BB107

Topic 1
Introduction to Microeconomics

by Ooi Soon Beng

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Textbook
McConnell, C.R., and Brue, S.L. (2011). Economics: Principles, Problems and Policies, 19th Edition, New York: Irwin McGraw-Hill.
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Learning Outcomes
Define economics and the features of the economic perspective. Distinguish microeconomics from macroeconomics.

Distinguish positive economics from normative economics.

List the categories of scarce resources and nature of the economizing problem. Apply production possibilities analysis, increasing opportunity costs, and economic growth.
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Introduction Originated from ancient Greek word oikos nomos -One who manages a household.
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Introduction

Economics is the study of how society manages its scarce resources!

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Economic wants are unlimited. Resources are limited. Scarcity arises because wants are unlimited and resources are limited.
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Art or Science?

Is economics an Art or a Science?

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Art or Science?
Natural scientists can test with much greater precision than can economists. They have the advantage of controlled laboratory experiment.

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Art or Science?
Economists must test their theories using the real world as their laboratory.
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? Art or Science?

Or is it a dismal science?

A science like Maths or Physics usually gets its satisfaction from proving something to be irrevocably true. Economics, on the other hand, can rarely give a simple answer. Ask five economists a question and youll get six different answers!
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Art or Science?
Economics is a social science concerned with the efficient use of scarce resources to achieve the maximum satisfaction of economic wants!
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Scarcity and Choice

Resources are scarce. Wants are unlimited. Hence, people have to make choices. Every choice has a trade-off giving up one thing to get something else.
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Examples:

Guns v. butter
Food v. clothing

Leisure time versus work

Scarcity and Choice

Opportunity cost is what you give up to get what you want.

What is your opportunity cost of attending college?

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What do Steve Jobs, Michael Dell, Bill Gates, Sir Richard Branson and Simon Cowell have in common?
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Scarcity and Choice

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Is scarcity same as poverty?

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Scarcity and Choice

Theres no free lunch!
Anything of any value that is offered for free still has a cost. The resources that were used to provide the free lunch could have been put to an alternative use!
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The Economic Perspective

Thinking like an economist.

Key features:
1) Scarcity and choice 2) Purposeful behavior

3) Marginal analysis

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The Economic Perspective

Scarcity and Choices: Economics recognizes that there is a general condition of scarcity that forces individuals and society to make choices. Purposeful Behavior: Economics assumes that private or public decision-making is based on rational self-interest.
Marginal Analysis: Economics focuses on marginal analysis when making an economic decision.
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The Economic Perspective

Best decisions are made by thinking at the margin.

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People compare extra benefits (MB) and extra costs (MC) before making decision. Marginal means extra.
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Pop Quiz
Given the following estimates of the benefits and costs, what is the optimal or efficient number of hospital beds according to economic theory?
No. of beds 0 1000 Total Benefits $11 million Total Costs $4 million

2000
3000 4000

$21 million
$30 million $38 million

$10 million
$18 million $28 million
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Pop Quiz

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Airlines can raise profits by thinking 20 at the margin. How?

Theories, Principles, and Models

Economists use the scientific method to establish theories, principles and models.

The scientific method:

Observe Formulate a hypothesis Accept, reject, or modify the hypothesis Continue to test the hypothesis, if necessary Form a theory, principle or model
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Test the hypothesis

So, you aspire to be an economist?

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Theories, Principles, and Models

Theories, principles, and models are purposeful simplifications. Principles are used to explain and/or predict the behavior of individuals and institutions. Economic principles:

Generalizations Other-things-equal or ceteris paribus

assumption

Graphical expression
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Theories, Principles, and Models

Generalizations: Economic principles are expressed as the tendencies of the typical or average consumer, worker, or business firm. Other things equal: In order to judge the effect one variable has upon another it is necessary to hold other contributing factors constant.

Graphical Expression: Many economic relationships are quantitative, and are demonstrated efficiently with graphs.
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Theories, Principles, and Models

Why are economic theories and principles imprecise?

They are generalizations relating to economic behavior.

They reflect tendencies or averages across large groups that may not apply to a particular individual.
Example: If the price of a product drops significantly, the quantity demanded among consumers as a group is expected to increase. But, some consumers may not increase their purchases. 25

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Microeconomics and Macroeconomics

Microeconomics focuses on the individual parts of the economy.
How households and firms make decisions and how they interact in specific markets.

Macroeconomics looks at the economy as a whole.

Economy-wide phenomena like inflation, unemployment, economic growth.

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Macroeconomics
is a general overview examining the beach, not the sand, rocks, and shells.

Microeconomics is an examination of sand, rocks, and

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shells, and not the beach. LO3

Pop Quiz
Indicate whether each one pertain to microeconomics or macroeconomics?
1) The inflation rate in the United States hit its lowest level in the last twenty years. 2) The profits of Microsoft rose 20 percent during the past quarter. 3) The nations economy grew at an annual rate of 3.7 percent in the final quarter of the year. 4) General Motors plans to spend $800 million on a new automobile plant. 28
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Positive and Normative Economics

Positive economics Normative economics A subjective perspective of the economy. When an economist wonders how things should be, then we have a normative issue.

Deals with economic facts. When an economist is asking about why things are in the way they are, we are facing a positive question.
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Positive and Normative Economics

Positive economics Example: Big tax cuts will help many people, but government budget constraints make that option infeasible. Normative economics

Example: We should cut taxes in half to increase disposable income levels.

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Pop Quiz
Indicate whether it is positive or normative economics. 1) The government should provide free tuition to all university students. 2) An effective way to increase the skills of the work force is to provide free tuition to all university students. 3) The Graduate Training Scheme will increase the skill requirements of workers in Malaysia. 4) Students should work very hard in order to do well in the final examinations.
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Individuals Economizing Problem

Individual faces limited income and unlimited wants. A budget line shows the various combinations of two products a consumer can purchase with a specific money income. The model assumes two goods, but the analysis generalizes to all goods available to consumers. The location of a budget line depends on a consumers money income, and the prices of the two products under analysis.
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Individuals Economizing Problem

If income = $120. Price of DVDs = $20. Price of books = $10.
$120 Budget
DVDs Books $20 $10

12 10 Quantity of DVDs

6 5 4 3 2 1 0
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0 2 4 6 8 10 12

Income = $120 Pdvd = $20

=6

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Unattainable
Income = $120 = 12 Pb = $10 Attainable
2 4 6 8 10 12 14 Quantity of Paperback Books

4
2 0

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Individuals Economizing Problem

Points on or inside the budget line represent points that are attainable given the relevant income and prices. Points outside the budget line are unattainable. The negative slope of the budget line represents the trade off that consumers must make in their consumption decisions. The value of the slope measures the opportunity cost of one more unit of a good under analysis.
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Individuals Economizing Problem

Income changes will shift the budget line.

Greater income will shift the line out and to the right, allowing consumers to purchase more of both goods.
Lower income will shift the line in and to the left, allowing consumers to purchase less of both goods.

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Individuals Economizing Problem

If income rises to $160. Price of DVDs = $20. Price of books = $10.
12 10
Quantity of DVDs

8 6 4

Income = $160 Pdvd = $20

=8

Income = $160 Pb = $10 = 16

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12

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Quantity of Paperback Books

Societys Economizing Problem

Society faces scarce resources and unlimited desires.

Land Labor Capital Entrepreneurial Ability

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Production Possibilities Model

A production possibilities curve (PPC) shows the maximum amounts of two goods that can be produced, assuming the full use of available resources. Points on the curve represent maximum possible combinations of robots and pizza that can be produced given the availability resources and technology. Points inside the curve represent underemployment of resources. Points outside the curve are unattainable at present.
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Production Possibilities Model

A PPC is drawn based on the following assumptions:

Full employment Fixed resources Fixed technology Two goods

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Production Possibilities Table

Production Alternatives Type of Product Pizzas

(in hundred thousands)

A
0

B
1

C
2

D
3

E
4

Industrial Robots
(in thousands)

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Plot the Points to Create the Graph

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Production Possibilities Curve

14 13 12 11 10 9 8 7 6 5 4 3 2 1 0

Industrial Robots

A B C

Unattainable
D

The slope of the PPC becomes steeper, demonstrating increasing opportunity cost.

Attainable
E 1 2 3 4 5 6 7 8 9

The increasing opportunity costs makes the PPC concave.

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Pizzas
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Production Possibilities Curve

Economic rationale for the concave PPC: 1) Economic resources are not uniform. 2) To get increasing amounts of pizza, resources not particularly well suited for the purpose of making pizza must be used.

For example, workers that are accustomed to producing robots on an assembly line may not do well as kitchen help.
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A Growing Economy
There are 3 main sources of economic growth: 1) Discovery of more resources 2) Improved resource quality

3) Technological advances

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A Growing Economy

Production Alternatives Type of Product Pizzas

(in hundred thousands)

A'
0 14

B'
2 12

C'
4 9

D'
6 5

E'
8 0

Industrial Robots
(in thousands)

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A Growing Economy
14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 A B A B C

Unattainable

Industrial Robots

Economic Growth
D

Now Attainable
Attainable
E 1 2 3 4 5 6 7 E 8 9
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Pizzas
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Production Possibilities Model

The decision as to how to allocate resources in the present will create more or less economic growth in the future. Using resources to invest in technological advance, education, and capital goods involves sacrificing present consumption for greater future consumption.
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Present Choices, Future Possibilities

Goods for the Future

Future Curve

Goods for the Future

Future Curve

Current Curve

Current Curve

Goods for the Present Presentville

Goods for the Present Futureville

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International Trade
A nation can also avoid the output limits of its domestic production possibilities through international specialization and trade.
Specialization and trade have the same effect as having more and better resources of improved technology.
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