ECO 240 -1

Introducing Economics
Introduction to Microeconomics
• Main Text:
John Sloman Economics 6th ed. Prentice Hall Readings
2006 [SLO]

References: • SLO Chapter 1

• 1.Begg D Fischer S & Dornbuseh R (2005) • LCR Chapters 1, 2 & 3
Economics, 8th ed. McGraw-Hill Education [BD}
• BD Chapters 1 & 2
• Lipsey RG Courant PN & Ragan CTS (1999)
Economics 12th ed. Addison – Wesley [LCR]

Microeconomics To Learn a Way of Thinking...

• economic behaviuor of individuals (households), Three Fundamental Concepts of
firms, government agencies, and societies on
how scarce resources are allocated among Economic Thinking
conflicting demands
• concerned with the operation of individual • Opportunity Cost
markets, consumer behaviuor and purchasing
decisions, and firms’ output decisions • Marginalism
• deals with the pricing of goods and services,
taxation, regulation and other considerations • Efficiency
which may affect prices and output of individual
markets

Economic Issues Economic Issues (cont’d)

• Allocation of scarcity of resources among • Need to know whether a society chooses
competing uses for the satisfaction of to have competitive institutes or others say
unlimited wants cooperative structure
• Basic Problems: • Whether decisions are made through a
What to produce decentralized / centralized / a mixture if
How to produce competitive and cooperative structure
When to produce • Whether decisions are made through a
How much to produce decentralized / centralized / a mixture of
For whom both decentralized and centralized
Where to produce

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 Production
• Transformation of of raw materials into final
goods and services for the purposes of
satisfying consumer wants
• Factors of production are land, labour, capital
and entrepreneurship
• Resources / factors of production are limited
• Resources have alternative/competing uses
• Wants are unlimited
• Between wants and resources there is a conflict
Marginalism
• In weighing the costs and benefits of
a decision, it is important to weigh
only the costs and benefits that arise
from the decision. (That is, the
additional costs/benefits that are
added as a result of that decision.)
Static and Dynamic Efficiency
• Static efficiency -- occurs when resources are
allocated efficiently at a point in time.
e.g. whether a country could produce more if cut
its unemployment rate
• Dynamic efficiency -- occurs when resources
are allocated efficiently over time, e. .g. Would
there be greater efficiency if more resources
were devoted to investment rather than
consumption over time?
Opportunity Costs
• The opportunity cost of
something is that which we give
up when we make that choice or
that decision.
Opportunity costs imply that nearly all
decisions involve trade-offs
Efficiency
• Efficiency is concerned with how well
resources , such as time, talents or
materials, are used to produce an end
result.
• In economics, it is concerned with the
relationship between scarce inputs
and outputs.
Productive Efficiency &
Allocative Efficiency
• Both are static efficiency
• Allocativer efficiency of economic efficiency –
occurs when resources are distributed in such a
way that no consumers become worse off i.e. if
a consumer wants schooling for her child, is
education available?
• Productive efficiency – is achieved when
production is achieved at lowest cost. It can only
exit if there is technical efficiency ( i.e. when a
given quantity of output is produced with the
minimum number of inputs).
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 The Method of Economics
• Positive Economics
• An objective / scientific approach to economics
that seeks to understand behavior and the
operation of systems without making
judgments. It describes what exists and how it
works.
For example: the model of price determination
states that a rise in price will lead to a fall in the
quantity demanded – this is a positive model.
The Method of Economics
• Normative Economics
An approach to economics that analyzes
outcomes of economic behavior, evaluates them
as good or bad, and may prescribe courses of
action. Normative economics will many times
apply value judgments
Example: “The government has a duty to protect
the incomes of everybody in society, not just the
well off”. The statement contains a value
judgment about the role of government.

Opportunity Cost The Theory of Comparative Advantage

The opportunity cost is that which we give up
or forgo, when we make a decision or a
choice given
the limited resources to satisfy the unlimited
human wants.
Such cost is also known as economic cost or
real cost or real opportunity cost
It is measured in physical units and not in
monetary terms.
Comparative advantage – the advantage in the
production of a product enjoyed by one country
over another when the product can be
produced at lower cost in terms of other goods
than it could be in the other country
Absolute advantage – the advantage in the
production of a product enjoyed by one country
over another when it uses fewer resources to
produce that product than the other country
does

Comparative Advantage: Begin by calculating the opportunity

An Example cost of each good for each person.
PRODUCTION FUEL FOOD
Consider an economy composed of 2
agents, Bill and Hillary. PER DAY (logs) (bushels)
Hillary 10 10
PRODUCTION Fuel OR Food Bill 5 8
PER DAY (logs) (bushels)
10 logs cost Hillary 10 bushels of food.
Hillary 0 10 10 logs cost Bill 16 bushels of food.
8 bushels of food cost Hillary 8 logs.
Bill 5 8
8 bushels of food cost Bill 5 logs.

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 The opportunity costs can be
summarized as follows:
For LOGS:
1 log costs Hillary 1 bushel of food.
1 log costs Bill 1.6 bushels of food.
For FOOD:
1 bushel of food costs Hillary 1 log.
1 bushel of food costs Bill 5/8, or .625 logs.
Capital Goods
A capital good can be
considered as anything that
is produced that will be used
to produce other valuable
goods or services over time
Production Possibility Frontier -- PPF
The PPF is a graphical device that shows
all the possible combinations of goods
and services that a country can
produce within a specified time period
with all of the country’s resources fully
efficiently employed.
So, how should Hillary and Bill
specialize and trade?
• Hillary can produce logs cheaper
than Bill. Colleen should
produce fuel.
• Bill can produce food cheaper
than Hillary. Bill should produce
food.
Consumer Goods
Consumer goods are
those goods produced
for present consumption.
PPF -- Assumptions
• Only two goods to be produced
• A given state of technology
• The curve/frontier is concave to origin
• On the frontier/curve resources are fully utilized
I.e. full employment
• Below the curve –- under-employment
• Slope of PPF reflects the opportunity costs
• PPF is a straight line when opportunity costs are
constant
• PPF may shift when labour/capital/technology
changes
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 Production Possibility
Production Possibility Frontier Frontier

The curve has a negative
Capital goods

Capital goods
slope.

The curve is concave to the
. A

origin.
800 .F
550
. .E
D
. B

Consumer goods 1100 1300

Consumer goods

Marginal Rate of Transformation

(MRT) in Production Law of Increasing Opportunity Costs
• The marginal rate of transformation in
Production is the amount of good Y that the
producer will have to give up producing for an
increase in production of good X The opportunity cost of
∆Y/∆X producing a good
If total costs of production are to remain
unchanged, then MRT = the ratio of marginal increases as more
cost of X to the marginal cost of Y I.e. resources are shifted
MRT = MCx/MCy
into its production.

Production Possibilities Schedule and Frontier for

Corn and Wheat Production -- Boundary
separates the attainable from the unattainable
Economic Growth
Bushels of corn per year (millions)

TOTAL CORN TOTAL WHEAT

800
POINT PRODUCTION
ON PPF (mills. of bushels)
PRODUCTION
(mills of bushels)
Economic growth indicates an
A
700
600
B
C
per year per year
increase in the total output of an
500 A 700 100
400 D
E
economy.
300
B 650 200
200
100 It occurs when society acquires new
0 C 510 380
0 200 400 600 800 resources or when it learns to
Bushels of wheat per year D 400 500
(millions)
produce more using existing
E 300 550
resources.

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Economic growth shifts the PPF Command Economy / Laissez-
Laissez-Faire Economies
Up and to the Right / Free Market System
`Bushels of corn
per year (millions) The central government either
directly or indirectly sets targets for
output, incomes, and prices.
. 1995

.
1975

Also: advantages & disadvantages

.
1955

Bushels of wheat per

year (millions)

Command Economy Laissez-

Laissez-faire Economy
• The state plans the allocation of resources as
follows: The Central Planning Authority (CPA) An economy in which individual
• 1. Allocating resources between current people and firms pursue their
consumption and investment for future consumption
• 2. CPA plans the output for each industry and firm, own self-interests without any
the techniques that will be used, the labour and central direction or regulation.
other resources each industry and firms require(s).
• 3. CPA plans the distribution of output between
consumers pending on government ‘s aim, CPA’s
Judgement on people’s needs or it may give more to
The central institution in these
those who produce more economies are called the markets!
• CPA may decide the distribution of money income to
allow consumers to decide how to spend the money

Interdependence of Markets Interdependence of Markets

• Goods markets – demand for goods rises
creating shortages and causing prices to rise to
choke off some of excess demand - Firms
respond by producing more
• Factor market – increased production causes an
increase in demand for factor inputs creating
shortages and causing prices to rise in order to
choke off some of the excess demand and at the
same time to encourage suppliers of inputs to
supply more
• Discovery of new raw materials will lower
the price and the cost of production
• Production would increase giving rise to
excess supply of the finished goods
• Resulting surplus causes the price to fall
encouraging consumers to buy more (as
purchasing power of money increases)

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 Free Markets -- Problems
Markets
• Competition between firms is often limited
• High profits may reduce the firms’ incentives to be
efficient
• May bring about an unequal distribution of power
The institutions through
and property which buyers and sellers
• Practices of some firms may be socially undesirable
e.g. environmental pollution interact and engage in
• Firms may not wish to produce some socially exchange.
exchange
desirable goods e.g. lighthouse
• Macroeconomic instability – high unemployment
falling output during recession & high prices
• Unethical – rewarding self-interested behaviour may
lead to selfishness, greed, materialism & power
acquisition

Important aspects of Market

Economies: Consumer Sovereignty

• Consumer sovereignty The idea that consumers

ultimately dictate what will
• Free enterprise
be produced (or not
• Distribution of output produced) by choosing
decentralized what to purchase (and what
• Price theory not to purchase).

Role for Government :

Mixed Market Economies Government Controls
• Minimize market inefficiencies • Relative prices of goods and inputs by taxing or
subsidizing them or by direct price controls.
• Provide public goods • Relative incomes through income taxes, welfare
• Redistribute income payments, direct controls over wages, profits,
rents and etc.
• Stabilize the macro economy • Control production and consumption through
–Promote low levels of legislation, direct provision of goods and
services, by taxes and subsidies or by
unemployment nationalization.
–Promote low levels of inflation

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 Government Controls
• Macroeconomics problems of
unemployment, inflation, lack of growth
and balance of payments deficit – using
Fiscal ( taxes and government
expenditure ) & monetary ( control of
bank lending & interest rates, the direct
price control and the control of foreign
exchange rate.
• Control malpractices of monopoly
Government Controls
• Note:
Government intervention / controls are not
perfect measures to correct various social
inefficiencies
Government actions may bring adverse as
well as beneficial consequences

Questions
1. Imagine that you won millions of pounds
on the National Lottery. Would your
‘economic problems’ be solved?
2. In what ways does specialization reduce
the problem of scarcity?
3. Would redistributing incomes from the
rich to the poor reduce the overall
problem of scarcity?