Principles of Microeconomics

LUMS
Fall-18
Basic Principles of Microeconomics
• Economics agents engage in purposeful behavior:
– People respond to incentives.
• Economic agents think on the margin:
– People evaluate trade-offs based on marginal (incremental)
benefits and costs of their choices.
– Do sunk costs matter?
• Economic agents account for opportunity costs whilst
making their choices:
– Opportunity costs mean that accounting and economic profits
are not the same.
– What are the costs and benefits of acquiring an MBA?
 An Economists’ Worldview
• Market Economy: An economic system where resources are allocated
through the “decentralized” decisions of households and firms.
 Economists’ Worldview
• Prices emerge from the interaction between consumers
and producers in a market economy.
• Prices coordinate economic activity in market economies
by conveying information about:
– What to produce? How much to produce? How to produce? For
whom to produce?
• Invisible Hand: By acting in one’s own self interest each
economic actor leads the economy towards the best
possible outcome.
– Fails under conditions of Imperfect Competition, Information
Asymmetries, Externalities and Provision for Public Goods.
 Semantics of Economics
• Branches of economics:
– Microeconomics: deals with the behavior of individual economic
agents in markets.
– Macroeconomics: deals with aggregate economic variables.
• Types of microeconomic analysis:
– Theory: Build models to understand social phenomena.
– Empirics: Analyze data to test predictions of models.
• Positive versus Normative Economics:
– Why things are a certain way? Build models and use data to
understand mechanisms behind observed data.
– How things should be? Values determine the ideal state of the
world and policy interventions used to realize this ideal.