MicroEconomics Chapter 1

The Study of Economics

The Study of Economics

is the study how people make choices under conditions of scarcity and of the results of those choices in society

Scarcity

The limited nature of society’s resources.

Economics

the study of how society manages scarce resources.

Effeciency

aims at maximizing the size of the “economic pie” / An improvement in efficiency means that the entire “economic pie” has gotten larger.

Equity

aims at equating the size of every individual’s “slice” of the “Economic Pie” / a more equal “cutting” of the pie means an improvement in equity"

Opportunity Cost

The Opportunity cost of any item is whatever must be given up to obtain it

It is the relevant cost for decision making

Rational People

systematically and purposefully do the best they can achieve to their objectives.

Rational People Think at the margin.

Marginal Changes

Incremental adjustments to an existing plan

rational people make decisions by evaluating costs and benefits of marginal changes.

Optimize

Given a choice amongst alternatives, a rational individual will choose the one that is best for him//her/they

Rational People optimize

Incentive

something that induces a person to act, i.e. the prospect of a reward or punishment.

Knowing the incentives people face makes it easier to predict how they will behave

Market

A group of buyers and sellers (need not be in specific location)

Market Economy

Allocates resources through the decentralized decisions of many house holds and firms as they interact in markets.

Market Failure

when the market fails to allocate society’s resources efficiently

Externalities (i.e. pollution)

Market Power ( Monopolies)

Public Goods ( National Defense)

Asymmetric Information ( Insurance Markets)

Scientific Method (in economy)

the dispassionate development and testing of theories about how the world works.

Positive Statements

As scientist, economist make positive statements which attempt to describe the world how as it is

Positive statements can be confirmed or refuted, normative statements cannot

Normative Statements

As policy advisors, economists make normative statements which attempt to prescribe how the world should be

Positive statements can be confirmed or refuted, normative statements cannot

A model

Simplified representation of reality (thought experiments) (complexity)

Assumptions

Economists make assumptions in building models to analyze how the world works

Assumptions simplify the complex world to make it easier to understand

Circular Flow Diagram

A visual of the economy, shows how dollar flow through the market among households and firms

Factors of Production

Labor, Land, Capital ( buildings and machines used in production), Entrepreneurial spirit (abstract), Knowledge (abstract)

Households

Own the factors of production, sells/rent them firms for income

Buy and consumes goods & services

Firms

Buy/Hire factors of production, use them to produce goods and services

Sell goods & services

Explicit cost

require a cash outlet (tuitons,books,room board)

Implicit cost

could been working in the job industry, instead of going to college

The Central assumtpion of economics

Rationality

Example of Postitive statement

cutting taxes tend to results in increased economic (output)

The Market for good a Services

Output

The Market for “Factors of Production”

Input