27/09/2014

EC1008 Introduction to

Microeconomics

Introduction to Microeconomics
Textbook: John Sloman, Economics, 8th edition
Lecturer: Dr. Claudia Jefferies
Claudias office: D329
Claudias e- mail address:
Claudia.jefferies.1@city.ac.uk

WHAT IS ECONOMICS?
The study of how we deal with scarcity!
Scarcity principle having more of one good
thing usually means having less of another
Every choice is a trade-off
Resources are limited and wants are unlimited!
What resources?

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Factors of Production
Land and natural resources
Labor
Capital
These are inputs into the production process.

CHOICES/TRADE-OFFS
As individuals, households and society we
have to make tough choices

What?
How?
How much?
For Whom?

WHAT IS ECONOMICS?
It is the study of human behaviour when
confronted with scarcity of resources
What is the best way for society to manage its
scarce resources?
Subject is often split into
Microeconomics: Concerned with individual
parts of the economy consumers, firms in
particular markets
Macroeconomics: Concerned with the economy
as a whole

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What do Economists Study?

Macroeconomic issues
growth

unemployment

inflation

balance of payments problems

cyclical fluctuations

What do Economists Study?

Microeconomic issues
choices: what, how and for whom
the concept of opportunity cost
rational economic decision making
marginal costs and marginal benefits
MC > MB do more
MC > MB do less
microeconomic objectives
efficiency
equity

MAKING CHOICES
What is the best way of making these decisions
for individuals, households and society?
Economics tries to find answers to the previous
question by comparing the benefits and the
costs.
It sounds so simple but it may not be that
simple.
When economists say cost, they mean
opportunity cost .
Focus on marginal benefits and costs

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OPPORTUNITY COST

Easy to define, but often it is surprisingly

difficult to apply.

Value of the next best alternative that must be

forgone.

OPPORTUNITY COST

Forgone benefit is a cost

of the decision
(the good thing you give
up)

Decision

Forgone costs is a benefit

(the bad thing you avoid)

Some Key Ideas

Dont ignore the implicit costs no actual
transfer of money
Think at the margin dont focus on the
average
Ignore sunk costs very counter-intuitive
Rational Choice: Weighing up marginal costs
and marginal benefits before making a decision.

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HOW DOES SOCIETY ALLOCATE

RESOURCES ?
Who decides what, how and for whom?
In most cases it is the combined interactions of
millions of households/ individuals and firms
Decentralised within limits people are free to
make whatever decisions they want.
This interaction happens in markets
Willingness to pay of buyers
Cost of production for sellers

ECONOMICS AS A SCIENCE
Try to approach issues with a scientists
objectivity
Scientific method - dispassionate development
and testing of theories about how the world
works
Observation
Devise theories/models that explain or predict
observed economic phenomenon
Collect data
Test theory

DEVELOPING THEORIES/MODELS
A model is a simplified representation of an
aspect of reality (thought experiment)
Only the key factors are included.
Factors are excluded by making assumptions.
Holding other factors constant
Ceteris paribus
Deliberately abstract from reality

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WHY ABSTRACT?
Simplify the complex world and make it easier to
understand.
Helps economists to focus on the key economic
relationships.
Enable the influence of one factor at a time to be
isolated in an imaginary world.
The art is deciding which assumptions to make.
Lots of non-economists simplify the real world.
Ignoring details can be useful.

Production possibility frontier:

An example
A diagram showing all the possible combinations
of two goods that can be produced within a
specified time period, with all resources fully and
efficiently employed

It demonstrates the
Use of models
Use of diagrams
Idea of trade-offs
Concept of opportunity cost

Example

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Example

A production possibility curve

8

6
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)

4 8m 0.0
7m 2.2m
3 6m 4.0m
5m 5.0m
4m 5.6m
2 3m 6.0m
2m 6.4m
1m 6.7m
1
0 7.0m

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

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A production possibility curve

8
a

6
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)

4 a 8m 0.0
7m 2.2m
3 6m 4.0m
5m 5.0m
4m 5.6m
2 3m 6.0m
2m 6.4m
1m 6.7m
1
0 7.0m

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

A production possibility curve

8
b
7

6
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)

4 8m 0.0
b 7m 2.2m
3 6m 4.0m
5m 5.0m
4m 5.6m
2 3m 6.0m
2m 6.4m
1m 6.7m
1
0 7.0m

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

A production possibility curve

8

7
c
6
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)

4 8m 0.0
7m 2.2m
3 c 6m 4.0m
5m 5.0m
4m 5.6m
2 3m 6.0m
2m 6.4m
1m 6.7m
1
0 7.0m

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

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A production possibility curve

8

7 w
x
6
Units of food (millions)

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

Increasing opportunity costs

8

x
6
Units of food (millions)

1 y
5
1
4

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

Increasing opportunity costs

8

x
6
Units of food (millions)

1 y
5
1
4 2

3
z
1

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

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Making a fuller use of resources

Production inside
Food

y
the production
possibility curve

O
Clothing

Growth in potential and actual output

x
Food

O
Clothing

HOW ARE MODELS JUDGED?

(1) Ability to offer insight/ help understanding
PPF
(2) Prediction
This will need to be tested against the facts.
Not judged on how closely they resemble reality.

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TESTING PREDICTIONS
Economists often analyse real world data
Problem
Model contains assumptions ceteris paribus
Real world data is determined by the
simultaneous impact of many factors e.g.
demand
Try to isolate the impact of each individual factor
Economists use statistical tools - econometrics

ECONOMICS AND POLICY

How the world is

Positive
Testable
statement
Empirical or Logical
How the world should be
Normative
Not testable
statement
Based on value judgements

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