Chapter 1

Principles of Microeconomics
Douglas Curtis & Ian Irvine
Learning outcome
 By the end of this chapter you should understand..
 What is economics?

 What do economists do ?

 How economists do that stuff?

 Is economics a science?

 Micro and macro economics.

 The roles of government in economy

 Opportunity cost, productivity advantage and efficiency

 Specialization, exchange and markets

 The production possibility frontier

 Full employment, booms, recessions and economic growth

What is economics ?
 Economics is “ the study how people, businesses, societies or nations deal
with scarcity.
What do economists do?

 Economists try to provide information that will be useful for decision-maker.

 They analyze anything that involves decision-making.
 They analyze anything that involves choices and trade off.

what is the nature and magnitude of cause-and-effect

how did we get here
what would happen if..
what are the costs and benefits of an action or inaction?
what is the best way to accomplish a goals?

When economists analyze the situation they tend to do so without personal thinking.
How economists do that stuff?

• Theory
• A theory is a logical view of how things work, and is frequently formulated on
the basis of observation.
• Models
• A model is a formalization of theory that facilitates scientific enquiry.
• Data
• Statistical methods.
Is economics a science?

 Yes and no
 Science can viewed as the study of things that can be proven false (Karl popper)
 Economists use theory to examine how facts fit together.
 Economists empirically test theory to see whether the facts support what theory
predicts
 But unlike some physical scientists, economists rarely use controlled
experiments to test theories.
 We must use whatever facts are available and rely on statistical analysis to draw
conclusion.
 Economics is a social science because is concerned with ideas that may improve
society.
Is economics a science?

 “ The problems that we want economists to help solve are more like
predicting how leaves will fall on a windy day than predicting how objects
will fall in a vacuum.”( Daniel hausman)
Some topics in economics

 Macroeconomics
 Microeconomics
 Public economics
 Health education and welfare
 Financial economics
 Environmental economics
 Other special topics
Micro and macro

 Macroeconomics : studies the economy as a system in which feedbacks among

sectors determine national output, employment and prices.
 Some fields in macro economics:
 Monetary economics
money central banking and policy
interest rates
credit markets
 International economics
trade
exchange rate
international investment
growth and development
Micro and macro

• Microeconomics is the study of individual behavior in the context of scarcity.

• Some field of microeconomics:
• Health economics
• Economics of education
• Environmental and natural resources economics
• Industrial organization
• Urban economics
• Labour economics
• And other
The Roles of Government

 Maintain the Legal and Social Framework:

Define and enforce property rights
Establish a monetary system
 Maintain Competition:
Create and enforce antitrust laws, and regulate natural monopolies
 Provide Public Goods and Services:
Public goods and services are those that markets will not provide in sufficient quantities.
 Correct for Externalities:
Reduce negative externalities.
Encourage increased production of goods and services that have positive externalities.
 Stabilize the Economy:
Reduce unemployment and inflation, and promote economic growth.
 Redistribute Income:
Redistribute income from people who have higher incomes to those with lower incomes
Opportunity Cost and markets

 Markets are central to our economic lives – they permit us to trade, work
efficiently and improve our living standards
 The opportunity cost of a choice is what must be sacrificed when a choice is
made.
 opportunity cost is “ TiNSTaaFL”
 There is no such thing as a free lunch
A Model of Exchange and Specialization
Opportunity Cost

 Now we can apply the concept of opportunity cost in this example:

 For Amanda the opportunity cost is 3 units of V for 2 units of F (divide both
side by 2) or is 1.5 units of V for 1 unit of F or 18 units of V for 12 units of F.

 For Zoe the opportunity cost is 2 units of V for 4 units of F (divide both side
by 2) or is 1 units of V for 2 unit of F or 9 units of V for 18 units of F.
Specialization

 Let’s now see what can happen as a result of each individual specializing in
the production of the good where their opportunity cost dictates:
• Amanda specializes in Vegetable
• Zoe specializes in Fish

• We are about to develop our first graphical model

Absolute Advantage - Production
From Production to Consumption

 Let us see how specialization, that produces more output can translate into
more consumption. It is consumption rather than production which is of
ultimate interest
 First they must decide upon a rate at which to exchange the two goods:

• If each individual is to benefit this rate should lie between their individual
rates of transformation. To illustrate: suppose they exchange at a rate of 1:1
Absolute Advantage - Consumption
Trade is not a zero-sum game

 In the model above note that each of the participants stands to gain from
trade. The gains to one do not arise as a transfer from the other participant.

• Trade is not a zero-sum game. A net gain accrues to the trading economy as a
result of the more efficient production pattern. That net gain can be shared
by all of the participants. A zero-sum gain is by definition one where there is
not net gain, and the gains to one participant are exactly offset by the losses
incurred by the other.
Trade is not a zero-sum game
 North America Free Trade Agreement – NAFTA Canada, US Mexico

 US wants to renegotiate in 2017. US is running a B/P deficit

 Issues:
• Softwood lumber
• Dairy and farmer protection in Canada
 Does everybody win? No.

 Do the gains outweigh the losses?

 Why is protectionism strong? Many small gainers, fewer bigger losers

From Individuals to the Economy

 Can we represent the production possibilities of the whole economy by

‘aggregating’ the production capabilities of each individual?

• The economy-wide PPF is the set of products combinations that can be

produced in the economy when all available productive resources are in use.
Economy wide PPF
A Multi-person PPF
Outward shift in PPF

 Economic growth is an increase in what an economy can produce if it is using

all its scarce resources. ( when we have growth in productive capacity)
 An increase in an economy’s productive potential can be shown by an outward
shift in the economy’s production possibility frontier (PPF).
 What creates growth:
 1.Labour productivity is an important economic indicator that is closely linked
to economic growth.(Y/L)
 2.Employs new technology
 3.Employs new production methods
 4. Increases its labour force
 5. Discovers new raw materials
Inward shift in PPF

 A PPF will shift inwards when an economy has suffered a loss or exhaustion of
some of its scarce resources. This reduces an economy’s productive potential.
 What creates an inward shift of a PPF
 1. Resources run out
 2. Failure to invest
 3.Natural disaster
Recessions and Booms

• In an economic recession output falls below the economy’s capacity output.

• ( In recession we will see an inward shift in PPF)

• A boom is a period of high growth that raises output above normal capacity
output.
• ( In a boom we will see a upward shift in PPF)
Full Employment and the PPF

• When everyone who is willing to work at current wage rates and normal hours
of work is actually working, the economy is a full employment.
• In April 2016 the actual unemployment was 7.1% in Canada. Economists
believe that full employment corresponds to approximately 6% unemployment

• Hence the PPF in Canada has an associated unemployment rate of 6%! Why?

• Some workers are ‘between jobs’; reeducating themselves; moving from ‘old’
economy to ‘new’ economy; migrating between provinces.
Chapter Summary

 Economics: methods and ideas for the improvement of society. the study how people,
businesses, societies or nations deal with scarcity.

 Economists use models to test theories with data

 Markets improve the economy’s efficiency

 Governments perform many central functions in modern economies

 Opportunity cost reflects the alternative possibilities

 Production possibility frontier represents the capabilities of the economy when functioning
efficiently
Chapter Summary

• Absolute advantage refers to greater absolute efficiency

• Specialization increases consumption possibilities

• With many individuals the PPF may be concave

• Economic growth shifts the PPF

• Booms and recessions see increases and decreases in output beyond what is
normal