Chapter 1 What is Microeconomics? McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

2 Learning Objectives What is economics? What are key assumptions of economics? What is Production Possibility Frontier? What is opportunity cost? What is the difference between microeconomics and macroeconomics? 1-2

3 What is Economics? Economics is the study of human behavior using math and statistics. 1-3

4 Key Assumptions People are self-interested. People are rational. People have unlimited desires but limited resources. 1-4

5 Self-Interest Most human behavior is motivated by self- interest. Self-interest is much more than greed. It encompasses anything that makes the person happy, e.g. children's welfare, charity. 1-5

6 Self-Interest Self-interested people most often take actions that are in the best interests of society. Only sometimes, self-interested people take actions that harm society as a whole, e.g. creating pollution. 1-6

7 Rational People Are you rational? Rational people consider all consequences of their actions. Rational people take actions that promote their self-interest. Rational people respond to incentives. 1-7

8 Indirect Effects Incentives to rational people can create indirect effects of government policies. For example: Policy: Pharmaceutical companies have to sell lifesaving drugs at lower prices to reduce the cost of medical care. Indirect effect: Pharmaceutical companies spend less money on research and development of new drugs. 1-8

9 Indirect Effects By studying rational decisions, economics helps to forecast indirect effects of proposed policies. 1-9

10 Unlimited Desires vs. Limited Resources All people have unlimited desires but face limited resources, which means ‘scarcity’. We cannot satisfy all our wants. Economics studies how people use their limited resources to satisfy unlimited wants. 1-10

11 Tradeoffs We have to choose which wants to satisfy. Scarcity forces tradeoffs. 1-11

12 Production Possibility Frontier (PPF) If a country produces only computers and TVs, using all their resources: it can produce 10 million computers and 5 million TVs, or it can produce 6 million computers and 12 million TVs. million Computers million Televisions A B 1-12

13 Production Possibility Frontier (PPF) PPF is a line that shows combinations of goods a country can make using all of its productive resources. It shows tradeoffs a country has to face. By moving from one point to another on PPF, a country has to give up production of one good for another. million Computers million Televisions A B 1-13

14 Production Possibility Frontier (PPF) Inside PPF = Not using all resources = Can produce more of both Outside PPF = Production is not possible million Computers million Televisions C D 1-14

15 Opportunity Cost Opportunity cost = Best opportunity lost. = Value of the next best alternative given for the chosen action. 1-15

16 Increasing Wealth Increase in wealth results from increase in production. Specialization = developing high skills by concentrating on only one task. High skills = more and better production. 1-16

17 Increasing Wealth Innovation = Finding new improved ways for production. = Increase in production possibility shifts PPF outwards. Computers Televisions Old PPF New PPF after innovation 1-17

18 Increasing Wealth Markets = Voluntary exchange of goods, services, money and resources. Markets create wealth by providing incentives for trade and specialization. 1-18

19 Microeconomics vs. Macroeconomics Microeconomics = The study of individuals and businesses. Macroeconomics = The study of the performance of the entire economy. 1-19

20 Do You Know? Do rational people ever make mistakes? Yes. Rational people unknowingly make mistakes but avoid the same mistakes in the future. Why do we all face tradeoffs? All of us have unlimited wants and limited resources so we have to choose some wants and give up others. 1-20

21 Do You Know? Why might it be cheaper to hire someone else to shovel your driveway than do it yourself? Opportunity cost. How could we ever have too little pollution? By giving up most of the goods and services we are used to in the modern world. 1-21

22 Summary Economics is the study of human behavior. Microeconomics studies choices of individuals and businesses. Most human behavior is motivated by self- interest. People face tradeoffs because of their limited resources to satisfy unlimited wants. Specialization, innovations and markets increase wealth. 1-22

23 Coming Up What is a market? What is demand and supply? 1-23