1. principles of microeconomics introduction WEBsite: http://scholar
July 18, 2014
Akos Lada

2. Contents
Course’s objectives and contents
Key economic principles

3. Course objectives and Contents

4. Course objectives
(re) Introduce you to Economics and its public policy applications
Familiarize you with Econ vocabulary and tools
The course focuses on Microeconomics
It is NOT meant to replace a full-semester course in Microeconomics

5. Webpage
Instructions on how to access the course webpage can be found on the syllabus
Every day after 5 PM you will find on the webpage the following day’s Power Point slides
You can also find here the syllabus, the reading lists, assignments, and other reference materials

6. Class meetings
Meets punctually from 9:00 to 10:30 AM from Monday to Friday, except for Wednesdays
Active participation of all members of the section (not just of a few!) is expected

7. Assignments WRITTEN ASSIGNMENTS
READINGS
Textbook
Principles of Economics (N. Gregory Mankiw), any from 3rd to 6th editions
Articles
Current events or stories related to each of the topics we study
Presentations
Present a current article (e.g. The Economist, your own country’s media) in 5 minutes (a few minutes discussion)
WRITTEN ASSIGNMENTS
For almost every session (total of 10) a “problem of the day”
Key for your learning experience in this course
To be handed out at the end of each class
Students can work in groups but must turn in individual assignments
Both “problems of the day” and ‘Fridayly’ problem sets (posted Tuesdays)

8. Exams A take-home midterm Final exam
2 to 4 hours of focused individual work
Handed out on Tuesday, July 29th
To be turned in on Monday, August 1st
Final exam
Tuesday, August 12th
90 Minutes long, closed book

9. Evaluation and feedback
No official grade
However:
You will receive graded assignments with feedback and answer keys the day after turning them in
Tests will also be graded in a 100 scale
Section’s average grades will be posted on the website for your reference

10. Tentative course contents
Intro
Key economic concepts
Demand, Supply and Equilibrium
Comparative Statics
Elasticity
Government interventions (taxes, subsidies and price controls)
Welfare analysis
(Possibly) Poverty and Inequality
Production
Competition and Monopolies
Externalities
Public Goods
Final Review
The frontiers of Micro-economics
Fall
Semester
WEEK 1
Firms and Consumers
WEEK 2
The Government and the Economy
WEEK 4
Additional topics and final review
WEEK 3
Markets in Action

11. Key Economic Principles*
* Slides from Mankiw’s Principles of Economics Teaching Companion

12. What Economics Is All About
Scarcity: the limited nature of society’s resources
Economics: the study of how society manages its scarce resources, e.g.
how people decide what to buy, how much to work, save, and spend
how firms decide how much to produce, how many workers to hire
how society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs
You might want to elaborate a bit on some of the points made here. Some examples:
“How do people decide how much to work?” Time is scarce resource – there’s just not enough time to do everything we’d like to do. How do we decide how much of our time to spend working? There’s a tradeoff: the more time we spend working, the higher our income, and therefore the more stuff we can buy. But, the more time we spend working, the less time we have for leisure – hanging out with friends, going hiking, watching movies, etc. (You might want to ask your students how THEY decide how much time to spend working. Some will say it depends on how many classes they are taking, or the time requirements of the available jobs. But probably at least a few will say the wage – the higher the wage, the more worthwhile to work.)
“How do firms decide what kind of labor to hire?” Firms can hire unskilled or skilled workers. The skilled workers are more productive, but cost more than the unskilled workers.
“How do firms decide how much to produce?” Ask your students, and see if any of them say “it depends on the price of the product they sell.” (Probably some will say “it depends on whether there’s a lot of demand for the product”. To which you might respond “and if there’s a lot of demand for the product, what does that mean for the price that firms can get for the product?”) 12

13. The principles of HOW PEOPLE MAKE DECISIONS
The principles of HOW PEOPLE MAKE DECISIONS
Decision-making is at the heart of economics. The individual must decide how much to save for retirement, how much to spend on different goods and services, how many hours a week to work. The firm must decide how much to produce, what kind of labor to hire. Society as a whole must decide how much to spend on national defense (“guns”) versus how much to spend on consumer goods (“butter”). 13

14. Principle #1: People Face Tradeoffs
Principle #1: People Face Tradeoffs
All decisions involve tradeoffs. Examples:
Going to a party the night before your midterm leaves less time for studying.
Having more money to buy stuff requires working longer hours, which leaves less time for leisure.
Protecting the environment requires resources that could otherwise be used to produce consumer goods. 14

15. Principle #1: People Face Tradeoffs
Principle #1: People Face Tradeoffs
Society faces an important tradeoff: efficiency vs. equality
Efficiency: when society gets the most from its scarce resources
Equality: when prosperity is distributed uniformly among society’s members
Tradeoff: To achieve greater equality, could redistribute income from wealthy to poor. But this may reduce incentive to work and produce, shrinks the size of the economic “pie.”
HEADS UP. The 5th edition uses “equality.” The fourth and earlier editions used “equity” here.
You may want to elaborate verbally on the last bullet to insure that the point is clear.
“Redistribute income from wealthy to poor” is accomplished through the progressive tax system, as well as social programs like food stamps and unemployment insurance that try to provide a safety net for people at the low end of the income distribution.
“But this reduces the incentive to work” – the reward for working hard is a high income. Taxes reduce this reward, and therefore reduce the incentive to work hard. 15

16. Principle #2: The Cost of Something Is What You Give Up to Get It
Making decisions requires comparing the costs and benefits of alternative choices.
The opportunity cost of any item is whatever must be given up to obtain it.
It is the relevant cost for decision making. 16

17. Principle #2: The Cost of Something Is What You Give Up to Get It
Examples: The opportunity cost of…
…going to college for a year is not just the tuition, books, and fees, but also the foregone wages.
…seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater.
Here’s a fun tangent if you have the class time and are so inclined:
Ask your students about the saying “The best things in life are free.” Ask them to name some of these things that supposedly are free. Ask them what “free” means in this context. The idea here is to get them to see that even things without an explicit monetary cost are not truly “free” because they have an opportunity cost.
For example, when you ask them to name the “best things” that are “free,” they will respond with answers like love, sitting at the top of a mountain you just climbed and enjoying an awesome view, or maybe witnessing the joy of a child who has just been given a new toy. In each case, there is no explicit monetary cost, but there’s an opportunity cost.
For example, a day spent climbing a mountain represents a day of foregone wages. And the fact that the mountain offers the incredible view probably means that land has been set aside for a national park that might otherwise have been used to produce industrial chemicals, or for a subdivision of million-dollar homes.
With love, it’s less obvious, but if prodded enough, your students will be able to think of non-monetary costs associated with love. For example, you might not want to see the latest Ashton Kutcher film, you might think he’s the world’s worst actor. But your boyfriend/girlfriend/teenage daughter or other loved one is DYING to see it, they are BEGGING you to take them. So you take them. That’s true love, don’t you think? And it’s certainly not free. 17

18. Principle #3: Rational People Think at the Margin
systematically and purposefully do the best they can to achieve their objectives.
make decisions by evaluating costs and benefits of marginal changes – incremental adjustments to an existing plan. 18

19. Principle #3: Rational People Think at the Margin
Examples:
When a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education.
When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue.
See the textbook for two classic examples:
1. The diamond-water paradox: water is essential for life but virtually free; diamonds are inessential but expensive.
2. The near-zero marginal cost of an airline taking an extra passenger when the flight isn’t full. 19

20. Principle #4: People Respond to Incentives
Incentive: something that induces a person to act, i.e. the prospect of a reward or punishment.
Rational people respond to incentives.
Examples:
When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling SUVs.
When cigarette taxes increase, teen smoking falls. 20

21. The principles of HOW PEOPLE INTERACT
The principles of HOW PEOPLE INTERACT
Whether we’re talking about the U.S. economy, or the local economy, the term “economy” simply means a group of people interacting with each other.
These interactions play a critical role in the allocation of society’s scarce resources. For example, the interaction of buyers and sellers determines the prices of goods and the amounts produced and sold. These interactions are an important part of what economists study. 21

22. Principle #5: Trade Can Make Everyone Better Off
Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods.
Countries also benefit from trade & specialization:
Get a better price abroad for goods they produce
Buy other goods more cheaply from abroad than could be produced at home
If each person had to grow his own food, make his own clothes, cut his own hair, we would have a world full of skinny, unfashionable poor people having bad hair days every day of the week.
It’s far more efficient for each person to specialize in producing a good or service, and then exchanging it with other people for the things they produce.
The statement “trade can make everyone better off” should not be hard to understand, if you think about it for a moment: Each of two parties would not voluntarily enter into an exchange if it made either of them worse off, now would they?
The same principles apply at the national and international level: International trade allows countries to sell their exports abroad and get a higher price, and to buy things from abroad more cheaply than they could produce at home.
In addition, trade gives a country’s consumers access to a greater variety of goods – including goods they might not be able to get at all. For example, U.S. consumers enjoy a variety of fresh produce year-round. This would not be possible without international trade. 22

23. Principle #6: Markets Are Usually A Good Way to Organize Economic Activity
Market: a group of buyers and sellers (need not be in a single location)
“Organize economic activity” means determining
what goods to produce
how to produce them
how much of each to produce
who gets them
A market economy is “decentralized,” meaning that there is no government committee that makes the decisions about what goods to produce and so forth. Instead, many households and firms make their own decisions:
* Each of many households decides who to work for and what goods to buy.
* Each of many firms decides whom to hire and what goods to produce. 23

24. Principle #6: Markets Are Usually A Good Way to Organize Economic Activity
A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets.
Famous insight by Adam Smith in The Wealth of Nations (1776):
Each of these households and firms acts as if “led by an invisible hand” to promote general economic well-being.
In all versions of this textbook except Brief Principles of Macroeconomics, market efficiency and the invisible hand are covered more thoroughly in Chapter 7. 24

25. Principle #6: Markets Are Usually A Good Way to Organize Economic Activity
The invisible hand works through the price system:
The interaction of buyers and sellers determines prices.
Each price reflects the good’s value to buyers and the cost of producing the good.
Prices guide self-interested households and firms to make decisions that, in many cases, maximize society’s economic well-being. 25

26. Principle #7: Governments Can Sometimes Improve Market Outcomes
Property rights
Market failure: when the market fails to allocate society’s resources efficiently
Causes:
Externalities, when the production or consumption of a good affects bystanders (e.g. pollution)
Market power, a single buyer or seller has substantial influence on market price (e.g. monopoly)
In such cases, public policy can promote efficiency. 26

27. The Economist as a Scientist
Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
In the first, economists employ the scientific method, the dispassionate development and testing of theories about how the world works. 27

28. Assumptions & Models
Assumptions simplify the complex world, make it easier to understand.
Example: To study international trade, assume two countries and two goods.
Unrealistic, but simple to learn and gives useful insights about the real world.
Model: a highly simplified representation of a more complicated reality. Economists use models to study economic issues. 28

29. Some Familiar Models 29

30. Our First Model: The Circular-Flow Diagram
The Circular-Flow Diagram: a visual model of the economy, shows how dollars flow through markets among households and firms
Two types of “actors”:
households
firms
Two markets:
the market for goods and services
the market for “factors of production” 30

31. Factors of Production
Factors of production: the resources the economy uses to produce goods & services, including
labor
land
capital (buildings & machines used in production) 31

32. The Circular-Flow Diagram
Households:
Own the factors of production, sell/rent them to firms for income
Buy and consume goods & services
Firms
Households
Firms:
Buy/hire factors of production, use them to produce goods and services
Sell goods & services
This and the following slide build the Circular-Flow Diagram piece by piece. 32

33. The Circular-Flow Diagram
Revenue
Markets for Goods & Services
Spending
G & S sold
G & S bought
Firms
Households
Wages, rent, profit
Factors of production
Income
Labor, land, capital
Markets for Factors of Production
In this diagram, the green arrows represent flows of income/payments. The red arrows represent flows of goods & services (including services of the factors of production in the lower half of the diagram).
To keep the graph simple, we have omitted the government, financial system, and foreign sector, as discussed on the next slide.
You may wish to change the order in which the elements appear. To do so, look for “Custom Animation” in your version of PowerPoint. 33

34. principles of microeconomics introduction
July 18, 2014
Akos Lada