Economics 211Principles of

Microeconomics

Dr. Greg Delemeester

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

Paying Not to Go to the Gym

Economic Fundamentals Self Interest

Rationality Maximizing behavior Responding to incentives

Best Undergrad College Degrees by SalaryMajor Starting Median Salary Mid-Career Median Salary

Chemical Engineering $63,200 $107,000

Economics $50,100 $98,600

Physics $50,300 $97,300

Math $45,400 $92,400

Physician Assistant $74,300 $91,700

Finance $47,900 $88,300

MIS $49,200 $82,300

Chemistry $42,600 $79,900

Marketing $40,800 $79,600

Political Science $40,800 $78,200

Accounting $46,000 $77,100

Management $43,000 $72,100

History $39,200 $71,000

Journalism $35,600 $66,700

English $38,000 $64,700

Psychology $35,900 $60,400

Source: www.payscale.com

Mini Experiment

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

Space Mountain(Problem Set 1, #9)

You have waited 30 minutes in a line for the Space Mountain ride at Disneyworld. You see a sign that says, "From this point on your wait is 45 minutes." You must decide whether to continue in line or to move elsewhere.

On what basis do you make the decision?Do the 30 minutes you've already stood in line come into play?

Marginal Analysis ignores sunk costs!

William installs custom sound systems in cars. If he installs 7 per day, his total costs are $300. If he installs 8 per day, his total costs are $400. William will install only 8 sound systems per day if the 8th customer is willing to pay at least:

1 2 3 4 5

50 120 300 400

0% 0%0%0%

1. $502. $1203. $3004. $400

1. $502. $1203. $3004. $400

“I’d like to introduce you to Marty Thorndecker. He’s an economist but he’s really very nice.”

Greg Delemeester

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 Analysis Positive Analysis Normative 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!

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

Economic Model of Crime

Which of the following will cause property crime to increase?

0% 0%0%0%

a) An increase in jail terms.b) A decrease in personal

incomes.c) An increase in the probability

of arrest.d) A decrease in the expected

benefit.

a) An increase in jail terms.b) A decrease in personal

incomes.c) An increase in the probability

of arrest.d) A decrease in the expected

benefit.

1 2 3 4 5

Applications(#3, Problem Set 1) A few years ago, Tina ranked three

available options as follows: 1st Choice: pay $21,000 tuition and finish a

Master's degree in fine arts at the Ohio State University.

2nd Choice: earn $19,000 working part-time managing a small local theater and spend her spare time pursuing her theater hobby as a volunteer director of small-theater plays.

3rd Choice: earn $44,000 working full-time reviewing yellow page advertisements for Ameritech.

a) $19,000b) $21,000c) $65,000d) $84,000

What is the minimum value of Tina’s opportunity cost for pursuing her first choice?

19000 21000 65000 84000

0% 0%0%0%

1 2 3 4 5

1st Choice: pay $21,000 tuition and finish a Master's degree in fine arts at the Ohio State University.2nd Choice: earn $19,000 working part-time managing a small local theater and spend her spare time pursuing her theater hobby as a volunteer director of small-theater plays.3rd Choice: earn $44,000 working full-time reviewing yellow page advertisements for Ameritech.

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

Assume a concave production possibility frontier. Suppose that the society decides to increase the production of beer by 20,000 kegs, and that as a result the output of cars falls by 1000. If a further increase of 20,000 kegs of beer is sought, we can expect that the output of cars will:

fall

by 10

00.

fall

by le

ss th

an...

fall

by m

ore th

an...

incr

ease

by

less

...

0% 0%0%0%

a) fall by 1000. b) fall by less than 1000. c) fall by more than 1000.d) increase by less than 1000.

a) fall by 1000. b) fall by less than 1000. c) fall by more than 1000.d) increase by less than 1000.

1 2 3 4 5

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 GrowthEconomic Growth requires an expanding PPF

Examples Cars v. Beer: more efficient brewing process Houses v. Computers: immigration Jazz v. Shrimp: Hurricane Katrina Food v. Electronics: China’s Cultural Revolution

Production Possibilities Frontier

Consider the PPF depicted below. A reduction in the amount of unemployment could be described as the movement from:

0

20

40

60

80

100

120

0 2 4 6 8 10 12

Books

Mu

sic

CD

s

A

B

CD

E

0% 0%0%0%

a) A to Bb) B to Dc) D to Cd) B to E

a) A to Bb) B to Dc) D to Cd) B to E

1 2 3 4 5

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…

And now for a little humor…

Communism:

You have two cows. The government takes both of them and gives you part of the milk.

Socialism:

You have two cows. The government takes one and gives it to your neighbor.

Fascism:

You have two cows. The government takes both cows and sells you the milk.

Nazism:

You have two cows. The government takes both cows, then shoots you.

Bureaucracy:

You have two cows. The government takes both of them, shoots one, milks the other, then pours the milk down the drain.

Capitalism:

You have two cows. You sell one and buy a bull.

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

Assume that Robinson and Crusoe live on a desert island. With a day’s labor, Robinson can produce 6 fish or 4 coconuts; Crusoe can produce 3 fish or 1 coconut. Robinson’s opportunity cost of producing 1 coconut is ____, and he should specialize in the production of ____.

1 2 3 4 5

1/4

fish

; coc.

..

1.5

fish

; coc.

..

3 fi

sh; f

ish

6 fi

sh; c

oconuts

0% 0%0%0%

a) 1/4 fish; coconutsb) 1.5 fish; coconutsc) 3 fish; fishd) 6 fish; coconuts

a) 1/4 fish; coconutsb) 1.5 fish; coconutsc) 3 fish; fishd) 6 fish; coconuts

0

5

10

15

20

25

30

35

40

45

50

0 5 10 15 20 25

Wine

Co

mp

ute

rs

No Trade With Trade

Computers Wine Computers Wine

Germany

Belgium

World

15 2

20 10

35 12

25 0

12 14

37 14

16

21

3

11

BelgiumGermany

Germany trades 3W for 9C

ΔW = - 3

ΔC = 9

Belgium: 1W : 5C Germany: 1W : 2C

Output per hour Opportunity cost of …

Country Tons of Steel

Bushels of Wheat

1 ton of steel

1 bushel of wheat

US 6 60

South Korea 3 6

US South Korea

Steel Wheat Steel Wheat

Production change -6 +60

Trade +10 -50

Consumption change

10 W

2 W

1/10 S

1/2 S

+12 -24

-10 +50

+4 +10 +2 +26

US switches 1 hour of labor from steel to wheat

SK switches 4 hours of labor from wheat to steel

Trade: 50 W for 10 S

Problem Set 1: #21

Corner offices in high-rise office buildings usually cost more to rent than other offices. This best illustrates the economic principle of:

Sca

rce

reso

urces

Mar

ginal

anal

ysis

Equili

brium

Oppo

rtunity

cost

s

0% 0%0%0%

a) Scarce resourcesb) Marginal analysisc) Equilibrium d) Opportunity costs

a) Scarce resourcesb) Marginal analysisc) Equilibrium d) Opportunity costs

1 2 3 4 5

a) Zero—the ticket is free.b) $15c) $55d) $40

a) Zero—the ticket is free.b) $15c) $55d) $40

A friend comes up to you and offers to give you a free ticket to the local professional team's baseball game that night. You decide to attend the game. It takes five hours to go to the game and costs you $15 for transportation. If you had not attended the game, you would have worked at your part-time job for $8 an hour. What is the cost of you attending the game?

Ze

ro—

the

tic

ke

t is

fre

e. 5

5

0% 0%0%0%

1 2 3 4 5

a) 10 million cups of teab) 5 million sconesc) 10 million scones

d) The answer is impossible to determine from the information given.

a) 10 million cups of teab) 5 million sconesc) 10 million scones

d) The answer is impossible to determine from the information given.

In the accompanying figure, Tealand is currently producing at point C on its production possibilities frontier. What is the opportunity cost in Tealand of increasing the production of tea from 20 million cups to 30 million cups?

0% 0%0%0%

1 2 3 4 5

a) International trade will increase the average income of Americans.

b) Higher expenditures on health care will reduce infant mortality rates.

c) We ought to reduce our dependence on oil imports in order to increase our national security.

d) Increased defense spending will lead to higher budget deficits.

a) International trade will increase the average income of Americans.

b) Higher expenditures on health care will reduce infant mortality rates.

c) We ought to reduce our dependence on oil imports in order to increase our national security.

d) Increased defense spending will lead to higher budget deficits.

Which of the following is a normative statement?

Inte

rnat

ional

tra.

.

Hig

her e

xpen

di...

We

ought t

o re...

Incr

ease

d def

en..

0% 0%0%0%

1 2 3 4 5

a) you will be better off if you eat one more slice.

b) the total cost of eating the pizza will be more than the total benefit of eating the pizza.

c) you will be worse off if you eat one more slice.

d) you will be no better off and no worse off from eating one more slice.  

a) you will be better off if you eat one more slice.

b) the total cost of eating the pizza will be more than the total benefit of eating the pizza.

c) you will be worse off if you eat one more slice.

d) you will be no better off and no worse off from eating one more slice.  

While eating pizza, you discover that the marginal benefit of eating one more slice is greater than the marginal cost of that slice. You then conclude:

0% 0%0%0%

1 2 3 4 5

Which of the graphs below shows the impact of scientists developing a more powerful fertilizer?

0% 0%0%0%

a) Figure Ab) Figure Bc) Figure Cd) Figure D

a) Figure Ab) Figure Bc) Figure Cd) Figure D

1 2 3 4 5

If they spend all night writing computer programs, Derek can write 10 programs while Tian can write 5. If they spend all night making sunglasses, Derek can make 6 while Tian can make 4. From this information we know that:

Tia

n’s

oppo...

Der

ek’s

op...

Tia

n’s

oppo...

Der

ek’s

op...

0% 0%0%0%

a) Tian’s opportunity cost of writing programs is less than that of Derek.

b) Derek’s opportunity cost of writing programs and of making sunglasses is less than that of Tian.

c) Tian’s opportunity cost of writing programs and of making sunglasses is less than that of Derek.

d) Derek’s opportunity cost of writing programs is less than that of Tian.

a) Tian’s opportunity cost of writing programs is less than that of Derek.

b) Derek’s opportunity cost of writing programs and of making sunglasses is less than that of Tian.

c) Tian’s opportunity cost of writing programs and of making sunglasses is less than that of Derek.

d) Derek’s opportunity cost of writing programs is less than that of Tian.

1 2 3 4 5

Problem Set 1: #14

Go to college

Tuition $17,000

Food + Rent $ 7,000

Parties $ 3,000

Books $ 600

Car $ 3,600

Don’t go to college

Job $19,000

Food + Rent $ 7,000

Parties $ 3,000

Car $ 3,600

Cost of going to college =$17,000 + $600 + $19,000 = $36,600

Sue Student