MICRO ECONOMICSIntroduction

EconomicsEconomics is the social science that

analyzes the Production Distribution and consumption of goods and services. The term economics comes from the

Ancient Greek word oikonomia, "management of a household, administration")

Microeconomics

Economic ProblemUnlimited wantsLimited Resources

Economics, the Science of Scarcity

The science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.

Scarcity A case in

which our wants are greater than available resources.

In This Lecture1. Microeconomics &

Macroeconomics2. Positive &

Normative Economics

3. Goods and Bads4. Resources

In This Lecture (Continued)ScarcityOpportunity CostsCosts and BenefitsDecisions Made at the

MarginEfficiencyUnintended EffectsExchange

Microeconomics Microeconomics is the

part of economics concerned with individual units such as a

Person a household a firm or an industry.

Microeconomic Questions How does a market work? What level of output does a firm produce? What price does a firm charge for the good it

produces? How does a consumer determine how much

of a good he or she will buy? Can government policy affect business

behavior? Can government policy affect consumer

behavior?

Macroeconomics Macroeconomics

deals with human behavior and choices as they relate to highly aggregate markets

the goods and services market or the entire

economy.

Macroeconomic Questions How does the economy work? Why is the unemployment rate sometimes

high and sometimes low? What causes inflation? Why do some national economies grow faster

than other national economies? What might cause interest rates to be low one

year and high the next? How do changes in the money supply affect

the economy? How do changes in government spending and

taxes affect the economy?

Positive vs. Normative Economics

Positive - The study of “what is” in economic matters.

Cause Effect Normative – The study of “what should be” in economic matters

Judgment and Opinion

Positive Statements Examples: A rise in interest rates will cause a rise in the

exchange rate and an increase in the demand for imported products

Lower taxes may stimulate an increase in the active labour supply

A national minimum wage is likely to cause a contraction in the demand for low-skilled labour

The UK economy now has lower unemployment than Germany

The American stock market has boomed in recent years

Normative Statements Examples: The decision to grant independence for the Bank of

England is unwise and should be reversed A national minimum wage is totally undesirable as it

does not help the poor and causes higher unemployment and inflation

The national minimum wage should be increased to �5

As a method of reducing poverty Protectionism is the only proper way to improve the

living standards of workers whose jobs are threatened by cheap imports

Goods and Services

Good - Anything from which individuals receive utility or satisfaction.

Durable Non DurableUtility - The satisfaction one receives from

a good.Services- A service is the intangible

equivalent of an economic good.

Five Big Microeconomics Questions

• What goods and services will be produced?

• How will the goods and services be produced?

• Who will get the goods and services?• How will the system accommodate

change?• How will the system promote progress?

Factors of Production There are four Factors of Production1. Land2. Labour3. Capital4. Entrepreneurship

Building A Definition of Economics ~ Resources ~

Land - All natural resources, such as minerals, forests, water, and unimproved land.

Building A Definition of Economics ~ Resources ~

Labor - The physical and mental talents people contribute to the production process.

Skilled Unskilled Semi Skilled

Building A Definition of Economics ~ Resources ~

Capital - Produced goods that can be used as inputs for further production, such as factories, machinery, tools, computers, and buildings.

Building A Definition of Economics ~ Resources ~

Entrepreneurship - The particular talent that some people have for:organizing the resources of land, labor, and capital to produce goodsseeking new business opportunities, and developing new ways of doing things.

Opportunity Costs

The thing we have to forego to have another.

The higher the opportunity cost of doing something, the less likely it will be done.

Study or Play

Benefit

Cost

Consumer decisions Should you attend school for another

year? Should you study an extra hour for an

exam? Should you supersize your fries?

Similarly, should a business expand or reduce its output?

Should government increase or decrease its

funding for a missile defense system?

Scarcity, Choice and Opportunity Costs

Marginal Benefits Is additional benefits. The benefits connected to consuming an additional unit of a good or undertaking one more unit of an activity.

Marginal Costs Is additional costs. The costs connected to consuming an additional unit of a good or undertaking one more unit of an activity.

Exchange/Trade

The process of giving up one thing for another.

Question: Why do people enter into exchanges?

Rationing Device

A means for deciding who gets what of available resources and goods.

Purposeful Behavior

Economics assumes that human behavior reflects “rational

self-interest.” Individuals look for and pursue opportunities to

increase their utility —the pleasure, happiness, or satisfaction obtained from consuming a good or service.

They allocate their time, energy, and money to maximize their satisfaction.

They weigh costs and benefits, their economic decisions are

“purposeful” or “rational,” not “random” or “chaotic.”

The Scientific Method: Observation, Theory, and More Observation

Uses abstract models to help explain how a complex, real world operates.

Develops theories, collects, and analyzes data to evaluate the theories.

Economists use models to simplify reality in order to improve our understanding of the world

Two of the most basic economic models include: The Circular Flow Diagram The Production Possibilities Frontier

Economic Models

Our First Model: The Circular-Flow Diagram

The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms.

Figure 1 The Circular Flow

Copyright © 2004 South-Western

Spending

Goods andservicesbought

Revenue

Goodsand servicessold

Labor, land,and capital

Income = Flow of inputs

and outputs = Flow of dollars

Factors ofproduction

Wages, rent,and profit

FIRMS•Produce and sellgoods and services

•Hire and use factorsof production

•Buy and consumegoods and services

•Own and sell factorsof production

HOUSEHOLDS

•Households sell•Firms buy

MARKETSFOR

FACTORS OF PRODUCTION

•Firms sell•Households buy

MARKETSFOR

GOODS AND SERVICES

Our First Model: The Circular-Flow Diagram

Firms Produce and sell goods and services Hire and use factors of production

Households Buy and consume goods and services Own and sell factors of production

Our First Model: The Circular-Flow Diagram Markets for Goods and Services

Firms sell Households buy

Markets for Factors of Production Households sell Firms buy

The Production Possibilities Frontier

The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.

Figure 2 The Production Possibilities Frontier

Copyright©2003 Southwestern/Thomson Learning

Productionpossibilitiesfrontier

A

B

C

Quantity ofCars Produced

2,200

600

1,000

3000 700

2,000

3,000

1,000

Quantity ofComputers

Produced

D

Our Second Model: The Production Possibilities Frontier

Concepts Illustrated by the Production Possibilities Frontier Efficiency Tradeoffs Opportunity Cost Economic Growth

Figure 3 A Shift in the Production Possibilities Frontier

Copyright © 2004 South-Western

E

Quantity ofCars Produced

2,000

700

2,100

7500

4,000

3,000

1,000

Quantity ofComputers

Produced

A

Practice Question-15. State whether statements applies to

microeconomics or macroeconomics:a. The unemployment rate in the United States

was 5.2 percent in January 2005.b. A U.S. software firm discharged 15 workers last

month and transferred the work to India.c. An unexpected freeze in central Florida reduced

the citrus crop and caused the price of oranges to rise.

d. U.S. output, adjusted for inflation, grew by 3.5 percent in 2005.

2-Below is a production possibilities table forconsumer goods (automobiles) and capital

goods (forklifts):

a. Show these data graphically. Upon what specific

assumptions is this production possibilities curve based?

b. If the economy is at point C , what is the cost of one more automobile? Of one more forklift? Explain how the production possibilities curve reflects the law of increasing opportunity costs.

c. If the economy characterized by this production possibilities table and curve were producing 3 automobiles and 20 fork lifts, what could you conclude about its use of its available resources?

d. What would production at a point outside the production possibilities curve indicate? What must occur before the economy can attain such a level of production?

e. Last week Wells Fargo Bank lowered its interest rate on business loans by one-half of 1 percentage point.

f. The consumer price index rose by 3.4 percent in 2005.

3-

On average, households in China save 40 percent of their annual income each

year, whereas households in the United States save less than 5 percent. Production possibilities are growing at roughly 9 percent annually

in China and 3.5 percent in the United States. Use graphical analysis of “present goods” versus “future goods” to explain the differences in growth rates.