1. Introduction - Basic Concepts

Lecture 1
Fundamental Concepts
of
Economics
Class Policies
Be on time
Cell phones are silent
Questions are welcomed
Respect and transparency
Chapter 1: Economics: Foundations and Models
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 2 of 38
Education
Is
Power
Assessment
5th Week- Mid Exam 30%

9th week –Project Presentation 20%
Attendance and Participation 10%
Final Exam 40%
-------------------------------------------------------
Total 100%
Economics
4.1
Economics The study of the choices

people make to attain their goals,
given their scarce resources.
Scarcity A situation in which unlimited

wants exceed the limited resources
available to fulfill those wants.
1.1 LEARNING OBJECTIVE
Three Key Economic Ideas Explain these three key economic ideas:
People are rational. People respond to
incentives. Optimal decisions are made
at the margin.
As we study how people make choices and

interact in markets, we will return to three
important ideas:
1.People are rational.

2.People respond to economic incentives.
3.Optimal decisions are made at the margin.
Marginal analysis: Analysis that involves

comparing marginal benefits and marginal costs.
Explain these three key economic ideas:
Solved Problem 1-1 People are rational. People respond to
incentives. Optimal decisions are made
Apple Computer Makes a at the margin.
Decision at the Margin
Should Apple produce an additional 1 million iPhones?
In solving the problem, consider the following:

• Optimal decisions are made at the margin.
• An activity should be continued to the point where
the marginal benefit is equal to the marginal cost.
• In this case, the correct decision requires
information about additional revenue and additional
cost.
Microeconomics and Macroeconomics
Microeconomics The study of how households

and firms make choices, how they interact in
markets, and how the government attempts to
influence their choices.
Macroeconomics The study of the economy as

a whole, including topics such as inflation,
unemployment, and economic growth.
The Economic Problem That Discuss how an economy answers these
Every Society Must Solve questions: What goods and services will
be produced? How will the goods and
services be produced? Who will receive
the goods and services produced?
Trade-offs force society to make choices when

answering the following three fundamental
questions:
1. What goods and services will be produced?

2. How will the goods and services be
produced?
3. Who will receive the goods and services
produced?
The Market System Explain the basic idea of how
a market system works.
Factors of production are divided into four broad categories:

• Labor includes all types of work, from the part-time labor of
teenagers working at McDonald’s to the work of top managers in
large corporations.
• Capital refers to physical capital, such as computers and
machine tools, that is used to produce other goods.
• Natural resources (Land) include land, water, oil, iron ore, and
other raw materials (or “gifts of nature”) that are used in
producing goods.
• An entrepreneur is someone who operates a business.
Entrepreneurial ability is the ability to bring together the other
factors of production to successfully produce and sell goods and
services.
Market A group of buyers and sellers of a good or

service and the institution or arrangement by which
they come together to trade.
Input markets Markets for goods—such as

computers—and services—such as medical treatment.
Output markets Markets for the factors of production,

such as labor, capital, natural resources, and
entrepreneurial ability.
Centrally Planned Economies the goods and services produced?
versus Market Economies
Centrally planned economy An economy in

which the government decides how economic
resources will be allocated.
Market economy An economy in which the

decisions of households and firms interacting in
markets allocate economic resources.
Mixed economy An economy in which most

economic decisions result from the interaction of
buyers and sellers in markets but in which the
government plays a significant role in the
allocation of resources.
Free Markets
Free market A market with few

government restrictions on how a
good or service can be produced or
sold or on how a factor of production
can be employed.
The Market Mechanism
Individuals usually act in a rational, self-

interested way. Adam Smith understood
that people’s motives can be complex.
In a famous phrase, Smith said that

firms would be led by the “invisible

hand” of the market to provide
consumers with what they wanted.
Production Possibilities Frontiers Use a production possibilities
and Opportunity Costs frontier to analyze opportunity
costs and trade-offs.
Scarcity A situation in which unlimited

wants exceed the limited resources
available to fulfill those wants.
Trade-off The idea that because of scarcity,

producing more of one good or service means
producing less of another good or service.
the goods and services produced?
Production possibilities frontier (PPF)

A curve showing the maximum attainable
combinations of two products that may be
produced with available resources and
current technology.
Opportunity cost The highest-valued

alternative that must be given up to engage in
an activity.
Graphing the Production Possibilities Frontier

FIGURE 2-1
BMW’s Production
Possibilities Frontier
BMW faces a trade-off: To build
one more roadster, it must build
one less SUV. The production
possibilities frontier illustrates the
trade-off BMW faces.
Combinations on the production
possibilities frontier—like points A,
B, C, D, and E—are technically
efficient because the maximum
output is being obtained from the
available resources.
Combinations inside the frontier—
like point F—are inefficient
because some resources are not
being used.
Combinations outside the
frontier—like point G—are
unattainable with current
resources.
Use a production possibilities
Solved Problem 2-1 frontier to analyze opportunity
Drawing a Production Possibilities
Frontier for Rosie’s Boston Bakery
Rosie’s Boston Bakery specializes in cakes and pies.

Rosie has 5 hours per day to devote to baking. In an
hour, Rosie can prepare either 1 cake or 2 pies.
Use a production possibilities
Solved Problem 2-1 frontier to analyze opportunity
Drawing a Production Possibilities
Frontier for Rosie’s Boston Bakery
QUANTITY MADE
CHOICE CAKES PIES
A 5 0
B 4 2
C 3 4
D 2 6
E 1 8
F 0 10
Moving from choice D to choice E

increases Rosie’s production of
pies by 2 but lowers her
production of cakes by 1.
Therefore, her opportunity cost of
making 2 more pies is making 1
less cake.
Opportunity cost The highest-valued alternative that must be

given up to engage in an activity.
If we produce only goods X and Y, then
# of units of Y we have to give up
Opportunity Cost of producing a unit of X =
# of units of X we gain
Moving from D to E,
# of cakes we have to give up 1
Opportunity Cost of producing one more pie = =
# of pies we gain 2
Moving from E to D,
# of pies we have to give up 2
Opportunity Cost of producing one more cake = = =2
# of cakes we gain 1
Between Any two points on a PPF,
1
Opportunity Cost of one unit of X =
Opportunity Cost of one unit of Y
Making A Story of the Market Explain the basic idea of how
the System in Action: How
Connection Do You Make an iPod?
An iPod contains about 450 parts, designed and

manufactured by firms around the world. Many of
these firms are not even aware of which other
firms are also producing components for the iPod.
The invisible hand of the market has led these

firms to contribute their knowledge and resources
to the process that ultimately results in an iPod
available for sale in a store in the United States.

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Lecture 1

5th Week- Mid Exam 30%

Economics The study of the choices

Scarcity A situation in which unlimited

As we study how people make choices and

1.People are rational.

Marginal analysis: Analysis that involves

Should Apple produce an additional 1 million iPhones?

In solving the problem, consider the following:

Microeconomics The study of how households

Macroeconomics The study of the economy as

Trade-offs force society to make choices when

1. What goods and services will be produced?

Factors of production are divided into four broad categories:

Market A group of buyers and sellers of a good or

Input markets Markets for goods—such as

Output markets Markets for the factors of production,

versus Market Economies

Centrally planned economy An economy in

Market economy An economy in which the

Mixed economy An economy in which most

Free market A market with few

The Market Mechanism

Individuals usually act in a rational, self-

In a famous phrase, Smith said that

firms would be led by the “invisible

Scarcity A situation in which unlimited

Trade-off The idea that because of scarcity,

Production possibilities frontier (PPF)

Opportunity cost The highest-valued

Graphing the Production Possibilities Frontier

Rosie’s Boston Bakery specializes in cakes and pies.

Moving from choice D to choice E

Opportunity cost The highest-valued alternative that must be

An iPod contains about 450 parts, designed and

The invisible hand of the market has led these

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