Econ 101Introduction to Microeconomics

•Why study Economics?

•What’s it all about?

Lorne Priemaza, M.A.

Lorne.priemaza@ualberta.ca

What’s it all about?• Not: business or finance• Not: the stock market

• Economics examines issues from a social perspective : Social Science– Analysis of human behavior– Close relative of psychology and sociology

• Economics = Social Studies + Math

DEFINITION

• 1. ECONOMICS– The study of how individuals &

societies allocate limited resources to satisfy unlimited wants

– The study of how choices are made & coordinated

What’s it all about? SCOPE

• MICROECONOMICS

– scarcity– supply & demand

• markets• consumer• producer• changes/impacts

– efficiency– technology– resources

• MACROECONOMICS

– business cycles– unemployment/

employment– inflation– trade,

international markets (global economy)

SCOPE

• MICROECONOMICS

– The study of the decisions and interactions of individual people & businesses, & the effects of government regulation & taxes on prices & quantities of goods & services.

• MACROECONOMICS– The study of the

national economy & the global economy, the way that overall economic variables fluctuate & grow, & the effects of government actions on them.

DEFINITION

• 1. ECONOMICS

– The study of the problems that arise from scarcity, & of the institutions that resolve the inescapable conflicts over the uses of scarce resources.

DEFINITION

•2. ECONOMIC RESOURCES:

–people or things that possess the ability to help produce commodities (goods & services) that people value.

DEFINITION

•2. ECONOMIC RESOURCES:

– i) LAND (natural resources) : sites : productive items on or under the earth’s surface

DEFINITION

• 2. ECONOMIC RESOURCES:

– ii) LABOUR :productive people

& their efforts to produce goods

& services

DEFINITION

• 2. ECONOMIC RESOURCES:

– iii) PHYSICAL CAPITAL – all human made items used to produce goods & services.

(produced means of production)- ie:ie: Computers and Factories– not:not: Money

DEFINITION

• 2. ECONOMIC RESOURCES:

– iv) HUMAN CAPITAL – characterization of the education and training of workers

(productivity of workers)- ie:ie: years of university or years of job experience or innate ability

• 2. ECONOMIC RESOURCES:

– v) Other: ENTREPRENEURIAL ABILITY :the innovator, the risk bearer,

the initiator

DEFINITION

RETURNS TO RESOURCES

• Rent, Wages, Interest, Profit:

– Rent is income earned by land– Wages are income earned by labour– Interest is income earned by capital– Profit is income earned by

entrepreneurs

DEFINITION• 3. Scarcity

•Peoples’ wants are greater than the economy’s ability to produce desirable goods & services

‘scarcity’ scarce (limited) resourcesunlimited wants (always want more)

Scarce Resources + Unlimited Wants = Choice

Scarcity ≠ Poverty• A homeless man who wants to eat

but cannot faces scarcity

• A university student who wants to own a Mustang convertible but cannot faces scarcity

• A millionaire who wants to be Prime Minister but cannot faces scarcity (only one spot available)

Scarcity CHOICES

1.)WhatWhat do we do with our scarce resources?

2.)HowHow do we make the best use of our resources? (Efficiency)

3.)ForFor WhomWhom will things be produced? (Who will get what is available?) (Equity)

“Scarcity” necessitates a “rationing device” - which guides choices.

Prices are the “rationing device” in our Economy

Prices direct scarce resources to their most valued uses.

Rationing

Sometimes market forces alone do the rationing, sometimes other forces are operating as well;

E.g. legal

moral

social

Rationing

1.Terminology (definitions)

2.Economic Thinking/Reasoning

3.Economic Principles/Theory

4.Economic Policy Options

5.Economic Institutions

Basics: 1.) Terminology

• The language of Economics.• The world through “economics” glasses

• You need to learn French to participate in a French literature class

• You need to learn chemical notation to succeed in Chemistry

• You need economic language to understand Economics

Basics 2.) Economic Reasoning

• Choices made under conditions of scarcity involve tradeoffs: – advantages and disadvantages: costs and

benefits: incentives and disincentives.

• Economic reasoning is making decisions by comparing costs and benefits.

The Rationality AssumptionAn individual makes decisions based on

maximizing his or her own self-interest.

Therefore

People do not intentionally make decisions that would leave them

worse off

Non-Satiation AssumptionMore goods are always preferable to

fewer goods; people are never satiated

People will always pick a job with the highest wage

People will always eat 10 pieces of pizza instead of 1

Costs and Benefits

• The relevant costs and benefits to economic reasoning are the expected incremental or additional costs incurred and the expected incremental or additional benefits of a decision– That is only the costs and benefits that will

be affected by the decision are considered– ADDITTIONAL costs or ADDITIONAL

benefits

Marginal Cost, Marginal Benefit

• M.C.(marginal cost) is the extra cost associated with the additional activity….

• M.B.(marginal benefit) is the extra benefit associated with the additional activity….

• $’s are used to measure these in order to facilitate comparisons

No Sunk Costs•Sunk Costs

– Have already been incurred and will not change as a result of the decision you are about to make.

– Represent past decisions.

– Are therefore not counted in a cost benefit decision

– Ie: Cost of factory, rental costs, training costs, membership costs

ECONOMIC DECISION MAKING RULE:

(COST/BENEFIT)•If the benefits of an action exceed the costs

DO IT

•If the costs of an action exceed the benefits

DON’T DO IT

•In the case of more than one alternative

CHOOSE THE ACTION WITH THE GREATEST NET ADVANTAGE

Opportunity Cost

• The basis of economic cost benefit analysis

• When a choice is made in favour of one alternative, another alternative is given up

• The next best alternative that is given up when a choice is made is called the

opportunity cost of the choice.

THE OPPORTUNITY THE OPPORTUNITY COSTCOST of an action is of an action is

the the next bestnext best foregone alternative.foregone alternative.

Cost Benefit Exercise:Example of economic decision

making in action: Should I Go To University?

• Consider the “marginal” costs: and the “marginal” benefits of this decision.

• Consider the Opportunity Cost

Opportunity Cost ExampleCost of 1 year of University:

Tuition: $5000

Books:$500

Opportunity Cost of 1 year University:

40 hr/week, 50 weeks/year,

$20/hour $40,000

Total University Cost: $45,500

Basics: 3.)Theory• Simplified statement/ generalization about some part

of the economy, based on assumptions– Assumptions define the circumstances under which

a theory is likely to apply• ceteris paribus assumption -everything else

held constant

• Abstraction from reality• Helps us to understand/explains some part of the

economy

Theory Assumptions

Set the StageSet the Stage

SimplifySimplify

•AssumptionsWhy make Assumptions?

In order you understand a theory, you must understand the assumptions underlying the theory.

• Method– observe patterns in raw data

• generalize about the observed pattern

• Model:– name for more specific statement of a

theory

Theory

Testing Theories

• It is wrong to judge the validity of a theory on the basis of

• the “unrealistic” assumptions.• how closely it represents reality.

• A model is “good” if it yields usable predictions and explanations of the real world – when a model is no longer supported by factual evidence,

it is “no good” – we need a new theory

Basics: 4) Policy

• In order to carry out effective policy, the policy maker must understand how the economy works

• The is called POSITIVE ECONOMICS;; The economics of facts & theory

-ie: Minimum wage increase causes unemployment increase

Basics: 4) Policy

• In order to conduct policy, the policy maker must have some goals in mind

•NORMATIVE ECONOMICS is the study of what the goals of the economy should be

--ie: We should lower the minimum wage in order to lower unemployment

Basics: 4) Policy

• Formulated to achieve the normative GOALS for the economy– Efficiency: use all our resources, (full

employment), use them in the best way possible.

– Equity in the distribution of income

– Economic GrowthGrowth– Stability: stable prices, stable growth

– Full Employment: Everyone looking for a job finds one fairly quickly

Basics 5.) Economic Institutions

• EconomicEconomic InstitutionsInstitutions emerge from a complicated combination of historical circumstance & economic, cultural, social & political pressures.

• Corporations, governments and cultural norms are all economic institutions. They differ significantly among nations

• Institutions give models context