Economics 201 Week 1 – Day 2

Introduction to Microeconomics

It is the study of how people make choices in the marketplace◦ Consumers (you and me)

How to allocate your time Studying versus work versus socializing versus sleep

How to allocate your income Saving versus consuming Among various goods

Food, housing, transportation, “fun”

What is Economics

It is the study of how people make choices in the marketplace◦ Firms (and their managers)

Which goods to produce How to allocate your investment (capital) How to allocate your labor among various goods or

models of the product Which technology to use

Capital or labor Which inputs, quality of inputs

What is Economics

The reason people/firms need to make choices is because of scarcity◦ “You can’t have it all”

Limits on resources, time, money/income “dictate” that individuals have to choose how to allocate their “scarce” resources to their maximum value/use

◦ “Opportunity costs” : since resources are scarce and you will have to make choice Means that there are “opportunity costs” of making a

choice That is, there are tradeoffs between alternatives

Choices and Scarcity

Lionel Robbins (1932): "the science which studies human

behaviour as a relationship between ends and scarce means which have alternative uses." ◦ Scarcity :available resources are insufficient to

satisfy all wants and needs. Absent scarcity and alternative uses of

available resources, there is no economic problem.

Economics involves the study of choices as they are affected by incentives and resources.

Economics and Scarcity

What is economics?◦ Greek: okonos: manager or administrator of a household

More recently (borrowed from Wikipedia)◦ Adam Smith (1776): "an inquiry into the nature and causes of the wealth of

nations,"◦ Thomas Carlyle (1849): coined 'the dismal science' as an epithet for

classical economics linked to the pessimistic analysis of Malthus (1798).[

◦ John Stuart Mill (1844) the science which traces the laws of such of the phenomena of society as arise from the combined operations of mankind for the production of wealth, in so far as those phenomena are not modified by the pursuit of any other object.

◦ Alfred Marshall Principles of Economics (1890): Study of man in the ordinary business of life. It enquires how he gets his income and how he uses it. Thus, it is on the one side, the study of wealth and on the other and more important side, a part of the study of man.

◦ Lionel Robbins (1932): Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.

What is Economics?

Alchian and Allen◦ Discovery and analysis of the different ways in

which individual goals and activities can be coordinated without central planning

◦ The unit of analysis is the individual◦ Economic analysis is scientific, not normative

Formulates hypothesis about behavior, subjects these hypotheses to tests/analysis with data, accepts/rejects the model based on the results

It helps explains what conditions lead to what consequences

What is Economics?

◦ 2 major fields of inquiry Microeconomics

Study of individual markets and factors that affect market price, quantity supplied two principal actors: consumers/households and

firms/producers Macroeconomics

Study of a system of (national) markets focusing on national income (gross national product), price levels (inflation), employment/unemployment and international trade

Focuses on the role of government (Congress and budgets, Federal Reserve Bank), regulation (and regulatory agencies, business cycles and their effect on the economy

What is Economics

Alchian and Allen

1. For each person, some goods are scarce2. Each person desires many goods and goals3. Each person is willing to give up some of one

economic good to get more of another economic good

4. The more one has of a good, the lower is its personal marginal value

5. Not all people have identical tastes and preferences

6. People are innovative and rational

Key Assumptions About Individual Economic Behavior

For each person, some goods are scarce◦ Can’t get all that you want

you will have to make choices between 2 or more goods – tradeoff comparing benefits and costs of alternatives Shimano Dura-Ace/Ultegra/105 – weight/product quality/

dollars

Each person desires many goods and services

Carbon fiber frame or carbon fiber wheels or 11-speed shifters/gears

Implications of the assumptions

The more one has of a good, the lower is its personal marginal value◦ First unit(s) purchased have a higher value to the

individual than subsequent units purchased Satiation accounts for diminishing marginal (use) value Implies demand curves are downward sloping

Basis for the First Law of Demand

Each person is willing to give up some of one economic good to get more of another economic good◦ But will depend on how much of each good you already

have

Implications of the assumptions

For each person, some goods are scarce◦ Can’t get all that you want

you will have to make choices between 2 or more goods – tradeoff comparing benefits and costs of alternatives Shimano Dura-Ace/Ultegra/105 – weight/product quality/

dollars

Each person desires many goods and services

Carbon fiber frame or carbon fiber wheels or 11-speed shifters/gears or a power meter

Implications of the assumptions

Scarcity◦ For each person, some goods are scarce

What does scarcity mean:◦ “there is never enough” – time, money, a specific

good or set of goods So what?

◦ People have to choose between various goods, how to spend their money, use their time

◦ Economics develops and uses models to explain how they make these decisions and what factors affect their decisions Model of human behavior in an economic context

Implications of the assumptions

Scarcity / People Desire Many Goods◦ Scarcity implies that you “can’t have it all”◦ Have to make choices about which goods to

consume and how much of each good given your constraints (income and time)

◦ Face tradeoffs when making these choices Compare additional benefits and costs of choices “opportunity costs”: value of the highest alternative

not chosen – lower bound on the value of the alternative chosen

Always an “opportunity cost” associated with any choice Milton Friedman’s “no such thing as a free lunch”

Implications

People are innovative and rational◦ When making decisions, people will rationally

choose the alternative with the highest net (additional) benefit (net = benefit – cost)

◦ Take into account how much they currently have when assessing the value of the next unit

People do not have identical tastes and preferences◦ May have different personal value for goods

Will not make identical decisions Can be a basis for trade

Implications

Table 1

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Ten Principles of Economics (Greg Mankiw)