Mircroeconomics: Chapter 1

What is economics?
The study of how society mange its scarce resources to accommodate society as a
whole

Scarcity
Resources
Factors of production
o Land, labour, physical capital

What is the difference between micro and macroeconomics?

Microeconomics focuses on the individual parts of the economy

Macroeconomics focuses on the economy as a whole
1. How people make decisions
2. How people interact
3. How the economy works as a whole

How do people make economic decisions? There are three principles:

1. People face tradeoffs
2. The cost of something is what you give up to get it
Opportunity Cost The cost of the best foregone alternative
EXAMPLE: School expenses
Tuition - $7000
Books - $1000
Housing - $5000
TOTAL: $13 000
Alternatively, you could potentially have a $13 000 car & lived at home
for free with a full time job earning $28 0000. You gave up the $28 000
(This is a larger foregone alternative and implicit cost)

Explicit cost Direct outlay of money

Implicit cost Indirect outlay of money

So what is the opportunity cost?

Explicit cost + Implicit cost = Opportunity cost
It is the value of the best foregone alternative: the lost wages (value of
$28 000 [implicit cost] vs the $13 000 car) + the $13 000 spent on
tuition (explicit cost), books, and housing. Therefore, the total
opportunity cost of attending Mac would be:
$28 000 + $13 000 = $41 000

Mac
Tuition - $7 000
Books - $1 000
Apartment - $5 000 (minus $2 000)
TOTAL - $11 000 + $28 000 = $39 000

Not living at home for free

Work - $28 000
Apartment - $2 000

3. Rational people think at the margin

Rational people consider costs & benefits of some action
o
o
o
o

Thinking at the Margin: Rational people make Marginal Changes

(small incremental changes to an existing plan)
Marginal Benefit: Additional satisfaction from consuming
(households) or producing (firms) one more unit of a good service
Marginal Cost: Additional cost from consuming or producing one
more unit of a good/service
Marginal benefit has to exceed Marginal cost

4. People respond to incentives

Incentive: something that encourages a person to act a certain way
For example, cigarette prices increase as an incentive to assist
smokers quit

How do people interact?

5. Trade can make everyone better off
We specialize in tasks we do best and trade with others for the things we
need that they can provide. We have gains from trade & enjoy a greater
variety of goods/services.
6. Markets are a good way to organize economic activity
Market Economy: Allocates resources through the decentralized (not one
person is making the decisions) decisions of firms and households
Example: Adam Smith observed that households and firms act as if
guided by an invisible hand if the consumer allowed to choose freely
what to buy, and the producer is allowed to choose freely what to sell
and how to produce it, then the market will settle on a product
distribution and prices that are beneficial to the community as a whole.
7. Governments can (sometimes) improve market outcomes

Markets only work if Property Rights (ability of individual to own and

exercise control over scarce resources) are assigned. There are 2
reasons for government intervention:
1. Promote efficiency
Efficiency: society makes the best use of its resources (size
of the pie)
Markets left to operate freely usually lead to efficiency
2. Promote equity
Equity: Involves the fair distribution of resources (how the
pie is divided)
There is always an efficiency/equity trade off like welfare & taxes

Efficiency and equity are inversely proportional

Market Failure: Market is unsuccessful at allocating resources efficiently.

Possible causes of this are:
1. Externality impact of one persons actions of the well-being of a
bystander
Negative Externality examples include increasing the
price of cigarettes and the regulation of pollution with taxes
Positive Externality examples include vaccines, education
2. Market Power ability of a single person or firm to have a
substantial influence on market prices
Negative Market Power examples include monopolies
charging large amounts of money for something that can
be cheaper