MicroEconomics

• Introduction
Understanding Economics and Scarcity

• Economics is the study of choice under conditions of scarcity. As individuals,

and as a society, Economics is the study of how society manages its scarce
resources. In most societies, resources are allocated not by a single central
planner but through the combined actions of millions of households and
firms
• Scarcity means that there are never enough resources to satisfy all human
wants. Every society, at every level, must make choices about how to use its
resources.
Concept of Opportunity Cost

Opportunity Cost: Is what we give up when we choose one thing over another,
the value of the next best alternative.

Individual Decisions: In some cases, recognizing the opportunity cost can

alter personal behavior.

Societal Decisions: Opportunity cost comes into play with societal decisions. Universal
health care would be nice, but the opportunity cost of such a decision would be less
housing, environmental protection, or national defense. These trade-offs also arise with
government policies.
Goods and Services
• Goods and services are the outputs offered by businesses to satisfy the
demands of consumer and industrial markets. They are differentiated on the
basis of four characteristics:

• Tangibility: Goods are tangible products such as cars, clothing, and

machinery. They have shape and can be seen and touched. Services are
intangible. Hair styling, pest control, and equipment repair, for example, do
not have a physical presence.

• Perishability: All goods have some degree of durability beyond the time of
purchase. Services do not; they perish as they are delivered.

• Separability: Goods can be stored for later use. Thus, production and
consumption are typically separate. Because the production and
consumption of services are simultaneous, services and the service provider
cannot be separated.

• Standardization: The quality of goods can be controlled through

standardization and grading in the production process. The quality of
services, however, is different each time they are delivered
.
Goods and Resources

• Economic Goods: goods or services a consumer must pay to obtain; also

called scarce goods.

• Free Goods: goods or services that a consumer can obtain for free because
they are abundant relative to the demand.

• Productive Resources: the inputs used in the production of goods and

services to make a profit: land, economic capital, and labor; also called
“factors of production”
Productive Resources

Four productive resources also

called factors of production:
• Land: any natural resource,
including actual land, but also
trees, plants, livestock, wind, sun,
water, etc.
• Economic capital: anything
that’s manufactured in order to While money isn’t directly
be used in the production of productive, the tools and
goods and services. Note the machinery that it buys can be.
distinction between financial
capital (which is not productive) • Labor: any human service—
and economic capital (which physical or intellectual. Also
is). referred to as human capital.
Economic agent

• An economic agent is an individual or a group that makes choices. Let’s start with a few types of individual
economic agents. For example, a consumer chooses to eat cheeseburgers or pizza. A student chooses to
attend his classes or to skip them. A worker chooses to do her job or pretend to work while texting. A
business leader chooses to open a new factory in Chile or China. Of course, you are also an economic agent
because you make an enormous number of choices every day.
Trade-offs and Budget Constraints
• To understand optimization, you need to understand trade-offs. Trade-offs arise when some benefits must
be given up in order to gain others. Think about Facebook. If you spend an hour on Facebook, then you
cannot spend that hour doing other things. For example, you cannot study at most part-time jobs at the same
time you are editing your Facebook profile. Economists use budget constraints to describe trade-offs. A
budget constraint is the set of things that a person can choose to do (or buy) without breaking her budget.

• Here’s an illustration. Suppose that you can do only one of two activities with your free time: study at a
part-time job or surf the Web. Suppose that you have 8 free hours in a day (once we take away necessities
like sleeping, eating, bathing, doing problem sets). Think of these 8 free hours as your budget of free time.
Then your budget constraint would be: 8 hours = Hours surfing the Web + Hours studying at part-time job.
This budget constraint equation implies that you face a trade-off. If you spend an extra hour surfing the Web,
you need to spend one less hour studying at the university. Likewise, if you spend an extra hour studying,
you need to spend one less hour surfing the Web. More of one activity implies less of the other. Budget
constraints are useful economic tools because they quantify trade-offs. When economists talk about the
choice that an economic agent faces, the economist first specifies the budget constraint.
Markets, and Trade

• What Is a Market?

• A market is a place where parties can gather to

facilitate the exchange of goods and services. The
parties involved are usually buyers and sellers. The
market may be physical, like a retail outlet, where
people meet face-to-face, or virtual, like an online
market, where there is no physical presence or
contact between buyers and sellers.

• Some key characteristics help define a market,

including the availability of an arena, buyers and
sellers, and a commodity that can be purchased
and sold.
Price :

• price, the amount of money that has to be paid to

acquire a given product, price is also a measure of
value. Insofar as the amount people are prepared to pay
for a product represents its value,
Microeconomics and Macroeconomics

Micro vs. Macro

• Macroeconomics: the branch of economics that focuses on broad issues
such as growth, unemployment, inflation, and trade balance.
• Microeconomics: the branch of economics that focuses on actions of
particular agents within the economy, like households, workers, and
businesses. We learn about the theory of consumer behavior and the theory
of the firm.
Understanding Macroeconomics

Macroeconomics: Macroeconomic policy pursues its goals through monetary

policy and fiscal policy.

• Monetary Policy: policy that involves altering the level of interest rates, the
availability of credit in the economy, and the extent of borrowing

• Fiscal Policy: economic policies that involve government spending and

. Positive Economics and Normative Economics

• We now have an idea of what economics is about: people’s choices. But what is the reason for studying
choices? Part of the answer is that economists are just curious, but that’s only a small part of the picture.
Understanding people’s choices is practically useful for two key reasons. Economic analysis:

1. Describes what people actually do (positive economics). Positive Economics Describes What People
Actually Do Descriptions of what people actually do are objective statements about the world. Such factual
statements can be confirmed or tested with data. For instance, it is a fact that in 2010, 50 percent of U.S.
households earned less than $52,000 per year. Describing what has happened or predicting what will happen
is referred to as positive economics or positive economic analysis.
Normative economics

.
• Recommends what people ought to do (normative economics). The first application is descriptive and the
second is advisory. Normative Economics Recommends What People Ought to Do Normative
economics, the second of the two types of economic analysis, advises individuals and society on their
choices. Normative economics is about what people ought to do. Normative economics is almost always
dependent on subjective judgments, which means that normative analysis depends at least in part on
personal feelings, tastes, or opinions. So whose subjective judgments do we try to use? Economists
believe that the person being advised should determine the preferences to be used
. Why study economics ?
• You now have a sense of what economics is about. But you might be wondering what distinguishes it from
the other social sciences, including, anthropology, history, political science, psychology, and sociology. All
of the social sciences study human behavior, so what sets economics apart? Economists emphasize three key
concepts.

.
. Why study economics (cont.)?
1. Optimization: We have explained economics as the study of people’s choices. The study of all human
choices may initially seem like an impossibly huge topic. And at first glance, choosing a double-bacon
cheeseburger at McDonalds does not appear to have much in common with a corporate executive’s decision to
build a $500 million laptop factory in China.

2. Equilibrium: The second principle of economics holds that economic systems tend to be in equilibrium, a
situation in which no agent would benefit personally by changing his or her own behavior. The economic
system is in equilibrium when each agent feels that he or she cannot do any better by picking another course of
action. In other words, equilibrium is a situation in which everyone is simultaneously optimizing.

3. Empiricism: The third principle of economics is an emphasis on empiricism—analysis that uses data or
analysis that is evidence-based. Economists use data to test theories and to determine what is causing things to
happen in the world.
Using Economic Models

Economic Model: a simplified version of reality that allows us to observe,

understand, and make predictions about economic behavior.
Economic Models and Math
• Economic models can be represented using words or using mathematics.
• Algebra and graphs are utilized to explain economic models.
Using Economic Models: Examples

Circular Flow Diagram: a diagram indicating

that the economy consists of households and
firms interacting in a goods-and-services
market and a labor market.
• goods-and-services market (also called
the product market), in which firms sell and
households buy.
• labor market, in which households sell labor
to business firms or other employees.
• real world, there are many different markets
for goods and services and markets for Note: Economists don’t figure out the solution to a
many different types of labor. The circular problem and then draw the graph. Instead, they use
the graph to help them discover the answer.
flow diagram simplifies these distinctions in
order to make the picture easier to grasp.
Purpose of Functions

• Function: a relationship or expression involving one or more variables.

• In economics, functions frequently describe cause and effect.
• The variable on the left-hand side is what is being explained (“the effect”).
• On the right-hand side is what’s doing the explaining (“the causes”).
• Economic models tend to express relationships using economic variables,
such as:
• Budget = money spent on econ books + money spent on music
Solving Simple Equations

Order of Operations Understanding Variables

• When you solve an equation it’s • Variable: a quantity that can assume a
important to do each operation in range of values represented by a letter or
the following order: a symbol.
• Simplify inside parentheses and brackets. • For example: y=9+3x
• Simplify the exponent.
Working with Variables
• Multiply and divide from left to right.
• Add and subtract from left to right. • When you’re trying to solve an equation
with one or more variables, you need to
Lines isolate the variable.
• In this course the most common • What does x equal if y=12?
equation you will see is for a line in
graphs: y = b+mx
Creating and Interpreting Graphs

• intercept: the point on a graph where a line

crosses the vertical axis or horizontal axis.
• slope: the change in the vertical axis divided by
the change in the horizontal axis.
• variable: a quantity that can assume a range of
values.
• x-axis: the horizontal line on a graph,
commonly represents quantity (q) on graphs in
economics.
• y-axis: the vertical line on a graph, commonly
represents price (p) on graphs in economics.
Creating and Interpreting Graphs (cont.)

Equation for a Line: y = mx + b

• In any equation for a line, m is the slope and b is the y-intercept.
Interpreting Graphs in Economics
• It is rare for real-world data points to arrange themselves as a
perfectly straight line.
• It often turns out that a straight line can offer a reasonable approximation of
actual data.
Interpreting Slope

What the Slope Means: the change in the

vertical axis divided by the change in the
horizontal axis.
• positive slope indicates that two variables
are positively related; when one variable
increases, so does the other, and when
one variable decreases, the other also
decreases.
Interpreting Slope: Negative Slope

What the Slope Means: the change in

the vertical axis divided by the change
in the horizontal axis.
• negative slope indicates that two
variables are negatively related;
when one variable increases, the
other decreases, and when one
variable decreases, the other
increases.
Interpreting Slope: Slope of Zero

What the Slope Means: the change

in the vertical axis divided by the
change in the horizontal axis.
• Slope of zero indicates that there
is a constant relationship between
two variables: when one variable
changes, the other does not
change.
Interpreting Slope: Calculating Slope

Calculating Slope
• The slope of a straight line between two points
can be calculated in numerical terms.
• To calculate slope, begin by designating one
point as the “starting point” and the other
point as the “end point” and then calculating
the rise over run between these two points.
Interpreting Slope: Calculating Slope (cont.)

Calculating Slope
• Graphs of economic relationships are not always straight lines but often
nonlinear (curved) lines.
• Can interpret nonlinear relationships similarly to the way we interpret linear
relationships.
• Their slopes can be positive or negative. We can calculate the slopes similarly also,
looking at the rise over the run of a segment of a curve.
Interpreting Slope: Nonlinear Relationships

Nonlinear relationships can be interpreted

similar to linear relationships.
• Their slopes can be positive (as in Figure
5) or negative.
• We can calculate the slopes similarly
also, looking at the rise over the run of a
segment of a curve.
• A higher positive slope means a steeper
upward tilt to the curve, which you can
see at higher output levels.
• A negative slope that is larger in absolute
value (that is, more negative) means a
steeper downward tilt to the line.
Interpreting Slope: Nonlinear Relationships (cont.)

Nonlinear relationships can be interpreted similar to

linear relationships.
• A slope of zero is a horizontal line.
• A vertical line has an infinite slope.
• If a line has a larger intercept, graphically, it
would shift out (or up) from the old origin, parallel
to the old line.
• If a line has a smaller intercept, it would shift in (or
down), parallel to the old line.
Types of Graphs: Line

Line Graphs: show a relationship

between two variables: one
measured on the horizontal axis
and the other measured on the
vertical axis.
• Sometimes it’s useful to show
more than one set of data on
the same axes.
• The data in the table, below, is
displayed in Figure 1, which
shows the relationship between
two variables: length and
median weight for American
baby boys and girls during the
first three years of life.
Types of Graphs: Line (cont.)

Line Graphs:
• The line graph measures length in inches
on the horizontal axis and weight in
pounds on the vertical axis. For example,
point A on the figure shows that a boy who
is 28 inches long will have a median weight
of about 19 pounds.
• One line on the graph shows the length-
weight relationship for boys, and the other
line shows the relationship for girls.
• This kind of graph is widely used by health-
care providers to check whether a child’s
physical development is roughly on track.
 How do you know which graph to use for your data?
• Line graphs are often the most effective
format for illustrating a relationship
between two variables that are both
changing.
• For example, time-series graphs can
show patterns as time changes, like
the unemployment rate over time.
• Line graphs are widely used in
economics to present continuous
data about prices, wages, quantities
bought and sold, the size of the
economy.
Quick Review

• What if scarcity? Explain its economic • How are equations and functions
impact. used to describe relationships? What
• What are productive resources? are the cause and effects?
• What is opportunity cost and its • What proper order of operations is
importance in decision-making? used while solving simple equations
with variables?
• Why do trade and markets exist?
• What is the difference between • How does a graph shows the
macroeconomics and relationship between two variables?
microeconomics? • How do you differentiate between a
• Why are economic models are useful positive relationship and a negative
to economists? relationship?
• What are common economic • How do you interpret economic
models? information on a graph?
Understanding Microeconomics

Questions to Ask with Microeconomics

• What determines how households • How do people decide

and individuals spend their whether to work, and if so,
budgets? whether to work full time or
part time?
• What combination of goods and
services will best fit their needs and • How do people decide how
wants, given the budget they have much to save for the future,
to spend? or whether they should
borrow to spend beyond
their current means?
Understanding Microeconomics (cont.)

More Microeconomics Questions

• What determines the products, • What determines how many

and how many of each, a firm workers it will hire?
will produce and sell? • How will a firm finance its
• What determines what prices a business?
firm will charge?
• When will a firm decide to
• What determines how a firm expand, downsize, or even
will produce its products? close?