Chapter 1

PreliminariesPreliminaries

Economics

Economics is the study of production and consumption of goods and services with the utilization of minimum resources.

Economics is divided into three school of thoughts:

Classical School of Thought

Neo-Classical School of Thought

Modern Economics

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Classical School of thought

The Scotland economist Adam Smith was first economist who gave the idea and define the economics as “Economics is the study of production or earning of money, distribution and interchange of money”.

Many other economists support this idea e.g. J.S. Mill, Recordo and Walker of American Economist. But after the some time many people put objection on this idea and named it the knowledge of diamal sciences and pig philosophy.

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Neo-Classical School of Thought

Due to the objection on Adam Simith idea and his followers then Dr. Marshal introduce the economics as “it is the knowledge of welfare and named it welfare economics”

After that Prof. Robens and many other economists objected that this definition limited that only cover the concept of human welfare.

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Modern Economics

According to Prof. Robens “Economics is the knowledge of human behavior and relationship between interchange of goods or services to get maximum benefit under the utilization of minimum resources”

According to Keynes “Economics is the knowledge which give the opportunities of earnings due to the utilization of minimum resources and enhance the income of the economy”

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Preliminaries

Microeconomics deals with:Behavior of individual units

When Consuming• How we choose what to buy

When Producing• How we choose what to produce

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Preliminaries

The Linkage Between Micro and Macro-economicsMicroeconomics is the foundation of

macroeconomic analysis

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Theories and Models

Microeconomic AnalysisModels:

a mathematical representation of a theory used to make a prediction.

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Positive Versus Normative Analysis

Positive AnalysisPositive analysis is the use of theories and

models to predict the impact of a choice.

Normative AnalysisNormative analysis addresses issues from the

perspective of “What ought to be?” A normative statement expresses a judgment about whether a situation is desirable or undesirable

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What is a Market? Markets

The interaction of consumers and producers

A geographically defined area where buyers and sellers interact to determine the price of a product or a set of products.

Markets vs. IndustriesIndustries are the supply side of the market.

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What is a Market? Arbitrage

Buying a product at a low price in one location and selling at a high price in another

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What is a Market? Competitive vs. Noncompetitive Markets

Competitive MarketsBecause of the large number of buyers and

sellers, no individual buyer or seller can influence the price.

Example: Most agricultural markets

Noncompetitive MarketsMarkets where individual producers can

influence the price.

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What is a Market?

Market PriceCompetitive markets establish one price.

Noncompetitive markets may set many prices for the same product.

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Real Versus Nominal Prices

Nominal price is the absolute or current dollar price of a good or service when it is sold.

Real price is the price relative to an aggregate measure of prices or constant dollar price.

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Real Versus Nominal Prices

Calculating Real Prices

yearcurrent yearcurrent

yearbase Price Nominal x CPI

CPI Price Real

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An Example:Calculating the Real Price of Milk

1970 .40 38.8 .40 = 38.8/38.8 x .40

1980 .65 82.4 .31 = 38.8/82.4 x .65

1999 1.05 167.0 .24 = 38.8/167.0 x 1.05

Nominal Price Real Price of MilkYear of Milk CPI in 1970 dollars

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Calculating Real Prices:An Example - Eggs & College

Consumer Price Index(1983) 38.8 53.8 82.4 107.6 130.7 163.0

Nominal PricesGrade A Large Eggs $0.61 $0.77 $0.84 $0.80 $0.98 $1.04College Education $2,530 $3,403 $4,912 $8,156 $12,800 $19,213

Real Prices ($1970)Grade A Large Eggs $0.61 $0.56 $0.40 $0.29 $0.30 $0.25College Education $2,530 $2,454 $2,313 $2,941 $3,800 $4,573

1970 1975 1980 1985 1990 1998

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Summary

Microeconomics is concerned with the decisions made by small economic units.

Microeconomics relies heavily on the use of theory and models.

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Summary

The market price is established by the interaction of buyers and sellers.

A market’s geographic boundaries and range of products must be defined.

To reduce the effects of inflation we measure real prices, rather than nominal prices.

Thanks