Chapter 1

Introduction

Introduction

 What is economics?
 What is microeconomics and
macroeconomics?
 What are the key themes of
microeconomics?
 What is a market?
 Why study microeconomics?

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What is Economics?

 ECONOMICS ...
 is the study of how people use limited
resources to meet unlimited demand
Resources: assets, funds, wealth, money,
capital, labor, machinery, raw materials, etc.
People face trade-offs every time they make
choices.
 Economics originates from the scarcity of
resources.

1.3
What is Economics?

 ECONOMICS ...
 is the study of how society decides:

What
For whom
How
to produce...
1.4

An increase in the price of oil

affects
 What to produce
less oil-intensive products
 How to produce
less oil-intensive techniques
 For whom to produce
oil producers have more buying power,
importers have less

1.5

Resource allocation

Resource allocation is crucial for a

society
and is handled in different ways in
different societies, e.g.:
Command economy (central-
planning economy)
Mixed economy
Free market economy
1.6
 Command economy

 In a command economy, a government

planning office decides what will be
produced, how it will be produced and for
whom it will be produced.
Detailed instructions are then issued to
households, firms and workers.

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Free market economy

 All decisions on what will be produced,

how it will be produced and for whom it
will be produced are made through prices
on the market.
Markets in which governments do not
intervene are called free markets.
The “invisible hand” theory: the
individual pursuit of self-interest within
free markets may allocate resources
efficiently from society’s viewpoint
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Mixed economy

 In a mixed economy, the government and

private sector jointly solve economic
problems.
The government influences decisions
through taxation, subsidies and
provision of free services.
The governement also regulates the
extent to which individuals may pursue
their own self-interest.

©2005 Pearson Education, Inc. Chapter 1 9

 Market orientation

China Sweden USA

Hungary Hong Kong
Cuba UK

Command Free
economy market
economy
Nowadays, no economy is purely either
centrally planning or free market, but mixed
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Scarcity forces choices to be

made
Opportunity cost
a crucial concept in economic
analysis
the quantity of other goods that must
be sacrificed to obtain another unit of
a good

1.11

The production possibility

frontier
A production possibility frontier (PPF) shows
the maximum possible output combinations
of two goods or services that an economy
can achieve when all resources are fully and
efficiently employed.

1.12
 Table 1.1. Production possibility
of a hypothetical economy

Alternatives Food Cloth

No. Output No. Output
workers workers
A 4 25 0 0
B 3 22 1 9
C 2 17 2 17
D 1 10 3 24
E 0 0 4 30

13

Figure 1.1. Production

possibility Frontier (PPF)
Food

25 A B
22
C
17

D
10

E Cloth
9 17 24 30
14

The production possibility frontier

 As the number of workers allocated to a

sector increases, output increases,
 Returns of an additional worker is decreasing.
 The Laws of diminishing returns.
 As output in food sector increases, output
in other sector decreases.

15
 Opportunity cost of producing a
good


16

Moving along the PPF vs. shift of PPF

 Given certain resources, producing more

one goods leads to producing less of
others
 Moving along the PPF, resources are fixed.
 Assume technical advance exists, labor
force is increasing, etc., the economy is
able to produce more all goods.
 PPF shifts to a new one.

17

Food (kg)
Moving along
PPF
A
B
2020
C
Shift of
2010 PPF
D

E Clothing
(quantity)
Figure 1.3. Moving along PPF vs shift of PPF

18
 Micro and Macro

 Microeconomics
offers a detailed treatment of individual
economic decisions about particular
commodities
 Macroeconomics
emphasizes the interactions in the economy
as a whole

1.19

Themes of Microeconomics

 Microeconomics deals with limits

Limited budgets
Limited time
Limited ability to produce
 How do we make the most of limits?
 How do we allocate scarce resources?

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Themes of Microeconomics

 Workers, firms and consumers must

make trade-offs
Do I work or go on vacation?
Do I purchase a new car or save my money?
Do we hire more workers or buy new
machinery?
 How are these trade-offs best made?

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 Themes of Microeconomics

 Consumers
Limited incomes
Consumer theory – describes how
consumers maximize their well-being, using
their preferences, to make decisions about
trade-offs
How do consumers make decisions about
consumption and savings?

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Themes of Microeconomics
 Workers
Individuals decide when and if to enter the
workforce
 Trade-offs of working now or obtaining more
education/training
What choices do individuals make in terms of
jobs or workplaces?
How many hours do individuals choose to
work?
 Trade-off of labor and leisure

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Themes of Microeconomics

 Firms
What types of products do firms produce?
 Constraintson production capacity and financial
resources create needs for trade-offs
Theory of the Firm – describes how these
trade-offs are best made

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 Themes of Microeconomics

 Prices
Trade-offs are often based on prices faced
by consumers and producers
Workers make decisions based on prices for
labor – wages
Firms make decisions based on wages and
prices for inputs and on prices for the goods
they produce

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Themes of Microeconomics

 Prices
How are prices determined?
 Centrally planned economies – governments
control prices
 Market economies – prices determined by
interaction of market participants
Markets – collection of buyers and sellers
whose interaction determines the prices of
goods

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What is a Market?

 Markets
Collection of buyers and sellers, through their
actual or potential interaction, determine the
prices of products
 Buyers: consumers purchase goods, companies
purchase labor and inputs
 Sellers: consumers sell labor, resource owners
sell inputs, firms sell goods

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 Market Price

 Transactions between buyers and sellers

are exchanges of goods for a certain
price
Market price – price prevailing in a
competitive market
 Some markets have one price: price of gold
 Some markets have more than one price: price
of Tide versus Wisk

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Market Definition

 Market Definition
Which buyers and sellers should be included
in a given market?
This depends on the extent of the market –
boundaries, geographical and by range of
products, to be included in it
 Market for housing in HCMC. or Can Tho
 Market for all detergents or rice

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Market Definition

 Importance of market definition

In order to set price, make budgeting
decisions, etc., companies must know
 Their competitors
 Product-characteristic
and geographic
boundaries of the market
Important for public policy decisions
 Shouldgovernment allow a merger between
companies in same market?

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 Why Study Microeconomics?

 Microeconomic concepts are used by

everyone to assist them in making
choices as consumers and producers
 Examples show the numerous levels of
microeconomic questions necessary in
many decisions

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Ford SUV’s

 Built Ford Explorer in 1991, Ford

Expedition in 1997 and Ford Excursion
in 1999
 In each of these cases, Ford had to
consider many aspects of the economy
to ensure their introduction was a sound
investment

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Ford SUV’s

 Questions
How strong is demand and how quickly will it
grow?
 Must understand consumer preferences and
trade-offs
What are the costs of manufacturing?
 Given all costs of production, how many should
be produced each year?

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 Ford SUV’s

 Questions (cont.)
Ford had to develop pricing strategy and
determine competitors’ reactions
Risk analysis
 Uncertainty of future prices: gas, wages
Organizational decisions
 Integration of all divisions of production
Government regulation
 Emissions standards

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