (or country) possesses a

comparative advantage in the
Comparative production of a good if the individual
advantage (or country) can produce the good at
the lowest opportunity cost.
Demand and Supply
A market is a set of arrangements for the exchange
of a good or a service

A barter system is a market system in which goods

or services are traded directly for other goods or
services.

In a monetary economy, individuals trade goods or

services for money and then use this money to buy
the goods or services that they wish to acquire.
Demand
The demand for a good or service is defined to be the relationship that
exists between the price of the good and the quantity demanded in a given
time period, ceteris paribus.

This inverse relationship between price and quantity demanded is so

common that economists have called it the law of demand: an inverse
relationship exists between the price of a good and the quantity demanded
in a given time period, ceteris paribus.
Determinants of demand
Tastes and
preferences

The prices of Income

related goods Some factors that might be
expected to change demand
for most goods and services.
These factors include:

Expectations of
The number of future prices as
consumers well of income
Determinants of demand
Fads will often increase the demand for a good for at least a short
period of time.

As fads fade away, the demand for the products falls.

Goods may be related in consumption as either: substitute goods,

or complementary goods. Two goods are said to be substitute goods if
an increase in the price of one results in an increase in the demand for
the other.

Economists say that two goods are complementary goods if an

increase in the price of one results in a reduction in the demand for the
other.
International effects
• When international markets are taken
into account, the demand for a product
includes both domestic and foreign
demand.

• The exchange rate is the rate at which

the currency of one country is converted
into the currency of another country.
Supply
• The law of supply states that a direct
relationship exists between the price of a good
and the quantity supplied in a given time
period, ceteris paribus.

Determinants of supply
• As in the case of demand, expectations
can play an important role in supply
decisions.
International effects
Another important concept is price ceiling, in which it is a legally mandated
maximum price. The purpose of a price ceiling is to keep the price of a
good below the market equilibrium price. Rent controls and regulated
gasoline prices during wartime and the energy crisis of the 1970s are
examples of price ceilings.

Another concept is the price floor which is a legally mandated minimum

price. The purpose of a price floor is to keep the price of a good above the
market equilibrium price. Agricultural price supports and minimum wage
laws are example of price ceiling