Chapter 1: Preliminaries What is microeconomic theory? Micro theory is about the allocation of scarce resources with a focus on individual economic units.

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Chapter 1: Preliminaries What is microeconomic theory? Micro theory is about the allocation of scarce resources with a focus on individual economic units like consumers and firms. It focuses on trade-offs or opportunity costs. Using economic jargon: individuals maximize utility subject to a budget constraint.

Economics as a Social Science Tries to explain observed behavior and make predictions about the future. Develops theories to explain observed phenomena. A model is a mathematical representation of a theory; no theory is perfect. Models are simplifications of the real world.

Positive versus Normative Positive: explanation and prediction (deals with actual observed phenomena); can be proven right or wrong. Normative: what ought to be (deals with opinions and recommendations); reflects value judgements. The two can be hard to disentangle.

Describing Markets Identify who is the supplier and who is the demander Define the extent of the market Describe units in which the output is measured. How competitive is the market?

Real versus Nominal Prices KEY: Real prices reflect influence of inflation so can make meaningful comparison of real prices across time. Real price: price of a good relative to an aggregate measure of prices (adjusts for inflation); must pick a base year. Nominal price: actual dollar price, not adjusted for inflation (price actually see) Aggregate measure of prices: CPI— Consumer Price Index

Formula to Calculate Real Price in Year X Real Price in Year X = (Nom.P in Year X) * (CPI base year/CPI Year X). Real P X = NomP X  (CPI B /CPI X ) Homework: Exercises #2 and # 3 on page 18 in textbook.

Examples Information given: Nominal price of college education = $15,212 in CPI values: 1985: : : Calculate the real price of a college education in 1993 in terms of 1985 dollars: Use: Nom P ’93 * (CPI 85 /CPI 93 ) $15,212 * (107.6/144.0) = $

Exercise YEARGas Price Per gallon CPI (base year 1982 = 100)

Exercise (cont.) Calculate the real price of gasoline for 1977 and 1989 using 1970 dollars. How did gasoline prices changed from from 1977 to 1989?

Exercise Solution 1. Real price in 1977, expressed in terms of 1970 dollars: 1977 nomP * (CPI 70 / CPI 77 ) = $0.58 * (38.8 / 60.6) = $ Real price in 1989, expressed in terms of 1970 dollars: 1989 nomP * (CPI 70 / CPI 89 ) = $1.10 * (38.8/124.0) = $0.34.