1 Microeconomics Notes Chapter 1 The Economic Approach What is economics It is the study of human behavior why do people do THAT It is a technique of thinking Economics is a social science Robert Higgs Economics is a science of choice Thomas Sowell But life does not ask us what we want It presents us with options Economics is one of the ways of trying to make the most of these options What is microeconomics Way of looking at small segments of the economy Microeconomic is the study of individuals and relatively small groups of individuals as consumers of businesses Areas of microeconomics that we ll address Business costs Taxes and subsidies Price controls Market failure inefficient outcomes Government failure inefficient policies Industry analysis The Economic Way of Thinking Things are not always as they appear to be o Analyze situations for yourself instead of simply believing someone else Milton Friedman The only person who can truly persuade you is yourself You must turn the issues over in your mind at leisure consider the many arguments let them simmer and after a long time turn your predictions into convictions Guidelines to economic thinking 1 There are always tradeoffs What you give up is your opportunity cost value of next best alternative Common mistake opportunity cost is NOT the sum of everything you give up There is no such thing as a free lunch 2 Individuals choose purposefully How can I do things to enhance value 2 Referred to as economizing behavior try to get the most benefits for the least cost or effort Also known as rational behavior 3 Incentives matter As the incentive goes up you will be more likely to do something or try to and vice versa The incentive doesn t have to be money 4 Think on the margin not in total or on average Marginal means additional or incremental Change in total Rule to live by Continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal cost 5 More information leads to better decision making but more information is costly to get Refer back to 1 through 4 There are always tradeoffs Think on the margin Individuals choose purposefully Incentives matter 6 Many choices create a secondary effect The primary effect is often immediate and visible The secondary effect usually comes later and is not as visible 7 Value is subjective Beauty is in the eyes of the beholder Value is determined by the purchaser 8 Economic thinking is scientific thinking Economists use date and information generated by people to explain and predict actions Economists do it with models Positive and Normative Economics Pitfalls To Avoid in Economic Thinking Don t make one of these errors 1 Violation of ceteris paribus Ceteris paribus is Latin for other things constant We want to isolate variables so we typically allow only one to change at a time 2 Good intentions do not necessarily result in good outcomes 3 Association is NOT causation not necessarily when THIS happens THAT is the result 4 Fallacy of Composition Assumption what s good for the individual is good for the group Making this assumption is the fallacy 3 Micro Chapter 2 Some Tools of the Economists Trade Creates Value Two opposing views of trade 1 When people trade one person gains while the other loses Referred to as zero sum gain 2 When people trade both parties gain Wealth is actually created by trade Transaction costs can be monetary or nonmonetary The Importance of Property Rights Two Kinds of Property Rights 1 Common Rights everybody owns it 2 Private Rights only one person owns it Property rights change the incentives for individuals Own versus renting a house Production Possibilities Curve PPC also called PP Frontier The PPC can shift Shift out growth produce more Shift in shrink produce less 4 Trade Output and Living Standards Law of Comparative Advantage Make the good for which you have a low opportunity cost and trade for the good for which you have a high opportunity cost Make something you re good at and trade for something you re not good at Chapter 3 Supply Demand and the Market Process Consumer Choice and the Law of Demand The Law of Demand the inverse relationship between price and quantity demanded When price rises quantity demanded falls Quantity demanded is a number It s how many units of a good you bought Why is the demand curve downward sloping Diminishing Marginal Utility The marginal benefit you receive from an item falls as you gain more of this item The demand curve represents you willingness to pay your maximum price not how much you actually paid What if the actual price is lower than your willingness to pay In Economics we call this difference consumer surplus CS Graphically CS is the area below demand out to quality and down to price Changes in Demand vs Changes in Quantity Demanded 5 Demand is the relationship between 2 variables Price and quantity demanded 1 When price changes quantity demand changes but demand does NOT change This is a movement ALONG a demand curve 2 When something else changes demand changes the relationship changes This is movement of the ENTIRE curve Another way to think about the difference between demand and quantity demanded Why is the consumer buying more or less If price is the reason then quantity demanded changes MOVE along the demand curve If any variable besides price is the reason then demand changes SHIFT the demand curve The price and demand for one good can be intimately tied to demand for another good 1 Substitute goods used in place of each other An increase in demand for the first good will decrease the demand for the second good An increase in price for the first good will increase demand for the second good 2 Compliment goods usually consumed at the same time An increase in demand for the first good will increase the demand for the second good An increase in price for first good will decrease demand for the second good Producer Choice and the Law of Supply 6 The Law of Supply The positive relationship between price and quantity supplied when price rises quantity supplied rises Quantity supplied is a number it is how many units you have produced Why is the supply curve upward sloping At higher price a product is usually more profitable firm has stronger incentive to make more What if the actual price is higher than your minimum price In economics we call this difference a producer surplus PS Graphically PS is the area above supply out to quantity and up to price Changes in Supply vs Changes
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