Principles Of Microeconomics MECO111 Fall 2024 Lecture 2 PDF

Dr. Ummad Mazhar SDSB, LUMS Principles of Microeconomics MECO111 Session 2 MECO111 Fall2024 1 Lecture 2: How Economists Think? Dr. Ummad MECO111 Fall 2024  Economic society Economics is a social science It means we look at society from t...

Dr. Ummad Mazhar SDSB, LUMS Principles of Microeconomics MECO111 Session 2 MECO111 Fall2024 1 Lecture 2: How Economists Think? Dr. Ummad MECO111 Fall 2024  Economic society Economics is a social science It means we look at society from the lens of economics Lens shape your view  using a lens having red color make everything appear red to you ‘Economy’ comes from Greek word Oikonomos which means ‘one who manages a household’ The decisions taken by a household and the decisions faced by a society have much in common Dr. Ummad MECO111 Fall 2024  Economic problem is caused by scarcity of resources Both households and society face scarcity of resources Scarcity => resources are less compared to wants Economics studies management of scarce resources – at the level of a household, – at the level of a society/country, – and at global level Dr. Ummad MECO111 Fall 2024  Choice is necessary when resources are scarce When resources are scarce relative to wants, we cannot satisfy all wants When resources are scarce we need to use them carefully We economize on the use of resources so that we can satisfy greatest number of our wants This is possible with the knowledge of economics Dr. Ummad MECO111 Fall 2024  Quick quiz Resources are scarce relative to ____________ A. needs B. wants C. population D. income Dr. Ummad MECO111 Fall 2024  Solutions to scarcity Three possible solutions to scarcity 1. Economize i.e., use resources efficiently 2. Create more resources 3. Cut down wants Economists’ solve the scarcity problem using options 1. Scientists (physicists, biologists, and others) solve it using option 2. Buddhists and mystics and those arguing “small is beautiful” use option 3 Dr. Ummad MECO111 Fall 2024  Ten Principles of Economics 1. Tradeoffs 2. Opportunity cost 3. Marginal analysis 4. Incentives 5. Trade 6. Markets 7. Government 8. Productivity 9. Inflation 10. Unemployment Dr. Ummad MECO111 Fall 2024  Ten Principles of Economics 1. Tradeoffs 2. Opportunity cost How economic agents decide 3. Marginal analysis 4. Incentives 5. Trade 6. Markets How economic agents interact 7. Government 8. Productivity 9. Inflation How economy works 10. Unemployment Dr. Ummad MECO111 Fall 2024  Ten Principles A. How people make choices 1. Tradeoffs 2. Opportunity cost 3. Marginal analysis 4. Incentives Dr. Ummad MECO111 Fall 2024  Ten Principles B. How people interact 5. Trade 6. Markets 7. Government Dr. Ummad MECO111 Fall 2024  10 Principles C. How the economy as a whole works 8. Productivity 9. Inflation 10. Unemployment Dr. Ummad MECO111 Fall 2024  1. Tradeoffs This principle states that people face tradeoffs Tradeoffs exist because – Resources are scarce relative to wants – Resources have alternative uses – Wants can be ranked If they go after one desire or objective, they have to sacrifice something This something may be an alternative or simply time Dr. Ummad MECO111 Fall 2024  Social Tradeoff between efficiency and equality Like individuals, society also faces tradeoffs A much-debated tradeoff at a social level is between efficiency and equality Efficiency is best possible use of scarce resources Equality is distributing resources fairly among members of society Dr. Ummad MECO111 Fall 2024  Efficiency-Equality tradeoff A society has three individuals: A, B, and C A is earning Rs. 500,000 per month. Each B and C are earning 200,000 per month To achieve equality: Take 200,000 each month from A’s income and give 100,000 to each of the B and C How will it affect the motivation of the A? It kills the incentive to put in the best efforts Higher taxes = less incentive to put in extra effort Thus, equality comes at the cost of efficiency Dr. Ummad MECO111 Fall 2024  Quick quiz There are many freshwater lakes in the Pakistan. However, freshwater is scarce because: a. it has no alternative uses. b. there is not enough of it to meet all needs. c. the government limits its use through regulations. d. it has a high opportunity cost. Dr. Ummad MECO111 Fall 2024  2. Opportunity cost Whatever must be given up in order to have something Individuals: Choose among various alternative goods, rules, relationships Societies: choose among alternative laws, rules, processes Dr. Ummad MECO111 Fall 2024  Tradeoff and opportunity cost If there is tradeoff between two goods, one cannot have them together. – “There is no free lunch.” Opportunity cost is best alternative that you forego in order to have your preferred option. – The cost of one’s choice. Dr. Ummad MECO111 Fall 2024  Illustrating the difference in tradeoff and opportunity cost Opportunity cost is the value of the best rejected alternative Example: A person is facing a tradeoff between chicken and mutton. The person can’t have both given his budget He can purchase 1 KG of chicken or half KG of mutton Suppose he chooses 1 KG of chicken Then opportunity cost of 1 KG of chicken is the 0.5 KG of mutton Bottom line: Opportunity cost is linked with a decision or a choice Dr. Ummad MECO111 Fall 2024  Quick quiz Whenever a good is purchased: a. overall efficiency increases. b. the cost of the good is easy to measure in terms of the price paid for it. c. the cost of the good is its opportunity cost. d. scarcity will increasingly constrain the future availability of the good. Dr. Ummad MECO111 Fall 2024  Quick quiz Aima spends $40,000 for one year's tuition at university. The opportunity cost of one year at university for Aima is: a. $40,000. b. whatever she would have purchased with the $40,000 had she not attended university. c. whatever she would have earned had she not attended university. d. whatever she would have purchased with the $40,000 plus whatever she would have earned had she not attended university. Dr. Ummad MECO111 Fall 2024  3. Rational people think at the margin Assumption of rationality Rationality means that individuals are systematic and purposeful in their actions When they are using resources, they know what is their objective When they are using resources, rational agents know how their actions are going to help them in achieving their objective When they are using resources, rational agents try their best to know how their actions are going to help them in achieving their objective Rationality = they use their resources time, money, etc., in the best way to achieve their goals Dr. Ummad MECO111 Fall 2024  Test your understanding Because people are rational, they have good objective. True or False? Because people are rational people they care about the consequences of their actions. True or false? Dr. Ummad MECO111 Fall 2024  Marginal cost and marginal benefits Marginal analysis is used when agents take how much type decisions How much more study before exam night? How much more proteins if you want to lose weight? Investor may think: How much more investment in property when interest rates are reduced? Dr. Ummad MECO111 Fall 2024  Quick quiz A busy mechanic needs to decide whether to stay at the garage and work on one more car or to go meet their wife for dinner. This is an example of: a. equity versus efficiency. b. how one person's spending is another person's income. c. economic incentives. d. marginal analysis. Dr. Ummad MECO111 Fall 2024  Diamond-water paradox Water is necessary for life, but is inexpensive Diamonds are not necessary for life but are very expensive Because marginal benefit of having an additional gallon of water is very small compared to the extra benefit offered by a diamond Change the situation: A thirsty person in a desert will be willing to give up diamond for a glass of water Marginal worth is determined by relative scarcity Dr. Ummad MECO111 Fall 2024  Sensitivity to small changes Consider this: Individuals have unlimited wants, they are facing scarcity of resources, they are purposeful in their behavior. Now if there is an opportunity to save their resources or satisfy more of their wants, should they ignore it? No. If they do not exploit such an opportunity they will act against the above principles: either they are not facing scarcity or they are not rational. Rational people should be ready to make small or incremental changes in their plans Dr. Ummad MECO111 Fall 2024  4. People respond to incentives Incentive is something that motivates a person to act In a market system, prices play two roles – Convey information about scarcity of resources – Provide incentives to act Higher prices give incentive to rational consumer to buy less of the expensive good Higher prices give incentive to rational producer to supply more of the expensive good Dr. Ummad MECO111 Fall 2024  Instructors penalizing late comers in class are incentivizing students to come in time. True or False? Instructors rewarding good behavior in class incentivizing students to stay focus and learn more. True or false? Dr. Ummad MECO111 Fall 2024  Identify the economic principle at work Free solar panel for low income earners. Economist recommends government to cut unproductive expenditures and shut down loss making organizations. If government spend more on perks and privileges of officers, lesser resources will be available for education and other development purposes. Adding an extra student costs very little to a university so they can offer scholarships. Dr. Ummad MECO111 Fall 2024  Think Pakistan is facing water shortage How can we structure incentives so that people economize their use of water? Dr. Ummad MECO111 Fall 2024  Final Point The principles of scarcity and tradeoff define the economic reality of a society Opportunity cost, rationality, calculating marginal costs and benefits define the behavior of economic agents. Dr. Ummad MECO111 Fall 2024  Take away points: People face tradeoffs because of scarcity of resources Identification of tradeoffs does not guide agents in decision making To best utilize their scarce resources agents calculate opportunity costs Agents are systematic and purposeful, respond to incentives and are ready to make marginal adjustments in their plans when conditions change Dr. Ummad MECO111 Fall 2024 See you next time Dr. Ummad MECO111 Fall 2024