Introduction to Microeconomics

Microeconomics

The study of the choices made by individuals in a world of scarcity and the expected consequences of those choices.

Consumption

The act of individuals with limited incomes choosing to acquire and use things that generate satisfaction (utility). These things are called products (goods and services).

Utility

The satisfaction generated by consuming products (goods and services). [Simplified]

Products

Things that generate satisfaction (utility), including goods and services.

Goods

Products that are physical/tangible. [Simplified]

Services

Products that are generally activities or actions provided to consumers. [Simplified]

Production

The act of individuals choosing to use things to continuously produce products and make those products available for people to consume.

Resources

The things used to produce products.

Four Main Groupings of Resources

Labor, land, capital, and entrepreneurial ability.

Labor

The innate ability of people to use the body to work with other resources to produce products.

Land

Natural resources.

Capital

Human-made resources, both physical and human.

Entrepreneurial Ability

The ability of people to manage and organize productive processes.

Exchange

Individuals choosing to trade (exchange) items that they place less value on for items they place greater value on.

Monetary Exchange

An exchange using units of money to buy an item.

In-Kind Exchange

An exchange of units of one item for units of another item.

Scarcity

A state where the quantity of an item available is less than the quantity of the item people are willing and able to use if the item were priced at zero.

Scarcity and Resources

By the definition used in the course, all resources are considered to be scarce.

Consequence of Scarce Resources #1

Products produced from scarce resources will also be scarce.

Consequence of Scarce Resources #2

Scarce resources and scarce products will have to be allocated.

Consequence of Scarce Resources #3

People will have to invent an allocation mechanism to cause scarce resources and scarce products to be allocated.

Allocation Mechanism

A method used to allocate scarce resources and scarce products. [Simplified]

Price Allocation Mechanism

An allocation mechanism that uses prices to allocate scarce resources and products.

Non-Price Allocation Mechanism

An allocation mechanism that does not use prices to allocate scarce resources and products.

Example of a Non-Price Allocation Mechanism

First come, first served.

Scarcity and Opportunity Cost

Because resources are scarce, if more scarce resources are used to produce more of one product, there will be a smaller quantity of another product produced. This is called the opportunity cost of producing more of one product.

Opportunity Cost

The smaller quantity of another product that results when scarce resources are used to produce more of one product. [Based on the course's explanation]

Three Key Assumptions About Decision Making

People are rational; people respond to economic incentives; optimal decisions are made at the margin.

People Are Rational

People make choices intended to achieve the best outcome according to the objective being considered. [Simplified]

Rational Consumption Decision

People allocate their limited income to consume a basket of products they assume will generate the greatest amount of utility.

Rational Production Decision

People that produce products allocate the products they produce so that the profits they earn will be a maximum or, in the event of losses, they will minimize the losses they incur.

Rational Resource Allocation Decision

People allocate the scarce resources they possess to earn the greatest amount of income.

People Respond to Economic Incentives

People change their choices in response to rewards, costs, prices, taxes, and other economic incentives. [Simplified]

Price Decrease and Buyers

If the price of an item decreases, some buyers would be willing and able to purchase more of that item.

Reward for Working Harder

If people are rewarded for working harder and better, some people will work harder and better.

Price Decrease and Sellers

If the price of an item decreases, some sellers will be willing and able to sell a smaller quantity of the item.

Lower Price as a Disincentive

The lower price is a disincentive for some sellers to sell as much.

Higher Government Taxes on Businesses

If the government raises the taxes that business firms have to pay to do business in a particular area, some businesses will choose not to do business in that area.

Optimal Decisions Are Made at the Margin

Individuals make decisions by considering whether to consume more, produce more, or sell more rights to resources they own.

Margin

The additional or next unit of an activity being considered. [Simplified]

Marginal Cost (MC)

The additional cost of a decision.

Marginal Benefit (MB)

The additional benefit of a decision.

Marginal Analysis

Comparing the marginal cost (MC) and marginal benefit (MB) of a decision.

The Economic Problem

Every society must make economic decisions because resources are scarce.

Trade-Off

The idea that, because of scarcity, producing more of one product (good or service) means producing less of another product (good or service).

Economic Problem: What to Produce

Every society must decide what products (goods and services) will be produced and in what quantity.

Economic Problem: Who Receives Products

Every society must decide who will receive the products (goods and services) produced and in what quantity.

Economic Problem: How to Produce

Every society must decide how the products (goods and services) will be produced.

Centrally Planned Economy

An economy in which the people that control the government decide how economic resources will be allocated.

Market Economy

An economy in which decisions of individual households and individuals managing firms interact in markets to allocate economic resources.

Mixed Economy

An economy in which most economic decisions result from the interaction of buyers and sellers in markets, but the people who run the government play a significant role in the allocation of resources.

Economic Model

A model used to study the economic decisions made by individuals.

Step 1 of an Economic Model

Decide on the assumptions to use.

Step 2 of an Economic Model

Formulate a testable hypothesis.

Step 3 of an Economic Model

Use economic data to test the hypothesis.

Step 4 of an Economic Model

Revise the model if it fails to explain the economic data well.

Step 5 of an Economic Model

Retain the revised model to help answer similar economic questions in the future.

Positive Analysis

Analysis concerned with what is and what is expected to be, not whether the outcome is good or bad.

Normative Analysis

Analysis concerned with what ought to be based on a certain value system, not the consequences of choices.

Positive vs. Normative Analysis

Positive analysis concerns what is or what is expected to be; normative analysis concerns what ought to be based on a value system. [Simplified]

Type of Analysis Used in This Course

The course is concerned with positive analysis, not normative analysis.

Mathematical Economic Model

An economic model that explains basic economic principles and is expressed mathematically.

Introductory Mathematical Model

A mathematical model that expresses a relationship between two variables.

Variable

A quantity or characteristic that can change. [Simplified]

y as a Function of x

The idea that variable y is a function of variable x: if x changes, y will change in a predictable manner.

"If, Then" Relationship

The mathematical relationship stating that if variable x changes, then variable y will change in a predictable manner.

Mathematical Notation for y as a Function of x

y = f(x), all else constant.

Mathematical Notation for x as a Function of y

x = f(y), all else constant.

Two Possible Relationships Between Variables

A positive relationship or a negative relationship.

Positive Relationship

Variable y is positively related to variable x, or variable x is positively related to variable y.

Negative Relationship

Variable y is negatively related to variable x, or variable x is negatively related to variable y.

Positive Relationship: x Increases

If variable x increases, variable y also increases.

Positive Relationship: x Decreases

If variable x decreases, variable y also decreases.

Positive Relationship: Graphical Movement

An upward movement along the curve states that as the size of variable x increases, the size of variable y increases.

Positive Relationship: Downward Movement

Downward movement along the same curve states that as the size of variable x decreases, the size of variable y decreases.

Negative Relationship: x Increases

If variable x increases, variable y decreases.

Negative Relationship: x Decreases

If variable x decreases, variable y increases.

Negative Relationship: Graphical Upward Movement

An upward movement along the curve states that as the size of variable x decreases, the size of variable y increases.

Negative Relationship: Graphical Downward Movement

A downward movement along the curve states that as the size of variable x increases, the size of variable y decreases.

Positive vs. Negative Relationship on Different Ranges

A relationship can be positive in one range and negative in another range.

Positive Relationship in One Range and Negative in Another

The graph can show a positive relationship over one range of x and a negative relationship over another range of x.