microeconomics

• Economy


  Group of people interacting with one another as they go about their lives
• Tradeoff


  Having to give up one thing to get another
• Tradeoffs faced by individuals

  • Studying economics vs. psychology
  • Spending money on food, clothing, or vacation
  • Working vs. leisure time
• Recognizing tradeoffs is important for making good decisions
• Opportunity cost


  What must be given up to obtain something
• Opportunity cost of going to college

  • Tuition, books, room and board
  • Wages forgone from not working
• Marginal changes


  Small incremental adjustments to a plan of action
• Marginal thinking


  • Deciding whether to take an extra year of school
  • Deciding whether to sell a standby airline ticket
• Rational decisionmaking


  Taking an action if and only if the marginal benefit exceeds the marginal cost
• People's behavior changes when the costs or benefits change
• Responses to incentives


  • Driving more fuel-efficient cars due to a gas tax
  • Driving more carefully without seat belts vs. with seat belts
• Policymakers must consider how their policies affect incentives
• Incentives


  Factors that influence the behavior of people and firms
• Drivers change their behavior in response to the incentives they face

  Drivers operate their cars with more speed and less care
• Rational people


  Compare the marginal benefit from safer driving to the marginal cost
• Roads are icy


  People drive more slowly and carefully
• Seat belt law


  Reduces the benefits to slow and careful driving
• Seat belt law


  Results in a larger number of accidents
• Seat belt law


  Increases the number of pedestrian deaths
• Economist Sam Peltzman showed that auto-safety laws have produced fewer deaths per accident but more accidents, with little change in the number of driver deaths and an increase in the number of pedestrian deaths
• People respond to incentives
• People drive smaller cars in Europe where gasoline taxes are high, than in the United States where gasoline taxes are low
• Policies can have effects that are not obvious in advance
• When analyzing any policy, we must consider not only the direct effects but also the indirect effects that work through incentives
• If the policy changes incentives, it will cause people to alter their behavior
• Basketball star Kobe Bryant decided to skip college and go straight to the NBA, where he earned about $10 million over four years, despite good high school grades and SAT scores
• Trade between the United States and Japan is not like a sports contest where one side wins and the other side loses
• Trade between two countries can make each country better off
• Trade allows each person to specialize in the activities he or she does best, and to buy a greater variety of goods and services at lower cost
• Countries as well as families benefit from the ability to trade with one another
• Market economy


  An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services
• The collapse of communism in the Soviet Union and Eastern Europe was the most important change in the world during the past half century
• Communist countries worked on the premise that central planners in the government were in the best position to guide economic activity
• Most countries that once had centrally planned economies have abandoned this system and are trying to develop market economies
• Invisible hand


  The idea that the decentralized decisions of many households and firms, all trying to maximize their own interests, end up promoting the overall economic well-being of society
• Prices reflect both the value of a good to society and the cost to society of making the good
• When the government prevents prices from adjusting naturally to supply and demand, it impedes the invisible hand's ability to coordinate the economy
• Market failure


  A situation in which the market on its own fails to allocate resources efficiently
• Externality


  The impact of one person's actions on the well-being of a bystander
• Market power


  The ability of a single person (or small group of people) to unduly influence market prices