ECON 103 Microeconomics Dr. Malcolm Rutherford Office: BEC 340 Office hours: Tuesday 10:30-11:30 and Wednesday 11:30-12:30, or by appointment. Office phone: 721-6481 E-mail: rutherfo@uvic.ca

Econ 103 Microeconomics Text Web sites Labs Help Centre Study guide exercises Outline Exams Grading Other policies, rules, and regulations

Part 1 Basic Concepts and Models Interest in economic problems But specific problems and issues change over time General analytic framework—how to think about any economic problem Abstraction and model building Simplified models that capture key general characteristics Empirical testing of models Economics and policy Positive and normative

Economics Economics is about “the economy” The way in which individuals and social groups “make a living” Provides the material well being of individuals and society Economics can also be defined in terms of technique—choice in the face of scarcity Techniques of economic analysis sometimes applied to non-economic subject matter

The Market Economy Production and distribution result largely from individuals pursuing their own self interest, in the institutional context of markets Specialization and exchange Decentralized Complex and interdependent How does this complex and decentralized system work, rather than becoming chaotic? Markets provide information and incentives (prices, profits) and coordinate economic decisions

The Market Economy Markets allocate resources BUT: Markets and the distribution of income Markets and market power Markets in everything? Constraints on market activity Misbehaving markets? Market failures Government and markets

Basic Concepts: Scarcity Limited resources—land, labour, capital, and entrepreneurship Unlimited wants Scarcity of resources relative to wants Need for choice between alternative uses of resources This leads to the next important concept: cost

Basic Concepts: Opportunity Costs Cost derives from scarcity and the need to make choices The cost of doing one thing is what is foregone Explicit costs and implicit costs The economists’ and the accountants’ definition of cost The implicit cost of capital and economic profit

Basic Concepts: Decisions at the Margin Some decisions involve all or nothing choices Many decisions involve decisions at the margin How much of something should I consume or produce? Marginal cost and marginal benefit Optimal point where MC=MB

Decisions at the Margin Optimal rounds of golf per week for Dr. R. $ MC MB Q Q*

Basic Concepts: Efficiency Productive efficiency—production at least cost Allocative efficiency is where resources are allocated to their highest valued use Marginal benefit=Marginal cost At the margin people value this good (in terms of willingness to forego other things) just what it costs to produce (in terms of opportunity costs) All costs and benefits must be included

Efficient Use of Resources What must be foregone for an additional unit What people will forego for an additional unit $ MC Benefit exceeds cost Cost exceeds benefits MB Q* Q of good X

Basic Concepts: Incentives People tend to respond to economic incentives Price changes Opportunities to increase income or reduce debts Changes in incentives vs moral suasion Incentives in the longer term Unintended consequences and incentives

Some Basic Models: Production Possibilities Production possibility curve gives a simplified representation of an economy Two goods Given resources and technology Can use this model to think about opportunity cost and concepts of efficiency

Production Possibility Frontier With given resources and technology Unattainable Quantity of Military goods PPF Attainable Quantity of Civilian goods

Opportunity Cost Productive efficiency—on the PPF Tradeoffs along the frontier Opportunity cost Constant opportunity cost Increasing opportunity cost Allocative efficiency—where on the PPF?

Economic Growth Economic growth can be represented as an outward shift in the PPF due to accumulation of capital or technological change Y X

Some Basic Models: Gains from Trade Without trade a person or nation is limited to their own domestic production possibilities curve Gains from trade Absolute advantage—based on different costs Comparative advantage—based on different relative costs An example of two individuals with different abilities or endowments and two activities—hunting for meat or collecting plants and berries—each with constant marginal opportunity costs

Gains from Trade Absolute Advantage Meat (kgs) Person 1 1 kg meat costs 2 kgs plants 1 kg plants costs .5 kg meat 10 Plants (kgs) Meat (kgs) 20 20 Person 2 1 kg meat costs .5 kg plants 1 kg plants costs 2 kgs meat 10 Plants (kgs)

Gains from Trade Meat (kgs) Person 2’s ppf 20 b’ Trade line c 10 Plants (Kgs) The trade line drawn here assumes terms of trade of 1:1 and equal division of the gains from trade

Gains from Trade Comparative Advantage Meat Person 1 30 1M=1.33P Plants 40 Meat Person 2 20 1M=0.5P Plants 10

Gains From Trade Comparative Advantage Assume trade at 1P=1M M 30 Person 1 produces 40P and trades 10 10 P 40 30 M Person 2 produces 20 M and trades 10 20 10 P 10

Some Basic Models: Circular Flow Circular Flow Diagram expenditures incomes Households factors goods Factor markets Goods markets inputs outputs Firms Factor payments sales revenues

The Market Economy Individual and households choose what factors to supply for income and what goods to spend that income on Firms choose what goods to produce and what factors to buy in order to produce them Interdependence Choice and constraints on choice Incentives Markets and efficiency Market failures