Microeconomics Chapter 1 PDF

Chapter 1: The Economic Way of Thinking Economics Overview The Economic Problem Production Possibilities Economic Analysis  Economics is a unique way analyzing many areas of human behavior. Indeed, the range of topics to which economic analysis can be applied is broad. Many researcher...

Chapter 1: The Economic Way of Thinking Economics Overview The Economic Problem Production Possibilities Economic Analysis  Economics is a unique way analyzing many areas of human behavior. Indeed, the range of topics to which economic analysis can be applied is broad. Many researchers discover that the economic approach to human behavior sheds light on social problems that have been with us for long time: discrimination, education, crime, divorce, political favoritism, and more. What do we mean by ECONOMICS? Derived from the Greek word Oeconomicus, which referred to the management of household affairs. Is the study of the choices we make among our many wants and desires given our limited resources Is the proper allocation and efficient use of available resources for the maximum satisfaction of human wants. I. The Economic Problem the basic economic problem is scarcity: -- wants are unlimited, but resources are limited so with scarcity, we must make choices, and with choices, come costs  Cost is the opportunity cost -- what you give up when you make a choice -- “there’s no such thing as a free lunch” Cost of going to college -- what you can buy with tuition & fees -- what you could earn by working -- what you could do with the free time  you are willing to give up -- tuition -- wages -- leisure time to go to college -- b/c you expect higher income or more rewarding career economics is the study of choices of how to allocate scarce resources choices made by -- consumers -- businesses -- governments What are resources? use resources to produce goods and services factors of production -- land -- labor -- capital -- entrepreneurship Land all natural resources -- land -- minerals -- water -- wildlife Labor size of labor force (quantity) skills of labor force (quality) -- human capital the value of time Capital physical capital -- goods used to make other goods -- factories -- machines -- infrastructure  NOT financial capital -- stocks, bonds, bank loans financial capital facilitates building of physical capital entrepreneurship human resource ideas -- doing things better -- e-commerce -- new products The Three Basic Economics Problem Are: What goods and services to produce and how much? In business, a feasibility study determines whether certain goods or services become profitable or not in a given market. Investors are only willing to produce goods and services which give them good profit. Apparently, there is no problem. Just simply conduct a market study or feasibility study. The Three Basic Economics Problem Cont… In reality, however, it is not always possible to produce all the goods and services that people need, because resources are limited. For example, without oil our factories can not function. There are times when factories can not operate because the imported raw materials are not available. The Three Basic Economics Problem Cont… In poor countries, there is no need to conduct a survey to determine the real needs of the people. This is necessary to determine only the quantity of goods to be produced. It is very obvious that they lack food, clothing and shelter. Millions of them are dying from hunger. Many of them have not seen the face of doctor. Since human wants are many while available resources are few, there is a need to establish priorities. The Three Basic Economics Problem Cont… It is not possible to satisfy all our needs or wants at the same time. For instance, a father with limited financial resources has to decide whether to build a new house or send his son to college. A student has to choose whether to purchase his textbooks or have a good time. It is rather unfortunate that the poorest among us have extremely limited priorities. In not a few cases, they do not at all have the opportunity to choose – for those there is none. The Three Basic Economics Problem Cont… Many people can not buy food and medicine because they have no money. Those who survive the agonies of hunger and disease have been fortunate to taste the limited relief goods of the rich countries. The Three Basic Economics Problem Cont… How to produce the goods and services This is a problem of production technology or methods of production. As a general rule, goods and services must be produced in the most efficient manner. This means maximum output with minimum input without sacrificing quality. Although the rich countries use advance technology in the production of goods and services, there are still goods and services which could not be produced efficiently: hence, the continuous research and development projects. The Three Basic Economics Problem Cont… The application of modern technology has increased output and decreased cost of production. Such production efficiency has greatly contributed to the high standard of living of the industrial countries. In fact, it is cheaper for them to use machines than employ workers. This has not created unemployment problems because of the many commercial and service activities of the rich country. In Japan, robots are being used in factories, hospitals and offices due to the shortage of manpower. The Three Basic Economics Problem Cont… In case of poor countries, they can not afford to apply modern technology. This requires modern machines which are expensive. Besides, modern technology is not yet appropriate for the poor countries. They have an oversupply of idle labor force. The use of more machines only creates greater unemployment problems. For this reason, it has been suggested that poor countries should use labor – intensive technology. This means more labor and less machines. The Three Basic Economics Problem Cont… For whom are the goods and services This is a problem of distribution. Who gets the goods like rice, clothes, shoes, and the services such as education, medicare, etc.? In a pure market economy or capitalism, goods and services are definitely for those who have money and are willing to purchase them. Clearly, the rich require more goods and services than the poor. The rich have several cars, mansions, and elegant clothes and jewelries. Their children study in most prestigious foreign universities. Their doctors are the most famous. They can buy all the goods and services that money can buy. The Three Basic Economics Problem Cont… In contrast, the poor, especially the poorest, can only acquire goods and services depending on their purchasing power. Some of them do not eat three times a day. In a certain regions like Africa, people eat only every other day. Millions of children die in the arms of their mothers because of hunger and malnutrition. Goods and services are for sale. Businessmen do not offer these for charity or for free. Otherwise, they would be out of business. Market Structure The interconnected characteristics of a market, such as the number and relative strength of buyers and sellers and degree of collusion among them, level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market. Types of Market Structure pure capitalism The factors of production and distribution are owned and manage by private individuals or corporations Characteristics Private property Economic freedom Free competition Profit motive  command system The factors of production and distribution are owned and manage by the state Characteristics No private property No free competition ( the government is the only seller) No economic freedoms No profit motive Presence of central planning Mixed Market or Socialism The major strategic industries are owned and managed by the state while the minor industries belong to the private sector. How to judge an economic system Abundance Stability Security Efficiency Justice & Equity Economic freedom Growth Abundance This refers to goods and services that individual members of society have received. Are these sufficient and are the people satisfied? Are there no problems in food, clothing, shelter, medicare, education, and recreation? Has the economic system eliminated mass poverty? Abundance If the answer to all these questions are in the affirmative, then it is good performance. The people are definitely fortunate for not having experienced the pains and indignities of poverty. Growth The growth of the economy is tangible, and is measurable in terms of the number of buildings, houses, schools, cars, hospitals, factories, or machines made in a given year. More of these mean greater economic growth. However, many question such economic growth because of its destructive fruits like pollution, drug abuse, and sex crimes. Stability This refers to the absence of inflation and unemployment. However, if the ups and downs of economic activities like production, consumption, and saving, among other things, are minimal, there is still economic stability. Stability When prices are abnormally high, the purchasing power of the consumers decreases. This means they can buy less number of goods, and this reduces production of goods. The result is unemployment. A family man who is jobless becomes a social risk or liability. Security Economic security generally depends on economic stability. Workers and employees do not lose their jobs if there is prosperity in the economy. In fact, there is a great demand for jobs. Efficiency It simply means productivity. It measured in terms of unit cost or average cost. Specialization How do we get the most out of our resources? We specialize in what we do best and trade that for what we need  I teach. I get paid for it. I use the money to buy food oil changes clothes  If I grew my own food made my own clothes fixed my own car I would not consume as much Specialization produces gains! I can consume more than what I could make on my own Who specializes in what? Comparative advantage if you produce a good at a lower opportunity cost then you should specialize in it Absolute Advantage The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity produces that good or service. Comparative Advantage The ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other firms or individuals. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins. Example: married couple Husband: surgeon $250,000 /year Wife: 5th grade teacher $50,000 /year who should run the household? Who has lower opportunity cost? The wife. with specialization, division of labor different people specialize in different things people become very good at their task efficiency gains -- get more out of same resources specialization is everywhere doctors neurosurgeon, obstetrics, pediatrics,… lawyers divorce, real estate, patent law, personal injury... The bottom line: Scarcity & opportunity cost are unavoidable. BUT efficiency & specialization make the most of scarce resources II. Production Possibilities Frontier (PPF) model of scarcity, choice, & opportunity cost choice between 2 goods PPF shows maximum possible output combos of 2 goods, given current resources Production Possibilities Frontier A curve depicting all maximum output possibilities for two or more goods given a set of inputs (resources, labor, etc.). The PPF assumes that all inputs are used efficiently. PPF example 2 goods: -- CDs -- bottled water use land, labor, capital to make these goods  Bottled Suppose CDs Water these are (millions per (millions per 6 possible yr.) yr.) pairs: A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 We can graph the table & get the PPF: CDs 15 9 bottled 3 water 5 Using the PPF points on or inside the PPF are possible CDs points INSIDE the PPF are inefficient -- do not use all resources 9 points ON the PPF are efficient 6 -- use all resources bottled 2 3 water Using the PPF points outside the PPF are NOT possible at this time CDs cannot produce 15 CDs AND 6 bottles of water 15 9 bottled 3 6 water scarcity & tradeoffs the PPF shows limits to production so must choose between bottled water & CD combinations -- give up water to get more CDs -- give up CDs to get more water -- TRADEOFF Shifts in the PPF if we get more resources OR if technology improves then the PPF will shift out produce more CDs and more water economic growth!  With economic growth, CDs the unattainable becomes attainable 15 9 bottled 3 6 water II. Economic analysis models positive vs. normative fallacies Microeconomics studies choices of consumers, firms, and how government affects these choices studies parts of the economy or a particular market Macroeconomics studies whole economy -- inflation -- unemployment -- recessions Building economic models ask a question simplify reality make assumptions make prediction test the prediction  Models may be described with -- words -- math -- pictures (graphs) example Model consumer behavior in buying pizza how does a change in price of pizza impact the amount of pizza bought?  assume only price changes, and other factors remain constant -- “ceteris paribus” “other things being equal” Ceteris Paribus used as a shorthand for indicating the effect of one economic variable on another, holding constant all other variables that may affect the second variable.  make a prediction: Words: “when the price of pizza rises, people buy less pizza” Math: quantity of pizza = 10 -.2(price of pizza)  graph price demand Quantity of pizza Positive statements statements about “what is” may be right or wrong testable Normative statements statements about “what ought to be” based on opinions and values not testable Faulty economic analysis correlation vs. causation post hoc, ergo propter hoc fallacy of composition correlation vs. causation if “a” rises when “b” rises, positively correlated NOT necessarily true that “a” causes “b” “b” could cause “a” OR third factor causes both “a” and “b”  Correlation does not imply causation is a phrase used in science and statistics to emphasize that a correlation between two variables does not necessarily imply that one causes the other. Example assault and ice cream sales are positively correlated Does ice cream make people want to hit someone? Do bullies go out for ice cream after a good fight? No, both increase due to warmer weather  Ice cream consumption leads to murder. A pirate shortage caused global warming. Living in a poor country increases penis size. Facebook also cancelled out the cholesterol-lowering effects of Justin Bieber. post hoc, ergo propter hoc if A happened right before B, then A must have caused B. what about coincidence? a third unrelated causal factor? post hoc, ergo propter hoc A fallacy in which one event is said to be the cause of a later event simply because it occurred earlier. fallacy of composition “what is true for one part is true for the whole” arises when one infers that something is true of the whole from the fact that it is true of some part of the whole (or even of every proper part).  example: Paradox of thrift should you save more $? what if everybody did?  The paradox states that if everyone tries to save more money during times of economic recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. EXAMPLES OF FALLACY OF COMPOSITION If someone stands up out of their seat at a baseball game, they can see better. Therefore, if everyone stands up they can all see better. If a runner runs faster, she can win the race. Therefore if all the runners run faster, they can all win the race.