lu 1 introduction to micro

8/12/2019 LU 1 Introduction to Micro

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EBE 1 53:

Principle of Economics


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Learning Objectives

At the end of the lecture class, students will beable to:

1. Define the meaning of economics and several

economics terms2. Illustrate the Production Possibility Curve3. Provide comparison between different type of

economic system


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WHAT IS

E-C-O-N-O-M-I-C-S?


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OriginThe term "economy," from which we get "economics," comes most

directly from the Old French word "economie," meaning"management of a household."

The French adopted the term from the Latin word "oeconomia,"which was in turn derived from the Greek word "oikonomia."Oikonomia came from the word "oikonomos," which separates into

"oikos," meaning house, and "-nomos" meaning managing.The oldest recognized written work in the field of economics is

Oeconomicus, a book on farming and household management,written by the Greek philosopher Xenophon.


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In short,

one who managesa household.


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Microeconomicsis the branch of economicsthat examines the individualeconomics unitsor particular parts of the economy

Macroeconomicsis the branch of economicsthat examines the behavior of economicaggregates income, output, employment,and so onon a national scale


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Examples of Microeconomic and Macroeconomic concerns

Production Prices Income Employment

Micro Production/Output

in Individual

Industries and

Businesses

How much steel

How many offices

How many cars

Price of Individual

Goods and Services

Price of medical care

Price of gasoline

Food prices

Apartment rents

Distribution of

Income and Wealth

Wages in the auto

industry

Minimum wages

Executive salaries

Poverty

Employment by

Individual

Businesses &

Industries

Jobs in the steel

industry

Number of

employees in a

firm

Macro National

Production/Output

Total Industrial

Output

Gross Domestic

Product

Growth of Output

Aggregate Price

Level

Consumer prices

Producer Prices

Rate of Inflation

National Income

Total wages andsalaries

Total corporate

profits

Employment

and

Unemploymentin the Economy

Total number of

jobs

Unemployment

rate


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Concerned with the efficient use of limitedor scarce resourcesto achieve maximumsatisfaction of human materials wants.

Human wants are unlimited, but the means tosatisfy the wants are limited. Thus, economics

is the study of the use of scarce resourcetosatisfy unlimited human wants.


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Or economics is the study of how individualsand societies chooseto use the scarceresourcesthat nature and previousgenerations have provided. In large measure itis the study of how people make choices.

Resources ??


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Land: gifts of nature that we use to produce

goods and services. eg. Water, tree, mineral,etc.

Labor: time and effort that we devote toproduce goods and services. Both physical andmental.

Capital: the goods that we have produced andthat we can now use to produce other goodsand services. Physical capital such as factoryand human capital consists of knowledge andskill.

Entrepreneurship: the resource that organizesother factors of production.


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Resources Categories

Resources/Input

Production Commodities

Consumption

Goods

Services

Value thegoods &services


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Economists call such resources as inputs or factorsof production because they are used to producethings what people desire.

The things produced are called commodities.Commodities may be divided into goods andservices. Goods are tangible (e.g cars or shoes), and

service are intangible (e.g haircuts or education).People use goods and services to satisfy many of

their wants (needs). The act of making goods andservices called production, and the act of usingthem to satisfy wants is called consumption.

Goods are valued for services they provide. Anautomobile, for example, helps to satisfy its ownersdesires for transportation, mobility and possibilitystatus.


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Scarcity, Choice andOpportunity Cost

Scarcity: the centraleconomic problem

Scarcity. . . means that society has limited resourcesand therefore cannot produce all the goods and

services people wish to have.


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ChoicesBecause resources are scares, all societies

face the problem of deciding whatto produce

and howto produce and divide the products

among their members.

Societies differ in who makes the choices and

how they are made, but the need to choose is

common to all. Just as scarcity implies the needfor choice, so choice implies the existence of

cost.

Human wants are unlimited, butresources are not!!


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The best alternative that we forgo, or give up, when

we make a choice or a decision.

Every decision means giving up something. Economistsare fond of trade-offs as a way of thinking aboutdecision making. Taking one action usually means giving

up something else.

Opportunity costs arise because resources are scarce.Resources are scarce because human wants exceed what

we can produce from our current resources.

Opportunity cost


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There is no such thing asa free lunch!

Nearly all decisions involve trade-offs. Thecost of something is what you give up to get it.

Rational people think at the margin. Peoplerespond to incentives.

Opportunity cost


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Making decisions requires tradingoff one goal against another.

To get one thing, we usually have to give up

another thing. Whether to go to college or to work? Whether to study or go out on a date? Whether to go to class or sleep in?

Decisions require comparing costs and benefitsof alternatives. The opportunity cost of anitem is what you give up to obtain that item.


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1. Products provided for free to an individual

are not free for society because of therequired use of scarce resources to producethem.

2. Companies provide freegoods as a marketingstrategy to promote brand awareness.

3. Products that are promoted as free to the

individual may actually be bundled with anothergood for which the consumer must pay.Because a purchase is required to obtain them,these products are not really free to thebuyer.

Consider This Free for All?


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All decisions involve tradeoffs. Examples: Going to a party the night before your midterm

leaves less time for studying. Having more money to buy stuff requires

working longer hours, which leaves less time forleisure.

Protecting the environment requires resourcesthat could otherwise be used to produceconsumer goods.

Principle 1: People Face Tradeoffs


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Society faces an important tradeoff:

efficiency vs. equality Efficiency: when society gets the most from

its scarce resources

Equality: when prosperity is distributed

uniformly among societys members Tradeoff: To achieve greater equality,

could redistribute income from wealthy to poor.But this reduces incentive to work and produce,

shrinks the size of the economic pie.

Principle 1: People Face Tradeoffs


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Making decisions requires comparing the costs andbenefits of alternative choices. The opportunity costof any item is

whatever must be given up to obtain it. It is the relevant cost for decision making.

Examples:

The opportunity cost of

going to college for a year is not just the tuition, books,

and fees, but also the foregone wages.seeing a movie is not just the price of the ticket,

but the value of the time you spend in the theater.

Principle 2: The Cost of Something Is

What You Give Up to Get It


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Rational people

systematically and purposefully do the best they can toachieve their objectives.

make decisions by evaluating costs and benefits ofmarginal changesincremental adjustments to an

existing plan.Examples:

When a student considers whether to go to college for anadditional year, he compares the fees & foregone wages

to the extra incomehe could earn with the extra year of education.

When a manager considers whether to increase output,she compares the cost of the needed labor and materialsto the extra revenue.

Principle 3: Rational People Think at the

Margin


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Incentive: something that induces a person to

act, i.e. the prospect of a reward orpunishment. Rational people respond to incentives.

Examples:

When gas prices rises, encourages people tocarpool and take public transportation. When cigarette taxes increase,

teen smoking falls.

Principle 4: People Respond to Incentives


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Rather than being self-sufficient,people can specialize in producingone good or service and exchangeit for other goods.

Countries also benefit from trade& specialization: Get a better price abroad for goods

they produce Buy other goods more cheaply from

abroad than could be produced at home

Principle 5: Trade Can Make Everyone

Better Off


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Market: a group of buyers and sellers(need not be in a single location)

Organize economic activity means determining what goods to produce how to produce them how much of each to produce who gets them

A market economyallocates resources through thedecentralized decisions of many households andfirms as they interact in markets.

Principle 6: Markets Are Usually A Good

Way to Organize Economic Activity


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Famous insight by Adam Smith in The Wealth of Nations(1776):Each of these households and firms acts as if

led by an invisible hand to promote generaleconomic well-being.

The invisible hand works through the price system: The interaction of buyers and sellers

determines prices.

Each price reflects the goods value to buyers and the

cost of producing the good. Prices guide self-interested households and firms tomake decisions that, in many cases, maximize societys

economic well-being.

Principle 6: Markets Are Usually A Good

Way to Organize Economic Activity


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Important role for govt: enforce property rights(with police, courts) People are less inclined to work, produce, invest, or

purchase if large risk of their property being stolen.

Market failure: when the market fails to allocate

societys resources efficiently Causes:

Externalities, when the production or consumptionof a good affects bystanders (e.g.pollution)

Market power, a single buyer or seller has substantialinfluence on market price (e.g.monopoly)

In such cases, public policy may promote efficiency.

Principle 7: Governments Can Sometimes

Improve Market Outcomes


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Govt may alter market outcome to promoteequity

If the markets distribution of economic

well-being is not desirable, tax or welfarepolicies can change how the economic pieis divided.

Principle 7: Governments Can

Sometimes Improve Market Outcomes


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Huge variation in living standards across countries andover time:

Average income in rich countries is more than tentimes average income in poor countries.

The U.S. standard of living today is abouteight times larger than 100 years ago.

The most important determinant of living standards:productivity, the amount of goods and services produced

per unit of labor. Productivity depends on the equipment, skills, and

technology available to workers. Other factors (e.g.,labor unions, competition from

abroad) have far less impact on living standards.

Principle 8: A countrys standard of living

depends on its ability to produce goods &

services.


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Inflation: increases in the general levelof prices.

In the long run, inflation is almost alwayscaused by excessive growth in thequantity of money, which causes thevalue of money to fall.

The faster the govt creates money,

the greater the inflation rate.

Principle 9: Prices rise when the

government prints too much money


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In the short-run (1 2 years),many economic policies push inflation and

unemployment in opposite directions. Other factors can make this tradeoff

more or less favorable, but the tradeoffis always present.

Principle 10: Society faces a short-run

tradeoff between inflation and

unemployment


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An important reason for studying economics is to learna way of thinking. It is an essential part of the studyof society.

Most political problems have an economic aspect,whether it is balancing the budget, fighting over thetax structure, welfare reform, international trade, orconcern for the environment.

Economic decisions often have enormous consequences.


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Why Study Economics?

THE ECONOMIST is like A SCIENTIST to theeconomy. Involves thinking analytically andobjectively.e.g. what sort of formula is the best forthe country or maybe firm. [The pegging of RM toUS$ (RM3.80 = US$1)]. Was it the best option?

An understanding of economics is essential to anunderstanding of global affairs. e.g. the impact of1997 crisis, 911 and the world oil prices increase.

The study of economics helps to develop anindividuals analytical skills and allows students tobetter predict the logical consequences of theiractions.

Wh St d E i ?


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Economics can help individuals make betterbuying decisions, better employment choicesand better financial investments.

Economics is however, mainly an academic, not avocational subject. Its primary objective is toexamine problems and decisions from a socialrather than personal point of view. It is not aseries of howto make moneyexamples.

Evan Lau for EBE1053 (CHAP 1)

Why Study Economics?


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One of the most important

generalizations in economicsis

ceteris paribus


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Other-Things-Equal

ceteris paribus, or all else equal,assumption, economists study the relationshipbetween two variables while the values ofother variables remain constant.

The Latin phrase "ceteris paribus" and its usein economic commentary are centuries older

than the formal discipline of economics.

Ceteris Paribus

P b


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Other-Things-EqualThe first recorded use of the phrase in an

economic context was in "De Officiis," writtenby Cicero in 44 B.C. Cicero (106-43 B.C.) wrote

that "the proper way to render aid is - ifcetera are paria - to bring it to one who needsit most, and not to one whom we expect to beuseful for us."

Ceteris Paribus


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Production possibilities curve: a curve thatshowing alternative combinations of goodswhen available resources are used fully andefficiently.

Assumptions:1. Full employment level2. Level of technology is fixed

3. Only two goods can be produced4. Resources are fixed in quantity and quality.

A production possibility curve


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0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8Units of clothing (millions)

Unitsoffood(millions)

Units of food Units of clothing

(millions) (millions)

8.0 0.07.0 2.2

6.0 4.0

5.0 5.0

4.0 5.6

3.0 6.0

2.0 6.4

1.0 6.7

0.0 7.0

Sloman, Norris: Principles of Economics 2004 Pearson Education Australia




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0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8




a 8.0 0.07.0 2.2

6.0 4.0

5.0 5.0

4.0 5.6

3.0 6.0

2.0 6.4

1.0 6.7

0.0 7.0

a

Sloman, Norris: Principles of Economics 2004 Pearson Education AustraliaUnits of clothing (millions)




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0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8




8.0 0.0b 7.0 2.2

6.0 4.0

5.0 5.0

4.0 5.6

3.0 6.0

2.0 6.4

1.0 6.7

0.0 7.0

b


pro uct on poss ty cur



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0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8




8.0 0.07.0 2.2

c 6.0 4.0

5.0 5.0

4.0 5.6

3.0 6.0

2.0 6.4

1.0 6.7

0.0 7.0

c





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0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8

Unitsoffoo

d(millions)



a 8.0 0.0b 7.0 2.2

c 6.0 4.0

d 5.0 5.0

e 4.0 5.6

f 3.0 6.0

g 2.0 6.4

h 1.0 6.7

i 0.0 7.0




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Point C is one of the possible combinations of

goods produced when resources are fully andefficiently employed.

Point Fis desirable because it yields more of bothgoods, but it is not attainable given the amount of

resources available in the economy.

Points inside of the curve are inefficient. At pointH, resources are either unemployed, or are usedinefficiently.


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A move along the curve illustrates the concept ofopportunity cost. Opportunity cost increasesbecause resources are not all perfectly adaptable tothe production of both types of goods.

From point D, an increase the production of capitalgoods requires a decrease in the amount ofconsumer goods.


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The slope of the curve is also called the marginalrate of transformation (MRT).

The negative slope of the reflects the law ofincreasing opportunity cost. As we increase theproduction of one good, we sacrifice progressivelymore of the other.


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ARE YOU WITH ME???

Can the PPC shifts?


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Growth in production capacity could berepresented by a pushing outward of theproduction possibility boundary.

If an economyscapacity to produce goods

and services is growing, combinations thatare unattainable today will becomeattainable tomorrow. Growth makes itpossible to have more of all goods.

Possibility of shifts in PPC

1. Changes in resource availability

2. Technological change

3. Increases in the capital stocks

Can the PPC shifts?

Growth in potential output


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O

F

ood

Now

Clothing

p p



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O

F

ood

Now

5 years time

Clothing

p p



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O

F

ood

Clothing

p p

Growth in potential and actual output


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O

F

ood

xy

Clothing

p p


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Every society has some system or mechanismthat transforms that societys scarceresources into useful goods and services.

Three basic questions that must be answeredto understand the functioning of economicsystem.

What gets produced?

How is it produced? Who gets what is produced?


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To demonstrate we used circular-flow diagram.

This diagram is a visual model of the economythat outline the flow of resources, products,income and revenue among economic decisionmaker.

Households as resource suppliers and demandersfor goods and services. They attempt tomaximize utility.

Firm exists when a person or group of peopledecides to produce output by transforminginputs into output through production process.Objective is to maximize profit.

Circular-Flow Diagram


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Copyright 2004 South-Western

Spending

Goods and

services

bought

Revenue

Goods

and services

sold

Labor, land,and capital

Income

= Flow of inputs

and outputs

= Flow of money

Factors of

production

Wages, rent,

and profit

FIRMS

Produce and sell

goods and services

Hire and use factors

of production

Buy and consume

goods and services

Own and sell factors

of production

HOUSEHOLDS

Households sell

Firms buy

MARKETS

FOR

FACTORS OF PRODUCTION

Firms sell

Households buy

MARKETSFOR

GOODS AND SERVICES

g



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Firms Produce and sell goods and services Hire and use factors of production

Households Buy and consume goods and services Own and sell factors of productionfirms and

households

Circular Flow Diagram



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Markets for Goods and Services Firms sell Households buy

Markets for Factors of Production Households sell Firms buy

Factors of Production Inputs used to produce goods and services

Land, labor, and capital

g


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Economic systems are the basic arrangements

made by societies to solve the economic problem.

1. Capitalist system. This is also known as laissez-faire, market economy, free enterprise, and pricemechanism, free market economy.

2. Command economy. This is also known as plannedeconomy system, centrally planned economy,controlled economy or totalitarian economy.

3. Mixed economy system. A combination betweenboth capitalist and command economy system.

4. Traditional Economy system (extreme case)5. Economies Based on Custom or Religion

(extreme case)

1 Laissez-faire economy


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Characteristics

Individuals and firms pursue their own self interest

without any central direction or regulation. Also impliesa complete lack of government involvement in theeconomy.

Existence of consumer sovereignty. i.e. consumers arethe ones who would determine and influence the types

and quantities of goods to be produced. In other wordsconsumers decision would influence the producersdecision of what to produce. The consumer is said to bea King.

Price mechanism (market) answer the economicquestions and demand and supply decisions. The invisiblehandworks in the economy. If demand shortage pricerises while surplus price falls and settle atequilibrium price where demand equals supply.

1.Laissez-faire economy

What is invisible hand


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Term used by Adam Smith to describe the natural force

that guides free market through competition for scarceresources.

According to Adam Smith, in a free market each

participant will try to maximize self-interest, and theinteraction of market participants, leading to exchange ofgoods and services

No regulation of any type would be needed to ensure thatthe mutually beneficial exchange of goods and servicestook place, since this "invisible hand" would guide marketparticipants to trade in the most mutually beneficialmanner.

What is invisible hand

Problems of a free-market economy


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i. Competitionmay be limited

ii. Inequality- wide gap between the rich andthe poor. This will result in apyramid-shapedincome distribution patternin the economy.

iii. Environment and social goals may be ignored

iv. Monopoly

v. By-product

vi. Do not produce public goods

vii. No central authority to protect propertyrights, enforce contracts

Problems of a free market economy

2. The command economy


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Characteristics

An economy in which a central governmentplanning either directly or indirectly setsoutput targets, incomes, and prices. The threebasic economic problems will be solved by the

government.

Consumerssovereignty does not exist in this

system. Consumers have no choice but to exceptall the decision made by the government or thecentral authorities.

. mm my

2. The command economy


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High investment, high and stable growth

There is no different in society socially or economically - nodifferent between the rich and the poor. However, in practice,there is still a gap between the two groups although the gap is notas apparent as in a capitalist system.

Theoretically, unemployment does not exist in a communist

economy, because every potential worker available will be given ajob by the government. However, in practice, this is not possiblebecause of the scarce resources. Government will not be able toprovide job opportunities for everyone.

mm my

2 Problems of a command economy


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Problems of gathering information (e.g. getting reliable data)

inefficient allocation of resources - government may producesgoods that are not required by the public.

no system of prices

shortages and surpluses lack of response to consumer demand

inappropriate incentives

less freedomfor the society in making economic choice choice ofoccupation

2. Problems of a command economy

3. The mixed economy


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Characteristics

There are both public and private sectors working hand in

handso to ensure economic growth of the economy.

The role of the public sector is to complement the privatesector by providing the infrastructure so that economicactivities can be carried out effectively and efficiently.

The government will try to reduce income inequality byimposing a progressive tax system where higher incomeearners are taxed more than the lower income earners. In

this way, the gap between the rich and the poor will benarrowed.




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The government will also control the existence of monopoliesand regulate the power of monopolists.

Since markets are not perfect, governments intervene andoften play a major role in the economy. Some of the goals ofgovernment are to

Minimize market inefficiencies

Provide public goods

Redistribute income

Stabilize the macro foundation of the economy

Promote low levels of unemployment

Promote low levels of inflation

y

4. Traditional Economy system


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Characteristics

Situation in which individuals producecommodities primarily for their own use.

(a) No market

(b) No money

(c) Low level of technology

(d) Low standard of living

(e) Primitive transportation system

y y

5. Economies Based on Custom orReligion


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ECONOMICALLY

DEPRESSED


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Positive economics studies economic behavior without

making judgments. Positive economics can be referredto as What is, what was, and what probably will beeconomics.

Positive economics is based on sound economic theory,probability, and statistical methods. (e.g. study anddetermines the probable outcomes from an increase ordecrease in taxes)


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Normative economics, also called policy economics, analyzesoutcomes of economic behavior, evaluates them as good or

bad, and may prescribe courses of action. It tends to besubjective, value laden, and emotional in its presentation.

Normative economics is often referred to as Whatought tobe economics. We ought to do this, or we ought to dothat.

(e.g. during political elections, candidates claims have theanswer to all the countrys economic problems. We shouldraise taxes. We should lower taxes. The rich do not payenough taxes).


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Theoretical economics: The systematic arranging offacts, interpretation of the facts, making

generalizations. Empirical economicsrefers to the collection and use of

data to test economic theories. Many data sets areavailable to facilitate economic research. They arecollected by both government agencies and privatecompanies, Theories involve models, and models involvevariables.

A modelis a formal statement of a theory. It is usuallya mathematical statement of a presumed relationshipbetween two or more variables. (e.g. DD=f(P,Y,Y*,PRE)

A variable is a measure that can change fromobservation to observation. Economists use the scientificmethodto establish theories, laws, and principles.

Scientific Method


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The scientific method consists of:

a. The observation of facts (real data).b. The formulations of explanations of cause

and effect relationships (hypotheses) based

upon the facts.c. The testing of the hypotheses.d. The acceptance, rejection, or modification of

the hypotheses.

e. The determination of a theory, law, principle,or model.

Scientific Method

Uses abstract models to help explain how a


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Uses abstract models to help explain how acomplex, real world operates developstheories, collects, and analyzes data to

evaluate the theories.

Economists use models to simplify reality inorder to improve our understanding of theworld. Makes use of the scientific method e.g.

econometrics model to evaluate the impact ofoil price increase to the economy. Economistsmake assumptions in order to make the worldeasier to understand.

The art in scientific thinking is deciding whichassumptions to make. Economists usedifferent assumptions to answer differentquestions.

Economic Concepts


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Economic Concepts

Define the following terms:

1. Free goods2. Economic goods

3. Public goods4. Merit goods5. Consumption

6. Production7. Utility


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Conclusion


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lu 1 introduction to micro

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