Econ 2610: Principles of Microeconomics Yogesh Uppal

Chapter 1 Thinking Like an Economist

Microeconomics vs Macroeconomics  Microeconomics studies choice and its implications for price and quantity in individual markets  Sugar  Carpets  House cleaning services  Microeconomics considers topics such as  Costs of production  Demand for a product  Exchange rates

Microeconomics vs Macroeconomics Macroeconomics studies the performance of national economies and the policies that governments use to try to improve that performance Inflation Unemployment Growth Macroeconomics considers Monetary policy Deficits Tax policy

Learning Objectives 1. The Scarcity Principle: having more of any good thing necessarily requires having less of something else 2. The Cost-Benefit Principle: an action should be taken if and only if its benefit is at least as great as its costs 3. The Incentive Principle: examine people's incentives to predict their behavior

The Scarcity Principle Economics: The study of choices and results under scarcity The Scarcity Principle: Unlimited wants and limited resources means having more of one good means having less of another. Also called No Free-Lunch Principle

The Cost-Benefit Principle Take an action if and only if the extra benefits are at least as great as the extra costs Costs and benefits are not just money Marginal Benefits Marginal Costs

Cost – Benefit Example Walk to town to save $10 on an item? Benefits are clear Costs are harder to define  Would you walk to town if someone paid you $9?  If you would walk to town for less than $10, you gain from buying the item in town

Cost – Benefit Principle Examples You clip grocery coupons but Bill and Melinda Gates do not You speed on the way to work but not on the way to school At the ball park, you pay extra to buy a soda from the hawkers in the stands You skip your regular dental check-up

Economic Surplus Benefit of an action minus its costs Economic Surplus Total Benefits Total Costs

Opportunity Cost The value of what must be foregone in order to undertake an activity Consider explicit and implicit costs (Caution: NOT the combined value of all possible activities Opportunity cost considers only your best alternative)

Three Decision Pitfalls Economic analysis predicts likely behavior Three general cases of mistakes 1. Measuring costs and benefits as proportions instead of absolute amounts 2. Ignoring implicit costs 3. Failure to think at the margin

Pitfall #1 Measuring costs and benefits as proportions instead of absolute amount Would you walk to town to save $10 on a $25 item? Would you walk to town to save $10 on a $2,500 item? Action Marginal Costs Marginal Benefits

Pitfall #2 Ignoring implicit costs Consider your alternatives The value of a Frequent Flyer coupon depends on its next best use Expiration date Do you have time for another trip? Cost of the next best trip Explicit Costs Implicit Costs Opportunity Cost

Pitfall #3 Failure to think at the margin Sunk costs cannot be recovered Examples: Eating at an all-you- can-eat restaurant Attend a second year of law school Marginal Benefits Marginal Costs

Marginal Analysis Ideas Marginal cost is the increase in total cost from one additional unit of an activity Marginal benefit is the increase in total benefit from one additional unit of an activity

Normative and Positive Economics Normative economic statements say how people should behave Gas prices are too high Building a space base on the moon will cost too much Positive economic statements predict how people will behave The average price of gasoline in May 2008 was higher than in May 2007 Building a space base on the moon will cost more than the shuttle program

Incentive Principle Incentives are central to people's choices Benefits Actions are more likely to be taken if their benefits rise Costs Actions are less likely to be taken if their costs rise

Economics Is Everywhere There are many things that economics can help to explain Economic Naturalist topics Why is expensive software bundled with PCs? Why can't you buy a car without heaters Drive-up ATMs with Braille