AP Micro Economics Unit 1 Introduction to Economics

Micro-Music It’s a Small World Rockin’ with the Rolling Stones Barenaked Ladies Dancing with Dire Straits Queen

Chapter Objectives Microeconomics and Macroeconomics Economics Defined Economic Perspective (Economic Way of Thinking) Role of Economic Theory Scarce Resources The Economizing Problem Budget Lines Production Possibilities

Let’s Get Started Economics Defined Economics is the social science of making the best choices given scarce resources. It is the process of analyzing how to provide the most goods, services, and satisfaction with the limited resources we have available for use. Economic Perspective (Economic Way of Thinking) Scarcity – only a limited number of goods and services can be produced because we have limited resources available to produce them Choice – We must choose how we will use our finite resources to produce the goods and services available in our markets

The Economic Perspective Scarcity and Choice Opportunity Cost represents what we give up in exchange for what we obtain when we alter our choices. Although you may not immediately identify with the concept, in reality you are quite familiar with it. You and I make opportunity cost-based decisions on a daily basis. For instance, your opportunity cost in this particular moment is the alternative use of your time. What might you be doing right now instead of experiencing this lecture? Sleeping, eating, exercising? An opportunity cost is best represented as your next best alternative use of money, time, or anything else of value. Let’s Take a Closer Look… Upfront – Beef, It’s What’s For Dinner! Video: The Family Man: Opportunity Cost Video: Saving Private Ryan. - Opportunity Cost Video: Along Came Polly- Efficiency, Optimal Behavior Video: Lost in Translation - Incentives, Comparative Advantage, and Opportunity Cost

Purposeful Behavior Utility represents the satisfaction or benefit we receive from consuming a good or service. We weigh the costs of our choices by comparing the different degrees of satisfaction or utility we will receive from each choice. We then seek to make those choices that yield the greatest amount of satisfaction. We go about this process purposefully, or with rational thoughts. Although the utility maximization process might at first glance suggest that we make selfish choices, in reality, acting in self-interest is not the same as selfishness. People often make choices that are self-sacrificial and beneficial to others. These people derive pleasure (utility) from these acts of self sacrifice. For instance, philanthropists give freely to help others because they gain a greater degree of satisfaction from seeing others better off than they would have if they used their money to purchase more goods and services for themselves. Self-interested behavior maximizes personal satisfaction (utility).

Challenges in measuring utility One significant challenge we face when studying economics is measuring the satisfaction (utility) we derive from our choices. We are quite capable of detailing whether we personally gain more satisfaction than we give up when we make choices, but quantifying this satisfaction is another matter. There is no standard measure of satisfaction. As such we most often study the aggregate behavior (choices) of people and draw broad conclusions from these behaviors about utility. For instance, although each of us may say that we gain a lot of satisfaction from owning another pair of brand-name jeans, we have no way of detailing whether our level of satisfaction is the same as someone else who bought the same jeans. However, we can definitively determine in aggregate how much additional satisfaction groups of people receive from owning more of these pairs of jeans because their purchasing decisions within their budget constraints reflect their satisfaction levels (or they vote with their purchases, which can be measured).

Marginal Analysis MC = MB Marginal – Means additional or change in Marginal Benefits & Marginal Costs We compare the cost of providing additional benefits with the additional satisfaction received (utility) from the choice. We select those choices that yield more benefits than costs. You and I participate in this process each time we buy something at a store or restaurant. Will our purchase be "worth it"? Will that dessert be worth the calories? Will that new television be worth the cost? We are constantly in the process of refining our choices in the struggle to maximize our satisfaction within our budgetary constraints. Marginal analysis also provides another perspective from which to view opportunity costs. We are constantly comparing the satisfaction we might have enjoyed with an alternative choice with the satisfaction derived from our current choice. MC = MB

Theories Principles and Models The Scientific Method Economic Principle Generalizations Other-Things-Equal Assumption (ceteris paribus) We assume other things are held equal because a change in one economic variable will most likely have ripple effects throughout the economy. These reverberation effects become secondary causal effects for other variables and so forth and so on. However, by holding the assumption that other things remain constant, we can observe a causal variable and one, or perhaps two effect variables and draw generalizations from their response. Graphical Expression

Macro and Microeconomics Macroeconomics Aggregate Microeconomics Individual Units Positive Economics Normative Economics

How do Macroeconomics and Microeconomics differ? Macroeconomics examines either the economy as a whole (often referred to as aggregates). Aggregates are collections of specific economic units treated as though they were one unit. Examples of aggregates include government, household, and business sectors. Another example is found when we lump our entire national population together and study them as consumers. We measure aggregate data such as total output, total employment, total income, aggregate spending, price levels, et cetera. Note that we pay very little attention, if any, to the specific units making up the various aggregates. In a sense macroeconomics looks at the beach and not the grains of sand, rocks, and shells of which it is comprised. Microeconomics is concerned with individual units such as a household, firm, or industry and their respective challenges and behaviors. We look at facets such as measuring the price of a specific product, the number of workers employed by a single firm (or perhaps an industry), the revenue of a particular firm or household, or the expenditures of a specific firm, government entity, or family. In microeconomics, we examine the sand, rocks, and shells, but not the beach in aggregate. You should realize that the discipline is not so neatly compartmentalized that is affords us the luxury of precisely distinguishing dividing lines between macroeconomics and microeconomics. There are many topics and concepts that share roots in both areas and there is often some degree of confusion regarding exactly how they differ. So What’s the Difference Ferris Bueller’s Day Off - Understanding the Difference Between Microeconomics and Macroeconomics

Individual’s Economizing Problem Limited Income Unlimited Wants A Budget Line Attainable and Unattainable Combinations Tradeoffs & Opportunity Costs Choice Income Change

Individual’s Economizing Problem $120 Budget 12 10 8 6 4 2 DVDs $20 Books $10 6 5 4 3 2 1 2 4 6 8 10 12 Income = $120 Pdvd = $20 = 6 Unattainable Quantity of DVDs Income = $120 Pb = $10 = 12 Attainable 2 4 6 8 10 12 14 Quantity of Books

Society’s Economizing Problem Scarce Resources Resource Categories Land Labor Capital Investment Entrepreneurial Ability Factors of Production

Production Possibilities Model Full Employment Fixed Resources Fixed Technology Two Goods Consumer Goods (Pizzas) Capital Goods (Industrial Robots) Three peasants wrestle with how to spend 15 silver coins that they have won in a jousting tournament. One of the peasants (played by Heath Ledger) encourages the other peasants to reinvest their winnings in training and equipment so that they can make more money later. This creates tension between consuming more now and saving more with the hopes of enjoying a higher standard of living later. The three peasants, after an extended argument, decide to spend two coins now and reinvest the other 13 coins in jousting equipment and training. You can use this decision to show how an increase in investment can expand the PPC in the long run. - Production Possibilities Curve

Assumptions in Production Possibilities Models The following items must be held constant as assumptions for our model. We are fully employed at the societal level and are using all our available resources. The quantity and quality of our factors of production are fixed. The state of our technology (the methods used to produce output) is constant. The economy is producing two goods: pizza (consumer goods) and industrial robots (capital goods).

Production Possibilities Table Production Alternatives Type of Product A B C D E Pizzas (in hundred thousands) 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 Plot Points to Create Graph…

Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Economic Growth B C’ C Industrial Robots D’ D Now Attainable Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas

Production Possibilities Model A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Law of Increasing Opportunity Cost B C’ C Industrial Robots D’ Shape of the Curve D Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas

Production Possibilities Model A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable C’ Industrial Robots U D’ Under or Unemployment E’ 0 1 2 3 4 5 6 7 8 9 Pizzas

Production Possibilities Model Optimal Allocation of Resources MC a c 15 10 5 MB = MC e Marginal Benefit & Marginal Cost b d MB 1 2 3 Quantity of Pizza

Unemployment Growth and the Future A Growing Economy Economic Growth Increasing Resource Supplies Increasing Resource Quality Technological Advances

Present Choices & Future Possibilities Compare Two Hypothetical Economies Future Curve Future Curve F Goods for the Future Goods for the Future P Current Curve Current Curve Goods for the Present Goods for the Present Presentville Futureville Implications of International Trade

Pitfalls to Sound Economic Reasoning Biases Loaded Terminology Fallacy of Composition Post Hoc Fallacy Correlation but not Causation

Key Terms economics economic perspective opportunity cost utility marginal analysis scientific method economic principle other-things-equal assumption macroeconomics aggregate microeconomics positive economics normative economics economizing problem budget line economic resources land labor capital investment entrepreneurial ability factors of production consumer goods capital goods production possibilities curve law of increasing opportunity costs economic growth

Let’s Practice Interactive Graphs to Try Problems to Work Key Questions