MICROECONOMICS

• Basic Economic concepts

• Supply, Demand and Market equilibrium
• Supply, Demand and Government Policies
• International trade
• Elasticity
• Market Failures: Externality and public goods
• Production and Cost
• Market structures

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 BASIC ECONOMIC CONCEPTS
• Factors of production
• Basic economic questions
• Circular flow diagram
• Production Possibility frontier
• Microeconomics vs. Macroeconomics
• Normative vs. Positive analysis
• Absolute advantage and comparative advantage.
• Specialization and Exchange

Factors of productions
Resource inputs used to produce goods and
services.
• Land
• Labor
• Capital
• Entrepreneurship.

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Principles of Economics
• Scarcity: Society has limited resources, cannot
produce all the goods and services people wish to
have
• Economics: The study of how society manages its
scarce resources
• How People Make Decisions
• How People Interact
• How the economy as a whole works

How people make decision

• People face trade-offs among alternative goals
• The cost of any action is measured in terms of forgone
opportunities
• Rational people make decisions by comparing
marginal costs and marginal benefits
• People change their behavior in response to the
incentives they face

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How people interact
• Trade and interdependence can be mutually
beneficial
• Markets are usually a good way of coordinating
economic activity among people
• The government can potentially improve market
outcomes by remedying a market failure or by
promoting greater economic equality

The Different Kinds of Goods

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How economy as a whole works
• Productivity is the ultimate source of living
standards
• Growth in the quantity of money is the ultimate
source of inflation
• Society faces a short-run trade-off between
inflation and unemployment

Ten Principles of Economics

1-10

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Three Basic Economic Questions
• What to produce?
• How people decide what to buy, how much to work, save,
and spend
• How to produce?
• find an optimal method of producing goods and services.
• decide how much to produce, how many workers to hire
• For whom to produce?
• How society decides how to divide its resources between
national defense, consumer goods, protecting the
environment, and other needs

1. The opportunity cost of making a specific choice is:

a. useful primarily as an indicator of relative prices.
b. Its nominal costs in terms of all other goods.
c. the information that guides your decision.
d. measured by the subjective value of the best alternative you sacrifice.

2. Marrying the one you love involves opportunity costs, primarily because:
a. being married restricts your freedom to marry someone else, and you must
also consider making someone else happy when making decisions that affect
both of you.
b. two can live as cheaply as one.
c. having children is unavoidable and reduces the time you could work for pay.
d. income taxes on single people are heavier than on married couples.

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3. Economics is broadly defined as the study of how individuals and societies:
a. make choices about work and the division of labor.
b. attempt to maximize their financial incomes and wealth.
c. answer the basic economic questions of “Why, Where, and When.”
d. allocate scarce resources in attempts to satisfy human wants.

4. Economist often say there is no such thing as a free lunch. What do

economists mean when they say such a thing?
a. People never offer a lunch for free.
b. Even if someone literally offers you a free lunch, there is an opportunity cost
to the resources that are used to produce your free lunch.
c. Some resources cause significant negative externalities.
d. Economists, in this case, are talking about common resources.

Circular-flow diagram
Households:
 Own the factors of production,
sell/rent them to firms for income
 Buy and consume goods & services

Firms Households

Firms:
 Buy/hire factors of production,
use them to produce goods and services
 Sell goods & services

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 Circular-flow diagram
Revenue Spending
Markets for
G&S Goods &
G&S
sold Services bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income
profit

Market Interactions

Foreign market
Product
participants markets

Households Governments Business firms

Factor
Foreign market markets
participants

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5. Households play what role(s) in the circular flow diagram?
a. purchasers of factors of production and sellers of services
b. purchasers of factors of production and sellers of goods
c. purchasers of goods and services and sellers of factors of production
d. purchasers of goods and services only

6. In a circular-flow diagram,
a. taxes flow from households to firms, and transfer payments flow from firms
to households.
b. income payments flow from firms to households, and sales revenue flows
from households to firms.
c. resources flow from firms to households, and goods and services flow from
households to firms.
d. inputs and outputs flow in the same direction as the flow of dollars, from
firms to households.

Production possibilities frontier

• A graph: combinations of output that the economy can

possibly produce
• Given the available
• Factors of production and technology
• Example:
• Two goods: computers and wheat
• One resource: labor (measured in hours)
• Economy has 50,000 labor hours per month available for
production
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Production possibilities frontier
• Producing one computer requires 100 hours labor.
• Producing one ton of wheat requires 10 hours labor.
Employment of
Production
labor hours
Computers Wheat Computers Wheat
A 50,000 0 500 0
B 40,000 10,000 400 1,000
C 25,000 25,000 250 2,500
D 10,000 40,000 100 4,000
E 0 50,000 0 5,000

Production possibilities frontier Point on

Production

graph Com-
Wheat
Moving along a PPF puters
Involves shifting Wheat A 500 0
(tons)
resources from the B 400 1,000
production of one good 6,000
E C 250 2,500
to the other 5,000
Society faces a tradeoff 4,000 D D 100 4,000
Getting more of one 3,000 E 0 5,000
C
good requires sacrificing
2,000
some of the other B
The slope of the PPF 1,000
A
The opportunity cost of 0
0 100 200 300 400 500 600
one good in terms of
the other Computers

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Production Possibility frontier

• Point F: 100 computers, 3000 tons wheat

• Requires 40,000 hours of labor 6,000

• Possible but not efficient: could get 5,000

more of either good without sacrificing 4,000 G
any of the other 3,000
F
2,000
1,000
• Point G: 300 computers, 3500 tons wheat
0
• Requires 65,000 hours of labor. 0 100 200 300 400 500 600
• Not possible because the economy only
has 50,000 hours

7. The production possibilities frontier demonstrates the basic economic

principle that:
a. economies are always efficient.
b. assuming full employment, to produce more of any one thing, the economy must
produce less of at least one other good.
c. assuming full employment, an economy is efficient only when the production of
capital goods in a particular year is greater than the production of consumption
goods in that year.
d. assuming full employment, supply will always determine demand.

8. All points on a production possibilities frontier show the

a. maximum satisfaction that households receive from their purchases of goods.
b. minimum quantities of resources that must be used to produce a given quantity of
output.
c. maximum output that society can produce with given resources and technology.
d. minimum output that society can produce with given resources and technology.

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Macroeconomics & Microeconomics
• Microeconomics is The study of how households and firms make
decisions and how they interact in markets
• supply and demand
• pricing of output
• production processes
• cost structure
• Distribution
• Macroeconomics is The study of economy-wide phenomena
• national income analysis
• gross domestic product
• unemployment
• inflation
• fiscal policy
• monetary policy

9. Which of the following questions would NOT be of particular interest to a

microeconomist?
a. Why do national economies grow?
b. What percentage of consumer income is spent on entertainment?
c. Why do workers prefer the 4-day workweek?
d. What happens to worker productivity when a business shifts to a 4-day
workweek?
10. The relationship between microeconomics and macroeconomics is analogous
to the relationship between
a. the behavior of a single baseball player and the collective behavior of the entire
team out on the baseball field.
b. the behavior of a single race car driver and the collective behavior of all cars racing
on a race track.
c. the behavior of one football player and the collective behavior of the entire football
team out on the field.
d. all of the above

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 Positive vs. Normative
• Positive analysis: descriptive
• Positive analysis is the use of theories and models to predict the impact of
a choice.
• For example:
• What will be the impact of an import quota on foreign cars?

• What will be the impact of an increase in the gasoline excise tax?

• Normative Analysis: prescriptive

• Normative analysis addresses issues from the perspective of “What ought
to be?”
• For example:
• Consider the equity and efficiency trade-off of an increase in the
gasoline
25 excise tax versus import restriction on foreign oil.

11. “An increase in interest rates will lower economic growth.” This
statement is
a. a positive economic statement.
b. a normative economic statement.
c. untrue in every case.
d. controversial, and so not a valid economic issue.

12. The distinction between positive and normative economics

a. is that positive economics applies only to microeconomic problems.
b. is that normative economics applies only to microeconomic problems.
c. explains why economics is not a social science but a natural science.
d. helps us to understand why economists sometimes disagree with one
another.

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• People face Trade-off: To get something that we like, we have to give
up something else that we also like
• Opportunity cost: Whatever must be given up to obtain some item
• People respond to Incentives
• Rational people make decision at the margin
• Trade can make everyone better off
• Markets Are usually a good way to organize economic activity
• Market failure: Governments can sometimes improve market outcomes
• Productivity: Standard of living depends on its ability to produce goods
and services
• Inflation: Prices rise when the government prints too much money
• Short-run trade-off between inflation and unemployment

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