PP ECON ANALYSIS CHAP 1

What is microeconomics?

Focuses on individual actors (how do households decide what and how much to buy; firms decide what and how to make?)

examines the allocation of scarce resources (market EQ & prices determined)

examines different types of markets (perfect competition, monopolies, oligopolies, cartels)

Why study microeconomics?

governments (or nonprofits are not business firms) — produce goods and services (water, parks, public transit, emergency services); tools of ‘production theory’ can help guide decision making in gov agencies

Govs are NOT isolated actors — have direct or indirect effects on private economy; understand these effects when creating gov programs; knowledge of economics can avoid costly policy mistakes

helps you evaluate the pros and cons of choices made by ppl (private actors) and Govs (public actors)

• The Text: “governments (or nonprofits are not business firms) — produce goods and services (water, parks, public transit, emergency services); tools of ‘production theory’ can help guide decision making in gov agencies”

• Meaning: Even though governments aren't trying to make money like regular businesses, they still run production lines. They "produce" things like clean water, safe parks, and bus routes. Because they use resources (money, labor, time) to create these services, they can use economic "production theory" to figure out how to get the most output for the lowest cost, ensuring taxpayer money isn't wasted.

2. The Interconnected Economy

• The Text: “Govs are NOT isolated actors — have direct or indirect effects on private economy; understand these effects when creating gov programs; knowledge of economics can avoid costly policy mistakes”

• Meaning: Government actions do not happen in a vacuum; they ripple through the private sector. For example, if a city builds a new public transit line, it directly impacts private taxi companies, local businesses, and housing prices. Economics helps policymakers predict these ripple effects so they don't accidentally harm the economy or waste millions on a program that backfires.

3. Evaluating Choices (Trade-offs)

• The Text: “helps you evaluate the pros and cons of choices made by ppl (private actors) and Govs (public actors)”

• Meaning: Every choice has an opportunity cost (what you give up to get something). Economics gives you a structured framework to weigh the benefits against the drawbacks of decisions made by both everyday citizens (like buying a car) and governments (like raising taxes to build a bridge).

5 fundamental principles of economics

Principle 1: People face tradeoffs
Principle 2: The cost of something is what you give up to get it
Principle 3: Rational people think at the margin
Principle 4: People respond to incentives; People change their behavior when they are given incentives to do so.
Principle 5: Sometimes even well-intentioned policies have unintended
consequences

Principles 1: People face tradeoffs

Scarcity: the imbalance between the desires for goods and services
by individuals and the resources to satisfy these desires
• Because resources are scarce, individuals and societies face tradeoffs →
scarcity necessitates choices
• EX. We cannot pursue two or three different master’s programs at the same time
and thus have to make a choice (i.e., choose one program).

Principles 2: The cost of something is what you
give up to get it

Opportunity costs: the value of the next best alternative surrendered
when making a choice
• Economists tend to think of costs in a broader sense than do financial
accountants and therefore distinguish between accounting costs and
economic costs

accounting costs and economic costs

Accounting costs: actual expenses plus depreciation charges for capital
equipment
• Economic costs: costs of utilizing economic resources, including opportunity
costs. Typically, higher than accounting costs

• Accounting costs are the actual out-of-pocket bills and recorded paper expenses, while economic costs include those bills plus the hidden value of what you gave up. [1, 2]

  📊 The Core Difference

  • Accounting Costs: Only money spent and asset wear-and-tear. [1, 2]

  • Economic Costs: Accounting costs plus missed opportunities. [1, 2]

  • Why Higher: Economic costs count invisible sacrifices. [1, 2]

  🗒 A Simple Example

  Imagine you own a small bakery.

  • Accounting Cost ($50,000): You pay $30,000 for flour and rent, plus $20,000 in equipment wear (depreciation).

  • Economic Cost ($100,000): You take that $50,000 accounting cost and add $50,000 in salary you gave up by not working a corporate job.

ex: Sudokwon Landfill Site in Incheon, South Korea, one of the largest waste disposal sites in the world; accounting and economic costs and exernality?

Accounting costs: Wages for garbage collectors, depreciation of garbage trucks/capital inputs, and costs of running and maintaining the landfill.
Economic costs: The value to society of using the landfill site for another purpose and environmental damage caused by landfill construction.

externality: environmental damage

Principles 3: Rational people think at the margin; Marginal cost, marginal benefit, sunk cost

Marginal cost: the incremental cost associated with a choice
Marginal benefit: the incremental benefit associated with a choice
- A rational decision-maker should take action if and only if the
marginal benefit of that action exceeds the marginal cost.
- “Rational” indicates using all available information when taking actions.
• Sunk cost: a previously incurred cost that must be borne whether or
not any action is taken; sum of money that has already been spent and cannot be recovered
- While economists agree that opportunity costs should be taken into account
when making decisions, sunk costs cannot be recovered and should not
influence an individual’s decisions

you should base your future choices only on what lies ahead, ignoring money, time, or effort you already lost. [1]

💡 The Core Concepts

• 📉 Sunk Costs

  • Past expenses that can never be recovered.

  • Irrelevant to future outcomes.

  • Example: Spending $100 on a non-refundable concert ticket, then falling sick on the day of the show. The $100 is gone either way. [1, 2, 3]

• 📈 Opportunity Costs

  • The hidden value of what you give up when making a choice.

  • Crucial for comparing future alternatives.

  • Example: Choosing to spend your Saturday working an extra shift means giving up a relaxing day off or time with family

Ex. Healthcare

Original Program: Full-Coverage Health Insurance
• Suppose that it costs you $10,000 per year for full-coverage health
insurance
• Once you pay the $10,000, you can access all the health services you
desire
• What is the marginal cost of health care services once you pay your
premium?

• What is the sunk cost?

• What is the marginal cost of health care services once you pay your
premium?
• MC = 0, Once you pay the premium, the price of getting one additional unit of
health care services is zero.
• What is the sunk cost?
• $10,000 per year

Example: health care
• New Program: Copayments
• Now, suppose every time you visit the doctor, you have to pay a copayment of
$20

• Under the new program, what is the marginal cost of health care services?

• If Ikhwan gains a benefit of $21 per visit and decides to enroll in this program, is
his decision rational?

• Under the new program, what is the marginal cost of health care services?
• MC = $20/visit
• If Ikhwan gains a benefit of $21 per visit and decides to enroll in this program, is
his decision rational?
• True, Marginal benefit ($21/visit)>Marginal cost($20/visit)

economic models, why are they necessary?

An economy or economic problem is too complex (or too big) to describe in
detail and thus has been simplified to its most basic elements.
• Microeconomic “models” are theories about how these elements relate

good predicts of how private markets operate and how gov actions affect them

• "Too complex... simplified to its most basic elements"

  • The economy involves billions of people making trillions of choices daily.

  • To understand it, economists build simplified versions (models).

  • They isolate a few key variables (like price and quantity) and assume everything else stays the same.

• "Theories about how these elements relate"

  • Models create hypotheses about cause and effect.

  • Example: If the price of a good goes up, people will buy less of it.

• "Good predictors of how private markets operate..."

  • Even though these models are simplified, they work surprisingly well.

  • They accurately forecast how businesses and consumers behave in the real world.

• "...and how gov actions affect them"

  • Models help predict what will happen if the government intervenes.

  • Example: They help forecast if a new tax will raise revenue or accidentally crush a specific industry.

Economic actors in the market (3)

Major economic actors
• Households (consumers of goods and services)
• Firms (source of production of goods and services; sometimes consumers of certain
goods and services)
• Government

Markets

Meeting of buyers and sellers for a particular good or service
• Markets are where prices are set
• Understanding how markets works is at heart of understanding microeconomic

Prices

Provide economic actors with information and incentives needed to act in a way that benefits everyone
• Tells producers how much consumers value the good and consumers how much it costs producers to produce it
• Represent what producers receive from selling one additional good and what consumers give up by buying one additional good

Relative prices

Most important for us, is price relative the price of other goods
• When relative price changes, behavior change