Preliminaries
chapter 1
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Learning Objectives
• Describe the scope of microeconomics and
understand that it concerns the allocation of scarce
resources.
• Explain the goals of microeconomic theory.
• Explain how economists apply the scientific method
to common economic questions.
• Identify recurring economic themes within the field.
• Recognize a variety of situations where economic
ideas can be applied.
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Overview
• Microeconomics studies decision making by
individuals and how their decisions determine the
allocation of a society’s scarce resources
• Microeconomists use specific methods and tools
• There are recurring themes of microeconomics
• Microeconomics has important applications in
individual decision making as well as the analysis
and evaluation of public policy
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What Is Microeconomics?
• Main branches of economics
1. Microeconomics: individual decision making and
its collective effect on the allocation of a society’s
scarce resources
2. Macroeconomics: aggregate phenomena
• E.g., booms and recessions, economic growth,
unemployment
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Decentralization vs. Centralization
• Capitalist economy (decentralized)
– the means of production are mostly
owned by private individuals
– The allocation of resources is
governed by voluntary trading
among businesses and consumers
• Communist economy (centralized)
– The state owns and controls the
means of production and
distribution
• No economy is completely
centralized or decentralized
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Markets
• Markets are economic institutions that provide people
with opportunities and procedures for buying and
selling goods and services
• A market is associated with a single group of closely
related products that are offered for sale within
particular geographic boundaries
• A price is the rate at which someone can swap money
for a good
• A property right is an enforceable claim on a good or
resource
• Trade can occur only if property rights are transferable
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Market Economy
• A market economy allocates scarce resources
primarily through markets
• In a free market system the government
mostly allows markets to operate with little
regulation or other intervention
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Economic Motives
• Microeconomists usually assume that people are
motivated by material self-interest
– Consumers try to choose the mix of goods and services
that provides the highest possible level of personal
satisfaction
– Employees try to choose the mix of work and leisure that
provides the highest possible level of personal satisfaction
– Owners of firms try to choose the mix of inputs and
outputs that provides the highest possible level of profit
• Microeconomic theory can accommodate other
motivations
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Positive vs. Normative Analysis
• Positive economic
analysis addresses
factual questions
• Example: if the minimum
wage were raised to $9, how
would that affect
employment? Would
businesses hire fewer
workers?
• Example: if Dell were to
reduce the price of notebook
computers by 10 percent,
how many more notebooks
would the company sell?
Would the increase in the
sale of notebooks cut into
the sales of Dell’s desktop
computers? If so, by how
much?
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Positive vs. Normative Analysis
• Positive economic
analysis addresses
factual questions
• Normative
economic analysis
addresses
questions that
involve value
judgments
• Example: is society better off
with free trade between
countries or with trade
barriers?
• Example: what is the best
way to control carbon
emissions?
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Positive vs. Normative Analysis
• Positive economic analysis addresses
factual questions
• Normative economic analysis addresses
questions that involve value judgments
• The principle of individual sovereignty
holds that each person knows what’s best
for him or her
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Tools of Microeconomics
•
•
•
•
The scientific method
Models and mathematics
Simplifying assumptions
Data analysis
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The Scientific Method
Step 1: Initial observation
Step 2: Theorizing
Step 3: Identification of additional implications
Step 4: Further observation and testing
Step 5: Refinement of the theory
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Models and Mathematics
• A model is a simplified representation of a
phenomenon
• The variables taken as given are said to be exogenous,
and the variables determined by the model are said to
be endogenous
• Responses of endogenous variables to changes in
exogenous variables are called comparative statics
• An equilibrium is a point of balance at which there is
no tendency for a model’s endogenous variables to
change, given fixed values of the exogenous variables
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Simplifying Assumptions
• Social phenomena are extremely complex
• Models are simplified representations of the
real world, requiring many simplifying
assumptions
• A simplifying assumption can be reasonable in
one context but unreasonable in another
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Data Analysis
• The scientific method requires us to test our
theories by confronting them with data
– Records. E.g., financial information, personnel
records, customer databases
– Surveys. E.g., consumer expenditure survey, business
surveys
– Experiments. Lab experiments vs. natural experiments
• Econometrics is the application of statistical
methods to empirical questions in the field of
economics
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Why Economists Sometimes Disagree
• Positive matters: sometimes two economists
look at the same evidence and come to
different conclusions
• Normative matters: even when economists
reach the same positive conclusions, they may
disagree about the desirability of a particular
public policy
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Themes of Microeconomics – Decisions
• Trade-offs are unavoidable
• To choose well, focus on the margin
– To determine whether a particular choice is best, we ask
whether a small adjustment of the choice—a marginal
change—will lead to improved results
• People respond to incentives
– A good decision maker carefully weighs her benefits and
costs
• Prices provide incentives
– An increase in the price of a good reduces the incentive
to buy and increases the incentive to sell
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Themes of Microeconomics – Markets
• Trade can benefit everyone
• The competitive market price reflects both
value to consumers and cost to producers
• Compared to other methods of resource
allocation, markets have advantages
• Sometimes government policy can improve on
free-market resource allocations
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Uses of Microeconomics
• Making better economic decisions
• Evaluating public policy, measuring costs and
benefits of policies
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Review
• Microeconomics studies decision making by
individuals, and how their combined decisions
determine the allocation of scarce resources
• Economists often assume that people are
motivated by material self-interest
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Review
• Economists usually express their theories
through mathematical models that are
simplified representations of the real world,
and contrast the results against real economic
data
• Microeconomics plays a crucial role in
individual decision making, and in the
analysis and evaluation of public policy
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Looking forward
• Next we will start learning some fundamental
microeconomic tools—demand and supply.
• We will also start applying using economic
models, and the concepts of equilibrium and
comparative statics
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