eaton micro 6e ch01
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Chapter 1
Microeconomics:
A Working Methodology
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The economic environment poses manycomplex questions.
The only way to understand economicbehaviour is to find a method for settingout and then solving microeconomicproblems.
This methodology consists of a relativelysmall set of ideas that are applicable to avast number of situations.
Throughout this book you will be
introduced to the ideas of economicanalysis and shown how to use them toanswer many economic questions.
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A Water Shortage Problem
An imaginary island is sub-dividedinto the 100-home Estates.
Water for these homes comes from a
series of wells owned by the EstatesWater District at a total cost of $50000 per year.
Every household pays a flat fee of $500 per year for water (non-metered scheme).
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A Water Shortage problem
All householders are identical andthe typical household uses 80 000litres of water over July and August.
Water is sometime unavailable inAugust.
The householder currently has an
unbalanced water use profileconsisting of 60 000 litres in July and 20 000 in August.
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A Water Shortage Problem
The householder would actuallyprefer to consume 40 000 litres of water in each of July and August (the
balanced water profile).However the householder cannot
achieve the preferred water profileby his/her own effort, even thoughtotal water consumption under bothprofiles is the same.
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A Water Shortage problem
To see why suppose just one householderreduces personal water use from 60 000to 40 000 litres in July, leaving 20 000additional litres for August.
In August this water conserving householdwould get only 1/100 (2 000 litres) of thisadditional water as all other householddraw on the extra water supply.
Figure 1.1 shows all the water use profilesthe householder can personally achieveunder the non-metered scheme.
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Figure 1.1 Attainable water use profiles
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From Figure 1.1
What is the most preferred waterprofile along DCU?
Because all 100 householders see
the problem in the same way, theyfind an equilibrium at 60 000 litres inJuly and 20 000 litres in August.
There is nothing an individualhouseholder by themselves can do toattain a more preferred profile.
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From Figure 1.1
However, this equilibrium is unattractive.Even though total water usage is thesame, every householder would prefer toconsume the balanced profile of 40 000litres in each July and August.
Put differently, each householder could bebetter off if there were some way to
induce everyone to save 20 000 litres inJuly for use in August.
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A Water Monitoring Scheme
A metered water scheme, where theprice was sufficient to reduce Julyconsumption, could bring about the
balanced water profile. If it costs nothing to monitor water
consumption, all revenues raised by
the per litre charge could be used toreduce the householders fixed yearlyfee.
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A Water Monitoring Scheme
Monitoring is not costless.
The expense of collecting fees, mustbe compared with the benefits of
balanced water use.Such a comparison will determine if
the water monitoring scheme is
preferable to the non-monitoredscenario.
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Common Property Problems
The water shortage problem is referred toas a common property problem.
In the non-metered scheme, the district’s
wells are common property and there isinsufficient incentive to curb water usage.
With the metered scheme, the wellsbecome private property, the water is sold
to users and the cost of usage providesincentives for conservation.
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Competitive Equilibrium
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Agricultural Price Supports
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Describing an Economy: Four
Building Blocks
Resource endowment consists of all
resources available to an economy.
Technology specifies how resources can
be used to produce goods.
Preferences of individuals determines
what goods are produced in an economy.
Institutions are the rules by which the
economic “game” is played.
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The Equilibrium Method
An equilibrium consists of a set of choicesfor the individuals and a correspondingsocial state such that no individual can be
better off by making some other choice. Comparative static analysis is the method
of analyzing the impact of a change by comparing the equilibrium resulting fromthat change with the original equilibrium.
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Positive and Normative Economics
Positive economics is concerned withfactual matters. The answers to positiveeconomic questions can be settled by
factual observation. Normative economics involves value judgements. The answers to normativeeconomic questions are based on
judgements (opinions) and cannot besettled by appealing to the facts
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The Pareto Criterion
In comparing two social states (stateI and J) - state I is Pareto preferred to state J if no one is worse off in
state I then in state J, and if at least one person is better off in state I than in state J.
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Pareto Optimality
A social state is Pareto-optimal if noother attainable social state isPareto-preferred to it.
Pareto-optimal is synonymous witheconomic efficiency.
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Cost-Benefit Analysis
Net social benefits equals gross social benefits minus gross social costs
In the move from social state I to social
state J, if net social benefit is positive,then the cost-benefit criterion ranks J as
preferred to I.
If net social benefit is negative, then the
cost-benefit criterion ranks state I as preferred to state J.
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