Microeconomics: Introduction

Economics?
Discussion on Startup/Business
Economics & MBA
What is Economics?
What is Economics?
Is a subject which consists lots of graphs!!!

Economics is a ______science _______ with the way

_______ chooses to _______ its limited ______ which
have_________ uses to _______ goods and ________ for
_______ and future ________.

Resources Present Social

Alternatives Concerned Employ
Produce Society
Services Consumption
What is Economics?
Economics is a social science concerned with the way society chooses to
employ its limited resources which have alternative uses to produce goods
and services for present and future consumption

Scarcity
Economics is about how people/firms/governments/nations make choice
Economics - Queen of Social sciences
Mathematics – Mother of all subjects, Language of God/Nature
Ten Principles of Economics
How people make decision
• Principle 1: People face Trade-offs
• Principle 2: The Cost and benefit analysis
• Principle 3: Rational People Think at the margin
• Principle 4: People respond to incentives
How people interact
• Principle 5: Trade can make everyone better off
• Principle 6: Markets are usually a good way to organize economic activity
• Principle 7: Govt can sometimes improve market outcomes
How the economy as a whole works
• Principle 8: A country’s standard of living depends on its ability to produce goods and services
• Principle 9: Prices rises when Govt prints too much money
• Principle 10: Society faces a short-run trade off between inflation and unemployment
PRINCIPLE #1:
People Face Tradeoffs
All decisions involve tradeoffs.
Examples:
• Going to a party the night before your midterm leaves less time for
studying.
• Having more money to buy stuff requires working longer hours, which
leaves less time for leisure.
• Protecting the environment requires resources that could otherwise
be used to produce consumer goods.
 PRINCIPLE #1:
People Face Tradeoffs
• Society faces an important tradeoff: efficiency vs. equality
• Efficiency: when society gets the most from its scarce resources
• Equality: when prosperity is distributed uniformly among society’s
members
• Tradeoff: To achieve greater equality, could redistribute income
from wealthy to poor.
But this reduces incentive to work and produce, shrinks the size of
the economic “pie.”
PRINCIPLE #2:
The Cost of Something Is What You Give
Up to Get It
• Making decisions requires comparing the costs and benefits of alternative
choices.
• The opportunity cost of any item is whatever must be given up to obtain it.
• It is the relevant cost for decision making.
• There is no Free Lunch
Examples:
The opportunity cost of…
…going to college for a year is not just the tuition, books, and fees, but also the foregone
wages.
…seeing a movie is not just the price of the ticket, but the value of the time you spend in
the theater.
PRINCIPLE #3:
Rational People Think at the Margin

Rational people
• systematically and purposefully do the best they can to achieve their objectives.
• make decisions by evaluating costs and benefits of marginal changes, incremental
adjustments to an existing plan.
Examples:
• When a student considers whether to go to college for an additional year, he
compares the fees & foregone wages to the extra income he could earn with the
extra year of education.
• When a manager considers whether to increase output, she compares the cost of
the needed labor and materials to the extra revenue.
PRINCIPLE #4:
People Respond to Incentives
• Incentive: something that induces a person to act, i.e. the prospect of a
reward or punishment.
• Rational people respond to incentives.
Examples:
• When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling
SUVs.
• When cigarette taxes increase, teen smoking falls.
ACTIVE LEARNING 1
Applying the principles
You are selling your 1996 Mustang. You have already spent
$1000 on repairs.
At the last minute, the transmission dies. You can pay
$600 to have it repaired, or sell the car “as is.”
In each of the following scenarios, should you have the
transmission repaired? Explain.
A. Blue book value (what you could get for the car) is
$6500 if transmission works, $5700 if it doesn’t

B. Blue book value is $6000 if transmission works,

$5500 if it doesn’t
ACTIVE LEARNING 1
Answers
Cost of fixing transmission = $600
A. Blue book value is $6500 if transmission works,
$5700 if it doesn’t
Benefit of fixing the transmission = $800
($6500 – 5700).
It’s worthwhile to have the transmission fixed.
B. Blue book value is $6000 if transmission works,
$5500 if it doesn’t
Benefit of fixing the transmission is only $500.
Paying $600 to fix transmission is not worthwhile.
ACTIVE LEARNING 1
Observations
• The $1000 you previously spent on repairs is
irrelevant. What matters is the cost and benefit
of the marginal repair (the transmission).
• The change in incentives from scenario A
to scenario B caused your decision to change.
PRINCIPLE #5:
Trade Can Make Everyone Better Off
• Rather than being self-sufficient, people can specialize in producing
one good or service and exchange it for other goods.
• Countries also benefit from trade and specialization:
• Get a better price abroad for goods they produce
• Buy other goods more cheaply from abroad than could be produced at home
PRINCIPLE #6:
Markets Are Usually A Good Way to Organize
Economic Activity
• Market: a group of buyers and sellers (need not be in a single location)
• “Organize economic activity” means determining
• what goods to produce
• how to produce them
• how much of each to produce
• who gets them
• A market economy allocates resources through the decentralized decisions
of many households and firms as they interact in markets.
• Famous insight by Adam Smith in The Wealth of Nations (1776):
Each of these households and firms acts as if “led by an invisible hand”
to promote general economic well-being.
PRINCIPLE #6:
Markets Are Usually A Good Way to Organize
Economic Activity
• The invisible hand works through the price system:
• The interaction of buyers and sellers determines prices.
• Each price reflects the good’s value to buyers and the cost of producing
the good.
• Prices guide self-interested households and firms to make decisions
that, in many cases, maximize society’s economic well-being.
PRINCIPLE #7:
Governments Can Sometimes Improve Market
Outcomes
• Important role for govt: enforce property rights (with police, courts)
• People are less inclined to work, produce, invest, or purchase if large risk of their property
being stolen.
• Market failure: when the market fails to allocate society’s resources efficiently
• Causes of market failure:
• Externalities, when the production or consumption of a good affects bystanders (e.g. pollution)
• Market power, a single buyer or seller has substantial influence on market price (e.g. monopoly)
• Public policy may promote efficiency.
• Govt may alter market outcome to promote equity.
• If the market’s distribution of economic well-being is not desirable, tax or welfare policies can
change how the economic “pie” is divided.
ACTIVE LEARNING 2
Discussion Question
In each of the following situations, what is the government’s role?
Does the government’s intervention improve the outcome?
a. Public schools for K-12
b. Workplace safety regulations
c. Public highways
d. Patent laws, which allow drug companies to charge high prices for life-
saving drugs
PRINCIPLE #8:
A Country’s Standard of Living Depends on Its
Ability to Produce Goods & Services
• Huge variation in living standards across countries and over time:
• Average income in rich countries is more than ten times average income in
poor countries.
• The U.S. standard of living today is about eight times larger than 100 years
ago.
• The most important determinant of living standards: productivity,
the amount of goods and services produced per unit of labor.
• Productivity depends on the equipment, skills, and technology
available to workers.
• Other factors (e.g., labor unions, competition from abroad) have far
less impact on living standards.
PRINCIPLE #9:
Prices Rise When the Government Prints Too Much
Money
• Inflation: increases in the general level of prices.
• In the long run, inflation is almost always caused by excessive growth in
the quantity of money, which causes the value of money to fall.
• The faster the govt creates money, the greater the inflation rate.
PRINCIPLE #10:
Society Faces a Short-run Tradeoff Between
Inflation and Unemployment
• In the short-run (1–2 years), many economic policies push inflation and
unemployment in opposite directions.
• Other factors can make this tradeoff more or less favorable, but the
tradeoff is always present.
Ten Principles of Economics
How people make decision
• Principle 1: People face Trade-offs
• Principle 2: The Cost and benefit analysis
• Principle 3: Rational People Think at the margin
• Principle 4: People respond to incentives
How people interact
• Principle 5: Trade can make everyone better off
• Principle 6: Markets are usually a good way to organize economic activity
• Principle 7: Govt can sometimes improve market outcomes
How the economy as a whole works
• Principle 8: A country’s standard of living depends on its ability to produce goods and services
• Principle 9: Prices rises when Govt prints too much money
• Principle 10: Society faces a short-run trade off between inflation and unemployment
Thinking Like Economist?
Economic Problems
• What to produce?
• Where to produce?
• How to produce?
• How much to produce?
• For whom to produce?
• Are resources used economically?
• Are resources fully employed?
• Is the economy growing?
The Economist as Scientist
• Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
• In the first, economists employ the
scientific method,
the dispassionate development and testing of theories about how the
world works.
Assumptions & Models
• Assumptions simplify the complex world,
make it easier to understand.
• Example: To study international trade,
assume two countries and two goods.
Unrealistic, but simple to learn and
gives useful insights about the real world.
• Model: a highly simplified representation of
a more complicated reality.
Economists use models to study economic issues.
 Some Familiar Models

A road map

©wavebreakmedia/Shutterstock.com
 Some Familiar Models

A model of human
anatomy from high
school biology class

©Accord/Shutterstock.com
 Some Familiar Models

A model airplane
©Olga Rosi/Shutterstock.com
 Some Familiar Models
The model teeth at the
dentist’s office Don’t forget
to floss!

©ittipon/Shutterstock.com
Our First Model:
The Circular-Flow Diagram
• The Circular-Flow Diagram: a visual model of the
economy, shows how dollars flow through markets
among households and firms
• Two types of “actors”:
• households
• firms
• Two markets:
• the market for goods and services
• the market for “factors of production”
Factors of Production
• Factors of production: the resources the economy uses to produce
goods & services, including
• labor
• land
• capital (buildings and machines used in production)
FIGURE 1: The 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
FIGURE 1: The 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
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Our Second Model:
The Production Possibilities Frontier
• The Production Possibilities Frontier (PPF):
a graph that shows the combinations of
two goods the economy can possibly produce given the
available resources and the available technology
• Example:
• Two goods: computers and wheat
• One resource: labor (measured in hours)
• Economy has 50,000 labor hours per month available for production.
 PPF Example
• 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
 PPF Example

Wheat
Point Production
(tons)
on Com- 6,000
graph puters Wheat E
5,000
A 500 0 D
4,000
B 400 1,000
3,000 C
C 250 2,500
2,000
D 100 4,000 B
1,000
E 0 5,000 A
0
0 100 200 300 400 500 600
Computers

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Microeconomics and
Macroeconomics
• Microeconomics is the study of how households and firms make
decisions and how they interact in markets.
• Macroeconomics is the study of economy-wide phenomena,
including inflation, unemployment, and economic growth.
• These two branches of economics are closely intertwined, yet
distinct—they address different questions.
The Economist as Policy Advisor
• As scientists, economists make
positive statements,
which attempt to describe the world as it is.
• As policy advisors, economists make
normative statements,
which attempt to prescribe how the world should be.
• Positive statements can be confirmed or refuted,
normative statements cannot.
• Govt employs many economists for policy advice. E.g., the U.S.
President has a Council of Economic Advisors, which the author of
this textbook chaired from 2003 to 2005.
Why Economists Disagree
• Economists often give conflicting policy advice.
• They sometimes disagree about the validity of alternative positive
theories about the world.
• They may have different values and, therefore, different normative
views about what policy should try to accomplish.
• Yet, there are many propositions about which most economists agree.
Managerial Economics
The application of economic theory and the tools of decision science to
examine how an organization can achieve its aims or objectives most
efficiently.
• applications of economic theory
• quantitative methods
• statistical methods
• computational methods
Managerial Economics
Managerial Economics