Lecture 1

Introduction
and Math Review

Eric Doviak
Principles of Microeconomics

Helpful hints
x Economics doesn’t have to x Most important part of any
be difficult economic model are the:
x BUT... some people make ASSUMPTIONS
x it difficult for themselves. x If you understand the
x I did. assumptions of the model,
x If a model is unclear, don’t you will understand the
try to think of an example conclusions.
from the $10 trillion US x You will NOT understand
economy. the conclusions, if you don’t
x Instead, apply the model to understand the
a small rural village. assumptions.
x WHEN READING, DON’T
SKIP CHAPTERS!

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 Scope & Method of Economics
Why should I study economics?
x To learn a way of thinking! Hopefully, you’ll learn to use three
key concepts in your daily lives:
o efficient markets
o marginalism and
o opportunity cost

Efficient markets
x Profit opportunities are rare because everyone is looking for them.
x Efficient markets eliminate profit opportunities immediately.
x Ex. You’ll never find a good parking space, because if there was a
good one, it would already be taken before you got there.

Marginalism
Average cost – total cost divided by quantity
x If I spend 300 hours preparing 30 lessons for you:
x You had better study!
x My average cost per lesson is 10 hours.

Sunk cost – costs that can no longer be avoided because they have
already been “sunk”
x If I teach this class again next semester, I will have already sunk
300 hours into preparation.

Marginal cost – cost of producing one more unit

x Next semester I can recycle my notes, so my marginal cost per
lesson will equal 75 minutes.
x Compare that with my current 10 hours!
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 Opportunity Cost
x We all face choices. Resources are “scarce.”
x We can’t spend more time or money than we have, so we have to give up
one opportunity to take advantage of another.
x If I have a choice between earning $1000 per month by teaching this
course OR earning $500 per month by working at McDonald’s, then:
o It takes me one month to produce $1000 worth of teaching.
o It takes me one month to produce $500 worth of burger flipping.
x Q: What’s my opportunity cost of teaching?
x A: Half a burger flipping per unit of teaching.
one month
one month per $1000 of teaching $1000 of teaching
one month per $500 of burger flipping one month
$500 of burger flipping
$500 of burger flipping 1 burger flippings
$1000 of teaching 2 teaching
I’ll give a much, much better example in the next lecture.

Point plotting (X,Y):

x the first point in a pair lies on the
Math – tool of
X axis (horizontal axis)
x the second point in a pair lies on the
econ. analysis
Y axis (vertical axis)
Let’s graph the following equation
in red (square points):
y = –5x + 20
Connect points:
(0,20), (1,15), (2,10), (3,5) & (4,0)
y-intercept:
x the value of y, when x = 0
x here it’s 20, because:
20 = (–5*0 ) + 20
slope: (we’ll get back to that)
More examples:
y = 4x + 5 (blue, round points)
y = –2x + 15 (green, triangle points)
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 equation: slope: y-int: Math – tool of
y = –5x + 20 – 5 20
y = 4x + 5 4 5 econ. analysis
y = –2x + 15 – 2 15
What is SLOPE?
x the change in y divided by the
change in x
o y = –5x + 20
o x increases from 1 to 2
o y decreases from 15 to 10
o slope: 10 15  5 5
2 1 1
x positive slope: x and y increase
and decrease together
x negative slope: x and y
NB: in linear functions (such as the
increase and decrease inversely ones here) the slope equals the value
(when one rises the other falls) of the parameter by the variable X.

x Why does curve slope up?

x When is avg. consumption Analyzing
greater than avg. income?
How is this possible?
Graphs
x A statistical estimation of
the relationship between
avg. income and avg.
consumption is:
AC = 0.57*AI + 13,539
where: AC = avg. consumption
and AI = avg. income

x What’s the significance of

the y-intercept ($13,539)?
x What’s the significance of
the parameter next to the The graph illustrates relationship between
AI-variable (0.57)? average household income and average
consumption expenditure. Along the 45
degree line, income equals expenditure.
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 AC = 0.57*AI + 13,539
marginal propensity to consume
I’m using an example from macroeconomics, because some of you have already taken
a macro course. If you haven’t … Don’t worry. We’re just reviewing basic algebra.

x If your boss increased your income from $31,000 to $32,000, how much more
would you consume?
o On average, you would consume an extra $570 worth of goods.
o Put differently, if you were an average person, your expenditure on
consumption goods would rise from $31,209 to $31,779.
x Every $1000 increase in income raises consumption by $570. Why?
x marginal propensity to consume = 0.57 (NB: that’s the slope of the line!)

x What if you got fired? How much would you consume?

x Your income would fall to zero, but you’d still consume $13,539 worth of
goods. After all, you’ve got to eat!

x When your income is less than $31,486 your expenditures on consumption

goods exceed your income. (You run down your savings).
x When your income is more than $31,486 your income exceeds your
expenditures on consumption goods. (You save some of your income).

A few more definitions

AC = 0.57*AI + 13,539 Y = C + I + G + (X–M)

x Model – the formal statement of x Ceteris paribus – “all else

a theory, often presented using equal”
mathematical equations x How does an increase in
x Variable – a measure that can investment, I, affect national
change such as consumption or income, Y?
income x To answer this question we must
o Dependent variable hold all other variables constant,
o Independent variable while we determine the effect of
o In the example above, investment alone.
consumption depends on
income.
x Parameters – values which
remain constant in an equation
(here: 0.57 and 13,539)
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 Micro vs. Macro
MICROeconomics MACROeconomics
x Study of the decision-making x Study of aggregates
of individuals, households x What factors affect:
and firms o Gross Domestic Product?
x Study of distribution of o the price level?
wealth o the unemployment rate?

Positive vs. Normative Economics

Positive Normative
x No judgements x Makes judgements
x Just asking how the economy x Evaluates the outcomes of
operates economic behavior
x Policy recommendations

Economic policy
x Positive – economic policy starts with positive theories and
models to develop an understanding of how the economy works
x Then economic policy evaluates (normative) on the basis of:
o Efficiency – Is the economy producing what people want at
the least possible cost? (quantifiable)
o Equity – Is the distribution of wealth fair? Are landlords
treating low-income tenants fairly? (non-quantifiable)
o Growth – Increase in total output of the economy. Note:
efficiency gains lead to growth (quantifiable)
o Stability – steady growth, low inflation and full employment
of resources – capital and labor (quantifiable)
x And recommends (normative) courses of action to policy-makers
(presidents, congressmen, etc.)

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