Economics 211 Principles of Microeconomics Dr. Greg Delemeester Fall 2007

Economics Making choices under conditions of scarcity  How many hours should I study for biology?  What stocks should I buy for my portfolio?  How many cars should I steal?  How many job interviews should I go on? Making choices under conditions of scarcity  How many hours should I study for biology?  What stocks should I buy for my portfolio?  How many cars should I steal?  How many job interviews should I go on?

What Do Schoolteachers and Sumo Wrestlers Have in Common? How Is the Ku Klux Klan Like a Group of Real-Estate Agents? Why Do Drug Dealers Still Live with Their Moms? Where Have All the Criminals Gone? What Makes a Perfect Parent? Would a Roshanda by Any Other Name Smell as Sweet? Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill? Medium-Term Business Cycles Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle? Media Frenzies in Markets for Financial Information An Efficient Dynamic Auction for Heterogeneous Commodities Matching and Price Competition Paying Not to Go to the Gym On the Simple Economics of Advertising, Marketing, and Product Design

Economic Fundamentals Self Interest  Rationality  Maximizing behavior  Responding to incentives

Incentives Matter There are no $5 bills laying on the ground.

Economic Fundamentals Self Interest  Rationality  Maximizing behavior  Responding to incentives TANSTAAFL  Scarcity  Opportunity costs There Ain’t No Such Thing As A Free Lunch There Ain’t No Such Thing As A Free Lunch

Economic Fundamentals Self Interest  Rationality  Maximizing behavior  Responding to incentives TANSTAAFL  Scarcity  Opportunity costs Marginal Analysis  Behavior is modeled as if decisions were based on costs and benefits at the margin  Ignore sunk costs

Economic Fundamentals Unintended Consequences  CAFE standards 27.5 MPG fleet average Lighter + smaller cars = more dangerous cars ? National Academy of Sciences: 1300 to 2600 extra highway deaths each year Modes of Analysis  Positive Analysis  Normative Analysis

Guns Sold (Millions) Gun-Related Murders (Thousands) Correlation is not causation.

Economic Model of Crime Decision Rule  If MB > MC  steal another car Assumptions  Resale value on car = $40,000  Income = $20,000  Jail term = 5 years  Probability of Arrest = 20%  Probability of Conviction = 90% MB = $40,000 MC = (5)($20,000)(.20)(.90)= $18,000 Steal the car!

Economic Model of Crime Policy Implications [How to deter crime?]  Increase jail sentence  Increase probability of arrest  Increase probability of conviction  Increase income

Production Possibilities Frontier Shows tradeoffs facing an economy that produces two goods Assumptions  Resources are fixed Land Labor Capital Entrepreneurship  Technology is fixed Beer Cars A B C D E Unattainable Inefficient

Beer Cars A B C D Δ Beer - Δ Cars Slope of PPF = - Δ Cars / Δ Beer Concave PPF implies “law of increasing opportunity cost” (measures the Opportunity Cost)

Shifts in the PPF are due to:  Change in resources  Change in technology Shifts in the PPF are due to:  Change in resources  Change in technology PPF and Economic Growth Economic Growth requires an expanding PPF

All societies must answer basic questions:  What will be produced?  How will it be produced?  For whom will it be produced? Allocation Mechanisms  Tradition  Plan  Market Choices, choices, choices…

Gains From Trade Trade implies mutually beneficial exchanges  Not a zero-sum game! Comparative Advantage  David Ricardo  Lowest opportunity cost producer  Specialization and trade can allow individuals (and countries) to expand their consumption beyond their PPF constraints Trade implies mutually beneficial exchanges  Not a zero-sum game! Comparative Advantage  David Ricardo  Lowest opportunity cost producer  Specialization and trade can allow individuals (and countries) to expand their consumption beyond their PPF constraints

Pizza Cars ∆C = 50 ∆C = 25 ∆P = -200 ∆P = -300 Country A Country B Opportunity cost of 1 Car is 4 PizzasOpportunity cost of 1 Car is 12 Pizzas slope = ∆P/ ∆ C = -200/50 = - 4/1 slope = ∆P/ ∆ C = -300/25 = - 12/1 Country A has the comparative advantage in producing cars.

Pizza Cars Country A Pizza Cars Country B No TradeWith Trade PizzaCarsPizzaCars A B World Production