Introduction to Microeconomics Lecture 1: Foundations PDF

Introduction to Microeconomics Lecture 1: Foundations Shuo Xu September 12, 2024 1/37 About me Name: Shuo Xu Contact: [email protected] (1 to 1) and WeChat (announcement). From: Beijing, China. Field: Informati...

Introduction to Microeconomics Lecture 1: Foundations Shuo Xu September 12, 2024 1/37 About me Name: Shuo Xu Contact: [email protected] (1 to 1) and WeChat (announcement). From: Beijing, China. Field: Information Design, Mechanism Design, Experimental Economics OH: M 09:00-09:50 and Th 09:00-09:50 at IBS 607 Hobbies: soccer, cycling, video games. 2/37 Economics I The word economy comes from the Greek word oikonomos, which means “one who manages a household.” I Households decide what jobs will be done and who will do them. I Society allocates people (as well as land, buildings, and machines) to various jobs, and also distributes the goods and services they produce. I These decisions are important because resources are scarce. Definition I Scarcity: The limited nature of society’s resources. I Economics: The study of how society manages its scarce resources. 3/37 Resources Goods and Services produced by: I Land: Natural resources. I Labor: Human effort, physical and mental. I Capital: Tools and knowledge that increase productivity. I Entrepreneurial ability: Talent for taking risks and organizing all of the above resources into productive process. 4/37 Resources Goods and Services produced by: I Land: Natural resources. I Labor: Human effort, physical and mental. I Capital: Tools and knowledge that increase productivity. I Entrepreneurial ability: Talent for taking risks and organizing all of the above resources into productive process. Example I Land: farmland, oil I Labor: factory workers, computer programmers I Capital: machinery, algorithms I Entrepreneurial ability: Steve Jobs, Elon Musk 4/37 Scarcity Scarcity: Unlimited wants vs. Limited resources I Generally, if resource is used to satisfy one want, it cannot be used to satisfy another want. Relative scarcity: Some resources are more scarce than others. 5/37 Scarcity Scarcity: Unlimited wants vs. Limited resources I Generally, if resource is used to satisfy one want, it cannot be used to satisfy another want. Relative scarcity: Some resources are more scarce than others. Example I Scarcity: Time I Relative scarcity: water vs. drinkable water, air vs. clear air. 5/37 Principle 1: People Face Trade-Offs Making decisions requires trading off one goal for another: I How to allocate time? Economics vs. Another Subject, Studying vs. Entertaining I How to allocate money? Groceries vs. Vacation I How does a society allocate resources? Guns vs. Butters. Environment vs. Level of Income. I How does a society choose between Efficiency and Equality? Definition I Efficiency: The property of society getting the most it can from its scarce resources. I Equality: The property of distributing economic prosperity uniformly among the members of society. 6/37 Principle 2: The Cost of Something Is What You Give Up to Get It How to evaluate costs and benefits? I What is the cost of going to college? I Tuition, fees, books. What else? I Foods, bedroom, entertainment. But you need them anyway. I What about the time? You can get a job. Think about the NBA stars. Definition Opportunity Cost: Whatever must be given up to obtain some item. 7/37 Opportunity Cost Opportunity cost: Value of the next-best forgone alternative. I What you have to give up to choose what you want. 8/37 Opportunity Cost Opportunity cost: Value of the next-best forgone alternative. I What you have to give up to choose what you want. Example I You choose between three movies: The Godfather, The Lord of the Rings, and The Emoji Movie. I Suppose that the Emoji Movie is the least preferred. What’s the opportunity cost of watching The Godfather? I Value of watching the Lord of the Rings 8/37 Opportunity Cost Example Suppose you have been offered a choice between two part-time jobs: I 10 hours a week stacking shelves at the supermarket for $10 an hour; I 12 hours a week working in the bar of the local hotel for $8 an hour plus a free case of beer once a week. 9/37 Opportunity Cost Example Suppose you have been offered a choice between two part-time jobs: I 10 hours a week stacking shelves at the supermarket for $10 an hour; I 12 hours a week working in the bar of the local hotel for $8 an hour plus a free case of beer once a week. I The opportunity cost of taking the supermarket job: $96 plus a case of beer I The opportunity cost of taking the hotel job: $100 plus 2 hours of leisure. 9/37 Principle 3: Rational People Think at the Margin Economists often assume that people are rational. A good benchmark. I Firms decide hiring and pricing to maximize profits. I Individuals balance work and life to maximize levels of satisfaction. Definition I Rational People: People who systematically and purposefully do the best they can to achieve their objectives I Marginal Change: An incremental adjustment to a plan of action 10/37 Marginal Analysis Marginal analysis is the process of making choices in increments by evaluating the marginal benefit (MB) against the marginal cost (MC) I Marginal benefit: The extra benefit associated with one more unit of activity I Marginal cost: The extra cost associated with one more unit of activity 11/37 Marginal Analysis Marginal analysis is the process of making choices in increments by evaluating the marginal benefit (MB) against the marginal cost (MC) I Marginal benefit: The extra benefit associated with one more unit of activity I Marginal cost: The extra cost associated with one more unit of activity Optimization rule I If MB ≥ MC , do it. I If MB < MC , don’t do it. 11/37 Marginal Analysis I Generally, the marginal benefit of the last unit consumed is equal to its marginal cost. One exception is consumption in discrete (integer) units. Example (Discrete Units) The Marginal Benefits and Marginal Costs of Candies Quantities MB($) MC($) 1 2.00 1.00 2 1.20 1.00 3 0.40 1.00 4 -0.60 1.00 12/37 Marginal Analysis in Graphs I Total = Sum of the Marginals. I When in continuous units, Marginal = slope of the Total. 13/37 Marginal Benefits and Marginal Costs in Equilibrium I Decreasing marginal benefit: The marginal benefit goes down as the consumption increases. I Increasing marginal cost The marginal cost goes up as the production increases. I Optimal level of output: MB = MC. Efficient. 14/37 Marginal Benefits and Marginal Costs in Equilibrium 15/37 Principle 4: People Respond to Incentives An incentive is something that induces a person to act, such as the prospect of a punishment or reward. I How does a price change affect consumers and producers? I How does an increase of tax on gasoline affect SUVs vs. Electric Cars? Incentives are central and also subtle: I How does seat belt law affect safety? I Direct: More likely to survive a car accident. I Subtle: Driving slowly and carefully is costly. I Peltzman (1975) empirically showed that the law not only gives rise to fewer deaths per accident but also to more accidents. 16/37 Quick Quiz 1. Economics is best defined as the study of I how society manages its scarce resources. I how to run a business most profitably. I how to predict inflation, unemployment, and stock prices. I how the government can protect people from unchecked self-interest. 17/37 Quick Quiz 2. Your opportunity cost of going to a movie is I the price of the ticket. I the price of the ticket plus the cost of any soda and popcorn you buy at the theater. I the total cash expenditure needed to go to the movie plus the value of your time. I zero, as long as you enjoy the movie and consider it a worthwhile use of time and money. 18/37 Quick Quiz 2. Your opportunity cost of going to a movie is I the price of the ticket. I the price of the ticket plus the cost of any soda and popcorn you buy at the theater. I the total cash expenditure needed to go to the movie plus the value of your time. I zero, as long as you enjoy the movie and consider it a worthwhile use of time and money. 19/37 Quick Quiz 2. Your opportunity cost of going to a movie is I the price of the ticket. I the price of the ticket plus the cost of any soda and popcorn you buy at the theater. I the total cash expenditure needed to go to the movie plus the value of your time. I zero, as long as you enjoy the movie and consider it a worthwhile use of time and money. 20/37 Quick Quiz 3. A marginal change is one that I is not important for public policy. I incrementally alters an existing plan. I makes an outcome inefficient. I does not influence incentives. 21/37 Quick Quiz 4. Because people respond to incentives, I policymakers can alter outcomes by changing punishments or rewards. I policies can have unintended consequences. I society faces a trade-off between efficiency and equality. I All of the above are correct. 22/37 Principle 5: Trade Can Make Everyone Better Off I Isolation: A family would need to grow its own food, sew its own clothes, and build its own home. I Trade allows everyone to specialize in the activities they do best, whether it is farming, sewing, or home building. I By trading with others, people can buy a greater variety of goods and services at a lower cost. 23/37 Principle 6: Markets Are Usually a Good Way to Organize Economic Activity I The theory behind central planning was that the government needed to organize economic activity to ensure the well-being of the country and of like-minded nations. I At first glance, no one appears to be looking out for the well-being of society as a whole. I Yet despite decentralized decision making and self-interested decision makers, market economies have proven remarkably successful in organizing economic activity to promote prosperity. Definition I Market Economy: An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services 24/37 Principle 6: Markets Are Usually a Good Way to Organize Economic Activity Adam Smith’s Invisible Hand: I Price as the instrument that the invisible hand directs economic activity. I In competitive market, price reflects both consumers’ value of the product, and producers’ cost of production. Corollary: I When a government prevents prices from adjusting to supply and demand, it impedes the invisible hand’s ability to coordinate the decisions of the firms and households that make up an economy. 25/37 Principle 7: Governments Can Sometimes Improve Market Outcomes Definition I Property Rights: The ability of an individual to own and exercise control over scarce resources. 26/37 Principle 7: Governments Can Sometimes Improve Market Outcomes Definition I Market Failure: A situation in which a market left on its own does not allocate resources efficiently I Externality: The impact of one person’s actions on the well-being of a bystander I Market Power: The ability of a single economic actor (or small group of actors) to have a substantial influence on market prices 27/37 Principle 7: Governments Can Sometimes Improve Market Outcomes I Government enforces the rules and maintains the institutions that are key to a market economy. I In the presence of market failure, well-designed public policy can enhance efficiency. I The invisible hand does not ensure that everyone has enough food, decent clothing, and adequate healthcare. Government redistributes incomes through taxes and welfare system. 28/37 Quick Quiz 5. International trade benefits a nation when I its revenue from selling abroad exceeds its outlays from buying abroad. I its trading partners experience reduced economic well-being. I all nations specialize in doing what they do best. I no domestic jobs are lost because of trade. 29/37 Quick Quiz 6. Adam Smith’s “invisible hand” refers to I the subtle and often hidden methods that businesses use to profit at consumers’ expense. I the ability of competitive markets to reach desirable outcomes, despite the self-interest of market participants. I the ability of government regulation to benefit consumers, even if the consumers are unaware of the regulations. I the way in which producers or consumers in unregulated markets impose costs on innocent bystanders. 30/37 Quick Quiz 7. Governments may intervene in a market economy in order to I protect property rights. I correct a market failure due to externalities. I achieve a more equal distribution of income. I All of the above are correct. 31/37 Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services Definition I Productivity: The quantity of goods and services produced from each unit of labor input 32/37 Principle 9: Prices Rise When the Government Prints Too Much Money Definition I Inflation: an increase in the overall level of prices in the economy 33/37 Principle 10: Society Faces a Short-Run Trade-Off between Inflation and Unemployment I Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services. I Higher demand will, over time, cause firms to raise their prices, but in the meantime, it encourages them to hire more workers and produce a larger quantity of goods and services. I More hiring means lower unemployment. Definition I Business Cycle: Fluctuations in economic activity, such as employment and production 34/37 Quick Quiz 8. The main reason that some nations have higher average living standards than others is that I the richer nations have exploited the poorer ones. I the governments of some nations have created more money. I some nations have stronger laws protecting worker rights. I some nations have higher levels of productivity. 35/37 Quick Quiz 9. If a nation has high and persistent inflation, the most likely explanation is I the government creating excessive amounts of money. I unions bargaining for excessively high wages. I the government imposing excessive levels of taxation. I firms using their market power to enforce excessive price hikes. 36/37 Quick Quiz 10. If a government uses the tools of monetary policy to reduce the demand for goods and services, the likely result is [Blank] inflation and [Blank] unemployment in the short run. I lower; lower I lower; higher I higher; higher I higher; lower 37/37