Introduction to Microeconomics
Lecture 1
What is economics?
What is economics
Microeconomics studies subjects like
•
⁻ Choices of individuals
⁻ Choices of Firms
⁻ The determinants of prices and quantities in specific markets
⁻ Government policies for monopoly, how markets operate, decisions about
investment in health, education, etc.
Macroeconomics studies subjects like
•
⁻
⁻
⁻
⁻
The performance of national economies
Long run growth and prosperity
Short run booms and busts
Government policies to change performance, reduce inequality
• Core Question - when is it best to let the private decisions prevail, and
when does it make sense to use collective action or government to
change economic outcomes and welfare.
The main players
• The text mentions three economists – Adam
Smith, Alfred Marshall, John Maynard Keynes
• The first two are key in this course – Keynes will
be central in macro economics.
• Other economists who will be prominent in this
course are
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–
–
Joseph Schumpeter (champion of capitalism)
Milton Freidman (advocate of free markets)
Herbert Simon (critic of rational decision making)
Joseph Stiglitz (co-developer of the concept of market
failure)
Economics as a social science
• Economics tries to generalize human behaviour when it
comes to making decisions about
– Producing goods/services
– Consuming goods and services
– Distributing goods and services
• Abstract and often highly mathematical models are used to
focus on the core issue
• Simplifying assumptions are common
• Decisions are assumed to be rational
– This the core abstraction
– The reality is that humans individually and collectively find in
hard to behave rationally
Definitions of economics
Scarcity – The Robbins definition in the text is standard
• That definition focuses on stuff (possessions, raw
materials, etc.)
..\..\Videos\george carlin talks about stuff.mp4
• Even if we had enough stuff, human life has several key
features
– Time which flows in one direction, implying that we have ever
less of it
– While humans are conscious of their limited lives, most seem
to treat our time as unlimited making it a free good.
Thinking about time reveals key economic ideas.
Trade-offs - we need to make choices – giving up some things to get
others.
Where does an industry come from?
Problem: In the last decade
storage lockers have become
very large business, dominated
by three large North American
firms.
Question 1: Why has this
industry emerged?
Question 2: Why is the TV
show Storage Wars a ratings
success?
Answer 1: Increased mobility among workers created a demand for
facilities for temporary storage.
Answer 2: The recession caused may locker renters to default on
payments and the firm then auctions the contents to recover losses. The
show is really based on the bankruptcies of many American families and
small businesses.
The arrow of time
• Imagine your life can be represented by
simple rope
I need two volunteers from the audience (no there is no extra credit!)
• Let us assume (….the most import three words in
economics)
1. Assumption 1 - I will live to be 85
2. Assumption 2 - I will live completely healthy until
my instant death doing what I love best (teaching
economics of course!)
I am using the ceteris paribus technique of holding
everything else equal
What is the basis for these simplifying assumptions?
Assumptions are basic to economics
• Simplifying the problem makes it solvable
• Yes --- everything is connected to everything
else.
• Economics rests on two key concepts
1. It is possible to reduce any problem to core essential
principles and elements
2. The ceteris paribus process and Occam’s razor are used to
focus on the essentials.
Occam’s Razor – select any explanation/theory with the
fewest assumptions
Cost – benefit decision rule
• When difficult cases occur, they are difficult chiefly because while we have them
under consideration, all the reasons pro and con are not present to the mind at
the same time …
• To get over this, my way is to divide half a sheet of paper by a line into two
columns; writing over the one “Pro”, and the other “Con”. Then … I put down
under the different heads short hints of the different motives … for and against
the measure … I endeavour to estimate their respective weights; where I find
one on each side that seem equal, I strike them both out. If I find a reason pro
equal to two reasons con, I strike out three … and thus proceeding I find at
length where the balance lies …
• And, though the weight of reasons cannot be taken with the precision of
algebraic quantities, yet when each is thus considered, separately and
comparatively, and the whole lies before me, I think I can judge better, and am
less liable to take a rash step.
Benjamin Franklin
Cost-benefit principle
• Any decision where the benefits exceed the costs will
be beneficial.
• Obviously, if one can only do one activity (go to a
movie, attend this class, work at a part-time job…),
do the activity that produces the highest benefit to
cost result.
• Two complications:
1. Short vs. long run benefits and costs
2. Some benefits and costs are not easily
expressed in money terms.
Cost-benefit or benefitcost?
It makes no difference.
Most economists prefer
benefit-cost because it
shows the amount of
benefit per dollar of
cost.
Example of cost-benefit problems
• Is the long-term gain (in terms of expected lifetime earnings)
of post-secondary education worth the cost (and emotional
pain) of paying for the education and giving the wages that
could be earned?
• Does it pay-off to have compulsory vaccination for girls and
boys of age 12 for the HPV virus (the primary cause of cervical
cancers).
• Does public (government) support for a new football stadium?
Hint: The word “public” typically refers to government spending and
actions while “private” refers to spending decisions and actions made by
households, businesses, etc.
Thought experiment 1
• Imagine life as a time line
B
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N
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t
h
• Assumption 3 – once a minute (hour, day,
week…) has passed – it is gone forever. (This is
more a fact than an assumption).
Opportunity cost 1
• Cost in economics is not spending money.
• Money only keeps score, but it is not the cost.
• The is why “economic cost” and “accounting
costs” are different.
• Cost is the reduction in any resource.
Who here has never wasted time?
What are examples of how you have wasted
time?
Opportunity cost 2
• Opportunity cost is the value of the foregone
alternative:
– The value of the time lost on doing something else
than taking this course.
– The value of the alternative uses for any spending.
– Explicit opportunity cost involves a direct
expenditure of money or resources (not including
time)
– Implicit opportunity cost is typically the value of
time given up.
Sunk Costs
• Thought experiment 2
– Who has stood in a Starbuck or Tim
Horton’s line in the last month?
– Who has ever left the line before being
served?
– Why – was that not irrational, given the
time you had already spent?
– You demonstrated the benefit cost principle
Failure of ignoring sunk costs
• You have invested $300,000 in a small incomplete manufacturing
and worthless in its current state.
• It will cost another $290,000 to finish the job.
• But you could start a new, equally valuable manufacturing shop
from scratch for only $275,000.
• Two options—
– finishing off the original shop or
– starting a new shop from scratch
• The key is that the original $300,000 has already been spent. That
money is gone; it is a sunk cost.
• For the same return, you can either invest an additional $290,000
or invest an additional $275,000.
• Starting a new shop from scratch is the rational choice.
Average and marginal
• Applied to costs/benefit
– Marginal costs/benefit is the increase in
cost/benefit associated with one unit extra or less
of an activity.
– Average cost/benefit is cost/benefit averaged
across all units of an activity.
– The marginal cost/benefit may be greater or lower
than the average cost/benefit.
A restaurant decides to hire a new part-time server, estimating that the increased
cost ($400 for a 20 hour shift, will be exceeded by the average sales of $p
Key issues for economics 1
• Simplifying assumptions are used to expose
the main causal relations.
– Example: Will a higher tax on cigarettes increase
revenues? Reduce smoking by children? Reduce smoking in
general?
• Proving causal relationships is hard, and
confounded by spurious correlations.
– Example: Most people over 20, who contract cancer are
not virgins … therefore sex causes cancer.
Key issues for economics 2
• Fallacy of composition
– Example: The example of farmers in the text is good. One
farmer with a large crop may be better off, unless all farmers do
well and prices drop
• Production – what and when to produce
• Consumption – what to consume and when
• Distribution – who receives the outputs?
– Example: Modes of distribution (first come first save, willingness
to pay, administrative (command) rule (from each according to
their ability to each according to their needs…)
Data, data, data. I cannot make bricks
without clay! (Sherlock Holmes)
• Economics must be an
empirical science
• Facts, trends, statistics all
support the testing of
economic theories
• Just thinking about
economic data will
encourage thought
Example
Quebec exports more
maple syrup than any
other
province/state/country.
Why does it maintain a
strategic reserve of maple
syrup?