Lecture 1
Chapter 1
Thinking Like an
Economist
The Cost-Benefit Approach
• If the benefit of an activity exceeds its cost, do
it.
• Reservation price of activity x: the price at
which a person would be indifferent between
doing x and not doing x.
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Common Pitfalls in Decision Making
• Ignoring Implicit Costs
• Failing to Ignore Sunk Costs
• Measuring Costs and Benefits as
Proportions Rather than Absolute Dollar
Amounts
• Failure to Understand the AverageMarginal Distinction
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Pitfall #1: Ignoring Implicit Costs
• If doing activity x (education) means not being
able to do activity y, then the value to you of
doing y is an opportunity cost of doing x
(education).
• In other words, the opportunity cost is the
value of all that must be sacrificed to do the
activity.
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Pitfall #2: Failing to Ignore Sunk Costs
• An opportunity cost may not seem to be a
relevant cost when in reality it is.
• On the other hand, sometimes an expenditure
may seem relevant when in reality it is not.
– Sunk costs: costs that are beyond recovery at the
moment a decision is made.
– These costs should be ignored.
– Reservation price
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Pitfall #3: Measuring Costs and
Benefits as Proportions Rather Than
Absolute Dollar Amounts
• When comparing costs and benefits, always
use absolute dollar amounts, not proportions.
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Pitfall #4: Failure to Understand the
Average-Marginal Distinction
• Compare the benefit and cost of an additional
unit of activity.
– Marginal cost: the increase in total cost that results
from carrying out one additional unit of activity
– Marginal benefit: the increase in total benefit that
results from carrying out one additional unit of
activity
• Keep increasing the level of an activity as long as
its marginal benefit exceeds its marginal cost.
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Figure 1.1: The Optimal Quality of
Conversation
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The Invisible Hand
• Unaware of the effects of their actions, selfinterested consumers often act as if driven by
what Adam Smith called an invisible hand to
produce the greatest social good.
• External cost of an activity: a cost that falls on
people who are not directly involved in the
activity.
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Would Parents Want Their Daughter or
Son to Marry Homo Economicus?
• The stereotypical decision maker in the selfinterest model is given the label Homo
Economicus, or “economic man”
• Homo Economicus only cares about personal
material costs and benefits.
• Self-interest is one of the most important
human motives, but it is not the only
important motive.
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Woman’s Gains by saying “no”
Two men: John, Ake; Two girls: Lucia, Diana
John: Lucia > Diana
Ake: Diana > Lucia
Lucia: Ake > John
Diana: John > Ake
Japan: 80 %; USA: 20%
Highly respected Fukuzawa
11.15
Gender equality and Mixed Strategies
Two men: John, Ake; Two girls: Lucia, Diana
Topics for movies
John: Lucia > Diana
Ake: Diana > Lucia
Lucia: Ake > John
Diana: John > Ake
11.15
The Economic Naturalist
• An economic naturalist sees the mundane
details of ordinary existence in a sharp new
light—economics is around us everywhere.
• Why are some well-known European
restaurants closed for a few weeks in tourist
season?
•
• Why is milk sold in rectangular containers,
while soft drinks are sold in round ones?
• cultural value difference: America: proved
criminal; Japan: quick to admit
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Positive Questions and Normative
Questions
• Normative question: a question about what
policies or institutional arrangements lead to
the best outcomes.
• Positive question: a question about the
consequences of specific policies or
institutional arrangements.
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Microeconomics and Macroeconomics
• Microeconomics: the study of individual
choices and the study of group behavior in
individual markets
• Macroeconomics: the study of broader
aggregations of markets
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Chapter Outline
• The Cost-Benefit Approach to Decisions
• The Role of Economic Theory
• Common Pitfalls in Decision Making
• Using Marginal Benefit and Marginal Cost Graphically
• The Invisible Hand
• Would Parents want their Daughter or Son to Marry
Homo Economicus?
• The Economic Naturalist
• Positive Questions and Normative Questions
• Microeconomics and Macroeconomics
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Lecture 2
Chapter 2
Supply and Demand
Supply and Demand Curves
• A Market: consists of the buyers and sellers of
a good or service.
• Law of Demand: the empirical observation
that when the price of a product falls, people
demand larger quantities of it.
• Law of Supply: the empirical observation that
when the price of a product rises , firms offer
more of it for sale.
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Figure 2.1: The Demand Curve for
Lobsters in Hyannis, MA., July 20, 2014
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Figure 2.2: A Supply Schedule for
Lobsters in Hyannis, MA., July 20, 2014
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Equilibrium Quantity and Price
• Equilibrium quantity and price: it is the pricequantity pair at which both buyers and sellers are
satisfied.
• Excess supply: the amount by which quantity
supplied exceeds quantity demanded.
• Excess demand: the amount by which quantity
demanded exceeds quantity supplied.
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Figure 2.3: Equilibrium in the Lobster
Market
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Figure 2.4: Excess Supply and Excess
Demand
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Some Welfare Properties of
Equilibrium
• If price and quantity take anything other than
their equilibrium values, however, it will
always be possible to reallocate so as to make
at least some people better off without
harming others.
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Figure 2.5: An Opportunity for
Improvement in the Lobster Market
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Free Markets and the Poor
• Efficiency says that given the low incomes of
the poor, free exchange enables them to do
the best they can.
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Rent Controls
• A price ceiling for rents is a level beyond
which rents are not permitted to rise.
• Example: Figure 2.6
– The price ceiling creates an excess demand of
40,000 units.
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Figure 2.6: Rent Controls
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Price Supports
• A price support (or price floor) keep prices above
their equilibrium levels.
• Require the government to become an active
buyer in the market.
• Purpose of farm price supports is to ensure prices
high enough to provide adequate incomes for farm
families.
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Figure 2.7: A Price Support in the
Soybean Market
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The Rationing and Allocative Functions
of Prices
• Rationing function of price: the process
whereby price directs existing supplies of a
product to the users who value it most highly.
• Allocative function of price: the process
whereby price acts as a signal that guides
resources away from the production of goods
whose prices lie below cost toward the
production of goods whose prices exceed cost.
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Factors the Shift the Demand Curve
• Incomes
– Normal goods: the quantity demanded at any price
rises with income.
– Inferior goods: the quantity demanded at any price falls
with income.
• Tastes
• Price of Substitutes and Complements
– Complements - an increase in the price of one good
decreases demand for the other good.
– Substitutes - an increase in the price of one will tend to
increase the demand for the other.
• Expectations
• Populations
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Figure 2.8: Factors that Shift
Demand Curves
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Factors the Shift the Supply Curve
• Technology
• Factor Prices
• The Number of Suppliers
• Expectations
• Weather
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Figure 2.9: Factors that Shift Supply
Schedules
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Predicting Changes in Price and
Quantity
• An increase in demand → an increase in both the
equilibrium price and quantity.
• A decrease in demand → a decrease in both the
equilibrium price and quantity.
• An increase in supply → a decrease in the equilibrium
price and an increase in the equilibrium quantity.
• A decrease in supply → an increase in the
equilibrium price and a decrease in the equilibrium
quantity.
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Figure 2.10: Two Sources of Seasonal
Variation
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Figure 2.11: The Effect of Soybean Price Supports
on the Equilibrium Price and Quantity of Beef
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The Algebra of Supply and Demand
• For computing numerical values, it is more
convenient to find equilibrium prices and
quantities algebraically
– The supply schedule is: P= 2 + 3Qs
– Its demand schedule is: P = 10 – Qd
– In equilibrium we know that Qs = Qd, denoting this
common value as Q*, we arrive at:
2 + 3Q* = 10 – Q*
– Which gives Q* = 2, substituting this back into either
the supply or demand equation gives the equilibrium
price, P* = 8
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Figure 2.12: Graphs of the Supply and
Demand Equations
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