FCS 3450
Spring 2015
Unit 1
Microeconomics and
Macroeconomics
Microeconomics: focuses on the
behavior of individual consumers,
households, & businesses.
Examples:
1. Why do some couples choose to have three children while others elect to have
none?
2. Why do some families carry life insurance while others do not?
3. Why do some families save to purchase major appliances while others buy them
on credit?
Macroeconomics: focuses on
national economic policy and growth
Concept 1:
Nominal Price vs. Relative Price
Nominal Price
Reading – “What’s the Difference between Nominal & Real?”
Price paid for a product or service at the time of the
transaction.
Nominal prices are those that have not been adjusted to
remove the effect of changes in the purchasing power
of the dollar.
Nominal Price vs Relative Price
• RPx = relative price of commodity x
• NPx = nominal price of commodity x
• NPb = nominal price of the base
commodity (base commodity is whatever
commodity you choose as the comparison
basis).
Constructing Relative Prices Using Average Hourly
Wage Rate
Products
Year
Nominal Price
1969
1989
2010
Round Steak
$1.28
$2.39
$4.30
Bread (loaf)
$0.25
$1.00
$1.39
Average wage rate
$3.00
$10.00
$18.61
Concept 2: Diminishing marginal Value (Marginal
Utility), Demand, and Supply
• What is marginal value or marginal utility?
• Marginal value or marginal utility is the satisfaction
or pleasure you get from each additional unit or
consumption of the same good or service.
• What is declining marginal value or diminishing
marginal utility?
• We get less pleasure from additional units of a
product or service than from earlier units.
Relative Price of Round Steak
Round Steak (1 lb):
• 1969: RP = $1.28/$3.00 = 0.427 hour = 26 minutes
• 1989: RP = $2.39/$10.00 = 0.239 hour = 14 minutes
• 2010: RP = $4.30/$18.61 = 0.231 hour = 14 minutes
Implications of Declining Marginal Value
(Marginal Utility)
Implication 1: Consumers buy more of a product or service when its (relative)
price falls.
• The marginal value is the price you are willing to pay for that unit of product.
• Example: If you are very hungry, the marginal value of the first hamburger is
$3,00 to you. However, the marginal value of each hamburger after that
decreased until the marginal value may be $0 or close to it.
• So, if the price of a hamburger is $3.00, you will buy 1. If the price of
hamburger is $2.00 you will buy 2. If the price of hamburger is $0.80, you will
buy 3.
Implications of Declining Marginal Value
(Marginal Utility)
Implication 2: Sellers can use quantity discount as a pricing strategy to maximize
profit.
• In the previous example, if the seller sets the price at $2.00, the consumer will
buy 2 hamburgers. However, because of diminishing marginal utility, the
consumer was actually willing to pay $5.00 for 2 hamburgers ($3.00 for the first
and $2.00 for the second).
• The seller can package two hamburgers and sell both for $5.00 to maximize
profit. This is why sellers often offer quantity discounts.
Demand and Demand Curve
What is demand?
• The quantity of a product that a consumer, or a group of consumers, will purchase at a given price.
What is the relationship between demand and price?
• Inverse relationship between quantity demand and price:
• Price increases, demand decreases
• Price decreases, quantity demand increases
What is a demand curve?
• A graph that depicts the relationship between the prices of a product and the quantities of the
product that consumers purchase at these prices.
Demand for Donuts
Price/donut
1.2
1
0.8
0.6
D1
0.4
0.2
0
1
2
6
Quantity of Donuts (in 1,000’s)
12
Substitution and Income Effects of a Price Change
When the price of a product goes up, two things happen:
1. Substitution effect: The consumer switches to another product as a substitute.
1. The size of the substitution effect varies depending on how readily available
substitutes are. For example, the substitution effect for medical care is likely
to be small compared to the substitution effect for beef.
2. Income effect: When the price of a product goes up the real value of a consumer’s
income decrease.
The total effect of an own-price change = substitution effect + income effect.
Supply and Supply Curve
What is supply?
• The quantity of product that a producer, or a group of producers, will produce at given
prices.
How do producers respond to price changes?
• The producers try to maximize their profit, they will keep on producing as long as the cost of
producing one more unit is lower than the market selling price.
What is a supply curve?
• A graph depicting the relationship between the prices of a product and the quantities
producers will produce at these prices.
Supply of Donuts
Price/donut
1.2
S1
1
0.8
0.6
0.4
0.2
0
1
2
6
Quantity of Donuts (in 1,000’s)
12
Market Equilibrium?
What is market equilibrium?
• At equilibrium, quantity demand = quantity supply
• Market price is thus determined
Is the market always at equilibrium?
• In most cases, prices and quantities are moving towards the equilibrium.
Supply & Demand Intersect to
Determine Market Price
Price/donut
1.2
1
P1
S1
E1
0.8
0.6
0.4
D1
0.2
0
1
2
6
Q1
Quantity of Donuts (in 1,000’s)
12
Concept 3: Opportunity Cost
What is opportunity cost?
• When you spend time or money on anything, you give
up the opportunity to spend that time or money on
something else.
• Often defined as the cost of doing “the next best
thing.”
Concept 4: The Value of Time
Does time have value? Why?
• Time has value because it is a limited resource.
• Time is money
How is the value of time defined?
• The theoretical definition uses the opportunity cost approach:
• The value of your time in any activity depends on what else you
could do with that time.
• With this approach the value of time varies from individual to
individual and from activity to activity
• The empirical definition defines the price of an hour as a person’s hourly
wage rate.
• With this approach there is uniformity for each person.
Example: Housework tradeoffs - Friends are coming
to town for the weekend. Should you take them out to
dinner or cook for them at home?
• Assumption: the quality of meals is equal, you get no
enjoyment from cooking, and you don’t mind doing dishes
• Cooking at home: $50 (ingredients) + 6 hours of your time
preparing the meal and dealing with clean-up.
• Eating at a restaurant: $120 (including tax and tip), 15
minute drive to the restaurant, 30 minute wait for your
table, 15 minute drive back home but no time spent in meal
preparation.
• The economic answer depends on the rate at which you
value your time:
• $20/hr time costs: $50 + ($20/hr * 6 hrs) = $170 > $140 ==> eat
out!
• $10/hr time costs: $50 + ($10/hr * 6 hrs) = $110 < $130 ==> eat in!