Microeconomics looks at how individual economic agents consumers households producers firms etc make day to day decisions Macroeconomics looks at the overall behavior of the entire economy of a country In addition to households and firms it also look at the government and the rest of the world Three Types of Economic Agents Consumers consume goods and services objective is to maximize utility Producers produce goods and services objective is to maximize profit Government influences the workings of the economy in various ways role in controlling unemployment and inflation boosting the growth rate etc Production the process of using inputs to produce output goods and services Goods tangible things firms produce and consumers buy Services intangible activities firms provide and consumers buy Output o o Inputs Factors of Production o o o o Labor workers Capital goods that are created to produce other goods machines tools etc Land the actual land plus all natural resources that lie on or below it timber coal oil etc Entrepreneurship the brain that coordinates labor capital and land in the production process Circular Flow Diagram depicts the interaction between the households and the firms The Real Flow The Money Flow o o o Firms produce goods and services which the put up for sale in the goods and services market where the households buy them from the firms On their part the households supply resources or factors of production to the firms putting them up for sale in the resource or factor market In return households pay the firms the price of the goods and services they buy and the firms pay the households factor income wages for labor interest for capital rent for land and profit for entrepreneurship Scarcity We can t have as much as we want of everything as resources are finite in amount So we are forced to make choices and in order to have something we are forced to give up something else Production Possibility Frontier PPF the combinations of maximum possible amounts of goods and services an economy can produce given its resources also called the production possibility curve How about moving beyond the constraints of the PPF o PPF Economic growth an increase in the quantity of goods and services produced in the country Happens when the resources of a country go up The PPF shifts outward we produce at a point that is outside of the current PPF International trade Doesn t shift out the PPF But it lets us consume at a point outside the PPF o Notice that the PPF is not a straight line but is bowed outwards or is concave to the origin This is because of increasing opportunity cost Marginal rate of transformation MRT slope of the PPF gives us the amount by which the production of X increases if the product of Y decreases by one unit Opportunity cost of an action the value of the next best alternative of that action It is by definition foregone There are two goods X and Y Opportunity cost of X give upY gain X Increasing opportunity cost opportunity cost of X goes up and more and more of X is produced o o resources most efficient in a certain production process are used first then less and less efficient resources are used Cost of resources goes up as we produce more of a good The Basics of International Trade Absolute advantage a person has an absolute advantage in an activity if she can do more of it than others Comparative advantage a person has a comparative advantage in an activity if she can perform the activity at a lower opportunity cost than others Gains from specialization gains from trade PPF is at the same place but we can now consume outside of the PPF One way to measure a country s openness to trade and foreign investment is the International Chamber of Commerce ICC Open Markets Index Demand relationship showing the amount of a good or service a consumer is willing to purchase at a certain price Law of demand ceteris paribus price and quantity demanded move in opposite directions Ceteris paribus everything else remaining the same Reasons Why Demand Curve is Negatively Sloped o Income effect As income increases you buy more as income decreases you buy less Is price goes up that is as if our income has gone down in real terms as we can buy less goods and services with our money referred to as the purchasing power of money Hence if price rises we buy less If the price of a good increase we buy less of that good and more of other similar goods instead o Substitution effect Changes in quantity demanded o We move along the demand curve from one point to another o Reason a change in the own price of the good Change in demand reasons why the demand curve itself shifts 5 o Change in the price of related goods consumed Related goods can be one of two types Complements goods that are consumed together if the price of a complement goes up you buy less of the complement so you also buy less of the good in question Substitutes goods that s are consumed in place of each other if the price of a substitute foes up you buy less of the substitute so you buy more of the good in question If two girls are neither complements nor substitutes then they are said to be independent o o o o Change in income Population Normal goods goods which you buy more when your income goes up Inferior goods goods which you buy in lesser quantities when your income goes up If population goes up the demand for all goods and services go up Change in tastes and preferences The direction of this effect depends on the kind of change we are talking about If you decide to get in better shape and run to campus every morning then you will drive less and your demand for gas will go down Expected future prices If prices are expected to go up in the future then you will buy less of the good in the future You will buy more of the good now and hoard it for the future Hence current demand will increase the demand curve will shift to the left Supply relationship showing the amount of a good or service a firm is willing to produce at each price Reasons why the supply curve is positively sloped o The marginal cost of producing a good goes up as we produce more of the good Less efficient resources and more expensive inputs have to be used as we produce more output So we need to use these resources in greater quantities to get the same amount of output or spend more money than before to buy them Producers hence have to increase prices to cover the costs o When price is high the profits from selling the good are also high So traders