MICROECONOMICS:
CONSUMPTION AND PRODUCTION
TOPIC 1:
INTRODUCTION
Professor: Nuria Rodríguez Priego
Dpto. Análisis Económico: Teoría Economía e Historia Económica
[Link]@[Link]
Grado en Economía y Finanzas
Contents
■ What is Economics? Micro vs Macro / Normative vs
Positive
■ The way an economist think: models, theory
■ What to produce
■ How to choose
■ Opportunity cost, reservation price
■ The Production Possibilities Frontier
References
■ Chapter 1 and 2 Pindyck
WHAT IS THE ECONOMY?
WHAT IS THE ECONOMY?
■ “The study of choice”.
■ Scarcity reflects the human condition: fixed resources and unlimited wants,
needs, and desires.
■ Scarcity reflects the human condition: fixed resources and unlimited wants,
needs, and desires.
Since scarcity forces us to
choose, and economics is
the study of choice, scarcity
is the fundamental concept
of all economics. If there
were no scarcity, there
would be no need to choose
between alternatives, and
no economics!
Social science studying the satisfaction of illimited needs through
scarce resources that might be alternatively used for.
Economics is the study of how people interact with each other and with
their natural surroundings in producing their livelihoods, and how this
changes over time. Therefore, it is about:
How we come to acquire the things that make up our livelihood:
Things like food, clothing, shelter, or free time.
How we interact with each other: either as buyers and sellers,
employees or employers, citizens and public officials, parents,
children and other family members.
How we interact with our natural environment: from breathing, to
extracting raw materials from the earth.
How each of these changes over time.
Now time to discuss: What do economists do?
Take a look to the hastag #whateconomistsdo and find at least two or
three topics that economists do to explain the economy.
#WhatEconomistsDo
Tip! JEL classification of AEA
■ The real world is enormously complex. We must simplify the real
world to understand it.
■ A Model = simplified representation of the world, not intended to
be realistic (hypothesis), using symbols, such as a flow chart,
schematic, or equation.
■ Economists use maths, statistics, theory and data to help to solve
real-world problems. What problems does the real world have?
■ Economists try to provide useful information for policy and
decision-makers.
– What is the nature and magnitude of the cause and effect?
– What are the costs and benefits of action (or inaction)?
– What is the best way to accomplish a particular goal?
Like using
Google maps
to be able to
move down
the street!
■ We want to analyze human behavior and
decisions.
■ On human behavior it is all about
incentives.
[Link]
Do incentives works?
Gneezy and Rustichini (2000)
■ Day-care centers in Haifa (Israel) operate 7:30 – 16:00
■ Delays from parents to pick up their children meant that a teacher
had to wait.
■ Parents rarely came after 16:30.
Do incentives works?
Gneezy and Rustichini (2000)
■ Introduced a fine in 6 out of 10 day-care centers
■ Delays from parents to pick up their children meant:
NIS 10 per 10 minutes or more
Currency NIS (New Israeli Sheckel)
Do incentives works?
LATE PICK-UP CHILDREN NIS 10 per 10 minutes or more
■ ILLEGAL PARKING NIS 75
■ DRIVING THROUGH A RED LIGHT NIS 1,000
■ NOT COLLECTING THE DROPPINGS OF A DOG 360
■ BABY-SITTER EARNS NIS 15 – 20 / HOURS
■ AVERAGE GROSS SALARY / MONTH NIS 5,595
Result?
Day-care center - Israel
Do incentives works?
Result?
A fine is a Price.
(Title of the paper)
■ Our economic models are built and used following the Scientific
Method.
■ Scientific Method = A body of techniques for investigating
phenomena, acquiring new knowledge, or correcting and
integrating previous knowledge.
■ The major characteristic of the scientific method is to use
measurable evidence to support or detract from a given model
or theory. Following this method, economists will keep a theory
as long as evidence backs it up. If the evidence does not
support the model, the theory will be modified or replaced.
■ Science is limited, and the human condition continues to be
one of imperfect knowledge, finite lives, and an enduring search
for solutions to poverty, pain, and suffering.
■ Why economics needs data?
[Link]
■ Microeconomics = The study of individual decision-making
units, such as firms and households.
■ Macroeconomics = The study of economy-wide aggregates,
such as inflation, unemployment, economic growth, and
international trade.
This course studies microeconomics, the investigation of firm and
household decision making. Our basic assumption is that firms
desire to maximize profits, and households seek to maximize utility,
also called satisfaction.
■ Positive Economics = Statements that include only factual
information, with no value judgments. “What is.”
■ Normative Economics = Statements that include value
judgments, or opinions. “What ought to be.”
Which is related to Macro or to Micro?
■ The number of employees in the supermarket of the neighbourhood
■ The wage of a member of your family
■ The supply of cds that Aitana sold in 2019
■ The number of tickets sold in a match of Real Madrid
■ Inflation
■ Interest rate increases
■ The number of people watching Mrs. America on TV
■ The Central Bank
■ The minimum wage
■ Unions and wage bargaining
■ A sugar tax
What is a normative or positive?
■ The unemployment rate has decreased to a 15%.
■ To improve the health system, we should nationalize it.
■ I completely agree with the labour reform. We should
incentivize employment.
■ Subprime mortgages in the US have led to decreases in the
stock market prices of many countries in 2008.
■ There should be a increase on compulsory education to help
to reduce the percentage of non-skilled workers in the
country.
■ A reduction in income tax will improve the incentives of the
unemployed to find work
What to produce?
■ What is a good or a service?
■ A market is an interaction between buyers and sellers that,
through real or potential interactions, set a price of a good or
a service.
■ Now your turn: select one market, and explain the good or
service, agents that intervene in that market (buyers and
sellers), scope, sustituitive products, degree of competency
■ Individuals face decisions on
how to choose
■ There ain’t no such thing as a
free lunch! “Nada es gratis”
■ To choose something implies to
give up others. So it is necessary
to compare costs/benefits of each
action.
How to ■ Example: a student must choose
between studying microeconomics
choose? or flying to Dublin to listen to U2.
Same in a household (to work or
to take care of children)
■ Cost-benefit analysis
COST-BENEFIT – Implicit variables: reservation
ANALYSIS price and opportunity cost
■ Sometimes the cost is not evident:
how much does it cost come to
university?
■ The opportunity cost measures the loss of other alternatives when
one alternative is chosen (what we give up when choosing one
alternative).
■ If I produce 5 clothes, what is the opportunity cost of producing 5
clothes more?
Example 1: Suppose two travelers want to go
from Valladolid to Siena. They can go by
plane (300 euros and 3 hours) or by bus (100
euros and 15 hours). For traveler 1, each
hour is worth 50 euros and for traveler 2,
each hour is worth 10 euros. What is the
total cost per each traveler? Which
alternative will they choose?
Example 2: I have a ticket to watch a tennis match in Wimbledon, but I am thinking in attending
the final competition of triathlon, which will cost 200 euros. The final competition of triathlon
gives me a benefit (in terms of utility) of 250 euros. What benefit (utility) should the tennis
match report me to attend Wimbledon? What is the opportunity cost of going Wimbledon?
Example 1: Suppose two travelers want to go from Valladolid to Siena. They can
go by plane (300 euros and 3 hours) or by bus (100 euros and 15 hours). For
traveler 1, each hour is worth 50 euros and for traveler 2, each hour is worth 10
euros. What is the total cost per each traveler? Which alternative will they
choose?
Explicit PLANE: €300 and 3 hours 100€/h
Costs BUS: €100 and 15 hours 6,67€/h
Traveller 1: 50 euros per hour (subjective value for your time)
PLANE: 50 X 3 = €150
BUS: 50 X 15 = €750
Implicit
Costs Traveller 2: 10 euros per hour (subjective value for your time)
PLANE: 10 X 3 = €30
BUS: 10 X 15 = €150
Example 1: Suppose two travelers want to go from Valladolid to Siena. They can
go by plane (300 euros and 3 hours) or by bus (100 euros and 15 hours). For
traveler 1, each hour is worth 50 euros and for traveler 2, each hour is worth 10
euros. What is the total cost per each traveler? Which alternative will they
choose?
Benefits
Traveller 1:
PLANE: Benefit = - €300 - €150 = - €450
BUS: Benefit = - €100 - €750 = - €850
Traveller 2:
PLANE: Benefit = - €300 - €30 = - €330
BUS: Benefit = - €100 - €150 = - €250
COST-BENEFIT ANALYSIS
■ Cost-benefit analysis assume that individuals decide if the benefit of
doing it is higher than its cost: B(x) > C(x)
■ Economists measure cost and benefits in monetary terms.
■ Example: “Should I stay (in bed) or should I go (to class)?” Decision
will depend on the cost of getting up and the effort of going to class.
■ Reservation price is the monetary quantity an individual would be
willing to pay (or to accept) for doing (or not doing) something
(minimum benefit for us to getting up).
■ If I love to stay in bed until late, my reservation price for going to
class is the minimum value (in money terms) that makes me
indifferent between staying in bed and attending the class.”
– How much would the class need to be worth (to me, in money
terms) so that I prefer going to class instead of staying in bed?
Wooclap - Cost-benefit vs Marginal
Example: Beach or Micro?
There is a beach near the university. The value of going to the
beach is 60 euros and the monetary costs are 40 euros
(transport, meal…).
But these are not the only costs we will have.
If we go to the beach, we will not go to work as teaching
assistant of the Microeconomics professor, and she pays 45
euros per day. We also enjoy very much working for her, and
the tasks are really interesting, so we obtain a lot of utility
every day we work.
Will we go to the beach?
Total costs are direct (40) and also the opportunity cost (45),
which sum 85 euros.
The benefit, in terms of value, are 60 euros.
MARGINAL ANALYSIS
■ Individuals are rational and decide on the margin
■ conomists assume that individuals are RATIONAL (even if in
reality this is not always the case). Instead of making all-or-
nothing choices, individuals usually decide at the margin,
comparing the additional benefits and costs of small
changes.
■ For example: an student do not decide between study 24
hours a day or not, probably students decide between
finishing homework in one hour or not.
■ A household do not decide between eating anything or going
to the supermarket. It is usually between buying one box of
strawberries or having one or two croissants for breakfast.
■ Task: Why a diamond is more expensive than water? Water is
necessary for life and the diamond not. Think on the
additional utility on the margin.
■ What would you prefer? Ten chickens and zero box of chips, or
one chicken and one box of chips?
How many movies should Brad Pitt produce this year?
Total Total Average Average Benefit
Movies MgC MgB
cost revenues cost revenue (excess)
0 0 0
1 100 300
2 200 480
3 300 600
4 400 640
Source: Frank, chapter 2
AvgRevenue (4) > AvgCost (4), but MgC (4) > MgB (4), which implies that the
movie number 4 only produces losses.
The optimum is where MgB (x*) ≥ MgC (x*) → x* =3
How many movies should Brad Pitt produce this year?
Total Total Average Average Benefit
Movies MgC MgB
cost revenues cost revenue (excess)
0 0 0 - - 0 0 0
1 100 300 100 300 100 300 200
2 200 480 100 180 100 240 280
3 300 600 100 120 100 200 300
4 400 640 100 40 100 160 240
Source: Frank, chapter 2
AvgRevenue (4) > AvgCost (4), but MgC (4) > MgB (4), which implies that the
movie number 4 only produces losses.
The optimum is where MgB (x*) ≥ MgC (x*) → x* =3
MARGINAL VS COST-BENEFIT
What type of analysis should I perform to make the following
decisions?
1. The decision to use the car vs public transport to come to
the UAM
2. How many days a week do I use the car that I always have
available?
3. I hesitate between studying Business Analytics or
Computer Engineering
4. How many hours of study do I dedicate to Basic Statistics
5. Decide whether to check my Instagram or do the exercises
in Introduction to Microeconomics
29
■ Incentives are crucial to understand how markets
work. It is important to understand that individuals
respond to incentives.
■ If the price of apples increase, people will buy less
apples and producers will hire more workers to
produce more apples.
■ Taxes to gasoline consumption induce people to
have smaller cars and more efficient ones, to use
public tranport or to commute less (Europe vs USA)
■ Law to use the seat belt: Peltzman (1975) show
that individuals are less careful and there are more
accidents (but less people died in this accidents).
Like with face masks for avoiding coronavirus (risk
of “false security”).
■ Trade can benefit all countries
Some politicians (who?) argue that trade harms their
citizens and implement protectionist policies.
However, economists generally assume that trade
tends to benefit societies:
Protectionism?
Trade wars, Trump tariffs and
protectionism explained
[Link]
32
33
34
Venezuela: the cautionary tale of
consumption-based economic policy
[Link]
venezuela-the-cautionary-tale-of- 35
consumption-based-economic-policy/
■ Trade can benefit all countries
■ The existence of trade allows for specialization of workers and
specialization increases production of each inidivudal and
increase aggregate production of the economy, benefiting
also consumers (more choices, low prices…). There are some
gains and losses too (low skilled workers in some countries…),
but in aggregate terms, benefits exceed its losses.
■ Markets usually organize well the economy…
A price is information
■ Markets usually organize well the economy…
A price is information
■ … but governments sometimes can even improve the market.
– Property rights
– Market failures:
■ Externalities: when individuals action affect others (ex:
smoking)
■ Market power: when someone is the only owner and can
influence the price (ex: the owner of a waterhole in the
city).
– Equality: education, health system, redistribution
policies…
Production Possibilities Frontier
It depicts the combinations of output of two goods (rice and motorcycles) that
the economy (Vietnam or Japan) can produce given its available resources and
technology.
A: full employment
on the PPF
B: full employment
on the PPF
C: not feasible
D: feasible with
unemployed
resources
Mobile D Marginal
phones analysis!
C
Netflix subscription
Inefficient Efficient Unattainable
■ Assumptions
– Resource or technology conditions in Vietnam give
it a production possibilities frontier (PPF) that is
biased towards rice
– Resource or technology conditions in Japan give it
a PPF that is biased towards motorcycles
■ Vietnam might have superior technology in rice
production, and Japan might have superior technology in
motorcycle production or
■ Vietnam might be better endowed in rice production
factors (land and labor), and Japan might be better
endowed in motorcycles production factors (physical
capital)
Figure 5. Demand and PPFs in Vietnam and
Japan
Task:
■ Explain how would affect the previous PPF chart the following
changes:
1. A technological progress that allows for more
production of all goods.
2. An increase in the skilled population by increasing the
number of people finishing college..
3. An increase in the number of workers due to
inmigration.
4. A decrease in the water supply
5. An improvement in the machines that produce gears.
MICROECONOMICS:
CONSUMPTION AND PRODUCTION
TOPIC 1:
INTRODUCTION
Professor: Nuria Rodríguez Priego
Dpto. Análisis Económico: Teoría Economía e Historia Económica
[Link]@[Link]
Grado en Economía y Finanzas