Principles of Microeconomics

Principles of Microeconomics Chapter 1 Limits, Alternatives & Choices By Dr. Laura Lamb & material from McConnell, Brue, Flynn & Barbiero

Economics (definition) • The social science concerned with how individuals, institutions, and society make best choices under conditions of scarcity.

1.1. The Economic Way of Thinking The economic way of thinking (aka economic perspective) consists of numerous elements: • Scarcity & choice • Purposeful behaviour • Marginal Analysis

Scarcity & choice • What is scarce? • What are resources? • The concept of opportunity cost: the next best alternative foregone.

Scarcity & choice • The concept of opportunity cost: the next best alternative foregone. • What is the opportunity cost of attending this class today? • Illustrates that there is no free lunch!

Purposeful behaviour • Rational self-interest entails making decisions to achieve maximum satisfaction i.e. the economic concept of utility. • Different preferences and circumstances lead to different choices. • Rational self-interest is not the same as selfishness.

Marginal Analysis • the comparison of marginal benefits and marginal costs, usually for decision making. • Most decisions are made on the margin.

1.2 Theories, Principles & Models • Economics uses scientific method • Observe real world behaviour & outcomes • Based on observations, formulate a hypothesis • Test the hypothesis • Accept, reject, or modify the hypothesis based on testing • Continue to test against facts

Scientific method • If hypothesis is supported in many trials, the theory becomes an economic principle or economic law. • These economic principles are incorporated into models • Economic theories are developed to explain the behaviour of economic agents

Three Important facts about economic principles • Generalizations • Other-things-equal assumption (aka ceteris paribus) • Graphical expression

1.3 Microeconomics vs. Macroeconomics • Microeconomics looks at specific economic units • Macroeconomics examines the economy as a whole

Positive and Normative Economics • Positive economics describes the economy as it actually is. • Normative economics involves value judgments about what the economy should be like and the desirability of the policy options available.

Which headlines are microeconomics & which are macroeconomics? • The total revenue of Ford Motor Company have risen over the past 2 years. • The unemployment rate remains high at the end of 2012. • The price of gasoline continues to be volatile. • Sears is closing several store locations in 2012. • Inflation rates are relatively low.

Are the following statements normative or positive? • The unemployment rate is 7.2%. • The provincial governments should spend more on health care. • The unemployment rate remains lowest in Alberta. • The price of asparagus is too high.

1.4 The economic problem • The need to make choices because society’s material wants for goods and services are unlimited but the resources available to satisfy these wants are scarce. • The economic problem is experienced by individuals & society as a whole.

Individuals’ economic problem • Individuals are confronted with the need to make choices because their wants exceed their means to satisfy them. • Limited income – everyone, even the most wealthy, has a finite amount of money to spend. • Unlimited wants – people’s wants are virtually unlimited.

The combination of limited income and unlimited wants force us to choose those goods and services that will maximize our utility. • A budget line is used to illustrate the individual economic problem.

Budget Line • A schedule or curve that shows the various combinations of two products a consumer can purchase with a specific money income. • Used to identify attainable & unattainable bundles of products. • The budget line can change. When?

Society’s Economic Problem • Scarce resources • Resource categories: land, labour, capital, & entrepreneurial ability

1.5 Production possibilities model • Assumptions of the model: • Economy is employing all available resources. • Available supply of resources is fixed in quantity and quality at this point in time. • Technology is constant during analysis. • Economy produces only two types of products. Choices will be necessary because resources and technology are fixed. A production possibilities table illustrates some of the possible choices.

Production Possibilities Table

Law of increasing opportunity costs • The PPC illustrates increasing opportunity costs

PPC Questions ??? • What is the total opportunity cost of producing 3 units of butter? • When at Production alternative B, what is the opportunity cost of producing 1 more unit of butter? • Is the production of 3 units of butter & 3 units of guns attainable? • Is the production of 3 units of butter & 7 units of guns attainable?

What is the economic rationale for increasing opportunity costs?

Optimal allocation • How does society decide its optimal point on the production possibilities curve? • Use marginal analysis

1.6 Economic growth, present choices & future possibilities • Other uses of the PPC

Pitfalls to sound reasoning • Biases • Loaded terminology • Fallacy of composition • Causation fallacies • Post hoc fallacy • Correlation versus causation

Review • The textbook website offers many practice questions to test your understanding of the economic concepts. • Also, do the appendix study questions of graphing.

Principles of Microeconomics