Convey the scope of microeconomic theory.
1.1 THE SCOPE OF MICROECONOMIC
THEORY
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
3
What Economics is All About
⚫ Scarcity: the limited nature of society’s resources
⚫ Economics: the study of how society manages its
scarce resources, e.g.
⚫ how people decide what to buy,
how much to work, save, and spend
⚫ how firms decide how much to produce,
how many workers to hire
⚫ how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
4
The Scope of Microeconomic Theory
⚫ “micro-” derives from the Greek word “mikros-”
⚫ Microeconomics
⚫ the study of the behavior of small economic
units such as consumers and firms
⚫ focuses on individuals as fundamental decision
makers in a society
⚫ also referred to as “price theory”
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
5
Explain why theory, is essential to understanding and predicting realworld outcomes.
1.2 THE NATURE AND ROLE OF
THEORY
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
6
The Nature and Role of Theory
⚫ A theory shows how facts are related to one another.
⚫ Theory
⚫ is based on certain assumptions.
⚫ Assumptions simplify the complex world, making it
easier to understand (ceteris paribus; 2-goods world; 2countries world)
⚫ Theories can be used to predict as well as explain realworld outcomes.
⚫ “Good” theory – a theory that successfully explains and
predicts the phenomena that it is intended to explain and
predict.
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
7
Models
⚫ To understand a complex world, economics build
models
⚫ Model: a highly simplified representation of
a more complicated reality.
Economists use models to study economic
relationships between variables, economic issues,
behaviors, and events.
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
8
Some Familiar Models
A road map
©wavebreakmedia/Shutterstock.com
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
Some Familiar Models
A model of human
anatomy from high
school biology class
©Accord/Shutterstock.com
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
Some Familiar Models
A model airplane
©Olga Rosi/Shutterstock.com
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
Some Familiar Models
The model teeth at the dentist’s
office
Don’t forget
to floss!
©ittipon/Shutterstock.com
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
Distinguish between positive and normative analyses.
1.3 POSITIVE VERSUS NORMATIVE
ANALYSIS
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
13
Models We Will Study
⚫ Models of supply and demand
⚫ Models of consumer behavior
⚫ Models of producer behavior
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
14
Positive versus Normative Analysis
⚫ Positive analysis
⚫ Scientific assessment of expected objective
outcomes; draws on accepted rules of logic and
evidence
⚫ Deals with propositions (statements) that can be
tested using logic and evidence
⚫ Deals with “what is”, not whether it is “good or
bad”, “right or wrong”
⚫ Possible to determine truth or falsity of a
statement
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
15
Positive and normative analysis cont’d
⚫ Normative analysis
⚫ a nonscientific value judgment; subjective
⚫ cannot be proven right or wrong by facts,
evidence, or logic
⚫ Stems from value system of person making the
judgement
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
16
Minimum wage: Example of Positive
and Normative Analysis
⚫ Evaluating desirability of minimum wage requires 3 steps:
⚫ 1) Qualitative effects: does it decrease or increase
employment (positive analysis)
⚫ 2) Quantitative effect: magnitude of effect (positive
analysis)
⚫ 3) Is minimum wage policy desirable? (normative
analysis)
⚫ Questions 1) and 2) are positive analysis that economics can
answer
⚫ Question 3) is normative analysis that economists cannot
answer
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
17
Differentiate between real and nominal prices.
1.4 MARKET ANALYSIS AND REAL
VERSUS NOMINAL PRICES
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
18
Market Analysis and
Real versus Nominal Prices
⚫ Most of microeconomics is about how markets function
⚫ Markets – the interplay of all potential buyers and sellers of
a particular commodity or service
⚫ In analyzing markets, interest is on factors having the
greatest influence on buyers and sellers, namely, prices
⚫ Nominal (absolute) price – absolute price, not adjusted for
the changing value of money
⚫ Nominal price doesn’t tell how costly an item is since
money (Omani rial) is an elastic yardstick
⚫ Real (relative) price - nominal price adjusted for the
changing value of money
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
19
Describe the basic assumptions economists make about market
participants.
1.5 BASIC ASSUMPTIONS ABOUT
MARKET PARTICIPANTS
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
23
Basic Assumptions about Market
Participants
Economists make 3 assumptions buyers and sellers
⚫ Goal-oriented – market participants are interested in
fulfilling their own personal goals
⚫ Rational behavior – behavior is based on a careful,
deliberate process that weighs expected benefits and costs
⚫ Scarce resources – availability of resources is insufficient
for individuals to satisfy all desires
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
24
Introduce the concept of opportunity cost and explain how economic costs
differ from accounting costs.
1.6 OPPORTUNITY COST
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
25
Opportunity Cost
⚫ Explicit costs (market – money used in the pursuit
of a goal that could otherwise have been spent on
an alternative objective
⚫ Implicit costs – costs associated with the
individual’s use of his or her own time and other
resources in pursuit of a particular activity
⚫ Economic cost (aka “opportunity cost”)
= explicit costs + implicit costs
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
26
Other Costs
⚫ Accounting costs = costs reported in companies’
net income statements generated by accountants
⚫ Accounting costs don’t take into account
implicit costs
⚫ Sunk costs = costs that have already been incurred
and are beyond recovery
⚫ Sunk costs should not be taken into account
when making decisions
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
27
Show how a production possibility frontier graphically depicts the basic
assumptions economists make about market actors as well as the concept
of opportunity cost.
1.7 PRODUCTION POSSIBILITY
FRONTIER
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
28
Production Possibility Frontier
⚫ PPF - a depiction of all the different combinations of goods
that a rational actor with certain personal goals can attain
with a fixed amount of resources
⚫ PPF depicts 3 basic assumptions of markets participants,
namely,
⚫ 1) goal-oriented behavior
⚫ 2) scarce resources
⚫ Rationality and concept of opportunity cost
⚫ Constant versus increasing per-unit opportunity cost – effect
on shape of PPF
⚫ Constant opportunity costs: linear
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
29
Constant Opportunity Cost PPF (Fig. 1.1)
⚫ Scarce resources limit the university to be any combination
on or below the PPF boundary AZ
⚫ Rational behavior implies choice will be on the PPF
boundary rather than below. Why choose mix of output Y
(500R and 50T) when you can have more of both outputs
like at C
⚫ Opportunity cost is reflected in downward slope of the
PPF. More of R implies less of T and vice versa. This tradeoff is the opportunity cost
⚫ With straight line PPF, opportunity cost is constant and
equal to 2R for 1T
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
30
Figure 1.1 - A Production Possibility
Frontier (PPF)
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
31
Increasing Opportunity Cost PPF ((Fig 1.2)
⚫ More common PPF is concave to the origin
⚫ Slope becomes steeper as you move from to left to bottom
right
⚫ Slope refers to number of R units you must give up (on
vertical axis) for each additional unit of T (on horizontal
axis)
⚫ The opportunity cost of producing an additional unit of T, in
terms of units of R that must be given up, increases with the
total output of T
⚫ From A to B, opportunity cost of 1T is 1R
⚫ From Y to Z, opportunity cost of 1T is 100R
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
32
Figure1.2 - The Typical-Case PPF:
Concave to the Origin
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
33