Introduction to the Course
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Instructor: Clint Levitt
Email: cjl.eco@cbs.dk
Phone:
Office:
Communication: Unfortunately, I do not
speak french, so all emails must be
written in english.
Session 1
What do Economists
Study?
Objective 1
• Introduce the study of economics
• How to think like an economist
• Key Concepts
1. Scarcity and Tradeoffs
2. Opportunity Costs
3. Models
4. Introduce the first model:
Production Possibility Frontier
Objective 2
• Supply and Demand Models
• Key Concepts
• Markets
• Prices
• Law of Supply
• Law of Demand
• Excess Supply and Excess Demand
• Equilibrium
What is the Study of Microeconomics?
• How choices are made under the
condition of scarcity.
• Example 1: Income
• Example 2: Time
• OTHER EXAMPLES?
How to Study These Choices?
Cost benefit analysis
• Compare the benefits against the costs.
Question: Should I do x?
• Answer: If and only if B(x)>C(x).
• Example: Skiing
Practice Problem #1
• Mike has a flexible summer job. He works every day
but is allowed to take time off anytime he wants.
• His friend suggests they take off work to go to the
beach. It will cost them $20 each to get to the beach.
• Mike’s preferences are such that a day at the beach is
worth $45.
• Mike also likes his job and would be willing to pay $10
per day just to work.
1. If mike earns $10 if he works, should he go to the
beach?
2. How about is he earns $15?
3. How about if he earns $20?
Practice Problem #2
• Dana has purchased a $40 dollar ticket
to a rock concert.
• But, on the day of the concert she has
been invited to a party for a friend.
• She cannot attend both. If she had
known about the party, before buying the
ticket, she would have chosen the party.
• If she is rational, will she go to the party?
• Hint: Think about the costs and benefits
at the time of making the decision!
Models
• What is a Model?
An economic model is a simplified
framework designed to illustrate
complex processes
• We use models to focus on specific
processes that we are interested in
understanding.
• Models are necessarily a simplification
of reality.
Production Possibility Curve
• The production possibility curve
– what the curve shows
The various combinations of outputs that
can be produced with fixed inputs of
production, holding technology fixed.
– microeconomics and the production
possibility curve:
• choices and opportunity cost
• increasing opportunity cost
A production possibility curve
8
Units of food (millions)
7
6
Units of food Units of clothing
(millions)
(millions)
5
4
8m
7m
6m
5m
4m
3m
2m
1m
0
3
2
1
0.0
2.2m
4.0m
5.0m
5.6m
6.0m
6.4m
6.7m
7.0m
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
A production possibility curve
8
a
Units of food (millions)
7
6
5
Units of food Units of clothing
(millions)
(millions)
4
a
8m
7m
6m
5m
4m
3m
2m
1m
0
3
2
1
0.0
2.2m
4.0m
5.0m
5.6m
6.0m
6.4m
6.7m
7.0m
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
A production possibility curve
8
b
Units of food (millions)
7
6
Units of food Units of clothing
(millions)
(millions)
5
4
8m
7m
6m
5m
4m
3m
2m
1m
0
b
3
2
1
0.0
2.2m
4.0m
5.0m
5.6m
6.0m
6.4m
6.7m
7.0m
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
A production possibility curve
8
Units of food (millions)
7
c
6
Units of food Units of clothing
(millions)
(millions)
5
4
8m
7m
6m
5m
4m
3m
2m
1m
0
c
3
2
1
0.0
2.2m
4.0m
5.0m
5.6m
6.0m
6.4m
6.7m
7.0m
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
A production possibility curve
8
Units of food (millions)
7
6
Units of food Units of clothing
(millions)
(millions)
5
4
8m
7m
6m
5m
4m
3m
2m
1m
0
3
2
1
0.0
2.2m
4.0m
5.0m
5.6m
6.0m
6.4m
6.7m
7.0m
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
A production possibility curve
8
Units of food (millions)
7
6
5
4
3
2
1
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
A production possibility curve
8
w
Units of food (millions)
7
x
6
5
4
3
2
1
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
The Production Possibility Curve
• The production possibility curve
– What is the interpretation of the shape of the
curve?
– The slope of the curve is the marginal rate
of transformation.
– It describes the changes in the opportunity
costs of production
– MRT – amount of one good that must be
given up to produce one additional good.
Increasing opportunity costs
8
Units of food (millions)
7
x
6
1
5
y
1
4
3
2
1
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
Increasing opportunity costs
8
Units of food (millions)
7
x
6
1
5
y
1
2
4
z
3
1
2
1
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
Production Possibility Curve
• The production possibility curve
– what the curve shows
– microeconomics and the production
possibility curve:
• choices and opportunity cost
• increasing opportunity cost
Production Possibility Curve
• The production possibility curve
– macroeconomics and the production
possibility curve:
• production within the curve
Making a fuller use of resources
x
Food
Production inside
the production
possibility curve
y
v
O
Clothing
Production Possibility Curves
• The production possibility curve
macroeconomics and the production
possibility curve:
• production within the curve
• shifts in the curve
Food
Growth in potential output
Now
O
Clothing
Growth in potential output
Food
5 years’ time
Now
O
Clothing
Food
Growth in potential and actual output
O
Clothing
Growth in potential and actual output
y
Food
x
O
Clothing
Practice Problem #3
A country is capable of producing the following
combinations of goods and services per period of time,
assuming that it makes full use of its resources of land,
labour and capital.
Goods
(units)
Services
(units)
100
80
60
40
20
0
0
50
90
120
140
150
Sketch the Production Possibility Curve.
Practice Problem #3 Continued
• Is it possible for this country to produce the
following combinations of goods and
services?
a) 80 units of goods and 50 units of services
b) 70 units of goods and 90 units of services
c) 40 units of goods and 100 units of services
Practice Problem #3 Continued
• What is the opportunity cost (in terms of
services) of producing 20 extra units of goods
when this country is initially producing:
• A) 60 units of goods
• B) 20 units of goods
Discussion Question
• What happens to the production
possibility curve, if there is a general
increase the efficiency of production?
Microeconomics
• Microeconomics describes trade-offs
that must be made due to scarcity.
• We focus on
1. Consumer Theory
2. Theory of the firm
Microeconomics
• Microeconomics is also concerned with
the role of prices.
1. How prices are determined?
2. What is the central role of markets?
Economic Systems
Classifying economic systems
Totally
planned
economy
Totally
free-market
economy
Classifying economic systems
Mid 1980s
Totally
planned
economy
N. Korea China
Poland
Cuba
UK
France
USA
Hong
Kong
Totally
free-market
economy
Classifying economic systems
Mid 1980s
Totally
planned
economy
N. Korea China
Poland
Cuba
UK
France
USA
Hong
Kong
Totally
free-market
economy
N. Korea
Cuba
China
Poland France
USA
UK
China
(Hong
Kong)
Mid 2000s
ECONOMIC SYSTEMS
• The command economy
– features of a command economy
– planning:
• consumption and investment
• matching of inputs and outputs
• distribution of output
ECONOMIC SYSTEMS
• Advantages of a command economy
– high investment, high growth
– stable growth
– social goals pursued
– low unemployment
• Problems of a command economy
– problems of gathering information
– expensive to administer
– inappropriate incentives
– shortages and surpluses
ECONOMIC SYSTEMS
• The free-market economy
– demand and supply decisions
– the price mechanism:
• shortages and surpluses
• equilibrium price
• response to changes in demand and
supply
The price mechanism:
the effect of a rise in demand
Goods Market
Dg
shortage
(Dg > Sg)
Pg
Sg
Dg
until Dg = Sg
The price mechanism:
the effect of a rise in demand
Goods Market
Dg
shortage
(Dg > Sg)
Sg
Pg
Dg
until Dg = Sg
Factor Market
Sg
Df
shortage
(Df > Sf)
Pf
Sf
until Df = Sf
Df 
ECONOMIC SYSTEMS
• The free-market economy
– demand and supply decisions
– the price mechanism:
• shortages and surpluses
• equilibrium price
• response to changes in demand and
supply
– the interdependence of markets
The price mechanism:
the effect of a rise in demand
Goods Market
Dg
shortage
(Dg > Sg)
Sg
Pg
Dg
until Dg = Sg
Factor Market
Sg
Df
shortage
(Df > Sf)
Pf
Sf
until Df = Sf
Df 
ECONOMIC SYSTEMS
• Advantages of a free-market economy
– transmits information between buyers and
sellers
– no need for costly bureaucracy
– incentives to be efficient
– competitive markets responsive to
consumers
ECONOMIC SYSTEMS
• Problems of a free-market economy
– competition may be limited: problem of
market power
– inequality
– the environment and other social goals may
be ignored
• The mixed economy
Introducing Economics
The Nature of
Economic Reasoning
THE NATURE OF ECONOMIC REASONING
• Economics as a science
– models in economics
– building models
– using models
– assessing models
• Economics as a social science
– difficulties in conducting controlled
experiments in many parts of the subject
– problems of predicting human behaviour