Econ 1102 - Introductory Microeconomics - Chapter 1: Economic Foundations & Model

Microeconomics vs. Macroeconomics

  • Microeconomics: Study of individual agents (consumers, producers, government).
  • Macroeconomics: Study of the economy as a whole (unemployment, inflation, GDP).

Examples of Microeconomic Issues

  • How consumers react to changes in product prices.
  • How firms decide what prices to charge.
  • Government policies to reduce obesity.
  • Costs and benefits of approving a new prescription drug.
  • Efficient ways to reduce air pollution.

Examples of Macroeconomic Issues

  • Why economies experience recessions and unemployment.
  • Why some economies grow faster than others in the long run.
  • Determinants of the inflation rate.
  • Determinants of the U.S. dollar's value.
  • Whether government intervention can reduce the severity of recessions.

Key Economic Principles

  • People face tradeoffs (labor vs. leisure).
  • Society's main tradeoff: Equity vs. Efficiency.
    • Efficiency: Society gets the most from scarce resources.
    • Equity: Equal distribution of resources.

Opportunity Cost

  • People give up something when making tradeoffs.
  • Opportunity cost: The cost of giving up that something.

Rational People Think At the Margin

  • Rational people: Use available information to achieve goals.
  • Weigh costs and benefits of each action to make the best decision.
  • Thinking at the margin:
    • Example: Watching an extra hour of TV vs. studying.
    • Marginal cost (MC): Additional cost of a small amount extra of some action.
    • Marginal benefit (MB): Additional benefit of a small amount extra of some action.
    • Marginal analysis: Comparing MC and MB.

People Respond to Incentives

Markets

  • Economic agents interact in markets.
  • Market: Group of buyers and sellers trading a good or service.
    • Determines what goods to produce.
    • Determines how to produce them.
    • Determines how much of each to produce.
    • Determines who gets them.

What Goods and Services Will Be Produced?

  • Individuals, firms, and governments decide on goods and services to produce.
  • Increased production of one good requires reduced production of another.
  • Opportunity cost example: Funding space exploration vs. funding cancer research.

How Will the Goods and Services Be Produced?

  • Firms have different production methods.
  • Example: Music production: hiring a great singer vs. using Auto-Tune.

Who Will Receive the Goods and Services Produced?

  • In the U.S., higher-income people obtain more goods and services.
  • Tax and welfare policies can change income distribution.

Types of Economies

  • Centrally planned economy: Government allocates resources.
  • Market economy: Households and firms allocate resources through markets.
    • Adam Smith's insight: The "invisible hand" promotes general economic well-being.
    • Interaction of buyers and sellers determines prices.
    • Prices reflect value to buyers and cost to producers.
    • Prices guide self-interested parties to maximize society's economic well-being.

Mixed Economy

  • Most economic decisions result from market interactions, but the government plays a significant role.
  • The U.S. today is a mixed economy.

Efficiency of Market Economies

  • Market economies tend to be more efficient than centrally planned economies.
  • Market economies promote:
    • Productive efficiency: Goods produced at the lowest possible cost.
    • Allocative efficiency: Production aligns with consumer preferences; marginal benefit equals marginal cost for the last unit produced.

Market Economies and Equity

  • Efficient outcomes are not always desirable; equitable outcomes may be more fair.
  • Equity: Fair distribution of economic benefits.
  • Tradeoff: Efficiency vs. equity.
  • Example: Taxing income may reduce work effort, but funds programs for the poor.

Market Failure

  • Markets may not generate the most efficient outcome.
  • Governments may interfere with market outcomes.
  • Market failures: Inefficient allocation of resources.
  • Causes:
    • Externalities: Production or consumption affects bystanders (e.g., pollution).
    • Market power: A single buyer or seller influences market price (e.g., monopoly).

Economic Models

  • Economists use models to analyze real-world issues.
  • Steps:
    1. Define economic variables (measurable values like employment).
    2. Decide on assumptions (necessary for model usefulness).
    3. Formulate a testable hypothesis (generates predictions).
    4. Use economic data to test the hypothesis.
    5. Revise the model if it fails to explain data.
    6. Retain the revised model for similar questions.
  • Causal Relationship

Positive vs. Normative Statements

  • Positive statements: Describe the world as it is; can be tested with data.
  • Normative statements: Describe what ought to be; involve value judgments.
  • Examples:
    • Positive: Prices rise when the government increases the money supply.
    • Normative: The government should print less money.