Economics 211Principles of

Microeconomics

Dr. Greg DelemeesterFall 2007

Economics

Making choices under conditions of scarcity How many hours should I study for

biology? What stocks should I buy for my portfolio? How many cars should I steal? How many job interviews should I go on?

Making choices under conditions of scarcity How many hours should I study for

biology? What stocks should I buy for my portfolio? How many cars should I steal? How many job interviews should I go on?

What Do Schoolteachers and Sumo Wrestlers Have in Common?

How Is the Ku Klux Klan Like a Group of Real-Estate Agents?

Why Do Drug Dealers Still Live with Their Moms?

Where Have All the Criminals Gone?

What Makes a Perfect Parent? Would a Roshanda by Any Other

Name Smell as Sweet?

Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill?

Medium-Term Business Cycles Can Information Heterogeneity

Explain the Exchange Rate Determination Puzzle?

Media Frenzies in Markets for Financial Information

An Efficient Dynamic Auction for Heterogeneous Commodities

Matching and Price Competition Paying Not to Go to the Gym On the Simple Economics of

Advertising, Marketing, and Product Design

Economic Fundamentals Self Interest

Rationality Maximizing behavior Responding to incentives

Incentives Matter There are no $5 bills laying on the ground.

Economic Fundamentals Self Interest

Rationality Maximizing behavior Responding to incentives

TANSTAAFL Scarcity Opportunity costs

ThereAin’tNoSuchThingAsAFreeLunch

ThereAin’tNoSuchThingAsAFreeLunch

Economic Fundamentals Self Interest

Rationality Maximizing behavior Responding to incentives

TANSTAAFL Scarcity Opportunity costs

Marginal Analysis Behavior is modeled as if decisions were based

on costs and benefits at the margin Ignore sunk costs

Economic Fundamentals Unintended Consequences

CAFE standards 27.5 MPG fleet average Lighter + smaller cars = more dangerous

cars ? National Academy of Sciences: 1300 to 2600

extra highway deaths each year

Modes of AnalysisPositive AnalysisNormative Analysis

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

0.0 0.5 1.0 1.5 2.0 2.5 3.0

Guns Sold (Millions)

Gu

n-R

elat

ed M

urd

ers

(Th

ou

san

ds)

1965

1970

1975

1980

Correlation is not causation.

Economic Model of Crime

Decision Rule If MB > MC steal another car

Assumptions Resale value on car = $40,000 Income = $20,000 Jail term = 5 years Probability of Arrest = 20% Probability of Conviction = 90%

MB = $40,000

MC = (5)($20,000)(.20)(.90) = $18,000

Steal the car!

Economic Model of Crime

Policy Implications [How to deter crime?] Increase jail sentence Increase probability of arrest Increase probability of conviction Increase income

Production Possibilities Frontier Shows tradeoffs facing an economy that

produces two goods Assumptions

Resources are fixed Land Labor Capital Entrepreneurship

Technology is fixed

Beer

Cars

A

B

CD

E

Unattainable

Inefficient

Beer

Cars

A

B

C

D

Δ Beer

- Δ Cars

Slope of PPF = - Δ Cars / Δ Beer

Concave PPF implies “law of increasing opportunity cost”

(measures the Opportunity Cost)

Shifts in the PPF are due to: Change in resources Change in technology

Shifts in the PPF are due to: Change in resources Change in technology

PPF and Economic Growth

Economic Growth requires an expanding PPF

All societies must answer basic questions: What will be produced? How will it be produced? For whom will it be produced?

Allocation Mechanisms Tradition Plan Market

Choices, choices, choices…

Gains From Trade

Trade implies mutually beneficial exchanges Not a zero-sum game!

Comparative Advantage David Ricardo Lowest opportunity cost producer Specialization and trade can allow

individuals (and countries) to expand their consumption beyond their PPF constraints

Trade implies mutually beneficial exchanges Not a zero-sum game!

Comparative Advantage David Ricardo Lowest opportunity cost producer Specialization and trade can allow

individuals (and countries) to expand their consumption beyond their PPF constraints

Pizza Pizza

Cars Cars100

400

50

600

50 25

200

300

∆C = 50

∆C = 25

∆P = -200

∆P = -300

Country A Country B

Opportunity cost of 1 Car is 4 Pizzas Opportunity cost of 1 Car is 12 Pizzas

slope = ∆P/ ∆ C = -200/50 = - 4/1

slope = ∆P/ ∆ C = -300/25 = - 12/1

Country A has the comparative advantage in producing cars.

Pizza

Cars100

400

50

200

Country A

Pizza

Cars50

600

25

300

Country B

No Trade With Trade

Pizza Cars Pizza Cars

A

B

World

200

0600

0 100

500 75

25300

50

100600

Production