1. Chapter 1
Preliminaries

2. Introduction What are the key themes of microeconomics?
What is a market?
What is the difference between real and nominal prices?
Why study microeconomics?
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3. Themes of Microeconomics
Microeconomics deals with limits
Limited budgets
Limited time
Limited ability to produce
How do we make the most of limits?
How do we allocate scarce resources?
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4. 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?
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5. 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?
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6. Themes of Microeconomics
Workers
Individuals decide when and if to enter the workforce
Trade-offs of working now or obtaining more education/training
What choices do individuals make in terms of jobs or workplaces?
How many hours do individuals choose to work?
Trade-off of labor and leisure
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7. Themes of Microeconomics
Firms
What types of products do firms produce?
Constraints on production capacity and financial resources create needs for trade-offs
Theory of the Firm – describes how these trade-offs are best made
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8. Themes of Microeconomics
Prices
Trade-offs are often based on prices faced by consumers and producers
Workers make decisions based on prices for labor – wages
Firms make decisions based on wages and prices for inputs and on prices for the goods they produce
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9. 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
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10. Theories and Models
Economics is concerned with explanation of observed phenomena
Theories are used to explain observed phenomena in terms of a set of basic rules and assumptions:
The Theory of the Firm
The Theory of Consumer Behavior
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11. Theories and Models Theories are used to make predictions
Economic models are created from theories
Models are mathematical representations used to make quantitative predictions
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12. 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
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13. 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?
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14. 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?
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15. 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
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16. What is a Market? Market Definition Arbitrage
Determination of the buyers, sellers, and range of products that should be included in a particular market
Arbitrage
The practice of buying a product at a low price in one location and selling it for more in another location
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17. 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?
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18. 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
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19. Types of Markets Noncompetitive Markets
Markets where individual producers can influence the price
Cartels – groups of producers who act collectively
Example: OPEC dominates with world oil market
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20. Market Price
Transactions between buyers and sellers are exchanges of goods for a certain price
Market price – price prevailing in a competitive market
Some markets have one price: price of gold
Some markets have more than one price: price of Tide versus Wisk
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21. Market Definition Market Definition
Which buyers and sellers should be included in a given market?
This depends on the extent of the market – boundaries, geographical and by range of products, to be included in it
Market for housing in New York or Indianapolis
Market for all cameras or digital cameras
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22. Market Definition Importance of market definition
In order to set price, make budgeting decisions, etc., companies must know
Their competitors
Product-characteristic and geographic boundaries of the market
Important for public policy decisions
Should government allow a merger between companies in same market?
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23. Real Versus Nominal Prices
Comparing prices across time requires 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
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24. Real Versus Nominal Prices
Consumer Price Index (CPI) is 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
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25. Real Versus Nominal Prices
Calculating Real Prices
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26. Real Price of College Year Nom. Price CPI Real Price 1970 $2,530 38.8
1990
$12,018
130.7
2002
$18,273
181.0
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27. Real Price of Wages Observations
The minimum wage has been increasing in nominal terms since 1940
From 1930 at $0.25 to 2003 at $5.15
The 1999 real minimum wage was no higher in 1999 than 1950
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28. The Minimum Wage: Figure 1.1
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29. Why Study Microeconomics?
Microeconomic concepts are used by everyone to assist them in making choices as consumers and producers
Examples show the numerous levels of microeconomic questions necessary in many decisions
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30. Ford SUV’s
Built Ford Explorer in 1991, Ford Expedition in 1997 and 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
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31. Ford SUV’s
Questions
How strong is 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?
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32. Ford SUV’s Questions (cont.)
Ford had to develop pricing strategy and determine competitors’ reactions
Risk analysis
Uncertainty of future prices: gas, wages
Organizational decisions
Integration of all divisions of production
Government regulation
Emissions standards
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33. 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?
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