LECTURE #1: MICROECONOMICS

CHAPTER 1

Ten Principles
Economics as Science

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 Economics & Scarcity
 Society allocates people, land, buildings, and
machines to various productive tasks. It also
allocates the output of goods and services
produced.
 Society decides who will eat caviar and who will
eat potatoes. It must decide who will drive a
Ferrari and who will take the bus.
 Allocation is necessary because goods and
services are scarce relative to the demand for
those same goods and services.

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 Economics & Scarcity
 Scarcity means that society has limited resources
and therefore cannot produce all the goods and
services people wish to have. Just as each
member of a household cannot get everything
he or she wants, each individual in a society
cannot attain the highest standard of living to
which he or she might aspire.
 Economics is the study of how society manages
its scarce resources. How are resources allocated
and who makes the allocation decisions is the
subject of economics.
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 Ten Principles of Economics
How People Make Decisions
1. Decision makers face trade-offs.
"Guns vs. Butter" argument
Clean environment vs. high levels of income argument
Efficiency vs. Equality: dividing the pie – the role of gov't
2. All things incur opportunity costs
What must you give up in order to get something else?
3. People are economically rational
Decision making at the margins
The concept of marginal costs vs marginal benefits
4. Incentives Matter
What induces a person to act?
Government Policy and Social Objectives

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 Ten Principles of Economics
How People Interact
5. Trade makes every one better off
Comparative advantage and opportunity costs
6. Free markets are the most efficient way to organize
economic activity
Moving the allocation and production decisions to the individual
Price are an important allocation criterion
7. Governments can sometimes improve market outcomes
The key word is 'sometimes'
The property rights issue
Market power: ability to influence outcomes
Market failure: inefficient allocation of resources

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 Ten Principles of Economics
How The Economy As A Whole Works
8. The Standard of Living reflects the ability to produce
goods and services
What causes differences in the standard of living across countries?
Why is productivity important?
Why are property rights and stable democratic governments
necessary?
9. Governments can upset the economic cart
Financing public services by printing money >>> inflation
10. Is there a short-term trade-off between Inflation and
Unemployment
What causes inflation: too much money or too much demand or
both?
Does the economy need some level of inflation to work?
The role of governmental policy

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 Break Time

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 Economist as Scientist/Investigator
Chapter 2
Economics = Science => Economist=Scientist
The Scientific Method
Collect Data (observation or experimentation)
Formulate Behavioral Hypotheses
Make Predictions (attention to role of
uncertainty)
Run Experiments to prove/disprove behavioral
hypotheses.

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 Economist as Scientist/Investigator
Chapter 2
The Role of Assumptions
Simplifying facts about the world around us
Identifying the essential elements of the few to
generalize about the many
The Role of Models
Models are used to describe the way the world works
Models consist of diagrams and equations
Example 1: The Circular Flow of Money and Goods
(Figure 1)

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 Circular Flow of Money and Goods
Factor Inputs and Outputs
Diagram is a schematic
representation of the
organization of the economy.
Decisions are made by
households and firms.
Households and firms
interact in the markets for
goods and services and in the
markets for the factors of
production. The outer set of
arrows shows the flow of
dollars, and the inner set of
arrows shows the correspon-
ding flow of inputs and
outputs.

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 Production Possibilities Frontier
Production possibilities frontier
A graph showing the various combinations
of output that the economy can possibly
produce…
Given the available
Factors of production (labor, capital,
materials)
Production technology (capital
intensity)

G. Mankiw* 11
 Production Possibilities Frontier

Quantity of
Computers The production possibilities
Produced frontier shows the
combinations of output - in
C this case, cars and
3,000 F
computers - that the
Production
economy can possibly
A Possibilities
2,200 produce.
B Frontier
2,000 The economy can produce
any combination on or
inside the frontier.
D Points outside the frontier
1,000
are not feasible given the
E
economy’s resources.

0 300 600 700 1,000 Quantity of

Cars
G. Mankiw
Produced 12
 Productivity
Technological advance
Outward shift of the production possibilities
frontier
Economic growth
Produce more of both goods

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 3
A shift in the production possibilities frontier
Quantity of
Computers
Produced A technological advance in
4,000 the computer industry
enables the economy to
produce more computers
3,000 for any given number of
2,300 G cars. As a result, the
2,200 production possibilities
A frontier shifts outward. If
the economy moves from
point A to point G, then the
production of both cars and
computers increases.

0 600 650 1,000 Quantity of

Cars Produced
G. Mankiw 14
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 Economist as Policy Advisor
Chapter 2
The Positive vs. Normative [Argument]
Positive – the way things are (descriptive)
Normative – the way things ought to be (prescriptive)
Business Week (April 27: "What Good Are Economists Anyway?“)
"Why they failed to predict the global economic crisis – and
why their help is critical to a recovery."
The "reality" – predicting the future is more art than
science. A lot has to do with our assumptions and our
experiential memories.
Thomas Sargent (NYU): "…the economy is volatile, in
part, because households and businesses hold 'fragile
beliefs' that shift quickly." (pg 031)

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Sources of Disagreement among Economists
Chapter 2

Differences in Scientific Judgments

(opinions regarding interpretation)
Differences in Measuring Impact of Policy
The problem of perception versus reality

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 A Quick Review of Graphing
Chapter 2

Cause (X-axis) and Effect (Y-axis)

Magnitude (Y) and Time (X)
Grade Point Average (Y) and Time Spent
Studying (X)
Slope and Intercept
Slope = the rate of change in Y given a change
in X (y / x)
Intercept: The value of Y when X = zero.
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 Homework Assignment
Chapter 1:
Questions for Review: 1, 3, 4, 6, 8, 9
Problems and Applications: 1 (parts a, b, c, and
e), 8, 12 (parts a and b)
Chapter 2:
Questions for Review: 2, 3, 4, 7, 9
Problems and Applications: 4 (parts a, b), 6

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