ECONOMICS IS ABOUT

DECIDING
Economists do not restrict themselves to
considering only decision problems
involving money and markets, though
that is a big part of economics.

Introduction slide 1
 EXAMPLES OF SOME
DECISIONS ECONOMISTS
HAVE ANALYZED
Whether to buy a car this week.
Whether to have pizza for dinner tonight, or
something else.
Whether to marry your sweetheart.
How hard to study for this course.
Whether to go to college, and if so, which one.
Whether to buy a lottery ticket in the Michigan
lottery.
Introduction slide 2
 Factors in decision making

1. People face tradeoffs.

2. Opportunity cost.
3. Making decisions at the margin.
4. People respond to incentives.

Introduction slide 3
 How individual decisions affect
others

5. Trade (exchange) can benefit everyone.

6. Markets are often a good way to organize
exchange.
7. Government can sometimes improve on
markets.

Introduction slide 4
 MICROECONOMIC AGENTS
Firms
– Produce and sell goods and services
– Buy inputs (labor, capital & raw materials)

Consumers
– Buy goods and services
– Sell inputs (labor services, loanable funds)

Introduction slide 5
 Methodology: Positive v.
Normative Economics
Positive econ. -- Studies the way the world is.
How much will a new gasoline tax raise the price of
gasoline?
Will an increase in the minimum wage increase
unemployment?
Why is the price of corn $4.20 per bushel?
How much will a drought in the corn belt raise the price
of corn? Of wheat?
What will be the effect on Byron Brown’s pizza
consumption if we take $1000 away from Tom Izzo and
give it to Brown?
Introduction slide 6
 Methodology: Positive v. Normative
Economics
Normative econ. -- Studies the way the world should
be.
Should there be a new tax on gasoline?
Should there be an increase in the minimum wage?
Should $1000 be taken from M. Peter McPherson and
given to Byron Brown?
What should the price of corn be?

Introduction slide 7
 Models and theories
Model -- a hypothesis about the relationships among
variables.
Everyone uses models.
Because a model abstracts from reality it makes mistakes.
Models can contain two kinds of errors or mistakes:

the wrong explanatory variables may be included.

the functional form may be incorrect.

Introduction slide 8
 Contents of models
List of variables, especially a clear statement of what is to be
explained
Dependent v. independent variables

Hypothesized relationships among the variables.

Using tables of values, graphs, or equations.

Introduction slide 9
 A model of heights

H
height A H = a + b(A)

a b = H/A

age in years
Introduction slide 10
 A better (nonlinear) model of
heights
naive
(linear)
fancy

height

age in years

Introduction slide 11
 A better model?
Height = f(age, gender, parents’ heights,
nutrition, ...)

Introduction slide 12
 Gender effects in the better
model
Height = f(age, gender, parents’ heights,
nutrition, ...)
men

women
height

age
Introduction slide 13
 MODEL SUMMARY
Three ways to describe models
Graphs
Tables of values
Mathematical functions (equations)
Important concepts
Dependent and independent variables
Linear function, intercept and slope

Introduction slide 14
 AN ECONOMIC MODEL
The Production Possibility Curve
Purposes of model
Show scarcity constraint
Illustrate economic efficiency
Introduce opportunity cost concept
Variables
Quantities of goods that may be produced
Givens
Total amounts of inputs available
Technology of production

Introduction slide 15
 PPF DEFINED
The Production Possibility Curve (or frontier)
shows the maximum amount of a good you
can produce given the amounts of other
goods produced, and given the total
amounts of inputs available, and given the
technology of production.

Introduction slide 16
 PPC EXAMPLE
Assumptions:
There are only two goods, pizza and spaghetti.
There are limited inputs and given technology of
production.

Definition:
The PPC shows the maximum amount of pizza you can
produce, given the amount of spaghetti to be produced.

Introduction slide 17
 PRODUCTION POSSIBILITY
SPAGHETTI CURVE
400
Which
Which points
points are
are attainable
attainable
300 and
and which
which points
points are
are unattainable?
unattainable?

200
100
0
0 10 20 30 40 50 60
PIZZA
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Introduction slide 18
 PRODUCTION POSSIBILITY
SPAGHETTI CURVE
400 What’s
What’s the
in
in the
the effect
effect of
the technology
of an
technology for
an improvement
improvement
for producing
producing
spaghetti?
spaghetti?
300
200
100
0
0 10 20 30 40 50 60
PIZZA
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Introduction slide 20
 PRODUCTION POSSIBILITY
SPAGHETTI CURVE
400 What’s
What’s the
total
the effect
effect of
total resources
of an
an increase
resources (inputs)?
increase in
(inputs)?
in

300
200
100
0
0 10 20 30 40 50 60
PIZZA
Go to hidden slide
Introduction slide 22
Points “inside” the PPC are inefficient.
For any point “inside” there corresponds some
point that represents more production of
both goods.
Note that while points on the PPC are
efficient, we cannot say at this time whether
some are better for society than others.

Introduction slide 24
 OPPORTUNITY COST
DEFINED
The opportunity cost of doing something is what you
must give up in order to do it.
The cost of a pizza is what you must give up to consume
it, which in this case is easily computed in money.
The cost of a college education includes both money and
other foregone alternatives. For example, the cost of a
year at MSU includes not only tuition and books, but
the income you could have earned working on a full
time job.
The cost of attending a Lugnuts baseball game includes
the value of the time you could have spent studying
economics.
Introduction slide 25
 The PPC can show opportunity
cost
Suppose you are at some point on a PPC.
Then suppose you want to consume one more pizza.
The opportunity cost of one more pizza is the
amount of spaghetti you must give up in order to
get it.
Note that this opportunity cost is equal to minus the
slope of the PPC.

Introduction slide 26
 PRODUCTION POSSIBILITY
SPAGHETTI CURVE
400
300 More
More pizza
pizza means
means less
less spaghetti
spaghetti
200
100
0
0 10 20 30 40 50 60
PIZZA

Introduction slide 27
 OPPORTUNITY COST
INCREASES AS MORE OF A
GOOD IS PRODUCED
Not only does more pizza mean less spaghetti,
but each additional pizza costs more than
the one before it.

This idea shows up as the PPC being concave

to the origin. (The curve bows out.)

Introduction slide 28
 Production Possibility Curve
SPAGHETTI

400
300 Opportunity
Opportunity cost
constant.
constant.
cost of
of more
more pizza
pizza is
is

200
100
0
0 10 20 30 40 50 60
PIZZA
Introduction slide 29
We will use Production Possibilities Curves
that are straight lines (i.e., that have
constant opportunity cost) to illustrate some
important economic principles.

Introduction slide 30