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ECONOMICS 201 INTRODUCTION TO MICROECONOMICS Spring 2001 Introduction slide 1

ECONOMICS 201

INTRODUCTION TO

MICROECONOMICS

Spring 2001

ECONOMICS IS ABOUT

DECIDING

Economists do not restrict themselves to considering only decision problems involving money and markets, though that is a big part of economics.

EXAMPLES OF SOME

DECISIONS ECONOMISTS HAVE ANALYZED

Whether to buy a car this week.

Whether to have pizza for dinner tonight, or something else.

Whether to marry your sweetheart. How hard to study for this course. Whether to go to college, and if so, which one.

Whether to buy a lottery ticket in the Michigan

lottery.

Factors in decision making

  • 1. People face tradeoffs.

  • 2. Opportunity cost.

  • 3. Making decisions at the margin.

  • 4. People respond to incentives.

How individual decisions affect

others

  • 5. Trade (exchange) can benefit everyone.

  • 6. Markets are often a good way to organize exchange.

  • 7. Government can sometimes improve on markets.

MICROECONOMIC AGENTS

Firms

Produce and sell goods and services Buy inputs (labor, capital & raw materials)

Consumers

MICROECONOMIC AGENTS Firms – Produce and sell goods and services – Buy inputs (labor, capital &

Buy goods and services Sell inputs (labor services, loanable funds)

MICROECONOMIC AGENTS Firms – Produce and sell goods and services – Buy inputs (labor, capital &

Methodology: Positive v.

Normative Economics

Positive econ. -- Studies the way the world is.

How much will a new gasoline tax raise the price of

gasoline? Will an increase in the minimum wage increase unemployment? Why is the price of corn $4.20 per bushel?

How much will a drought in the corn belt raise the price of corn? Of wheat?

What will be the effect on Byron Brown’s pizza

consumption if we take $1000 away from Tom Izzo and

give it to Brown?

Methodology: Positive v. Normative Economics

Normative econ. -- Studies the way the world should be.

Should there be a new tax on gasoline? Should there be an increase in the minimum wage?

Should $1000 be taken from M. Peter McPherson and

given to Byron Brown? What should the price of corn be?

Models and theories

Model -- a hypothesis about the relationships among variables. Everyone uses models. Because a model abstracts from reality it makes mistakes.

Models can contain two kinds of errors or mistakes:

the wrong explanatory variables may be included. the functional form may be incorrect.

Contents of models

List of variables, especially a clear statement of what is to be explained

Dependent v. independent variables

Hypothesized relationships among the variables.

Using tables of values, graphs, or equations.

A model of heights

height

a

H A
H
A

H = a + b(A)

b = H/A

age in years

A better (nonlinear) model of

height

heights

naive

fancy
fancy

(linear)

age in years

A better model?

Height = f(age, gender, parents’ heights,

nutrition,

...

)

Gender effects in the better

model

Height = f(age, gender, parents’ heights,

nutrition,

...

)

height

men women age
men
women
age

MODEL SUMMARY

Three ways to describe models

Graphs Tables of values Mathematical functions (equations)

Important concepts

Dependent and independent variables

Linear function, intercept and slope

AN ECONOMIC MODEL

The Production Possibility Curve

Purposes of model Show scarcity constraint Illustrate economic efficiency Introduce opportunity cost concept

Variables

Quantities of goods that may be produced Givens

Total amounts of inputs available

Technology of production

PPF DEFINED

The Production Possibility Curve (or frontier)

shows the maximum amount of a good you

can produce given the amounts of other

goods produced, and given the total

amounts of inputs available, and given the

technology of production.

PPC EXAMPLE

Assumptions:

There are only two goods, pizza and spaghetti. There are limited inputs and given technology of production.

Definition:

The PPC shows the maximum amount of pizza you can produce, given the amount of spaghetti to be produced.

PRODUCTION POSSIBILITY

SPAGHETTI

CURVE

400 300 Which points are attainable and which points are unattainable? 200 100 0 0 10
400
300
Which points are attainable
and which points are unattainable?
200
100
0
0
10
20
30
40
50
60

Introduction

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PIZZA

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PRODUCTION POSSIBILITY

SPAGHETTI

CURVE

What’s the effect of an improvement 400 in the technology for producing spaghetti? 300 200 100
What’s the effect of an improvement
400
in the technology for producing
spaghetti?
300
200
100
0
0
10
20
30
40
50
60

Introduction

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PIZZA

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PRODUCTION POSSIBILITY

SPAGHETTI

CURVE

What’s the effect of an increase in 400 total resources (inputs)? 300 200 100 0 0
What’s the effect of an increase in
400
total resources (inputs)?
300
200
100
0
0
10
20
30
40
50
60

Introduction

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PIZZA

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Points “inside” the PPC are inefficient.

For any point “inside” there corresponds some

point that represents more production of

both goods.

Note that while points on the PPC are efficient, we cannot say at this time whether

some are better for society than others.

OPPORTUNITY COST DEFINED

The opportunity cost of doing something is what you must give up in order to do it.

The cost of a pizza is what you must give up to consume it, which in this case is easily computed in money.

The cost of a college education includes both money and

other foregone alternatives. For example, the cost of a

year at MSU includes not only tuition and books, but the income you could have earned working on a full time job.

The cost of attending a Lugnuts baseball game includes

the value of the time you could have spent studying

economics.

The PPC can show opportunity

cost

Suppose you are at some point on a PPC. Then suppose you want to consume one more pizza.

The opportunity cost of one more pizza is the amount of spaghetti you must give up in order to get it.

Note that this opportunity cost is equal to minus the slope of the PPC.

PRODUCTION POSSIBILITY

SPAGHETTI

CURVE

400 300 More pizza means less spaghetti 200 100 0 0 10 20 30 40 50
400
300
More pizza means less spaghetti
200
100
0
0
10
20
30
40
50
60

PIZZA

OPPORTUNITY COST

INCREASES AS MORE OF A GOOD IS PRODUCED

Not only does more pizza mean less spaghetti,

but each additional pizza costs more than the one before it.

This idea shows up as the PPC being concave to the origin. (The curve bows out.)

Introduction

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Production Possibility Curve

SPAGHETTI

400 300 Opportunity cost of more pizza is constant. 200 100 0 0 10 20 30
400
300
Opportunity cost of more pizza is
constant.
200
100
0
0
10
20
30
40
50
60
PIZZA
Introduction
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We will use Production Possibilities Curves

that are straight lines (i.e., that have constant opportunity cost) to illustrate some

important economic principles.

Introduction

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