Economics: Magalie DUBOIS

Introduction
magalie.dubois@bsb-education.com
Preamble: I say "economics", you say…
Objectives of this course

1. Define Economics and distinguish between

microeconomics and macroeconomics

2. Define the three biggest ideas of economics

3. Explain the key ideas that define the economic

way of thinking
Structure of this course

• Nine class sessions of three hours

• Five Microeconomics
• Exam Microeconomics / 2h / 50%
• Four Macroeconomics
• Exam Macroeconomics / 2h / 50%

• No computers for the exams

• Each class session will have roughly 1,5 hour of explanation

and 1,5 hours of practice work
Preliminary structure
Date Session Topic
30/09/2022 1 Introduction. Marginal analysis and diminishing
returns
07/10/2022 2 Supply and demand
14/10/2022 3 Elasticity
21/10/2022 4 Two goods: consumer theory
19-20/10/2022 5 Cost functions: Producer theory
25/10/2022 Exam Microeconomics
04/11/2022 Break time off
18/11/2022 6 Unemployment, GDP, inflation, interest rate
The circular flow and multipliers
25/11/2022 7 Fiscal policy
02/12/2022 8 Money and banking
06-07/12/2022 9 Monetary policy
12/12/2022 Exam Macroeconomics
The study of choice

• All social science investigates the determinants of human

behavior

• Anthropology: behavior determined by culture

• Sociology: behavior determined by social roles
• Psychology: behavior determined by brain
• History: behavior determined by sequence of events

• Economics: behavior determined by desires and constraints.

Choice and Rationality

• Reasoned behavior: behavior for a reason

• Given an end, and given means,

• what do people do? (Positive science)
• what should they do? (Normative science)

• Economic analysis must always start with a goal and constraints.

• Choosing the goals is the province of philosophers and theologians

• Choosing the means is the province of engineers
Choice and Rationality
The scope of economics

Microeconomics and Macroeconomics

The branch of economics that The branch of economics that

examines the functioning of examines the economic behaviour
individual industries and the of aggregates – income,
behaviour of individual decision- employment, output and so on – on
making units, firms/households. a national scale.

Microeconomics looks at the individual unit – the household, the firm, the
industry. It sees and examines the “trees”.
Macroeconomics looks at the whole, the aggregate. It sees and analyses the
“forest”.

9
Two scales of economic study

• Microeconomics: individual choices

• Firm (business)
Goal: profit;

Constraints: technology;

Choose: inputs

• Household (individual)
Goal: utility;

Constraints: budget;

Choose: consumption and possibly labor (vajúdás)

Two scales of economic study

• Macroeconomics: aggregate choices. Classically:

• Government
Goals: Growth, Stability, Full empolyment

Choose: Fiscal (spending) and Monetary (interest rate) policy

Constraints: Household and firm reactions

• Important variables
GDP: total income of country

Inflation: rate at which money loses value

Unemployment: Measure of imperfections in labor market

• Reactions modeled as an "economic machine"

Table 1.1 Examples of Microeconomic and Macroeconomic Concerns (Case et al., Principles of Economics, p.40)

Division of Production Prices Income Employment

Economics
Production/output in Prices of individual Distribution of Employement by
individual industries goods and services income and wealth individual businesses
and businesses Price of petrol Wages in the auto and industries
How much steel Food prices industry Jobs in the steel
How much office Apartment rents Minimum wage industry
Microeconomics space Executive salaries Number of
How many cars Poverty employees in a firm
Number of
accountants

National Aggregate price level National income Employment and

production/output Consumer prices Total wages and unemployment in the
Total industrial Producer prices salaries economy
output Rate of inflation Total corporate Total number of jobs
Macroeconomics Gross domestic profits Unemployment rate
product
Growth of output

12
 Economic concerns
EXERCISE

Which of the following do you think are microeconomic

concerns and which are macroeconomic?

 The causes of unemployment

 Euro currency value compared with other currencies
 Employees’ wages in the olive oil manufacturing industry
 Motor Oil announced an increase in its paid parental leave
 The growth of the Indian economy

PoM CBE 1500 Autumn 2020-2021

13
Positive VS normative approach
Given an end, and given means
Positive economics: understand the behaviour what do people do? (Positive
and the operation of systems without making what should they do? (Norma
judgements.
• Objective and fact-based, statements are precise,
descriptive and clearly measurable
• what do people do?

Normative economics: analyses outcomes of

economic behaviour, evaluates them as good or
bad, and may prescribe courses of action.
• Subjective and value-based, originating personal
perspectives, feelings or opinions involved in the
decision-making process.
• what should they do? (Normative analysis)
Markets: Wonder of the economic world

• Human ant-hill
• The earth is an open system – energy enters and leaves
• Open systems develop structures to more effectively dissipate energy
• Life is an example
• Markets are another
• Economics began – and largely continues – to be motivated by a study
of markets.
• Characteristics
• Decentralized, bilateral exchange among many individuals
• No externalities
• Emergent prices
Circular flows in the market economy
Markets and efficiency – the invisible hand ?

• Theoretical maximum dissipation: efficiency

• The greatest possible satisfaction of goals given constraints

• Commodity markets are extraordinarily efficient

• Prices give all the information needed for individual buyers and sellers to coordinate
• Buy if the price is less than your maximum willingness to pay;
Sell if the price is higher than your cost of production.

That’s enough!

• Auxiliary assumption: self-interest

• Efficiency of commodity markets does not require that people “like” each other, or even
know that others exist!
• Homo economicus: Minimal rational actor to function in a commodity market. “Rational
self-interest” – has become standard assumption
Markets and efficiency – the invisible hand ?

• Outside of commodity markets, the predictions of rational self-interest are not

accurate

• Asset markets (e.g., stock market) are not efficient

• Prices reflect people’s expectation of future, which is often misled.
• Results in bubbles and crashes
• Homo economicus breaks down because of knowledge

• Interpersonal interactions fare better than Homo econ.

• Self-interest ignores many aspects that are important for keeping human
behavior steady.
• Key examples: reciprocity, relative outcomes, altruism, norm-based behavior
• Homo economicus is not a sufficient descriptive model… thank goodness!
The biggest idea in economics: opportunity cost

• The cost of any action is equal by definition to the

benefit from the best alternative.

• Remember goals and constraints. You want both X and Y

(goal), but the more X you choose, the less Y you can
have at the same time (constraint).

• We say choosing X costs you the opportunity to get Y.

• Further, we quantify what that cost is: the cost of choosing

X is equal to the benefit you could have had from Y.
The biggest idea in economics: opportunity cost
Socrative Quiz

VASILEIOU8338
The second-biggest idea: Marginal analysis

• Most choices not all-or-nothing. Not X or Y, but how much of

each?

• Ex: Study or sleep?

• Consider "how much" choices as a series of mini-decisions.

Every, say five seconds you decide whether to keep studying
or go to sleep.
The third-biggest idea: ?
Law of fundamental scarcity
or as diminishing returns or rising marginal costs

• This is one of the most general regularities of economics.

It says:
The marginal cost of producing a good rises.
The marginal benefit of acquiring a good falls.

• Also known as diminishing returns or rising marginal

costs
Scarcity Principle Definition (investopedia.com)

Marginal Cost Meaning, Formula, and Examples (investopedi

The principle of diminishing marginal returns
Video - example
benefit of acquiring cost of producing
a good falls a good rises
# of Cost/Wage Total Guests served Marginal cost Marginal
waiters cost (Total 100) Cost
1 100 $ 100 $ 50
2 100 $ 200 $ 80 =(200-100)/(80-50) 3.3 $/guest
3 100 $ 300 $ 90 =(300-200)/(90-80) 10 $/guest

Marginal Cost = Change in Total Expenses / Change in Quantity of Units Produced

Diminishing returns: examples

• There are exceptions, but fewer than you think!

• You get more benefit from your first meal of the day than your tenth
• The first person picked on the schoolyard football team scores more
points than the next
• Studying economics 10 hours, you learn less than twice the amount
studying 5 hours
• Quantity discounts are because people value the last marginal unit less
Diminishing returns: explanation
• Explanations for diminishing returns

• "Low-hanging fruit": rationally select the best option first, so later

ones are not as good.
• Congestion: resources get crowded and are less efficient.

• What about cigarettes? Social networks? Expertise? Teamwork?

• Ceteris paribus: all else held equal.

Ceteris paribus Other things being equal—all other relevant things remaining the same.

In general, doubling inputs gives double the output,

but doubling all inputs is impossible
Implication of diminishing returns

• Simple example: Sally. She sells seashells by the

sea shore.
• Goal: Sally wants to earn at least €10 per hour of collecting
shells. That’s how much she makes at Burger King
• Constraints: She gathers the shells in the waves. The more
shells she gets, the farther she has to go to get them, so the
longer each one takes. Each shell sells for €1.50.
• Choose: number of hours to work

• Look at the following table to see how many hours

she should work.
Video - example
Hours Shells [pcs] Cum. Shell $ Cumulative Burger King Cumulative
to work [pcs] Shell $ [BK] $/hour BK $
1 9 9 13.5 13.5 10 10
2 8 17 12 25.5 10 20
3 7 24 10.5 36 10 30
4 6 30 9 45 10 40
5 5 35 7.5 52.5 10 50
6 4 39 6 58.5 10 60
7 3 42 4.5 63 10 70

Marginal Cost = Change in Total Expenses / Change in Quantity of Units Produced

Result: stopping rule
• Key point: each hour after hour 5, she makes more at Burger King. If
she wants to maximize income, she should only(?!) collect shells for
five hours.

• This is because the marginal benefit of collecting is greater than 10,

only for hours 1, 2, 3, 4 & 5

• Notice:
• Total profit still rises after 5 hours (but less than it would at BK)
• Average wage is of no help at all!
• Lots of silly illustrative assumptions. For instance, the wage is not the only difference
between working at BK and collecting seashells. These are irrelevant to the key point.
• If the wage at BK changes, then what?
 Marginal analysis: behavioral implications

• Decreasing marginal returns and increasing marginal costs yield

simple behavioral predictions when faced with a price (P).

• Marginal benefit can be scaled as Willingness to Pay (WTP).

• Buyers continue purchasing a good as long as WTP > Price
• Marginal Cost of Production (CoP) defines a reservation
price for sellers
• Sellers offer goods for sale so long as Price > CoP

Reservation price, is a limit on the price of a good or a service. On the demand

side, it is the highest price that a buyer is willing to pay; on the supply side, it
is the lowest price a seller is willing to accept for a good or service.
Towards Demand & Supply

• Buyers continue purchasing a good as long as WTP > P

• As price rises….

• Sellers offer goods for sale so long as P > MC

• As price rises…
Towards Demand & Supply

• Buyers continue purchasing a good as long as

WTP > P
• As price rises this number of goods purchased goes down

• Sellers offer goods for sale so long as P > MC

• As price rises this number of goods offered goes up
Summary – definition of economics

• All economic questions arise from scarcity—from the fact

that wants exceed the resources available to satisfy them

• Economics is the social science that studies the choices

that people make as they cope with scarcity

• The subject divides into microeconomics and

macroeconomics
Summary- The economic way of thinking
• Every choice is a tradeoff - exchanging more of something for less of
something else.
• People make rational choices by comparing benefit and cost.
• Cost - opportunity cost - is what you must give up to get something.
• Most choices are “how much” choices made at the margin by comparing
marginal benefit and marginal cost.
• Choices respond to incentives.
Opportunity cost: The highest-valued alternative that we must give up to get something.
Marginal benefit: The benefit that a person receives from consuming one more unit of a
good or service. It is measured as the maximum amount that a person is willing to pay for
one more unit of the good or service.
Marginal cost: The opportunity cost of producing one more unit of a good or service. It is
the best alternative forgone. It is calculated as the increase in total cost divided by the
increase in output.
Summary - Economics as Social Science
and Policy Tool
• Economists distinguish between positive statements
—what is—and normative statements— what ought
to be.

• To explain the economic world, economists create

and test economic models.

• Economics is a toolkit used to provide advice on

government, business, and personal economic
decisions
And now, some exercices
Exercise
You are selling your 1996 Mustang. You have already
spent $1,000 on repairs.
At the last minute, the transmission dies. You can pay
$600 to have it repaired or sell the car “as it is.”
In each of the following scenarios, should you have the
transmission repaired?

A. Blue book value is $6,500 if transmission works,

$5,700 if it doesn’t
B. Blue book value is $6,000 if transmission works,
$5,500 if it doesn’t

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Answers

Cost of fixing transmission = $600

A. Blue book value is $6500 if transmission works,
$5,700 if it doesn’t
Benefit of fixing the transmission = $800
($6500 – 5700).
It’s worthwhile to have the transmission fixed.
B. Blue book value is $6,000 if transmission works,
$5500 if it doesn’t
Benefit of fixing the transmission is only $500.
Paying $600 to fix transmission is not worthwhile.

40
Glossary

• Benefit The benefit of something is the gain or pleasure that

it brings and is determined by preferences.
• Ceteris paribus Other things being equal—all other relevant
things remaining the same.
• Diminishing marginal returns The tendency for the
marginal product of an additional unit of a factor of
production to be less than the marginal product of the
previous unit of the factor.
• Diminishing marginal utility The tendency for marginal
utility to decrease as the quantity consumed of a good
increases
Glossary

• Economics The social science that studies the choices that

individuals, businesses, governments, and entire societies
make as they cope with scarcity and the incentives that
influence and reconcile those choices.
• Efficiency A situation in which the available resources are
used to produce goods and services at the lowest possible
cost and in quantities that give the greatest value or benefit
• Homo Economicus Theoretical human being who rationally
calculates the costs and benefits of every action before
making a decision, used as the basis for a number of
economic theories and models
• Incentive A reward that encourages an action or a penalty
that discourages one
Glossary

• Law of diminishing returns As a firm uses more of a

variable factor of production with a given quantity of the
fixed factor of production, the marginal product of the
variable factor of production eventually diminishes
• Macroeconomics The study of the performance of the
national economy and the global economy
• Marginal benefit The benefit that a person receives from
consuming one more unit of a good or service. It is
measured as the maximum amount that a person is willing
to pay for one more unit of the good or service.
• Marginal Utility the extra utility or satisfaction derived by a
consumer from the consumption of the last unit of a
commodity
Glossary

• Marginal cost The opportunity cost of producing one more unit of

a good or service. It is the best alternative forgone. It is calculated
as the increase in total cost divided by the increase in output.
• Microeconomics The study of the choices that individuals and
businesses make, the way these choices interact in markets, and
the influence of governments.
• Opportunity cost The highest-valued alternative, that we must
give up to get something.
• Rational choice A choice that compares costs and benefits and
achieves the greatest benefit over cost for the person making the
choice.
• Tradeoff A constraint that involves giving up one thing to get
something else
Glossary

• Marginal product, also called marginal physical product, is

the change in total output as one additional unit of input
is added to production.
In other words, it measures the how many additional units will be
produced by adding one unit of input like materials, labor, and overhead.
• Reservation price, is a limit on the price of a good or a
service. On the demand side, it is the highest price that a
buyer is willing to pay; on the supply side, it is the lowest
price a seller is willing to accept for a good or service.
A Marginal Cost Formula Example
Here is an example of how to calculate marginal cost:
Big Dynamo is a toy company that produces robot toys. Every month, they produce 2,000
robot toys for a total cost of $200,000. They expect to produce 4,000 robot toys next
month for $250,000.
Marginal Cost
Current production amount 2000
Current production cost $200,000
Future production amount 4000
Future cost of production $250,000
Marginal Cost Formula $25

Since we know that Marginal Cost = (Change in Total Cost)/ (Change in Quantity), we have:
Change in total cost = (250,000-$200,000) = $50,000
Change in total units = (4000-2000) = 2000
So, the marginal cost equals $50,000/2000 = $25
Note that the marginal cost represents the change in the cost of a good, not the total cost
of the good itself. This $25 represents the margin change.
• Opportunity cost: The highest-valued alternative, that we must give up to get
something. (banana & fish)
• Benefit The benefit of something is the gain or pleasure that it brings and is
determined by preferences.
• Marginal benefit The benefit that a person receives from consuming one more
unit of a good or service. It is measured as the maximum amount that a person is
willing to pay for one more unit of the good or service.
• Marginal cost The opportunity cost of producing one more unit of a good or
service. It is the best alternative forgone. It is calculated as the increase in total
cost divided by the increase in output.
• Marginal Utility the extra utility or satisfaction derived by a consumer from the
consumption of the last unit of a commodity.
• Marginal product, also called marginal physical product, is the change in total
output as one additional unit of input is added to production.
In other words, it measures the how many additional units will be produced by
adding one unit of input like materials, labor, and overhead.
• Law of diminishing returns (Law of fundamental scarcity or rising marginal
costs) As a firm uses more of a variable factor of production with a given quantity
of the fixed factor of production, the marginal product of the variable factor of
production eventually diminishes. (restaurant)
 Marginal analysis: behavioral implications

• Decreasing marginal benefit and increasing marginal costs yield simple

behavioral predictions when faced with a price (P).

• Marginal benefit can be scaled as Willingness to Pay (WTP).

• Buyers continue purchasing a good as long as WTP > Price

• Marginal Cost of Production (CoP) defines a reservation price for sellers

• Sellers offer goods for sale so long as Price > CoP
Reservation price, is a limit on the price of a good or a service. On the demand
side, it is the highest price that a buyer is willing to pay; on the supply side, it is
the lowest price a seller is willing to accept for a good or service.
Summary- The economic way of thinking
• Every choice is a tradeoff - exchanging more of something for less of
something else.
• People make rational choices by comparing benefit and cost.
• Cost - opportunity cost - is what you must give up to get something.
• Most choices are “how much” choices made at the margin by comparing
marginal benefit and marginal cost.
• Choices respond to incentives.
Opportunity cost: The highest-valued alternative that we must give up to get something.
Marginal benefit: The benefit that a person receives from consuming one more unit of a
good or service. It is measured as the maximum amount that a person is willing to pay for
one more unit of the good or service.
Marginal cost: The opportunity cost of producing one more unit of a good or service. It is
the best alternative forgone. It is calculated as the increase in total cost divided by the
increase in output.
https://www.opentextbooks.org.hk/ditatopic/24496