Chapter 1 page 1

Chapter 1: Economics and Institutions

Microeconomics: Many possible definitions
n
• [Def Frank-Parker] Microeconomics studies the choice of
individual agents under ________and the consequences of
these decisions

“The study of how people choose under conditions of scarcity.”

n
• [Alternative def ] how do individuals, in an attempt to
maximize their own self-interest, create a set of economic
institutions that structure their daily lives?
► Here, institution implies a convention of behaviour that
society has created to resolve a recurrent “problem”…
► OR a set of rules that constrain the _________of social
agents in particular situations…
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“Unlimited _____, limited resources.”

Scarce resources:

►____
►Money
►Energy
►Capacity

☻Primarily, human behaviour is driven by “scarcity and _____.”

The concept of choice leads directly to the weighing of marginal costs

and marginal benefits:
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Overview Intermediate Microeconomics 1

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When faced with making a decision or choice, economists decide by

employing cost-benefit analysis or ________ analysis.

We denote C(x) costs, B(x) benefits and x the situation to undertake or

not.

If B(x) > C(x), do x.

Of course, to apply this rule, we need some way to define and measure
cost and ________.

In terms of monetary value, this is simple. However, there are many

situations that have nothing to directly do with money.

For most decision, at least some of the _______or costs will be readily
available in monetary terms.
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What is Microeconomics?

A common rule → “If something is good, do more of it”

• This is called the cost-benefit approach (Section 1.1)
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Section 1.3: Three pitfalls of the cost-benefits approach

• Pitfall 1: Ignoring ___________ costs

Ignoring Implicit Costs:

Explicit costs are not the only costs of an activity.

____________ costs must not be ignored.

Opportunity cost is the “cost of taking an action as measured

by the benefit forgone by not taking the best alternative
action.” (FP, page 5)
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• Pitfall 2: Failure to ignore ____ costs

Some explicit expenditures that seem like a relevant cost are

actually not.
►These are costs that cannot be recovered at the moment
a decision is made.
►These costs should be ignored.

• Pitfall 3: Failure to realize the working of the ______

We look at the ______ to determine the extent of an action.

▪The cost-benefit rule tells us to keep increasing the level of

an activity as long as its marginal benefit is greater then its
marginal cost.

►However, individuals often fail to follow this rule.

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Number of boats Total Benefit Marginal Benefit Marginal Cost Average Benefit
(3) (cost per boat is (4)=(2)/(1)
(2) $100)
0 0 0
___ 100
1 300 300
___ 100
2 480 240
___ 100
3 600 200
____ 100
4 640 160

►MB > MC until we add a fourth boat

►Should only acquire 3 boats

►Average benefit is maximized at 1 boat.

►That amount would not maximize profit.

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What is Microeconomics?

Study hints Chapter 1

• Read this chapter and re-read it at least twice more during
the term. The Chapter makes more sense as we go along

• Maybe the catch-all phrase of the chapter is: “Individual agents

respond to __________.” These incentives may conflict with the
interest of others and even society as a whole (see for example
Section 1-4 and Economic Naturalist 1-2)

• During your entire studies at UVic and beyond: try to be an

economic naturalist!