Intro to Microeconomics: Scarcity, Opportunity Cost, and Market Outcomes (Lecture Notes)

Scarcity and the Study of Economics

  • Economics is the study of how society manages scarce resources.
  • Scarcity means resources are limited while wants are unlimited; scarcity arises because:
    • Resources (tools, machinery, buildings, entrepreneurship) are limited.
    • People have unlimited desires and uses for those resources.
  • The entrepreneur combines these limited factors to create production and value.
  • Resources are scarce even though wants are endless, leading society to allocate them efficiently.
  • Etymology: Economics comes from the Greek word ekonomos, meaning one who manages the household.
  • Two broad sub-disciplines:
    • Microeconomics: focuses on individuals, firms, or markets; examines price and quantity determination in markets through interactions of many buyers and sellers.
    • Macroeconomics: focuses on the overall economy (inflation, unemployment, GDP, economic growth); this course does not cover macro.
  • Time as a limited resource:
    • Sleep, study, family time, hobbies, etc. require time.
    • We face trade-offs in how we allocate time across wants (e.g., more family time vs. more study or hobbies).
  • Introduction to the seven core principles (overview):
    • The material emphasizes that many answers are “it depends,” reflecting real-world complexity.

Principle 1: People face trade-offs

  • Trade-offs arise when choosing between different uses of scarce resources (including time).
  • Example: Pollution regulation creates a trade-off between a cleaner environment and profits, wages, and prices:
    • Regulation raises production costs, which can lower profits and wages and potentially raise prices.
    • The question of whether to regulate pollution depends on the specific context.
  • Everyday trade-offs: time spent in class vs. other activities; time with family vs. studying or hobbies.
  • Prompt to reflect on other daily trade-offs and discuss with peers.

Principle 2: The cost of something is what you give up to get it (Opportunity Cost)

  • Definition: The opportunity cost of an item is the value of the next best alternative forgone when a decision is made.
    • Formal notion: OC=V(extnextbestalternative)OC = V( ext{next best alternative})
  • The difference between a trade-off and an opportunity cost:
    • Trade-off: the set of alternative options you give up when making a decision (includes the third-best option).
    • Opportunity cost: specifically the value of the next best alternative foregone.
  • The saying: there is no such thing as a free lunch; even a costless event requires giving up something else (e.g., free food still costs you the time or alternative uses of that time).
  • Examples:
    • Staying in school for an athlete who could earn millions by going pro:
    • Opportunity cost = millions in foregone earnings if the next best alternative is to turn pro.
    • The athlete still gains a degree, which has its own value.
    • Going to the movie for three hours:
    • Opportunity cost includes the three hours plus the movie ticket price.
    • Missing work:
    • Opportunity cost is the wages you would have earned.
    • Driving on a toll-free road with lots of traffic:
    • Time spent due to traffic is the opportunity cost (more time spent, even if no toll is paid).
  • Clarification: the difference between a trade-off (the overall choice) and the opportunity cost (value of the next best alternative).

Principle 3: Rational people think at the margin

  • Rational people systematically and purposefully pursue the best outcome given constraints and available opportunities.
  • Marginal change: a small incremental adjustment to a plan.
  • Decision rule: compare marginal benefits and marginal costs. Act if marginal benefit exceeds marginal cost.
    • Formal idea: do it if MB<em>extmarginal>MC</em>extmarginalMB<em>{ ext{marginal}} > MC</em>{ ext{marginal}}.
  • Example: eating one more apple is worth it if the marginal benefit of that additional apple exceeds the marginal cost (e.g., calories, price, etc.).
  • This course will return to marginal analysis in more depth later.

Principle 4: People respond to incentives

  • An incentive is something that induces a person to act.
  • Increases in price typically reduce quantity demanded for a good (law of demand) and incentivize substitution away from that good.
  • Examples of incentives:
    • Gas taxes raise the price of gasoline and incentivize reduced consumption.
    • In-class clicker questions incentivize attendance and engagement.
    • Late submission penalties incentivize on-time submissions (though the instructor notes some leniency).
    • Traffic tickets incentivize obedience to traffic laws.
  • Incentives operate in many domains; they shape behavior by altering costs and benefits.

Principle 5: Trade can make everyone better off

  • Trade and specialization allow people to focus on what they do best, lowering opportunity costs.
  • Example framework (cookies vs. brownies):
    • Initial production possibilities (before trade, each person could specialize fully):
    • Me: cookies = 15 if all resources to cookies; brownies = 10 if all resources to brownies.
    • You: cookies = 10 if all resources to cookies; brownies = 30 if all resources to brownies.
    • Opportunity costs of production (one good in terms of the other):
    • For me:
      • OC(cookie) = 0.667 brownies (i.e., to produce 1 cookie, I give up 2/3 brownie).
      • OC(brownie) = 1.5 cookies (i.e., to produce 1 brownie, I give up 1.5 cookies).
    • For you:
      • OC(cookie) = 3 brownies (to produce 1 cookie, you give up 3 brownies).
      • OC(brownie) = 0.333 cookies (to produce 1 brownie, you give up 1/3 cookie).
    • After evaluating comparative advantage, me specialized in cookies and you in brownies.
    • Specialization outcomes:
    • If I specialize in cookies, I can produce 15 cookies; if you specialize in brownies, you can produce 30 brownies.
    • After specialization, trading can occur. Suppose: I give you 5 cookies and you give me 10 brownies.
    • Post-trade consumption:
      • Me: 10 cookies and 10 brownies.
      • You: 5 cookies and 20 brownies.
    • Before trade vs. after trade:
    • Before (no trade): Me = 9 cookies, 4 brownies; You = 5 cookies, 15 brownies.
    • After trade: Me = 10 cookies, 10 brownies; You = 5 cookies, 20 brownies.
    • Takeaway: Trade and specialization increased both parties’ consumption (both are better off).
  • Note on policy: Tariffs can discourage trade, potentially reducing overall welfare. The advantage of trade must be weighed against policy instruments and context.

Principle 6: Markets are usually a good way to organize economic activity

  • A market is a group of buyers and sellers of a particular good or service.
  • Market economy: resources are allocated through decentralized decisions by many firms and households as they interact in markets for goods and services.
  • Contrast with central planning (command economy).
  • Why markets work:
    • Prices reflect the value to consumers and the costs to producers.
  • Markets are not perfect:
    • They can fail due to various reasons (depending on the setting), which is a central focus of analysis in this course.
  • The recurring caveat: many questions are contextual; the correct judgment often depends on the specific situation rather than a universal rule.

Principle 7: Governments can sometimes improve market outcomes

  • The government plays a crucial role in enforcing rules and institutions, including property rights (the ability of individuals to own and exercise control over resources).
  • Market failure occurs when markets left to themselves do not allocate resources efficiently, i.e., when the size of the economic pie could be larger with intervention.
  • Pollution is highlighted as a key source of market failure (an externality):
    • Externalities occur when parties not directly involved in an transaction are affected by it.
  • Other forms of market power can cause market failures:
    • Monopoly power (one seller), oligopolies (few sellers), monopsony (one buyer), and monopsony (one buyer, many sellers) on the opposite side.
  • Government intervention aims to improve efficiency (increase the size of the pie) by addressing externalities and market power (e.g., antitrust actions, pollution policy).
  • Government can also intervene to promote equality, reshaping how the pie is divided without necessarily changing its size (e.g., welfare programs).
  • Caveats:
    • Interventions can have unintended negative consequences if incentives are not properly considered.
    • The balance between efficiency and equality is a key policy consideration.

Costs, Efficiency, and Equality: Practical Implications

  • Even if the pie is efficiently sized, distributional concerns matter; policy can shift how gains are distributed.
  • Policymaking involves trade-offs between efficiency (maximizing total welfare) and equity (how wealth is distributed).
  • Real-world evaluation requires careful attention to incentives, unintended consequences, and contextual factors.

Course Context and Career Notes

  • The lecture introduces sub-disciplines and areas of emphasis within economics (examples provided): environmental economics, behavioral/experimental economics, industrial organization, public economics, econometrics.
  • ResEcon (UMass Resource Economics) is highlighted as a program area with a focus on environmental and resource topics.
  • Advising and program options:
    • Two departments at UMass: Resource Economics (ResEcon) and Economics.
    • ResEcon majors: Managerial Economics and ENRE (Environmental and Natural Resource Economics).
    • Economics majors and opportunities to explore environmental and resource topics within the department.
    • Advisors can connect students to opportunities in econometrics, causal identification, and related subfields.
  • The professor notes that there are many sub-disciplines beyond those listed and emphasizes exploring what aligns with your interests.
  • Final note: The lecture emphasizes reflecting on these principles and preparing for deeper dives in subsequent sessions.

Additional context from the speaker

  • Acknowledgment that the course includes a broader set of principles (some labeled H and 10 in the book) that will not be covered in this course.
  • The discussion ends with encouragement to engage with advising and explore different econ pathways.

Summary of Key Formulas and Concepts (for quick study)

  • Opportunity Cost: OC=V(extnextbestalternative)OC = V( ext{next best alternative})
  • Marginal Decision Rule: MB<em>extmarginal>MC</em>extmarginal(do the activity)MB<em>{ ext{marginal}} > MC</em>{ ext{marginal}} \text{(do the activity)}
  • Comparative Advantage (illustrated via the cookies-brownies example): specialization where each party has lower opportunity cost in a chosen good.
  • Market Efficiency vs. Market Failure: markets maximize total welfare under certain conditions; failures arise due to externalities, market power, information gaps, etc.
  • Government Role: enforce property rights, correct market failures, and promote equality when appropriate, while being mindful of incentives and potential unintended consequences.