1. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. What is Microeconomics? Economics –The study of the allocation of scarce resources among alternative uses Microeconomics –The study of the economic choices individuals and firms make and how those choices create markets

2. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. APPLICATION 1.1: Scarcity in Nature Nature provides examples of scarcity and choice –Birds of prey recognize a trade-off between spending time and energy in one area and moving to another location –To avoid using too much energy, animals will leave an area before the food supply is exhausted

3. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Economic Models Simple theoretical descriptions that capture the essentials of how the economy works –Used because the “real world” is too complicated to describe in detail –Models tend to be “unrealistic” but useful While they fail to show every detail (such as houses on a map) they provide enough structure to solve the problem (such as how a map provides you with a way to solve how to drive to a new location)

4. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Uses of Microeconomics Individuals making decisions regarding jobs, purchases, and finances Businesses making decisions regarding the demand for their product or their costs Governments making policy decisions regarding laws and regulations

5. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Model of Supply and Demand In Figure 1.2(a), the amount of a good purchased is shown on the horizontal axis and the price is on the vertical axis The demand curve shows the amount people want to buy at each price and is negatively sloped reflecting the marginalism principle

6. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Model of Supply and Demand The upward sloping supply curve reflects the idea of increasing cost of making one more unit of a good as total production increases Supply reflects increasing marginal costs and demand reflects decreasing marginal usefulness

7. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Price Demand Supply Equilibrium pointP* Quantity per week 0 Q* FIGURE 1.2: The Marshall Supply-Demand Cross

8. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Nonequilibrium Outcomes If something causes the price to be set above P*, demanders would wish to buy less than Q* while suppliers would produce more than Q* If something causes the price to be set below P*, demanders would wish to buy more than Q* while suppliers would produce less than Q*

9. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. APPLICATION 1.4: Shortages in Formerly Communist Economies In the former Soviet Union price controls on housing led to long waiting lists for people who wanted to move –underground economies were established through bribes and apartment swaps with cash payments High inflation rates resulted from the elimination price controls in Poland

10. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Shifters of Demand Income Preferences Other prices Expectations Not Price!!

11. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Price D D’S P* P** Quantity per week 0 Q*Q** FIGURE 1.3: An increase in Demand Alters Equilibrium Price and Quantity

12. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Shifters of Supply Costs Other prices Expectations Not Price!!

13. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Price D S’ S P* P** Quantity per week 0 Q**Q* FIGURE 1.4: A shift in Supply Alters Equilibrium Price and Quantity

14. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. The Production Possibility Frontier A graph showing all possible combinations of goods that can be produced with a fixed amount of resources

15. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Amount of food per week 4 10 A B Amount of clothing per week 0 312 FIGURE 1.5: Production Possibility Frontier

16. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Opportunity Cost The cost of a good or service as measured by the alternative uses that are foregone by producing the good or service

17. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Amount of food per week 4 9.5 10 A B Opportunity cost of clothing = ½ pound of food Opportunity cost of clothing = 2 pounds of food 2 Amount of clothing per week 0 341213 FIGURE 1.5: Production Possibility Frontier

18. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. Two General Equilibrium results from the Production Possibility Frontier Because resources are scare, producing more of one good means producing less of another good –“There is no such thing as a free lunch” The extent of the opportunity cost of any good depends upon how much of the good is currently being produced

19. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. How Economists Verify Theoretical Models Two methods are used –Testing Assumptions: Verifying economic models by examining validity of the assumptions on which they are based –Testing Predictions: Verifying economic models by asking if they can accurately predict real-world events

20. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. The Positive-Normative Distinction Distinction between theories that seek to explain the world as it is (positive) and theories that postulate the way the world should be (normative).

21. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. APPLICATION 1.6: Economic Confusion Many jokes and popular opinion suggest that economists do not agree on many issues This belief arises primarily because people fail to distinguish between positive and normative issues As Table 1 shows, there is much agreement regarding positive issues but much less agreement with normative issues

22. Copyright (c) 2000 by Harcourt, Inc. All rights reserved. TABLE 1: Percentage of Economists Agreeing with Various Propositions in Three Nations