Microeconomics Chapters 1 3 1 The Economic Approach What is economics about firms and government Scarcity and Tradeoffs i Economics tries to explain and predict the behavior of consumers i Scarcity leads to tradeoffs which result in making choices ii Mechanisms that have been used to deal with scarcity a Force b Tradition emphasized past ways relied on families c Authority government and church d Market e Combinations of the above iii Scarcity requires that some wants remain unfulfilled iv Issues of equity justice and fairness are embedded with scarcity The Economic Way of Thinking i Always have these guidelines in your economics thought process a There are always tradeoffs What you give up is your opportunity cost value of next best alternative NOT the sum of everything you give up b Individuals choose purposefully Referred to a economizing behavior try to get the most benefits for the least cost or effort Also known as rational behavior c Incentives matter As incentive goes up you will be more likely to do something and vise versa The incentive doesn t have to be money d Think on the margin not in total or on average Marginal means additional or incremental Marginal benefit is additional benefit Marginal cost is additional cost Continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal cost e More information leads to better decision making but more information is costly to get Refer back to a d f 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 g Value is subjective Beauty is in the eyes of the beholder h Economic thinking is scientific thinking Economics use data and information generated by people to explain and predict actions Positive and Normative Economics Pitfalls to Avoid in Economic Thinking i Don t make one of these errors a Violation of ceteris paribus Other things constant We want to isolate variables so we typically allow only one to change at a time b Good intentions do not necessarily result in good outcomes c Association is NOT causation d Fallacy of composition Assumption what s good for one individual is good for the group Making this assumption when it s false is the fallacy 2 Some Tools of the Economist Trade Creates Value i Two opposing views of trade a When people trade one person gains and the other person loses Referred to as the zero sum game b When people trade both parties gain Wealth is created by trade ii Voluntary trade creates wealth and promotes economic progress a With or without production with or without money exchanges voluntary trade is expected to benefit both parties involved b Potential trades Finished goods exchanged through barter Finished goods exchanged for money Businesses buying resources Consumers buying products iii Things that can reduce the value created by trade a A transaction cost is a monetary or nonmonetary barrier that lowers the benefits of trade The Importance of Property Rights i Two types of property rights a Common rights everybody owns it group b Private rights you own it ii Property rights change the incentives for individuals iii Incentives created by private property rights a Give proper care b Conserve for the future c Use resources in ways other people value d Mitigate possible harm to others iv Violating property rights can lead to undesirable behavior Good 1 2 o d G o Production Possibilities Curve i PPC also called PP Frontier ii Graph Inside the curve inefficient a On the curve efficient b c Outside the curve unattainable d Have to give some of one to get more of the other and vise versa tradeoffs iii The PPC can shift produce less Trade Output and Living Standards i Law of Comparative Advantage a Shifts out to the right mean there was growth produce more b Shifts in to the left mean there was regress shrinkage a Make the good for which you have a low opportunity cost and trade for the good for which you have a high opportunity cost In simpler terms make something you re good at and trade for something you re not good at b ii Importance of Comparative Advantage a Low opportunity cost Comparative advantage Specialization Division of Labor Voluntary Trade Increased Wealth iii Self sufficiency is the quickest wand most absolute path to poverty Economic Organization 3 Demand Supply and the Market Process Consumer Choice and the Law of Demand i The Law of Demand a The inverse relationship between price and quantity demanded when price rises quantity demanded falls and vise versa b Quantity demanded is a number its how many units of a good you bought ii Ways to express the law of demand a Words b Table c Math equation P 10 Q Q f Px Py M Q lnPx lnPy lnM d Picture Price iii Why is the demand curve a Diminishing marginal utility i t y n d e d D e m a Q u a n t downward sloping The marginal benefit you receive from an item falls as you gain more of the product The only way to get you to buy more is to lower the iv How do consumers react to price changes price a When the price of one good falls people substitute away from relatively more expensive goods to the relatively cheaper goods Called the Substitution Effect b When the price of one good falls real consumer income rises so people buy more like getting a raise Called the Income Effect c Both of these also cause the demand curve to be downward sloping v The demand curve represents your willingness to pay your maximum price not how much you actually paid a What if the actual price is lower than your willingness to pay In economics we call this difference Consumer Surplus Consumer surplus Price DC QD Changes in Demand Versus Changes in Quantity Demanded i Demand is a relationship between two variables price and quantity demanded ii Changes a When price changes quantity demanded changes but demand does NOT change This is movement along the demand curve b When something else changes demand changes the relationship changes This is movement of the entire curve shift c Typical something else changes Income Number of consumers Prices of related goods substitutes and complements Expectations Demographics Tastes and preferences iii Another way to think about the difference between demand and quantity demanded a Why is the consumer buying more less b If price is the reason then quantity demanded changes moves along the demand curve If something else is the reason then demand changes shift the demand curve c Change in
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