MICROECONOMICS

Chapter 1 Preliminaries
What is economics?

Study of how people and society choose among alternative uses of their scarce
resources
What is microeconomics?

Branch of economics that deals with behavior of individual economic units.

consumers, workers, investors, owners of land, business firms

any individual or entity that plays a role in the functioning of the economy

An important concern of microeconomics is how these units interact to form

larger units markets and industries
What is macroeconomics?

Branch of economics that deals with aggregate economic quantities

national output, interest rates, unemployment, inflation

Considers the economy as a whole

The boundary between macro and micro is becoming blurred.

Macro also involves analysis of markets specifically aggregate markets

for goods and services, labor, corporate bonds

Macroeconomic analysis uses the tools of microeconomics

Key Themes of Microeconomics

Limits and Trade-offs

Limits allocation of scarce resources;

consumers limited income, time, etc

producers (firms) limited budgets, technical know-how

workers (labor) limited time

Investors limited capital funds

Trade-offs => choices to be made

consumers between different goods and services, between

quality and quantity, between present and future

producers between alternative products or models/versions/etc,

quality versus volume, labor versus equipment

workers between leisure and work, between education or early

work, alternative types of employment

Investors between alternative investment opportunities, between

consumption and savings/investment

Positive versus Normative Analysis

Positive economics is descriptive or predictive

how and why economic entities behave or are expected to behave

under different circumstances

Normative economics is prescriptive

introduces value judgments or specific objectives in determining

how economic entities should behave, and why

E.g., public policymakers want whats in the best public

interest; or society believes that it is good to transfer
resources from rich to poor

Microeconomics does not make the value judgments; only help

illuminate issues given societys values

Why people disagree on policies

Different views on how the economy behaves (different data,

different models, different simplifying assumptions, different
statistical techniques) i.e., on positive aspects

Different values/objectives (e.g., trade-offs between present and

future consumption; importance of equity versus efficiency; different
moral or religious values) i.e., on normative aspects

Prices and Markets

consumers and producers make choices based on prices

markets are where consumers, producers, workers interact (much more

later)

One of the goals of microeconomics is to analyze market mechanisms

For establishing relative prices among goods and services

For allocating society's resources among their many alternative

uses.

The Market

Market collection of buyers and sellers that determine the price of a product

firms or individuals may act either as buyers or sellers in different markets

Buyers consumers purchasing goods and services; firms buying

labor, capital and raw materials

Sellers firms selling goods and services; workers selling labor;

resource owners renting or selling land or other non-labor inputs

Industry collection of firms that sell the same or closely related products

the supply side of the market

Market definition is the determination of buyers, sellers and range of

products that should be included when analyzing a particular market

First, be clear what market, exactly, is being analyzed

Not easy to do this

Depends on the business or policy question at hand

Geography or range/type of product may also be critical in defining market

E.g., market for cars; market for compact cars; market for 2-door
compact cars

market for cars; market for compact cars; market for 2-door compact cars

Importance of market definition

Market for a certain product in order to set price, make budgeting

decisions, etc., companies must know

Their competitors

Product characteristics and geographic boundaries of the market

Labor market in order to make decisions about whether to work, and

hours of work, individuals must know

What kinds of jobs/industries would require their skills

Where their place of work would be

 Competitive versus Noncompetitive Markets

Perfectly competitive market many independent buyers and sellers,

and no single buyer or seller has a significant impact on price

Noncompetitive market individual seller(s) or buyer(s) can influence

price

E.g., Cartels groups of producers who act collectively

Example: OPEC dominates world oil market

Not always an easy distinction between competitive and noncompetitive:

For analytical purposes, a market with a limited number of sellers

may be considered competitive if there is fierce competition
among the participating firms

E.g., market for drugs to control blood pressure or

cholesterol level (before major patents expired)

For analytical purposes, a market with a large number of sellers

may be noncompetitive if one seller is able to influence market
price

E.g., drug market with Mercury Drug dominant

Market Price

The market price is the price prevailing in a competitive market;

in a competitive market, there is usually one single prevailing price

(i.e., there is a tendency for actual prices to hover around this price)

In some competitive markets, market price can change rapidly (e.g., stock
or commodities markets)

In economics, relative price matters more than absolute price

Relative to other related goods or services (e.g., substitutes or

complements)

Relative to all other goods or services (real price measured using

a price index)