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Principles of Microeconomics

Chapter 1Limits, Alternatives & Choices

By Dr. Laura Lamb & material from McConnell, Brue, Flynn & Barbiero

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The social science concerned with how individuals, institutions, and society make best choices under conditions of scarcity.

Economics (definition)

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The economic way of thinking (aka economic perspective) consists of numerous elements:

a) Scarcity & choiceb) Purposeful behaviourc) Marginal Analysis

1.1. The Economic Way of Thinking

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What is scarce?

What are resources?

The concept of opportunity cost: the next best alternative foregone.

Scarcity & choice

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The concept of opportunity cost: the next best alternative foregone.

What is the opportunity cost of attending this class today?

Illustrates that there is no free lunch!

Scarcity & choice

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Rational self-interest entails making decisions to achieve maximum satisfaction i.e. the economic concept of utility.

Different preferences and circumstances lead to different choices.

Rational self-interest is not the same as selfishness.

Purposeful behaviour

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the comparison of marginal benefits and marginal costs, usually for decision making.

Most decisions are made on the margin.

Marginal Analysis

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Economics uses scientific method

Observe real world behaviour & outcomes  

Based on observations, formulate a hypothesis    Test the hypothesis  Accept, reject, or modify the hypothesis based on

testing

 Continue to test against facts

1.2 Theories, Principles & Models

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If hypothesis is supported in many trials, the theory becomes an economic principle or economic law.

These economic principles are incorporated into models

Economic theories are developed to explain the behaviour of economic agents

Scientific method

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1. Generalizations

2. Other-things-equal assumption (aka ceteris paribus)

3. Graphical expression

Three Important facts about economic principles

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Microeconomics looks at specific economic units

Macroeconomics examines the economy as a whole

1.3 Microeconomics vs. Macroeconomics

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Positive economics describes the economy as it actually is.

Normative economics involves value judgments about what the economy should be like and the desirability of the policy options available.

Positive and Normative Economics

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1. The total revenue of Ford Motor Company have risen over the past 2 years.

2. The unemployment rate remains high at the end of 2012.

3. The price of gasoline continues to be volatile.

4. Sears is closing several store locations in 2012.

5. Inflation rates are relatively low.

Which headlines are microeconomics & which are macroeconomics?

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1. The unemployment rate is 7.2%.

2. The provincial governments should spend more on health care.

3. The unemployment rate remains lowest in Alberta.

4. The price of asparagus is too high.

Are the following statements normative or positive?

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The need to make choices because society’s material wants for goods and services are unlimited but the resources available to satisfy these wants are scarce.

The economic problem is experienced by individuals & society as a whole.

1.4 The economic problem

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Individuals are confronted with the need to make choices because their wants exceed their means to satisfy them.

Limited income – everyone, even the most wealthy, has a finite amount of money to spend.

Unlimited wants – people’s wants are virtually unlimited.

 Individuals’ economic problem

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The combination of limited income and unlimited wants force us to choose those goods and services that will maximize our utility.

A budget line is used to illustrate the individual economic problem.

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A schedule or curve that shows the various combinations of two products a consumer can purchase with a specific money income.

Used to identify attainable & unattainable bundles of products.

The budget line can change. When?

Budget Line

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Scarce resources

Resource categories: land, labour, capital, & entrepreneurial ability

Society’s Economic Problem

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Assumptions of the model:1. Economy is employing all available resources.

2. Available supply of resources is fixed in quantity and quality at this point in time.

3. Technology is constant during analysis.

4. Economy produces only two types of products.

Choices will be necessary because resources and technology are fixed. A production possibilities table illustrates some of the possible choices.

1.5 Production possibilities model

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Production Alternatives

Product A B C D E

Butter 0 1 2 3 4

Guns 10 9 7 4 q

Production Possibilities Table

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The PPC illustrates increasing opportunity costs

Law of increasing opportunity costs

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1. What is the total opportunity cost of producing 3 units of butter?

2. When at Production alternative B, what is the opportunity cost of producing 1 more unit of butter?

3. Is the production of 3 units of butter & 3 units of guns attainable?

4. Is the production of 3 units of butter & 7 units of guns attainable?

PPC Questions ???

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What is the economic rationale for increasing opportunity costs?

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How does society decide its optimal point on the production possibilities curve?

Use marginal analysis

Optimal allocation

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Other uses of the PPC

1.6 Economic growth, present choices & future possibilities

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1. Biases

2. Loaded terminology

3. Fallacy of composition

4. Causation fallacies◦ Post hoc fallacy◦ Correlation versus causation

Pitfalls to sound reasoning

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The textbook website offers many practice questions to test your understanding of the economic concepts.

Also, do the appendix study questions of graphing.

Review