Lecture 1 Basic Economic Analysis

The Economic Framework For our purposes two basic sets of agents: –Consumers –Firms Both consumers and firms live within an environment defined by certain economic characteristics Faced with some environment, each agent makes decisions Decisions lead to economic outcomes

Economic Analysis Analysis of decisions of individual agents operating within an economic environment Make predictions on the observable outcomes of these decisions and how these observables are affected by the economic environment. Observable outcomes: Prices, Quantities, Profits, Product specifications, Advertising, Contractual Arrangements, Technological Change

Individual Decision Making The Basic Principles

PRINCIPLE 1 Individuals are self interested. Among the feasible alternatives individuals choose whatever they most prefer.

PRINCIPLE 2 Every choice results in foregone alternatives. The value of the foregone alternative represents the cost of the choice (OPPORTUNITY COST)

PRINCIPLE 3 Individuals adjust consumption decisions in response to prices. The amount of a good that an individual wishes to purchase (quantity demanded) falls as its price increases. The amount an individual wishes to sell (quantity supplied) increases when price increases

Competitive Equilibrium Demand curve summarizes how the decisions of individuals wishing to purchase the good are affected by changes in the price of the good: As price falls, desired quantity purchased rises. Supply curve summarizes how the decisions of individuals wishing to sell the good are affected by changes in the good’s price: As price rises, desired quantity sold rises. How are these decisions coordinated to produce a market outcome?

Equilibrium Cont’d Price adjustments are the means by which individual purchaser’s decision and individual seller’s decision coordinated. As price rises, quantity demanded falls and quantity supplied rises; as price falls, quantity demanded rises and quantity supplied falls Equilibrium price is the one for which quantity demanded equals quantity supplied: the amount that buyers wish to purchase is just equal to the amount sellers wish to sell.