Principles of Microeconomics Lecture 1 Overview of Economics

What is Economics? Economics is a social science. The prime two concepts that Economics deals with are : Resources are scarce (limited) 2) Society has unlimited needs and want. In Economics we try to find the “best” way to allocate limited resources in society to produce goods and services for satisfying our needs.

The Economic Problem Fundamental Questions of Economics - Scarcity requires all societies to answer the following questions: What is to be produced? How is to be produced? For whom will it be produced? What goods and services should an economy produce? – should the emphasis be on agriculture, manufacturing or services, should it be on sport and leisure or housing? How should goods and services be produced? – labour intensive, land intensive, capital intensive? Who should get the goods and services produced? – equal distribution? more for the rich? for those who work hard? This is the traditional three key questions any economic system has to answer. Many students would have difficulty defining what an ‘economy’ actually is! It is useful at this stage to clear this up – a system for the production and exchange of goods and services to satisfy the wants and needs of the population. This is open ended enough to be able to incorporate all manner of economic systems from a barter system that still exists in remote parts of the world to sophisticated economic systems such as the UK and US! The questions and the examples raised can be used for discussion – get the students to express their views at this stage and be as controversial as possible to stimulate discussion and involvement!

Main Two Branches of Economics Microeconomics is a branch of economics that studies the behaviour of individuals and firms in making decisions on the allocation of limited resources. Microeconomics examines how the decisions and behaviours of economic agents affect the supply and demand for goods and services, which determines prices. Macroeconomics is the field of economics that studies the behaviour of the economy as a whole. It deals with the issues like GDP growth, inflation, and unemployment etc.

Economic Agent In economics, an agent is a decision maker in a model. Typically, every agent makes decisions by solving a optimization/choice problem. In microeconomics there are two agents: Consumer / buyer Producer / seller

Factor of Production In economics, factors of production are the inputs that are used to the production process. There are three factors of production: Labor ( Both physical and mental labor) Capital ( Ex: machineries, buildings etc) Land (not only the site of production but natural resources above or below the soil) All three of these are required in combination at a time to produce a commodity. Question: What are the returns of these factors? Wage is the return of labor. Rent is the return of land. Interest is the return of capital.

PPF Production Possibility Frontier (PPF): It shows the maximum amount of goods and services that can be efficiently produced in an economy by available inputs/resources and technology.

The Production Possibilities Frontier Quantity of Computers Produced 3,000 D C 2,200 600 A 700 2,000 Production possibilities frontier 1,000 300 B 1,000 Quantity of Cars Produced

Shift of PPF Two factors can affect the PPF Increase or Decrease in Resource/ input Technological Change

A Shift in the Production Possibilities Frontier due to a Technological Advancement in the computer industry Quantity of Computers Produced 4,000 3,000 1,000 2,100 750 E 2,000 700 A Quantity of Cars Produced

Opportunity Cost Opportunity cost of a choice is the value of the best alternative forgone. It is the cost expressed in terms of the next best alternative sacrificed It helps us view the true cost of a decision. Example: The opportunity cost of labour/ work is leisure. For example if you are working then you cannot watch movie. So here the opportunity cost of working is watching movie. This is a key concept and one that often causes problems and misunderstanding but is central to students thinking like an economist. The crucial thing to knock out of students is their thinking that everything costs ‘money’. Because we have to make choices there are issues surrounding value judgements about what is important and what is not – it should not be difficult to stimulate discussion about what issues of government spending are important and what are not!

Opportunity Costs in Production Possibility Frontiers If the economy reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra X1 – Xo consumer goods is Yo – Y1 capital goods. Capital Goods Ym A Yo These slides introduce the diagrams and then have animation to show how points on the PPF relate to different resource use and allocation. Moving from point A to point B involves sacrificing some capital goods to gain more consumer goods and thus demonstrates the opportunity cost involved. Students doing history can be reminded about the resource allocation decisions taken by Stalin during the 1930s and the subsequent decisions by successive Soviet premiers since the war about what resources are important for a nation like the USSR! (you might of course have to explain a little bit about what the USSR was!) B Y1 Xo X1 Xm Consumer Goods

POSITIVE VERSUS NORMATIVE ANALYSIS Positive statements are statements that attempt to describe the world as it is. Example: An increase in the minimum wage will cause a decrease in employment among the least-skilled. Normative statements are statements about how the world should be. Example: The income gains from a higher minimum wage are worth more than any slight reductions in employment. 31