Econ 1110

What is Microeconomics?

Study of how society makes decisions with limited resources and unlimited wants and needs. Basically study of tradeoffs and choice. However, it is not about money or morality.

Categories of core principles of economics

1. how do people make choices

2. how do the choices of individuals interact

3. how does all that play out in the economy as a whole

Individuals and Choice

1. Choices are necessary since resources are scarce.

2. Opportunity cost matters. The cost of something is what you give up to get it.

   1. ex. cost of watching movie instead of studying is the movie ticket price and hours spent watching

3. People make quantity choices on “the margin”. People make “how much” choices in incremental steps.

4. People respond to incentives and exploit opportunities. People take advantage of opportunities to make themselves better off until there are no more advantages. Sometimes consequences are the point.

   1. ex. speed tickets incentivize people to drive slower.

Summary: People make decisions by weighing costs against benefits and picking what makes them best off.

resource

anything you use to get something else

marginal decisions

choices about how to value the next _____

marginal analysis

study of marginal decisions

incentive

things that motivate people to action (sometimes will produce an unintended consequence)

How do People’s Choices Interact?

5. There exists gains from trade. Giving the option to trade can only make people better off. This is how we can benefit from specialization and the economy does better with more trades.

6. Markets move towards equilibrium. People alter their behavior until it can’t make them any better. Connecting to 4, if someone is willing to pay for better service, someone will provide.

7. Resources should be used efficiently. Efficiency leads to pareto efficiency/optimality. Reality is that there may not be equity or fairness in an efficient economy. If we have surplus, everyone will have at least what they have and some people get more.

8. Markets usually lead to efficiency. Combined by 5, 6, and 7.

9. When markets don’t achieve efficiency, gov can help. Markets fail when there are side effects (externalities) on others, blocked deals that would normally exist, or goods ill suited for markets.

Pareto Efficiency

Optimality. No one can be made better off without making someone worse off.

note on incentives

Sometimes they don’t work. Structure barriers may get in the way (ex. poverty).

The Production Possibilities Frontier

• Simplify: a world with two goods to illustrate economic trade-offs

• shows max producible amount of one good, given some level of production for the other

• shows the trade off/opportunity cost in ratios

• economic growth shifts the PPF

Efficiency in production

All resources used such that we couldn’t product more of anything without giving up something else.

Efficiency in allocation

No other efficient in production point would be better from society’s point of viw.

Trade in a PPF World

From rule #5 (there exist potential gains from trade), focused resource allocation and trading for other goods and services can generate gains.

Steps to draw Join PPFs

1. Find opportunity costs, identify comparative advantage

2. Consider extrema where the economy produces one thing

3. Consider who has the comparative advantage, who should move away from the extrema first.

4. To draw it, find where that person’s time “runs out”

5. Start the other person’s PPF there, connect to other axis

Gains from trade

• based on comparative advantage (when one party has lower opportunity cost of something)

• joint PPFs shifts individual PPFs outward by the max comparative advantage production of the other person

Absolute advantage

you can produce more of something than others

Note: different from comparative advantage!

Advantage and trade

• gains from trade are comparative, not about absolute advantage

• if opportunity cost differs, then someone always has the comparative advantage in something, otherwise, no one has the comparative advantage

Is trading always good?

• models show trade results in potential for more things

• models don’t promise we share the benefits of trade”fairly”

• efficiency ≠ equity

• ties into positive vs normative

Positive

How the word is, definitively

Ex. “The current long term capital gains tax rate for a single household making $75,000 a year is 15%”

Normative

questions about how the world should work, which can vary by society/individual opinion

Ex. “The current long term capital gains tax for a single household making $75,000 a year is too long/high”

What makes a market “perfectly competitive”?

• enough different buyers/sellers where no person/firm can determine market prices

• standardized product

• largely unrestricted entry/exit of firms and consumers

What’s a “not perfectly competitive” market?

• buyers/sellers can determine market price through their actions

• differentiated goods

• barriers to entry

Basic Model Elements

• demand curve

• supply curve

• equilibrium price and quantity

• factors that shift supply/demand curves

• what drives changes in equilibrium when one or more curves shift

Demand

• how much of __ do consumers want at a give price?

• demand curve is the visual representation of this idea

• Law of demand: the higher the price, all else held equal, the lower the quantity demanded

What can a demand curve tell us?

• the relationships between price and quantity demanded (all else held equal)

• Can quantity demanded change without price changing?

• What might make the market want less at any price?

• x - quantity demanded

• y - price

• demand is the curve, quantity demanded is a point on that curve given a specific price

Two kinds of change in demand curves

• change in demand: movement of the curve

• change in quantity demand: movement along the curve