1. Microeconomics 1 notes
J French
IBM105

2. Relationships
A relationship between two or more variables can be expressed as an equation, table or graph
equations & graphs are “continuous”
tables contain “discrete” information
tables are less complete than equations
it is more difficult to see patterns in tabular data than it is with a graph -- economists prefer equations and graphs
J French
IBM105

3. Equations
a relationship between two variables can be expressed as an equation
the value of the “dependent variable” is determined by the equation and the value of the “independent variable.”
the value of the independent variable is determined outside the equation, i.e. it is “exogenous”
J French
IBM105

4. Y = 6 - 2X
The relationship between Y and X is determined; for each value of X there is one and only one value of Y [function]
Substitute a value of X into the equation to determine the value of Y
Values of X and Y may be positive or negative, for many uses in economics the values are positive [we use the NE quadrant]
J French
IBM105

5. Equations -- Graphs [Cartesian system]+1 +2 +3
The North East Quadrant
(NE), where X > 0, Y > 0
{both X and Y are positive
numbers}
The X axis
[horizontal]
(X,Y) where
X<0, Y>0
X<0 -3 -2 -1
X > 0 +1 +2 +3
Y<0 -1 -2 -3
(X,Y)
where X<0 and Y<0
(X,Y)
where X>0 and Y<0
(Left click mouse to add material)
The Y axis [vertical]
J French
IBM105

6. When the values of the independent and dependent variables
are positive, we use the North East quadrant
(Left click mouse to add material)
Go to the right {+3} units and
up {+5} units! 1 2 3 4 5 6
(X, Y)
(3, 5)
Right {+1} one
and up {+6} six
(1,6)
(5, 1)
(2.5, 3.2)
Right 5 and up 1
to the right 2.5 units
and up 3.2 units
J French
IBM105

7. Y X Given the relationship, Y = 6 - 2X, 1 2 3 4 5 6 A B
(Left click mouse to add
material) 1 2 3 4 5 6 A B
when X = 0 then Y = 6
[this is Y-intercept] Y
sets of (X, Y)
A line that slopes from
upper left to lower right
represents an inverse or
negative relationship, when the
value of X increases, Y
decreases!
when X = 1
then Y = 4
(0, 6)
(1, 4)
(2, 2)
(3, 0)
When X = 2, then Y = 2
The relationship for all positive
values of X and Y can be illustrated
by the line AB
When X = 3, Y = 0,
[this is X-intercept] X
J French
IBM105

8. Y 1 2 3 4 5 6 X What is the X-intercept?
(Left click mouse to add material)
Given a relationship, Y = X
(0,6)
(1,5.5)
(2, 5)
(4,4)
(6,3)
For every one unit increase in
the value of X, Y decreases by
one half unit. The slope of this
function is -.5! The Y-intercept is 6.
What is the X-intercept?
J French
IBM105

9. For a relationship, Y = 1 + 2X3 4 5 6 Y X
For a relationship, Y = 1 + 2X
When X=0, Y=1 (0,1)
When X = 1, Y = 3
slope = +2
(1,3)
When X = 2, Y = 5
run +1
rise +2
(2,5)
This function illustrates a positive relationship
between X and Y. For every one unit increase
in X, Y increases by 2 !
for a relationship
Y = X
This function shows that for a 1
unit increase in X, Y increases
one half unit
slope = + 1 2
run +2
rise +1 -1
(Left click mouse to add material)
J French
IBM105

10. Problem Graph the equation: Y = 9 - 3X Graph the equation Y = -5 + 2X
What is the Y intercept? The slope?
What is the X intercept? Is this a positive (direct) relationship or negative (inverse)?
Graph the equation Y = X
J French
IBM105

11. Equations in Economics
The quantity [Q] of a good that a person will buy is determined partly by the price [P] of the good. [Note that there are other factors that determine Q.]
Q is a function of P, given a Price the quantity of goods purchased is determined Q = fp (P)
A function is relationship between two sets in which there is one and only one element in the second set determined by each element in the first set.
J French
IBM105

12. Relationship [cont . . . ] Q = fp (P) {Q is a function of P}
Example: Q = P
If P = 0, then Q = 220
If P = 1, then Q = 215
for each one unit increase in the value of P, the value of Q decreases by 5
J French
IBM105

13. Q = 220 - 5P This is an inverse or negative relationship
as the value of P increases, the value of Q decreases
the “Y intercept” is 220, this is the value of Q when; P = 0
the “X intercept” is 44, this is the value of P when Q = 0
This is a “linear function,” i.e. a straight line
The “slope” of the function is -5
for every 1 unit change in P, Q changes by 5 in the opposite direction
J French
IBM105

14. The equation provides the information to construct a table.
However, it is not possible to make a table to include every
possible value of P. The table contains “discrete” data and does
not show all possible values!
J French
IBM105

15. Demand PRICE For the relationship, Q = 220 - 5P,
the relationship can be graphed ... $5 10 15 20 25 30 35 40 45 50 55
When the price is $44, 0 unit will be bought;
at a price of $0, 220 units will be bought. 44
Demand
Notice that we have drawn the
graph “backwards,” P{independent}
variable is placed on the Y-axis.
This is done because we eventually
want to put supply on the same
graph and one or the other must be
reversed! Sorry! 70
At P=$30,
Q = 70
170
At a price of $10, the
the quantity is 40 80
120
160
200
240
280
QUANTITY
(Left click mouse to add material)
J French
IBM105

16. Slopes and Shifts
Economists are interested in how one variable {the independent} “causes” changes in another variable {the dependent}
this is measured by the slope of the function
Economists are also interested in changes in the relationship between the variables
this is measured by “shifts” of the function
J French
IBM105

17. Slope of a function or “line”
The slope measures the change in the dependent variable that will be “caused” by a change in the independent variable
When, Y = a ± m X; m is the slope
J French
IBM105

18. Slope of a Line 1 2 3 4 5 6 Y X Y = 6 -.5X DY= -1 DX = 2
as the value of X
increases from 2 to 4,
the value of Y
decreases from
5 to 4
DY is the rise [or change in Y caused by DX]{in this case, -1}
so, slope is -1/2 or -.5
DX is the run {+2},
slope is
rise
run
J French
IBM105

19. Shifts of function
When the relationship between two variables changes, the function or line “shifts”
This shift is caused by a change in some variable not included in the equation
[the equation is a polynomial]
A shift of the function will change the intercepts [and in some cases the slope]
J French
IBM105

20. Given the function Y = 6 - .5X,
Shifts
right
an increase in the
function would
represent an
increase in the
intercept [from 6
to a larger number]
(Left click mouse to add material) 1 2 3 4 5 6 Y X
the function shifts and its
slope also changes
Given the function Y = X,
Just the slope
changes
{in this case, an increase in the absolute
value of .5 to -1.8}
Y” = X [x intercept = 3.3]
A decrease in the
function would be
Y’ = X
shifts
left
J French
IBM105

21. Shifts in functions
In Principles of Economics most functions are graphed in 2-dimensions, this means we have 2 variables. [The dependent and independent]
Most dependent variables are determined by several or many variables, this requires polynomials to express the relationships
a change in one of these variables which is not shown on a 2-D graph causes the function to “shift”
J French
IBM105

22. Slope and Production
The output of a good is determined by the amounts of inputs and technology used in production
example of a case where land is fixed and fertilizer is added to the production of tomatoes.
with no fertilizer some tomatoes, too much fertilizer and it destroys tomatoes
J French
IBM105

23. 1 2 3 4 5 6 7 8 9 10 11 12
The maximum output of T possible with all inputs
and existing technology is 10 units with 6 units of F
tons of
tomatoes
TPf
With the 3rd unit of F,
T increases to 9
With 2 units of F, the output of T
increases to 8
With 1 unit of Fertilizer [F], we get
6 tons
The increase in tomatoes [DT] “caused” by DF
is +3, this is the slope
With no fertilizer we get 3 tons of tomatoes
use of more F causes the tomatoes to “burn” and
output declines
(Left click mouse to add material) 1 2 3 4 5 6 7 8 9
FERTILIZER
J French
IBM105

24. Slope and Marginal Product
Since the output of tomatoes [T] is a function of Fertilizer [F] , the other inputs and technology we are able to graph the total product of Fertilizer [TPf]
From the TPf, we can calculate the marginal product of fertilizer [MPf]
MPf is the DTPf “caused” by the DF
J French
IBM105

25. TPf MPf [slope] 0 3 rise = +3 rise/run =+3 +31 2 3 4 5 6 7 8 9 10 11 12
Given: T = f (F, ), MPf = [DTPf/DF]
DTPf = +1, DF = +3; +1/+3 @ .33
[this is an approximation because DF>1]
TPf
DTPf = -1, DF = +2; -1/+2 = -.5
Fertilizer [F] Tomatoes [T]
0 3
MPf [slope] 3
{technically,
this is
between 0
and the first
unit of F} +3 3
run=1
rise = +3
2 8 2
3 9 1
6 10
.33
rise/run =+3
8 9
-.5 [a negative slope!]
DTPf = +3, DF = +1; +3/+1 = 3 [slope = +3]
DTPf = +2, DF = +1; +2/+1 = 2
DTPf = +1, DF = +1; +1/+1 = 1 1 2 3 4 5 6 7 8 9
J French
IBM105

26. or, P = 44 - .2 Q Q = 220 - 5P -220 -220 + Q = -5P -5 44 - Q = 1P
Given a functional relationship such as: Q = P,
we can express the equation for P as a function of Q
Think of an equation as a “balance scale,” what you do to one side
of the equation you must do to the other in order to maintain balance
Q = P
subtract 220 from both sides
-220
Q = -5P
divide every term in both sides by -5 -5
44 - 1 5
Q = 1P
or, P = Q
The equation P = Q
is the same as Q = P
(Left click mouse to add material)
J French
IBM105

27. How do economists estimate relationships?
Humans behavioral relationships are:
modeled on the basis of theories
models are verified through empirical observations and statistical methods
The relationships are estimates that represent populations {or distributions} not specific individuals or elements
J French
IBM105

28. An Example
Hypothesis: the amount of good X [Q] that Susan purchases is determined by the price of the good [Px], Susans’s income [Y], prices of other related goods [Pr] and Susan’s preferences.
Q = fi (Px,Y, Pr, preferences, . . .)
[ indicates there are other variables that are not included in the equation]
J French
IBM105

29. Model of Relationship
Q = fi (Px,Y, Pr, preferences, . . .) acts a a model to represent the relationships of each independent variable to Q [dependent variable]
For simplicity, the relationship is described as “linear.” If the relationship were believed not to be linear, with a bit more effort we might construct a “nonlinear model.”
J French
IBM105

30. Empirical verification
To test the model, we would like to observe Susan’s buying pattern.
If Px,Y, Pr and preferences were all changing at the same time, we would use a multivariate analysis called “multiple regression.” For simplicity we have been lucky enough to find a period where only Px has changed. Y, Pr and preferences have remained unchanged over the period in which we observe Susan’s purchases
J French
IBM105

31. Quantity per week Price of good X 2 4 6 8 10 12 14 16 18 2 4 6 8
During a 5 week period,
Susan was observed
making the following
purchases
Quantity per week
Price of good X 2 4 6 8 10 12 14 16 18
Data from these observations
can be plotted on the graph
Clearly there is a pattern, however it is not a perfect relationship.
Through statistical inference we can estimate some general
characteristics about the relationship 2 4 6 8 10 12 14 16 18 20 22
J French
IBM105

32. Given the observed data about Susan’s purchases:
We can estimate a line that minimizes the square of the
difference that each point [that represents two variables]
lies off the estimated line.
Quantity per week
Price of good X 2 4 6 8 10 12 14 16 18
P = Q may be written
Q = P
( Q= 10, P= $15)
No single point may lie
the line, but the line is an
estimate of the relationship
(15, 11)
(20,10)
(22,7)
(22,6)
P = Q is our estimate
of the relationship between the
price and the quantity that Susan
purchases each week, ceteris paribus or
all other things equal
J French
IBM105

33. Given the observed data about Susan’s purchases:
and our estimated function: P = Q or Q = P,
we would predict that at a price of $10 Susan would
purchase about units, [Q = P,
P = 10 so Q =17.37]
Quantity per week
Price of good X 2 4 6 8 10 12 14 16 18
We observed that Susan bought 20 units
when the price was $10 so estimate is off
by a small amount [-2.63 units]
At a price of $6 our equation predicts
that units will be purchased
Since we observed that she
purchased 22, we are off
by .67 units
Q = 17.37
P = 10
P = 6
Q = 22.67
our estimates are not perfect, but they
give an approximation of the relationship
J French
IBM105

34. Statistical Estimates
The estimates are not “perfect” but they provide reasonable estimates
There are many statistical tools that measure the confidence that we have in out predictions
these include such things as correlation, coefficient of determination, standard errors, t-scores and F-ratios
J French
IBM105

35. Slope & Calculus
In economics we are interested in how a change in one variable changes another
How a change in price changes sales. How a change in an input changes output. How a change in output changes cost. etc.
The rate of change is measured by the slope of the functional relationship
by subtraction the slope was calculated as rise over run where rise = DY = Y1 - Y2 and run = DX = X1 - X2,
J French
IBM105

36. Derivative There are still more slides on this topic
When we have a nonlinear function, a simple derivative can be used to calculate the slope of the tangent to the function at any value of the independent variable
The notation for a derivative is written:
J French
IBM105

37. Summary
a derivative is the slope of a tangent at a point on a function
is the rate of change, it measures the change in Y caused by a change in X as the change in X approaches 0
in economics jargon, [the slope or rate of change] is the “marginal” dY dX dY dX
J French
IBM105

38. Households (Individuals)
Circular Flow
Goods
and Services
Goods and services S D Q P
Goods Market
Personal Cons
Expenditure $
Revenue $ Q P
Households (Individuals)
Business
Firms
(Mouse Click to Advance)
Role:
Producers hire resource
(Mouse Click to advance)
(Mouse Click to advance)
(Mouse Click to advance)
(Mouse Click to advance)
(Mouse Click to advance)
(Mouse Click to advance)
(Mouse Click to advance)
Roles:
A. Resource
owners
Price
Resource
Resource Market
B. Consumers
$ Expense
Resource hired
$income S
Resource offered D N P
Mouse click for next slide
© L Reynolds, 1999
J French
IBM105

39. Households (Individuals)
Circular Flow
(Mouse Click to Advance)
(Mouse Click to Advance)
(Mouse Click to Advance)
Goods
and Services
Goods and services S D Q P
Personal Cons
Expenditure $
Revenue $ Q P
Government
Households (Individuals)
Business
Firms
Taxes
Gov’t
Purchases & transfers
Role:
Producers hire resource
Roles:
A. Resource
owners
B. Consumers
$ Expense
Resource hired
$income S
Resource offered
Price D N P
Finis
Resource
© L Reynolds, 1999
J French
Mouse click to end show, use back
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40. Finite world
individuals and society are confronted by limited resources
inputs or factors of production
time
budgets
information / knowledge / technology
J French
IBM105

41. Resources Typical taxonomy Alternative view land / natural resources
labor
Capital
Entrepreneurial ability
Alternative view
Matter
Energy
Time
Technology
J French
IBM105

42. Scarcity
Because of Scarcity, individuals and societies must make choices
All Choices in a finite world have “opportunity costs”
alternative uses of finite resources
Opportunity cost is the value of the next best alternative sacrificed
Can institutional structure create or increase scarcity?
J French
IBM105

43. Fundamental Economic Questions
What should be produced?
How many?
How should these goods (and services) be produced?
When should these goods be produced?
Who gets the goods (and services) that were produced?
J French
IBM105

44. Economics as a Social Science
Human behavior is influenced by a matrix of complex forces
Psychology
Sociology
Anthropology
Economics
Political Science
Religion...
J French
IBM105

45. Economics as Social Science [cont ...]
Need for integration of social sciences
deductive, historical and empirical [statistical] approaches
Philosophical and Historical Context
To speculate about where you are going, you need to understand where you are
To fully understand where you are, you need to know where you came from
J French
IBM105

46. Economics as Social Science [cont ...]
As a social science economics has a foundation based on a system of ethics
Ethics
[“Utilitarianism”]
deontological
ontological
J French
IBM105

47. Economics as a Decision Science
Optimization
Maximization of an objective
Minimization of an objective
Objectives
preferences
individual,
firm, [organization]
social
J French
IBM105

48. “Scientific Method” Scientific method is a subset of Epistemology
General approach is:
aware of problem
develop hypothesis [model]
gather data to test hypothesis
test hypothesis
accept or reject hypothesis
when hypothesis gathers general acceptance it becomes a “Theory”
J French
IBM105

49. Models
A model is a representation of reality, it necessarily abstracts form the “real world”
case of two models: Paper and clay. You model an airplane. Do the models look alike? No? Which model is “best?” Which is “best” to demonstrate the principle of lift and flight? Which model would be “best” in a wind tunnel at 700kph?
What you build your model from determines to some extent the nature of your model.
What you want to use the model for determines the process.
J French
IBM105

50. Goals of Science
to predict: On the basis of information currently known and theories, science would like the ability to estimate with some degree of probability, future events.
to explain: The process by which the causal processes of an event can be identified. [The identification of causal relationships.]
Story telling: Story telling is the process by which most societies pass on the cultural values, organizing myths and traditions that determine values and guide behavior.
J French
IBM105

51. Steps to Economic analysis
Identify the Objective
Identify all feasible alternatives
Alternatives are determined by technology
other constraints [finite resources, law, custom,...]
Develop Criteria to evaluate each alternative with respect to the objective
J French
IBM105

52. Objectives The objective is the goal or desired outcome of a choice
Individuals may try to maximize utility given the constraints of income, time, prices, etc.
Firms may have objectives such as the maximization of profits, sales, market share, etc. or the minimization of costs per unit
Social objective, maximize the well being of the members of society
J French
IBM105

53. Social Objectives
The philosophical foundation of Neoclassical economics is “Utilitarianism”
Jeremy Bentham [ ]
“The greatest good for the greatest number.” We want the greatest welfare for the members of a community.
Individual and Community
How can we maintain the autonomy of the individual and at the same time provide for the commonweal?
J French
IBM105

54. Economics as a Decision Science
Economics to analyze choices
At the margin
Marginal Benefits [MB]
Marginal Costs [MC]
MC is the same as opportunity cost
It is the value of what you sacrifice as a result of the choice
MB = MC as basic rule of optimization
J French
IBM105

55. Coordination and Integration
Individual choices must be coordinated and integrated by social institutions
Integrating / coordinating mechanisms in society
householding
redistribution
reciprocity
market exchange
J French
IBM105

56. Householding
each individual household or familial unit produces all the items they consume
subsistence type of economy
not prevalent in modern, industrial societies
largely ignored in Neoclassical economics
J French
IBM105

57. Redistribution
Redistribution occurs when a society’s recourses are distributed by an authority
Central organizing authority takes resource and allocates them by some criteria
Authority based on religion, political power, military strength, etc.
J French
IBM105

58. Reciprocity Defined in anthropology as “obligatory gift giving”
I do something for you and through social convention you are obliged to do something for me
Reciprocity requires a society that includes members who have a continuing relationship
J French
IBM105

59. Reciprocity [cont. . .]
When I help you harvest your crop as a member of a community, you have obligations to help me do something
Should you choose to ignore your social responsibilities often enough, you will eventually be ostracized. Reciprocity requires a sense of community
If I pay you for goods or services, it may substantially alter the good or service
J French
IBM105

60. Market Exchange
A market exchange is a “quid pro quo” mechanism. It is a contractual arrangement were we specify exactly what you will receive in return for a good or service rendered.
“I will give a yellow, #2 pencil for $.50“
We both know exactly what we are getting in the exchange
J French
IBM105

61. Market exchange [cont. . . ]
market exchange may occur between strangers. I do not need to know the shopkeeper where I buy a soft drink.
market exchange works best were exchanges are voluntary
this assures that one or both parties to an exchange benefit and no one is made “worse” off. Concept of Pareto Efficiency
“nonattenuated property rights” are required for markets to produce optimal results
J French
IBM105

62. Pareto Efficiency
Pareto efficiency is the primary criteria used in Neoclassical economics to evaluate alternatives
Pareto efficiency is a condition such that there are no alternatives that will improve the welfare of any person(s) without making some one else (or others) “worse off”
J French
IBM105

63. Pareto Efficiency [cont. . . ]
Clearly, if there is an alternative that will improve the welfare of at least one person and no one is any worse off, that alternative would improve the welfare of society. This is a Pareto improvement
If the utility of at least one person can be increased, but some one else (or others) is made worse off, it is not a Pareto improvement
Benefit/cost analysis is based on the Pareto criterion {rate of return on investment and others are also based on the Pareto criterion
J French
IBM105

64. Pareto Efficiency and Voluntary Exchanges
Market exchanges that are voluntary are said to be Pareto Optimal
It is believed that no one would voluntarily enter into a voluntary exchange and make themselves “worse off”
Therefore, one or both parties to a voluntary exchange is believed to be better off and no one is any worse off
J French
IBM105

65. Definition of economics
the study of how individuals and societies use limited resources to satisfy unlimited wants.
J French
IBM105

66. Fundamental economic problem
scarcity.
individuals and societies must choose among available alternatives.
J French
IBM105

67. Economic goods, free goods, and economic bads
economic good (scarce good) - the quantity demanded exceeds the quantity supplied at a zero price.
free good - the quantity supplied exceeds the quantity demanded at a zero price.
economic bad - people are willing to pay to avoid the item
J French
IBM105

68. Economic resources land labor capital entrepreneurial ability
natural resources, the “free gifts of nature”
labor
the contribution of human beings
capital
plant and equipment
this differs from “financial capital”
entrepreneurial ability
J French
IBM105

69. Resource payments Economic Resource Resource payment land rent
labor wages
capital interest
entrepreneurial ability profit
J French
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70. Rational self-interest
individuals select the choices that make them happiest, given the information available at the time of a decision.
self-interest vs. selfishness
J French
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71. Positive and normative analysis
positive economics
attempt to describe how the economy functions
relies on testable hypotheses
normative economics
relies on value judgements to evaluate or recommend alternative policies.
J French
IBM105

72. Logical fallacies fallacy of composition
occurs when it is incorrectly assumed that what is true for each and every individual in isolation is true for an entire group.
post hoc, ergo propter hoc fallacy (association as causation)
occurs when one incorrectly assumes that one event is the cause of another because it precedes the other.
J French
IBM105

73. Microeconomics vs. macroeconomics
microeconomics - the study of individual economic agents and individual markets
macroeconomics - the study of economic aggregates
J French
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74. Algebra and graphical analysis
direct relationship
J French
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75. Direct relationship
J French
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76. Inverse relationship
J French
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77. Linear relationships
A linear relationship possesses a constant slope, defined as:
J French
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78. Linear relationships (continued)
If an equation can be written in the form: Y=mX+b, then:
m = slope, and
b = Y - intercept.
J French
IBM105