Intermediate Microeconomics

Sylvester Lelimo
sylvesterlelimo@gmail.com

Department of Economics
National University of Lesotho (NUL)

Lecture 1

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 Introduction Outline

What we expect to learn

What is Microeconomics?
Economics, Incentives, and Economic Models
Predicting versus Judging Behavior and Social Outcomes
The Plan of Course

Lelimo S, (NUL ) Lecture 1 Intro EC2711 2 / 18

 Introduction Outline

Outline

1 Introduction
Outline

2 What is Microeconomic Theory

3 Economics, Incentives, and Economic Models

4 Plan of the Course

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 What is Microeconomic Theory

What is Microeconomic Theory

Microeconomics is a set of models constructed with the aim of

helping us understand the process by which scarce resources are
allocated among alternative uses, and of the role of prices and
markets in this process.
It is the study of how individuals and firms make themselves as
well off as possible in a world of scarcity, and the consequences
of those individual decisions for markets and the entire economy.
Microeconomics is often called price theory to emphasize the
important role that prices play in determining market outcomes.
Microeconomics explains how the actions of all buyers and
sellers determine prices, and how prices influence the decisions
and actions of individual buyers and sellers.

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 What is Microeconomic Theory

What is Microeconomic Theory

The basic units of analysis in microeconomics are the individual

economic agents or decision-takers.
Thus, it concerns the behaviour of individual economic
actors and the aggregation of their actions in different
institutional frameworks.
The individual actor
A consumer, A Firm, and Sometimes Government

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 What is Microeconomic Theory

What is Microeconomic Theory

The behaviour
Consumers select the mix of goods and services that makes them as
happy as possible given their limited wealth.
Firms decide which goods to produce, where to produce them, how
much to produce to maximize their profits, and how to produce those
levels of output at the lowest cost by using more or less of various
inputs such as labour, capital, materials, and energy.
Government decision makers decide which goods and services the
government will produce and whether to subsidize, tax, or regulate
industries and consumers to benefit consumers, firms, or government
employees.
Institutional framework
describes the nature of and availability of options the actors have and
the outcomes they receive.

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 What is Microeconomic Theory

What is Microeconomic Theory

Most economists formulate models that are rooted in economic theory and then check to
see whether the hypotheses that emerge are rejected by real-world observations.
Some economists actually do perform experiments, but most look at data from the
real world to see whether our predictions hold.
You will learn more about how this testing of hypotheses is done if you take
statistics and econometrics courses.
In this course, you will mainly learn about the underlying theory and models
that most economists use to formulate their hypotheses.
In these models, we assume that people are rational and in pursuit of their perceived
self-interest.
“rational” means that we pick the best available course of action to achieve our
self-interested goal. For example: decion on buying a car is not only on price but
also quantity of the product, for rational consumer.
Self- interest means improving ones’s welfare or the welfare of those you care
about. For example: When buying a computer, what motivared you purchase? 1)
Brand, 2) Price, 3) Income or wealth, etc?

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 What is Microeconomic Theory

What is Microeconomic Theory

Besides trying to understand rational, self-interested behaviour, we also try

to understand the social consequences of the interaction of rational,
self-interested individual behaviour.
That is, what happens when hundreds, thousands, or even millions of
rational, self-interested individuals pursue their individual goals given that
everyone else is doing the same.
Economists call the outcome of these interactions an “equilibrium,”
and it is in this equilibrium that we find the social consequences of
individual behaviour.
That is, in pursuit of the rationality and self-interested choices, which
are guided by the impersonal forces of market prices that tell
individuals where to work, what to produce, whom to sell to, etc.

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 What is Microeconomic Theory

What is Microeconomic Theory

Understanding when we can rely on individual self-interest to

give rise to cooperation—and when such self-interest impedes
cooperation—is one of the central goals of microeconomics.
For instance, we will get to understand why poverty persists,
how markets are distorted, and how some goods might never
get produced unless non-market institutions intervene.
With such an understanding, we can then formulate ways of
changing the circumstances in which decisions are made to bring
those decisions more in line with social goals:
to change the social consequences of rational, self-interested
behaviour by altering the incentives people face along the way.

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 Economics, Incentives, and Economic Models

Economic Models
Economics is then all about an exploration of the simple premise
that people respond to incentives because they generally
attempt to do the best they can given their circumstances.
Economics simply tries to provide a framework for systematically
studying aspects of human decision making that relate to our
desire to pursue our perceived self-interest in different
institutional settings, and how such self-interested decision
making affects society as a whole.
Economic models therefore are constructed to strip away all the
complexity, all the noise that gets in the way of a sound analysis
of particular economic problems and leave us with the essence of
individual decision making that matters for the questions at
hand.
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 Economics, Incentives, and Economic Models

Economic Models

Models, regardless of what they aim to predict, thus do not have to be

realistic. They can be, and it sometimes might help our understanding if
they are.
But at the same time, not all aspects of economic models need to be
fully realistic.
The models we’ll be using are specialized in some sense, but they are
general in the sense that each model can be applied to many different
real-world problems.
We use the framework of economics to develop skills that allow you to
translate knowledge across time and space.
Economics is one of the disciplines that can signal mastery of
conceptual thinking, and it furthermore provides an interesting
platform on which to develop such mastery.

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 Economics, Incentives, and Economic Models

Predicting vs Judging Behavior

What is the real point of these models, these simplified versions of
reality?

The point for most economists is to predict behaviour, and to

predict the social consequences of that behaviour.
Thus, a model is then “good” if it predicts well.
The self-interested goals individuals pursue matter in the
analysis because they help us predict how behaviour will change
as circumstances change.
What matters for predicting what you will do if I raise the price
of is how much you desire paraffin, not whether it is morally
good or bad to desire paraffin.
Whether it might be “good” or “bad” to raise the price of
paraffin is a very different question.
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 Economics, Incentives, and Economic Models

Positive Economics

The branch of economics that concerns itself primarily with such predictions
is known as positive economics.
The Objective is to predict what will actually happen as incentives
change, not make value judgments.
If you are a policy maker who is attempting to determine the best way
to lower infant mortality or provide a more equitable distribution of
educational opportunities, it is important to get the best positive
economic analysis of each of the policy alternatives you are
considering.
It is important to know what the real impact of each policy will
be before we attempt to choose the “best” policies.
The same is true if you are a business person who tries to price your
goods; you need to know how people will actually respond to different
prices.

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 Economics, Incentives, and Economic Models

Normative Economics

Normative economics that goes beyond a value-free analysis of what

will happen as incentives change.
Once the positive economist tells us his or her best prediction of
what will happen as a result of various possible policy alternatives,
a normative economist will try to use tools that capture explicit
value judgments about what outcomes are “good” and what
outcomes are “bad” to determine which of the policies is the
best for society.
In this course we are concerned with positive economics by
attempting to build a framework through which we can predict the
impact of different institutions on individual decision making.

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 Economics, Incentives, and Economic Models

Efficiency
We will define a situation as efficient (or Pareto efficient) if there is no
way (given the resources available) to change the situation so as to make
some people better off without making anyone worse off.
We will consider someone to be better off if she thinks she is better
off, and we will consider someone as worse off if he thinks himself
worse off
An inefficient situation is one where we can see how to make some people
better off without making anyone else worse off. But we should also be
careful not to assume immediately that moving toward greater efficiency is
always “good”.
A policy that increases the wealth of the rich by a lot while leaving the wealth of
the poor unchanged is probably a policy that moves us to greater efficiency, as is a
policy that makes the poor a lot wealthier while leaving the wealth of the rich
unchanged.
Allowing a healthy poor person to sell his or her kidney to someone who needs it
and can pay a lot for it may indeed make both of them better off, and yet there
are many who would have moral concerns over such transactions.

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 Plan of the Course

Individual Choice

Chapters 2 through 10 are therefore devoted to building the basic model

used by economists to investigate choices made by individuals in their roles
as consumers, workers, and people who plan for the future (savers and
borrowers).
Individuals are viewed as having tastes—over different kinds of goods,
over leisure and work, over consuming today and making sure they
can still consume in the future. In general, they would like to have
more of everything, but they are constrained by limited resources such
as income and time.
As a result, they try to “do the best they can” given the economic
circumstances and incentives they face.

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 Plan of the Course

Competitive Firm Choice

Chapters 11 through 13 then focus on the choices made by individuals in
their roles as producers (or “firms”).
The analysis of competitive firm choice then leads to the concepts of
supply curves (or functions) for goods as well as demand curves (or
functions) for labor and capital.
Chapters 14 through 16 brings consumers and producers together in competitive market
settings where individuals behave non-strategically.
That is, the settings is such that individuals have no impact on the economic
environment in which they make decisions because each individual is a very small
part of what generates that environment.
It is in such idealized settings that economists have arrived at a powerful insight:
Under certain circumstances, self-interested behavior is not inconsistent with the
collective “good,” and markets can generate socially desirable outcomes that could
not be achieved under government planning.
This insight, known as the First Welfare Theorem. The insight tells us that
markets are “efficient” under certain circumstances but may need
“correction” under others. (This is sometimes referred to as the "invisible
hand” of the market.)

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 Plan of the Course

Distortions of the “Invisible Hand” under

Competition

Chapters 18, 19 & 21, 23, 24 & 25 focuses on instances when

competitive markets fail to produce efficient outcomes.
This can happen when market prices are “distorted” through
policies like price controls or taxes.
Inefficiencies can also arise in competitive markets when our
actions in markets have direct “externality” costs or benefits for
nonmarket participants, as when production decisions result in
pollution.

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