Microeconomics

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 Road map of the first Class
1. General Introduction
2. Course Outlines
3. Conceptual Framework of Economics
4. Introduction of Microeconomics
5. Some key Concepts of Microeconomics

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Conceptual Framework of Economics
Economics
Microeconomics
Macroeconomics
Monetary Economics
Development Economics
International Trade
Mathematical Economics
Econometrics
etc.

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Economics
Economics is the study of how societies use
scarce resources to produce valuable
commodities and distribute them among
different people.

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Microeconomics
Preliminaries

Microeconomics deals with:

Behavior of individual units
WhenConsuming
How we choose what to buy

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 Preliminaries
 Microeconomics deals with:
– Behavior of individual units

• How and what to produce

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Preliminaries
Microeconomics deals with:
Markets: The interaction of consumers
and producers

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 Macroeconomics
Macroeconomics is the study of the structure and performance
of national economies and of the policies that GOVT use to
try to affect the economic performance.

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Macroeconomics
Preliminaries

Macroeconomics deals with:

Analysis of aggregate issues:
– Economic growth
– Inflation

– Unemployment

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 Microeconomics vs. Macroeconomics
The Linkage Between Micro and Macro-
economics
Microeconomics is the foundation of
macroeconomic analysis

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Micro economics in practical life
Real life examples

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Conceptual Framework of Economics
Normative and Positive Economics
Market
Scarcity
Factors of Production
Production Possibility Frontier (PPF)
Demand and Supply

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Scarcity: limited nature of society’s resources

 Scarcity forces us to chose among alternatives

 Something is scarce when there is less of it freely

available from nature than what people would like.

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 Scarcity and Poverty
Scarcity and Poverty are not the same thing!

 The absence of poverty implies that some basic level of need

has been met

 An absence of scarcity would imply that all of our desires

for goods has been met.

 We can eliminate poverty but never scarcity!

 Are wants really unlimited?

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 3 fundamental Qs of Economics
What goods/services to be produced?
How to produce?
Who gets them?
All are solved by prices.

2 main players; producers and consumers

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Positive Versus
Normative Economics
Positive Economics
Positive economics deals with the
observations or predictions of the facts of
economic life.
For example:

What will be the impact of an increase in

wages on the price of a product?
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 Basic Economic Concepts
Scarcity
- scarcity vs poverty
Choices
Opportunity Cost

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 Principle 1: Trade offs
There is no such thing as a free lunch!

Is public schooling free of cost?

Efficiency vs Equality
- Efficiency: to get the most out of resources
- Equality: when prosperity is distributed uniformly
among the society members

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 Principle 2: Cost of giving up
Cost benefit analysis

Opportunity cost

Opportunity cost of coming to this class?

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 Opportunity Cost: An example
 The cost of college

 Opportunity cost on tuitions and books $ 40,000

 Opportunity cost of college time ( 4 years working $ 20,000/year) $ 80,000
 Total $
120,000

We donot include costs that we would incur regardless like cost of
rent or food.

If the opportunity cost of an activity increases, people do less of

it.
College athletic stars leave college early!
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Principle # 3: Rational people think at the margin

Individuals always examine the cost vs benefit

They do the best they can to meet their objectives

They make decisions based on marginal benefit and

cost

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 Twin forces: Supply & Demand
Determine the prices

Water-diamond paradox: why is diamond more

expensive than water even though water is more
valuable and demanded?

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Principle # 4: People respond to incentives

As personal benefits (costs) from choosing an option

increases, a person will be more (less) likely to chose
that option.

When gas prices rise, consumers buy more of hybrid

cars
More examples??

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Principle # 5: Trade can make everyone better
off

Mutual gain is the foundation of trade

You dislike tomatoes in salad but your sister likes and

she dislikes mushrooms so can you exchange and be
better off?

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 Principle # 6: Markets organize economic
activity
What goods/services to be produced?
How to produce?
Who gets them?
These are all solved in the market through prices set.

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Positive versus
Normative Economics
Normative Economics
Normative Economics is the value judgments
about how economics should operate, based on
certain moral principles or preferences?”
For example:
What wage rate should be paid to the auto workers
to make them an active member of the society?

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What is a Market?
Markets
A defined area where buyers and sellers
interact to determine the price of a
product or a set of products.

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 Market Economy
Adam Smith and “Wealth of Nations”

“Invisible hand”

Competitive Economy

Prices lead decisions

Government role

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 Economics; Another Perspective
 Economics is the study of the choices
made by people who are faced with
scarcity.

 Scarcity is a situation in which

resources are limited but can be used
in different ways; so one good or
service must be sacrificed for another.

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Society’s Choices
 The decisions of producers, consumers and
government determine how an economic
system answers three fundamental questions:
1. What products do we produce?
2. How do we produce these products?
3. Who consumes the products?

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 Economic Systems:

A free market/capitalist economy is a system in which the

questions about what to produce, how to produce and for whom to
produce are decided primarily by the demand and supply
interactions in the market.( example)
Dictatorship is a system in which economic decisions are taken by
the dictator which may be an individual or a group of selected
people.(example)
A command or planned economy is a mode of economic
organization in which the key economic functions – for whom,
what, how to produce are principally determined by government
directive.(example)
Mixed economy.
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Theories and Models
Microeconomic Analysis
Theories are used to explain observed
phenomena in terms of a set of basic rules
and assumptions.
For example
The Theory of the Firm
The Theory of Consumer Behavior
 Theories and Models
Microeconomic Analysis
Models:
a mathematical representation of a theory
used to make a prediction.
Theories and Models
Microeconomic Analysis
Validating a Theory
– The validity of a theory is determined
by the quality of its prediction, given
the assumptions.
Theories and Models
Microeconomic Analysis
Evolving the Theory
Testing and refining theories is central to
the development of the science of
economics.
Factors of Production
Factors of production are the resources
that are used to produce goods and
services:
1. Natural resources:
The things created by acts of nature such
as land, water, mineral, oil and gas
deposits.

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Factors of Production
2. Labor:
The human effort, physical and mental,
used by workers in the production of
goods and services.

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Factors of Production
3. Physical capital.
All the machines, buildings, equipment,
roads and other objects made by human
beings to produce goods and services.

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Factors of Production
4. Human capital:
The knowledge and skills acquired by a
worker through education and experience.

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Factors of Production
5. Entrepreneurship:
The effort to coordinate the production and
sale of goods and services. Entrepreneurs
take risk and commit time and money to a
business without any guarantee of profit.

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 Two Big Economic Questions
Two big questions summarize the scope of
economics:
How do choices end up determining what,
how, and for whom goods and services get
produced?
When do choices made in the pursuit of self-
interest also promote the social interest?
 Two Big Economic Questions
What, How, and For Whom?
Goods and services are the objects that people
value and produce to satisfy human wants.
What?
Agriculture accounts for less than 1 percent of
total U.S. production, manufactured goods for
20 percent, and services for 80 percent.
In China, agriculture accounts for 10 percent of
total production, manufactured goods for 50
percent, and services for 40 percent.
 Two Big Economic Questions
How?
Goods and services are produced by using
productive resources that economists call factors
of production.
Factors of production are grouped into four
categories:
 Land
 Labor
 Capital
 Entrepreneurship
 Two Big Economic Questions
 The “gifts of nature” that we use to produce goods and services are
land.
 The work time and work effort that people devote to producing
goods and services is labor.
 The quality of labor depends on human capital, which is the
knowledge and skill that people obtain from education, on-the-job
training, and work experience.
 The tools, instruments, machines, buildings, and other
constructions that businesses use to produce goods and services are
capital.
 The human resource that organizes land, labor, and capital is
entrepreneurship.
 Two Big Economic Questions
For Whom?
Who gets the goods and services depends
on the incomes that people earn.
 Land earns rent.
 Labor earns wages.
 Capital earns interest.
 Entrepreneurship earns profit.
 Two Big Economic Questions
When is the Pursuit of Self-Interest in the Social
Interest?
Every day, 304 million Americans and 6.7 billion
people in other countries make economic choices that
result in What, How, and For Whom goods and
services are produced.
Do we produce the right things in the right quantities?
Do we use our factors of production in the best way?
Do the goods and services go to those who benefit
most from them?
Two Big Economic Questions
You make choices that are in your self-interest—
choices that you think are best for you.
Choices that are best for society as a whole are said to
be in the social interest.
An outcome is in the social interest if it uses
resources efficiently and distributes goods and
services fairly.
The Big Question
Is it possible that when each one of us makes choices
that are in our self-interest, it also turns out that
these choices are also in the social interest?
 The Economic Way of Thinking
Choices Bring Change
What, how, and for whom goods and services get
produced changes over time and the quality of our
economic lives improve.
But the quality of our economic lives and the rate
at which they improve depends on choices that
involve tradeoffs.
We face three tradeoffs between enjoying current
consumption and leisure time and increasing
future production, consumption, and leisure time.
The Economic Way of Thinking
If we save more, we can buy more capital and
increase our production.
If we take less leisure time, we can educate and
train ourselves to become more productive.
If businesses produce less and devote resources
to research and developing new technologies,
they can produce more in the future.
The choices we make in the face of these
tradeoffs determine the pace at which our
economic condition improves.
 Division of Labor
Production of good broken down and distributed
according to specialization.
Increase in output:
- can take advantage of the differences in the skills
- can become more skilled with time
- can adopt mass production technology

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 Comparative Advantage
David Ricardo (1817) law: Joint output of trading
partners will be greatest when each good is produced
by the low opportunity cost producer.

An individual (or country) has comparative advantage

if it can produce a good at the lowest opportunity cost.

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The Production Possibilities Frontier (PPF)
The PPF curve shows
the possible
combinations of goods
and services available to
an economy, given that
all productive resources
are fully and efficiently
employed.

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The Production Possibilities Frontier (PPF)

When the economy

is at point i,
resources are not
fully employed
and/or they are not
used efficiently.

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The Production Possibilities Frontier (PPF)
Point g is desirable
because it yields
more of both goods,
but not attainable
given the amount of
resources available.

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The Production Possibilities Frontier (PPF)
Point d is one of the
possible
combinations of
goods produced when
resources are fully
and efficiently
employed.

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Scarcity and the PPF
To increase the
amount of farm
goods by 10 tons,
we must sacrifice
100 tons of factory
goods.

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The Production Possibilities Frontier (PPF)
The PPF curve is bowed
out because resources
are not perfectly
adaptable to the
production of the two
goods.
As we increase the
production of one good,
we sacrifice
progressively more of
the other. 58
Shifting the PPF Curve
To increase the
production of one good
without decreasing the
production of the other,
the PPF curve must
shift outward.

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Shifting the PPF Curve
The PPF curve shifts
outward as a result of:

An increase in the
economy’s resources
OR
A technological innovation
that increases the output
obtained from a given
amount of resources

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Shifting the PPF Curve
From point d, an
additional 200 tons
of factory goods or
20 tons of farm
goods are now
possible (or any
combination in
between).

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PPF Curve for poor nations(luxuries and necessities)
PPF Curve for High Income nations

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Frontier Society( Public goods vs private goods
Urban Society

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Today's choices (current consumption and capital
Investments)
Future Consequences (future consumption and capital
Investments)

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 Factors of Shift
Economic growth

Technological advances

Population

Question

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 Thank you and
have a good day

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