Basic Concepts of Economics

MICROECONOMICS
LECTURE 1
BASIC CONCEPTS OF ECONOMICS
Definition of Economics
• economics is a social science that
studies human behavior and
institutional arrangements in societies
that influence the processes by which
relatively scarce resources are allocated
to alternative uses
• social science and decision science

components of economics
Economics as a Social Science
Human behavior is influenced by a matrix

of complex forces
– Psychology
– Sociology
– Anthropology
– Economics
– Political Science
– Religion, ...
Economics as Social Science
• Need for integration of social sciences

• deductive, historical and empirical
[statistical] approaches
• Philosophical and Historical Context
– To speculate about where you are going,
you need to understand where you are
– To fully understand where you are, you
need to know where you came from
Objectives
The objective is the goal or desired outcome of
a choice
– Individuals may try to maximize utility given the

constraints of income, time, prices, etc.
– Firms may have objectives such as the
maximization of profits, sales, market share, etc.
or the minimization of costs per unit
– Social objective, maximize the well being of the
members of society
WHAT IS ECONOMICS?
• scarcity
The resources we use to produce goods and services are limited.
• economics
The study of choices when there is scarcity.
Here are some examples of scarcity and the trade-offs associated with making
choices:
• You have a limited amount of time. If you take a part-time job, each hour
on the job means one less hour for study or play.
• A city has a limited amount of land. If the city uses an acre of land for a
park, it has one less acre for housing, retailers, or industry.
• You have limited income this year. If you spend $17 on a music CD, that’s
$17 less you have to spend on other products or to save. 6
THE ECONOMIC PROBLEM:
SCARCITY AND CHOICE
•Three basic questions must be answered in order to

understand an economic system:
– What gets produced?
– How is it produced?
– Who gets what is produced?
7
WHAT IS ECONOMICS?
Factors of production
The resources used to produce goods and services; also known as production
inputs.
• Natural resources/Land
Resources provided by nature and used to produce goods and services.
• labour
The physical and mental effort people use to produce goods and services.
• human capital
The knowledge and skills acquired by a worker through education and experience.
• physical capital & Financial Capital

The stock of equipment, machines, structures, and infrastructure that is used to
produce goods and services.
Input of funds
• entrepreneurship
The effort used to coordinate the factors of production—natural resources, labor,
physical capital, and human capital—to produce and sell products. 8
Resources
• Typical taxonomy
– land / natural resources
– labor
– Capital
– Entrepreneurial ability
• Alternative view
– Matter
– Energy
– Time
– Technology
WHAT IS ECONOMICS?
• Positive Versus Normative Analysis
• positive analysis Answers the question “What is?” or “What will be?”
• normative analysis Answers the question “What ought/should/ could/would to be?”
Table 1.1 COMPARING POSITIVE AND NORMATIVE QUESTIONS
Positive Questions Normative Questions

• If the government increases the minimum wage, • Should the government increase the minimum
how many workers will lose their jobs? wage?
• If two office-supply firms merge, will the price of • Should the government block the merger of two
office supplies increase? office-supply firms?
• How does a college education affect a person’s • Should the government subsidize a college
productivity and earnings? education?
• How do consumers respond to a cut in income • Should the government cut taxes to stimulate the
taxes? economy?
• If a nation restricts shoe imports, who benefits and • Should the government restrict imports?
who bears the cost? 10
THE ECONOMIC WAY OF THINKING
Four elements of the economic way of thinking:
1 Use Assumptions to Simplify

Economists use assumptions to make things simpler and focus attention on
what really matters.
2 Isolate Variables—Ceteris Paribus

Economic analysis often involves variables and how they affect one
another.
• variable
A measure of something that can take on different values.
• ceteris paribus
The Latin expression meaning other variables being held fixed.
11
THE ECONOMIC WAY OF
THINKING
3 Think at the Margin
Economists often consider how a small change in one variable affects another
variable and what impact that has on people’s decision making.
• marginal change
A small, one-unit change in value.
4 Rational People Respond to Incentives

A key assumption of most economic analysis is that people act
rationally, meaning that they act in their own self-interest.
12
Building a Foundation: Economics
and Individual Decisions
Market: An arrangement or institution that brings together

buyers and sellers of a good or service.
Three important ideas:

 People are rational
 People respond to economic incentives
• Marginal analysis : Analysis that involves

comparing marginal benefits and marginal costs.
13
Microeconomics and
Macroeconomics
Microeconomics The study of how households
and businesses make choices, how they interact in
markets, and how the government attempts to
influence their choices.
Macroeconomics The study of the economy as

a whole, including topics such as inflation,
unemployment, economic growth National income
etc.
14
SCARCITY, CHOICE, AND
OPPORTUNITY COST
•SCARCITY AND CHOICE IN A ONE-

PERSON ECONOMY
•Nearly all the same basic decisions that

characterize complex economies must also be
made in a simple economy.
15
Scarcity
• Because of Scarcity, individuals and
societies must make choices
• All Choices in a finite world have

“opportunity costs”
– alternative uses of finite resources
– Opportunity cost is the value of the next
best alternative sacrificed
– Can institutional structure create or
increase scarcity?
OPPORTUNITY COST
•The concepts of constrained choice and

scarcity are central to the discipline of
economics.
•opportunity costs The best alternative that

we give up, or forgo, when we make a choice or
decision.
17
OPPORTUNITY COST
•Capital Goods and Consumer Goods
•consumer goods Goods

produced for present
consumption.
•investment The process of
using resources to produce
new capital.
Because resources are scarce, the opportunity cost of every investment in capital is
forgone
present consumption.
18
OPPORTUNITY COST
•THE PRODUCTION POSSIBILITY
FRONTIER
•production
possibility frontier
(ppf) A graph that
shows all the
combinations of
•goods and services that
can be produced if all of
society’s resources are
used efficiently.
19
OPPORTUNITY COST
•FIGURE 2.3 Production Possibility Frontier

20
OPPORTUNITY COST
•Unemployment
•During economic downturns or recessions,
industrial plants run at less than their total capacity.
When there is unemployment of labor and capital,
we are not producing all that we can.
21
OPPORTUNITY COST
•Inefficiency
•Waste and mismanagement are the results of a firm’s
operating below its potential.
•Sometimes, inefficiency results from mismanagement of the

economy instead of mismanagement of individual private firms.
•The Efficient Mix of Output

•To be efficient, an economy must produce what people
want.
22
SCARCITY, CHOICE, AND OPPORTUNITY COST
•Negative Slope and Opportunity Cost
•marginal rate of
transformation
(MRT) The slope of
the production
possibility frontier
(ppf).
• FIGURE 2.4 Inefficiency from Misallocation

of Land in Farming
23
OPPORTUNITY COST
•The Law of Increasing Opportunity Cost
TABLE 2.1 Production Possibility

Schedule for Total Corn
and Wheat Production in
Ohio and Kansas
TOTAL TOTAL
CORN WHEAT
PRODUCTION PRODUCTION
POIN (MILLIONS (MILLIONS OF
T ON OF BUSHELS BUSHELS PER
PPF PER YEAR) YEAR)
A 700 100
B 650 200
C 510 380
D 400 500
E 300 550 • FIGURE 2.5 Corn
and Wheat Production 24
in Ohio and Kansas
OPPORTUNITY COST
•Economic Growth
•economic growth An increase

in the total output of an economy.
It occurs when a society acquires
new resources or when it learns to
produce more using existing
resources.
25
OPPORTUNITY COST
• FIGURE 2.6 Economic Growth Shifts the

26
ppf Up and to the Right
OPPORTUNITY COST
•THE ECONOMIC PROBLEM
•Recall the three basic questions facing all economic

systems:
• (1) What gets produced?
• (2) How is it produced?
• (3) Who gets it?
•Given scarce resources, how exactly do large, complex

societies go about answering the three basic economic
questions?
27
ECONOMIC SYSTEMS
•laissez-faire economy (free market)
Literally from the French: “allow [them] to
do.” An economy in which individual people
and firms pursue their own self-interests
without any central direction or regulation.
•market The institution through which buyers and sellers
interact and engage in exchange.
Some markets are simple and others are complex, but they all involve buyers and sellers
engaging in exchange. The behavior of buyers and sellers in a laissez-faire economy
determines what gets produced, how it is produced, and who gets it.
28
ECONOMIC SYSTEMS
•Command economy An economy in

which a central government either directly
or indirectly sets output targets, incomes,
and prices.
•Mixed economy is an economic system

that incorporates a mixture of private and
government ownership or control, or a
mixture of capitalism and socialism
29
The circular flow of goods and
incomes Goods and services
Consumer
expenditure
GOODS MARKETS
FACTOR MARKETS
Wages, rent
dividends, etc.
Services of factors of production (labour, etc)

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MICROECONOMICS

• social science and decision science

Human behavior is influenced by a matrix

• Need for integration of social sciences

– Individuals may try to maximize utility given the

•Three basic questions must be answered in order to

• physical capital & Financial Capital

Table 1.1 COMPARING POSITIVE AND NORMATIVE QUESTIONS

Positive Questions Normative Questions

1 Use Assumptions to Simplify

2 Isolate Variables—Ceteris Paribus

4 Rational People Respond to Incentives

Market: An arrangement or institution that brings together

Three important ideas:

• Marginal analysis : Analysis that involves

Macroeconomics The study of the economy as

•SCARCITY AND CHOICE IN A ONE-

•Nearly all the same basic decisions that

• All Choices in a finite world have

•The concepts of constrained choice and

•opportunity costs The best alternative that

•consumer goods Goods

•FIGURE 2.3 Production Possibility Frontier

•Sometimes, inefficiency results from mismanagement of the

•The Efficient Mix of Output

• FIGURE 2.4 Inefficiency from Misallocation

TABLE 2.1 Production Possibility

•economic growth An increase

• FIGURE 2.6 Economic Growth Shifts the

•THE ECONOMIC PROBLEM

•Recall the three basic questions facing all economic

•Given scarce resources, how exactly do large, complex

•Command economy An economy in

•Mixed economy is an economic system

Services of factors of production (labour, etc)

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