Econ 2: Microeconomics 6/18/2021

Introduction to Economic Theory Resources

Economics - Are inputs of production

- Broadly classified into: economic resources (the
The science of efficient allocation of scarce resources
command a price) and free resources
- Science – Economics follows scientific method (otherwise)
- Efficiency – making the most with minimum - Main characteristic
wasted effort or expense (not yet done)
- Scarcity – limited nature of society’s resources
Human Needs and Wants
Economics as a Science/Scientist Characteristics:
- It uses models - Unlimited, varied and insatiable
Models may be in the form of: Origins:
 Graphs, Diagrams - Survival
- Dictated by culture
E.g., demand and supply curves; utility and cast
- Generated by activity necessary to satisfy other
curves
needs and wants
 Equations
The Economist as a Policy Adviser
E.g., demand and supply equations; utility and cost
Positive vs. Normative Analysis
equations
Positive Statements
 Economic models
 Diagrams and equations - Attempt to prescribe how the would should be
 Omit many details - Prescriptive
 Allow us to see what’s truly important
Example: The government should allocate much of its
 Built with assumptions
budget on fighting terrorism
 Simplify reality to improve our
understanding of it Based on a person’s subjective judgment, and others
may not agree with it.
Example of an Economic Model
(not yet done)

- Apart from firms, we have banks, government

and foreign countries that affect economy
- It tells us about the interaction and flows of
both the firms and households
Econ 2: Microeconomics 6/18/2021

Basic Economic Problems

1. What goods and services to produce?

Econ 2: Microeconomics 6/18/2021
HOW PEOPLE MAKE DECISIONS

6/21/2021  Marginal benefits

- Additional benefits
Ten Principles of Economics
 Marginal costs
Principle 1: People face trade-offs - Additional costs
 Rational decision-maker
- Making decisions (making one choice means
- Takes action only if:
losing something else, usually forgoing a benefit
- Marginal benefits > marginal costs
or opportunity.)
 Trade-off one goal against another Principle 4: People respond to incentives
 Student-time
 Incentive
 Parents – income
 Something that indicates a person to act
 Society
 Higher price
- National defense vs. consumer goods
- Buyer – consume less
- Clean environment vs. high level of income
- Sellers – produce more
 Public policy
- Change costs or benefits
Environmental Kuznets Curve
- Change people’s behavior
(photo to be posted)

- There is direct relationship between income

Principle 5: Trade can make everyone better off
and resource use or waste emissions
- It is predicted that certain level of income is  Trade
achieved, the lesser the use of resources - Allows each person to specialize in the activities
he or she does best
- Enjoy a greater variety of goods and services at
Principle 2: The cost of something is what you give up lower cost
to get it

 People face trade-offs

- Make decisions
Compare cost with benefits or alternatives
 Opportunity cost
- Whatever must be given up to obtain one item
Principle 3: Rational people think at the margin
 Rational people
- systematically and purposefully do the best
they can do to achieve their objectives (knows
her interest and tries to maximize the best that
she can do to achieve that interest)
 Marginal changes
- Small incremental adjustment to a plan of
action (as long it benefit you, go for that
particular decision)
Principle 6: Markets are usually a good way to organize
economic activity
 Communist countries – central planning
 Government officials (central planners)
 Allocate economy’s scarce resources
- What goods and services were produced
- How much was produced
- Who produced and consumed these goods and
services
How people interact
 Market economy – allocates resources
- Through decentralized decisions of many firms
and households
- As they interact in markets for goods and
services
- Guided by prices and self-interest
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 Adam Smith’s invisible hand”
 Households and firms interacting in markets
Principle 9: Prices rise when the government prints too
- Acts as if they are guided by an “invisible hand”
much money
- Leads them to desirable market outcomes
 Corollary: Government intervention  Inflation – an increase in the overall level of
- Prevents the invisible hand’s ability to prices in the economy
coordinate the decisions of the household and  Causes for large/persistent inflation
firms that make up the economy - Growth in quantity of money
- Value of money falls
Principle 7: Government can sometimes improve
market outcomes

 We need government Principle 10: Society faces a short-run trade-off

 Enforce rules and maintain institutions between inflation and unemployment
- Enforce property rights
 Short-run effects of monetary injections:
 Promote efficiency
 Stimulates the overall level of spending
- Avoid market failure
- Higher demand for goods and services
 Promote equality
 Firms – raise prices; hire more workers; produce
- Avoid disparities in economic well-being
more goods and services
How people interact  Lower unemployment (normal 6%
unemployment)
- Causes for market failure
- Externality – impact of one person’s actions on
the well-being of a bystanders
- Market power – ability of a single economic
actor (or small group of actors) to have a
substantial influence in market place

 Disparities in economic well-being

 Market economy rewards people
- According to their ability to produce things that
other people are willing to pay for
 Government intervention: Public policies
 May diminish inequality
 Process far from perfect

HOW THE ECONOMY WORKS AS A WHOLE

Principle 8: A country’s standard of living depends on its

ability to produce goods and services

 Large differences in living standards

- Among countries
- Over time
 Explanation: difference in productivity