Module 2 Introduction to Microeconomics PDF

MODULE 2 INTRODUCTION TO MICROECONOMICS PRINCIPLES OF MICROECONOMICS  Microeconomics Definition  Microeconomics: Branch of economics that deals with the behavior of individual economic units - consumers, firms, workers, and investors - as well as...

MODULE 2 INTRODUCTION TO MICROECONOMICS PRINCIPLES OF MICROECONOMICS  Microeconomics Definition  Microeconomics: Branch of economics that deals with the behavior of individual economic units - consumers, firms, workers, and investors - as well as the markets that these units comprise.  how households and firms make decisions and how they interact in specific markets  Microeconomics deals with limits – in other words, how best to function in the face of constraints. E.g. - how much consumers can spend given their budget, - how much firms can produce given the limited hours employees can work.  Microeconomics is about the allocation of scarce resources. Macroeconomics: - the study of economy-wide phenomena, including inflation, unemployment, and economic growth, - deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation. Example Classify the following topics as relating to microeconomics or macroeconomics. a. a family’s decision about how much income to save b. the effect of government regulations on auto emissions c. the impact of higher national saving on economic growth d. a firm’s decision about how many workers to hire e. the relationship between the inflation rate and changes in the quantity of money Basic Problems  Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. Just as a household cannot give every member everything he or she wants, a society cannot give every individual the highest standard of living to which he or she might aspire.  Choices are many. Given limited resources what choices are best – for whom – firm, society? Also given scarce resources we cannot have everything. We have to give up some choices for others. How to allocate resources? Economic Decisions and Types  How economic agents (producers, consumers, government) make choices and allocate resources to achieve the best possible outcome.  Different types of decisions: - How much to produce? (Producer or Firm) - How many workers to hire? (Producer or Firm) - What to buy, how much to spend? (Consumer or Individual) - How many hours to work? (Consumer or Individual) - What to tax, how much income to tax, how much to redistribute? (Government) Fundamental Principles 1) People face tradeoffs - Efficiency vs equity 2) The cost of something is what you give up to get it - Opportunity cost 3) Rational people think at the margin – People make decisions by comparing costs and benefits at the margin. 4) People respond to incentives -  The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs! 5) Trade can make everyone better off. 6) Markets are usually a good way to organize economic activity.  A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. Households decide what to buy and who to work for. Firms decide who to hire and what to produce. 7) Governments can sometimes improve market outcomes. Market failure occurs when the market fails to allocate resources efficiently. When the market fails (breaks down) government can intervene to promote efficiency and equity.  Market failure may be caused by  an externality, which is the impact of one person or firm’s actions on the well-being of a bystander.  market power, which is the ability of a single person or firm to unduly influence market prices 8) The Standard of Living depends on a country’s ability to produce goods and services.  Standard of living may be measured in different ways: - By comparing personal incomes. - By comparing the total market value of a nation’s production. Almost all variations in living standards are explained by differences in countries’ productivities. Productivity is the amount of goods and services produced from each hour of a worker’s time. 9) Prices rise when the government prints too much money.  Inflation is an increase in the overall level of prices in the economy.  One cause of inflation is the growth in the quantity of money.  When the government creates large quantities of money, the value of the money falls. 10) Society faces a short-run tradeoff between inflation and unemployment. The Phillips Curve illustrates the tradeoff between inflation and unemployment: Inflation  Unemployment It’s a short-run tradeoff! If unemployment is low this implies labour is now scarce. In the short run labour supply is fixed. This drives up the price for labour and hence you get wage inflation. The wage inflation is then passed on to the price inflation.  Merits and Limitations of Microeconomics Merits - How to utilize scarce resources appropriately/helps in the efficient allocation of resources for production and consumption - Helps us predict the demand and supply of goods and services/determine price. E.g. demand forecasting - How individuals and firms behave/interact in markets as well as how different markets interact with each another - Based on logic and observed behaviour, microeconomists form models and test them against real world observations - Helps inform economic and industrial policy, also can help us understand the distribution of income (who gets what) Limitations - Studies individual units only (individual consumer, firm, industry) and not sum total of all economic activity (macroeconomics) - Assumptions may be unrealistic or not true for everyone - Data limitations – some data may not be available at the micro level Positive and Normative Economics Positive economics explains the world as it is and often describes cause and effect relationships. In other words, studies the data, builds theory, tests hypothesis and makes prediction. E.g. - Minimum-wage laws cause unemployment. - Raising the tax on gasoline increases the price of gasoline and affects consumers’ decision to buy small or big cars. Normative economics is about what should be done and makes value-based judgements. Moves beyond explanation and prediction to evaluate what is best, whether the outcome, policy etc. is right or wrong. E.g. - The government should raise the minimum wage. - Should we raise the tax on gasoline (affecting end-users and low-end consumers) or should an import tariff on oil be imposed (affecting only importers).  Example Which of the following are positive/normative? a. Society faces a short-run tradeoff between inflation and unemployment. b. A reduction in the rate of growth of money will reduce the rate of inflation. c. The Federal Reserve should reduce the rate of growth of money. d. Society ought to require welfare recipients to look for jobs. e. Lower tax rates encourage more work and more saving. Positive – a,b,e Normative – c,d References ▪ N. Gregory Mankiw, “Principles of Microeconomics”, Cengage Learning, 2015. ▪ Pindyck, R.S. and Rubinfeld, D.L; “Microeconomics”, Pearson Education edition-9, 2022.