chapter 1 Preliminaries Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-2 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. Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-3 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-4 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-5 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-6 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-7 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-8 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-9 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? Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-10 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? Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-11 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-12 Tools of Microeconomics The scientific method Models and mathematics Simplifying assumptions Data analysis Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-13 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-14 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-15 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-16 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-17 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-18 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-19 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-20 Uses of Microeconomics Making better economic decisions Evaluating public policy, measuring costs and benefits of policies Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-21 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-22 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

1-23 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 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.