Microeconomics 121 Chapter 1 INTRODUCTION Economy a system for coordinating society s productive activities it literally delivers the goods Economics the social science that studies the production distribution and consumption of goods and services Market Economy an economy in which decisions about production and consumption are made by individual producers and consumers there is no central authority telling people what to produce or where to ship it each individual producer makes what he or she thinks will be the most profitable each consumer buys what he or she chooses able to coordinate highly complex activities and are able to provide consumer with the goods and services they want Command Economy there is a central authority making decisions about production and consumption tried in the 1900 s in the Soviet Union but didn t work well producers were unable to produce because they did not have crucial raw materials or they succeeded in producing but then found that nobody wanted their products consumers were often unable to find necessary items command economies are famous for long lines at shops Invisible Hand refers to the way in which the individual pursuit of self interest can lead to good results for society as a whole Adam Smith wrote The Wealth of Nations talking about this theory Microeconomics the branch of economics that studies how people make decisions and how these decisions interact the key theme Adam Smiths s insight individuals pursuing their own interests often do promote the interests of society as a whole How can my society achieve the kind of prosperity you take for granted This society should learn to appreciate the virtues of a market economy and the power of the invisible hand Market Failure when the individual pursuit of self interest leads to bad results for the society as a whole ex traffic example Recession a downturn in the economy Macroeconomics is the branch of economics that is concerned with overall ups and downs in the economy at the beginning of the twentieth century most Americans lived under conditions that we would now think of as extreme poverty our lives change by economic growth Economic Growth the growing ability of the economy to produce goods and services CHAPTER ONE First Principles Principles that Underlines Individual Choice The Core of Economics every economic issue involved individual choice Individual Choice the decision by an individual of what to do which necessarily involves a decision of what not to do Four economic principles underlie the economics of individual choice 1 people must make choices because resources are scarce 2 the opportunity cost of an item what you must give up in order to get it is its true cost 3 How much decisions require making trade offs at the margin comparing the costs and benefits of doing a little bit more of an activity versus doing a little bit less 4 People usually respond to incentives exploiting opportunities to make themselves better off Principle 1 Choices Are Necessary Because Resources Are Scarce limited income and time keeps people from having everything they want people are willing to trade money for time ex convenience stores normally charge higher prices than a regular supermarket since they are willing to fulfill a valuable role catering to time pressured customers who would rather pay more than travel by further to People must make choices because resources are scarce Resource anything that can be used to produce something else land labor the time of workers capital machinery buildings and other man made the supermarket of scarce not enough of the resources are available to satisfy all the various ways a society productive assets and human capital the educational achievements and skills workers wants to use them there are many scarce resources which include natural resources resources that come from the physical environment such as minerals lumber and petroleum there is also a limited quantity of human resources labor skill and intelligence in a growing world economy with a rapidly increasing human population even clean air and water have become scarce resources resources land labor capital and human capital are scarce so individuals as well as societies must make choices about how to use these resources Principle 2 The True Cost of Something is its Opportunity Cost the real cost of an item true cost is its opportunity cost Opportunity Cost what you must give up in order to get the concept of opportunity cost is crucial to understanding individual choice because in the end all costs are opportunity costs every choice you make is forgoing some alternative example deciding between two electives for which one you will take example opportunity cost of attending college is what you pay for tuition and housing plus monetary costs are sometimes a good indicator of opportunity costs but not always the forgone income you would have earned in a job Principle 3 How Much Is a Decision at the Margin many choices involve not whether to do something but how much of it to do Trade Off a comparison of costs and benefits of doing something example how many hours should you study chemistry compared to economics look at the benefits chem is for your major while econ isn t Marginal Decisions decisions about whether to do a bit more or a bit less of an activity How Much decisions require making trade offs at the margin comparing the costs and benefits of doing a little bit more of an activity versus doing a little bit less the study of marginal decisions is known as marginal analysis Marginal Analysis the study of such decisions example How many workers should I hire in my shop At what mileage should I change the oil in my car What is an acceptable rate of negative side effects from a new medicine Marginal Analysis plays a central role in economics because it is the key to deciding how much of an activity to do Principle 4 People Usually Respond to Incentives Exploting Opportunities to Make Themselves Better Off example Go to Jiffy Lube to get your oil changed for 20 and keep your car there all day instead of parking in a parking garage for 30 Many people would do that because they normally because people usually exploit opportunities to make themselves better off incentives can when people are offered opportunities to make themselves better off take them people are responding to an incentive change people s behavior people respond to incentives Incentive anything that offers rewards to people who change