lecture 1

• Microeconomics is the analysis of the behavior of "small", individual economic entities (e.g., households/consumers, firms/managers, workers, investors) and the markets in which these entities interact
• Macroeconomics is the analysis of "large", aggregate economic variables and economy-wide phenomena (e.g., economic growth, unemployment, inflation, interest rates)
• Fundamental questions in microeconomics

  • How do markets work?
  • How do consumers make (demand) decisions?
  • How do firms make (supply) decisions?
  • Which price is charged and which quantity is exchanged in different market structures?
  • When and how do market outcomes differ from what is best for society?
• Structure of the course

  1. Fundamental concepts and vocabulary

  2. The big picture

  3. Quantitative analysis

  4. Demand in detail

  5. Supply in detail

  6. Market structures

  7. Introduction to additional perspectives
• Rational


  (in classical economic theory) economic agents are able to consider the outcome of their choices and recognise the net benefits of each one
• Rational agents will select the choice which presents the highest benefits
• Rationality in classical economic theory is a flawed assumption as people usually don't act rationally
• A firm increases advertising

  Demand curve shifts right
• Demand curve shifting right

  Increases the equilibrium price and quantity
• Marginal utility


  The additional utility (satisfaction) gained from the consumption of an additional product
• If you add up marginal utility for each unit you get total utility
• The economic problem is that society (and, e.g., a firm or a household) cannot fulfill all needs and wishes of all its members because resources are scarce
• Productive efficiency


  When all resources are used optimally in the production of goods and services, i.e., there is no "waste" and costs are minimized
• Allocative efficiency


  When the goods and services produced reflect society's preferences, i.e., the "right" quantities of goods and services are produced
• Production possibilities frontier (PPF)

  Shows the combinations of two goods that can be produced at maximum with the economy's factors of production
• Combinations above the PPF are infeasible, combinations on the PPF are productively efficient, and combinations below the PPF are inefficient
• Trade-off


  Increasing the achievement of one objective entails reducing the achievement of another objective
• Opportunity cost


  Whatever must be given up to obtain an item or achieve an objective; the value of the best alternative use of a resource
• Marginal change


  An incremental (one-unit) adjustment to an activity
• Marginal benefit (cost)


  The change in the total benefit (cost) of an activity resulting from a marginal change
• Marginal analysis


  Comparing marginal benefit to marginal cost in order to identify the optimal level of an activity
• Incentive


  A change in the (marginal) benefit or cost of an activity that induces a change in the level of the activity – i.e., a change in people's decisions and behavior
• Trade allows the trading parties to specialize in their comparative advantage and thereby increases the amount of goods available, which can make each economy better off
• Economists' predictions about individual behavior are based on how people (supposedly) respond to incentives, and economists tend to be skeptical of any attempt to change behavior that does not change incentives
• Who helped you get dressed this morning?

  • Trade between countries, households, or firms
• Trade is not a zero-sum game: It allows the trading parties to specialize in their comparative advantage and thereby increases the amount of goods available
• Trade between economies allows for Pareto improvements and can make each economy better off
• Adam Smith's contributions to economics

  • Recognition of the benefits of specialization and the division of labor
  • Trade is necessary to reap these benefits
• Most economists agree that international trade increases global welfare (even though issues such as worker safety and social equity also need to be addressed)
• Market economy


  An economic system that allocates resources and answers the three fundamental questions (what, how, for whom) through the decisions of consumers and firms as they interact in markets for goods and services and for factors of production
• Prices


  The main instrument that directs economic activity because they reflect supply and demand in markets
• If prices properly reflect the value of goods to society and the cost of producing them, markets lead to an efficient allocation of resources and thus maximize "social welfare"
• Most people are self-interested, and if the government does not guide their decisions, how can social welfare be maximized?
• Adam Smith: '"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. . . . Every individual. . . intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention."'
• Invisible hand


  A metaphor for the market - when one self-interested person wants to sell a good and another self-interested person wants to buy it, then carrying out the transaction is a mutually beneficial Pareto improvement and increases the welfare of both
• The "invisible hand" is not perfect: Markets have limitations
• Limitations of markets


  • Markets do not ensure an equitable distribution of prosperity
  • Markets lead to an efficient allocation of resources if and only if prices reflect the value and cost of goods
• Externalities


  When the costs of an activity are not reflected in the price of a good, leading to "too much" of the good being produced
• Market power


  When firms charge abnormally high prices, leading to "too little" of the good being produced
• There are some (well-defined) exceptions to the general rule that markets lead to efficiency. In such situations, many economists advocate government intervention.