Chapter 1 Preliminaries

©2005 Pearson Education, Inc.Chapter 12 Introduction Review basic terminologies, methodologies, and key assumptions imposed in microeconomic theory. What is economics? What is microeconomics? What are theories and models? What is positive and normative analysis? What is the difference between real and nominal prices

©2005 Pearson Education, Inc.Chapter 13 Themes of Economics Economics studies economic phenomena and the economic behavior of individual agents --- consumers, workers, firms, government, and other economic units as well as how they make choices so that limited resources are allocated among competing uses. A fundamental assumption on individual behavior is that an individual is rational (i.e., self-interested). Because resources are limited, but people's desires are unlimited, we need economics to study this fundamental conflict.

©2005 Pearson Education, Inc.Chapter 14 Four Basic Questions to be Answered by Any Institution: What goods and services should be produced and in what quantity? How should the product be produced? For whom should it be produced and how should it be distributed? Who makes the decision? The answers depend on economic institutions.

©2005 Pearson Education, Inc.Chapter 15 Two basic economic institutions used in the real world: Market economic institution:  Most decisions on economic activities are made by individuals, it is mainly a decentralized decision system. Planning economic institution:  Most decisions on economic activities are made by government, it is mainly a centralized decision system.

©2005 Pearson Education, Inc.Chapter 16 Themes of Modern Economics The market economy has been proved to be only economic institution so far that can keep an economy with sustainable development and growth. It is the most important economic institution discovered for reaching cooperation and solving the conflicts among individuals. Modern economics studies various economic phenomena and behavior under market economic environment by using an analytical approach such the demand and supply model.

©2005 Pearson Education, Inc.Chapter 17 Themes of Microeconomics Microeconomics: Branch of economics that deals with the behavior of individuals -- workers, firms and consumers– as well as how markets are organized It deals with limits:Limited budgets; Limited time; Limited ability to produce How do we allocate these limited resources?

©2005 Pearson Education, Inc.Chapter 18 Themes of Microeconomics Workers, firms and consumers must make trade-offs  Do I work or go on vacation?  Do I purchase a new car or save my money?  Do we hire more workers or buy new machinery? How are these trade-offs best made?

©2005 Pearson Education, Inc.Chapter 19 Themes of Microeconomics Consumers  Limited incomes  Consumer theory – describes how consumers maximize their well-being, using their preferences, to make decisions about trade-offs.  How do consumers make decisions about consumption and savings?

©2005 Pearson Education, Inc.Chapter 110 Themes of Microeconomics Workers  Individuals decide when and if to enter the work-force Trade-offs of working now or obtaining more education/training  What choices do individuals make in terms of jobs or work places?  How many hours do individuals choose to work? Trade-off of labor and leisure

©2005 Pearson Education, Inc.Chapter 111 Themes of Microeconomics Firms  What types of products do firms produce? Constraints on production capacity & financial resources create needs for trade-offs.  Theory of the Firm – describes how these trade-offs are best made

©2005 Pearson Education, Inc.Chapter 112 Themes of Microeconomics Prices  How are prices determined? Centrally planned economies -governments control prices Market economies – prices determined by interaction of market participants  Markets – collection of buyers and sellers whose interaction determines the prices of goods.

©2005 Pearson Education, Inc.Chapter 113 Theories and Models Economic theories are used to explain observed economic phenomena in terms of a set of basic rules and assumptions.  The Theory of the Firm  The Theory of Consumer Behavior  The Theory of Markets Theories are used to make predictions  Economic models are created from theories  Models are mathematical representations used to make quantitative predictions

©2005 Pearson Education, Inc.Chapter 114 Theories and Models Validating a Theory  The validity of a theory is determined by the quality of its prediction, given the assumptions.  Theories must be tested and refined  Theories are invariably imperfect – but gives much insight into observed phenomena

©2005 Pearson Education, Inc.Chapter 115 Positive & Normative Analysis Positive Analysis – statements that describe the relationship of cause and effect  Questions that deal with explanation and prediction What will be the impact of an import quota on foreign cars? What will be the impact of an increase in the gasoline excise tax?

©2005 Pearson Education, Inc.Chapter 116 Positive & Normative Analysis Normative Analysis – analysis examining questions of what ought to be  Often supplemented by value judgments Should the government impose a larger gasoline tax? Should the government decrease the tariffs on imported cars?

©2005 Pearson Education, Inc.Chapter 117 What is a Market? Markets  Collection of buyers and sellers, through their actual or potential interaction, determine the prices of products Buyers: consumers purchase goods, companies purchase labor and inputs Sellers: consumers sell labor, resource owners sell inputs, firms sell goods

©2005 Pearson Education, Inc.Chapter 118 What is a Market? Defining the Market  Many of the most interesting questions in economics concern the functioning of markets Why are there a lot of firms in some markets and not in others? Are consumers better off with many firms? Should the government intervene in markets?

©2005 Pearson Education, Inc.Chapter 119 Types of Markets Perfectly competitive markets  Because of the large number of buyers and sellers, no individual buyer or seller can influence the price. Example: Most agricultural markets  Fierce competition among firms can create a competitive market

©2005 Pearson Education, Inc.Chapter 120 Types of Markets Noncompetitive Markets  Markets where individual producers can influence the price. Cartel – groups of producers who act collectively Example: OPEC dominates with world oil market

©2005 Pearson Education, Inc.Chapter 121 Real Versus Nominal Prices Comparing prices across time required measuring prices relative to some overall price level  Nominal price is the absolute or current dollar price of a good or service when it is sold.  Real price is the price relative to an aggregate measure of prices or constant dollar price.

©2005 Pearson Education, Inc.Chapter 122 Real Versus Nominal Prices Consumer Price Index (CPI) often used as a measure of aggregate prices.  Records the prices of a large market basket of goods purchased by a “typical” consumer over time  Percent changes in CPI measure the rate of inflation

©2005 Pearson Education, Inc.Chapter 123 Real Versus Nominal Prices Calculating Real Prices

©2005 Pearson Education, Inc.Chapter 124 Real Price of College YearNom. Price CPIReal Price 1970$2, $12, $18,

©2005 Pearson Education, Inc.Chapter 125 Real Price of Wages Observations  The minimum wage has been increasing in nominal terms since From 1930 at $0.25 to 2003 at $5.15  The 1999 real minimum wage was no higher in 1999 than 1950.

©2005 Pearson Education, Inc.Chapter 126 The Minimum Wage: Figure 1.1

©2005 Pearson Education, Inc.Chapter 127 Why Study Microeconomics? Microeconomic concepts can be used to assist everyone in making choices as consumers and producers. Examples show the numerous levels of microeconomic questions necessary in many decisions

©2005 Pearson Education, Inc.Chapter 128 Ford SUV’s Built Ford Explorer in 1991, Ford Expedition in 1997 and the Ford Excursion in 1999 In each of these cases, Ford had to consider many aspects of the economy to ensure their introduction was a sound investment

©2005 Pearson Education, Inc.Chapter 129 Ford SUV’s Questions  How strong in demand and how quickly will it grow? Must understand consumer preferences and trade- offs  What are the costs of manufacturing Given all costs of production, how many should be produced each year?  Risk analysis Uncertainty of future prices: gas, wages  Ford had to develop pricing strategy and determine competitors reactions?

©2005 Pearson Education, Inc.Chapter 130 Emission Standards 1970 Clean Air Act imposed emissions standards and have become increasingly stringent  Questions What are the impacts on consumers? What are the impacts on producers? How should the standards be enforced? What are the benefits and costs?