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0
Microeconomics 1
o Lecturer: Dali Laxton, Junior Researcher at
CERGE-EI, Prague (dali.laxton@gmail.com)
o Text-book: Mankiw, Principles of Economics,
4th edition (available at the library).
➢Lectures / Seminars : Friday 13:00-16:50,
room P312
➢Office hours: Online Saturday 4:00-5:00 pm
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1
Agenda
➢2 Quizzes (30 points): 1 multiple choice, 1
conceptual question and 1 problem
➢First Quiz: 23.10.2020 (3rd week)
➢Midterm Exam (30 points): 06.11.2020
➢Final Exam (40 points): 08.01.2021
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Masaryk University
Microeconomics 1
Dali Laxton
Lecture
1
Ten Principles
of Economics
WojciechGerson(1831-1901)
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3
Newspapers and websites are filled
with articles related to economics—
either directly or indirectly. News
headlines may cover topics such as
unemployment, deficits, financial
markets, health care, Social Security,
energy issues, war, global warming,
and so on.
Photo by Robert Sexton
Why Economics?
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4
At the professional level:
• How can my firm minimize costs and
maximize profits?
• How much price should I charge and
how much should I produce?
Why Economics?
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5
At the personal level:
• How can I maximize my average
GPA given time constraints?
• Should I quit my job and pursue
university education?
• What is a marginal benefit of calling
my girlfriend compared to the cost of
spent time?
Why Economics?
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6
Why Economics?
The table shows gross wages in the Czech Republic before paying pension and insurance outlets. The data is retrieved from
https://www.euroeducation.cz/en/content/36/20.
It pays off ☺
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Lecture Today
• Introduction/revision of fundamental principles of
economics
• What kinds of questions does economics
address?
• What are the principles of how people make
decisions?
• What are the principles of how people interact?
• How do Economists think?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Readings
• Mankiw, Principles of Economics, Chapter 1
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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
The principles of
HOW PEOPLE
MAKE DECISIONS
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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.
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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 reduces incentive to work and produce,
shrinks the size of the economic “pie.”
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13
Even though designating
these parking spaces for
disabled drivers may not be
an efficient use of scarce
parking spaces (because
they are often not used),
many believe it is fair to give
these drivers a convenient
spot. The debate between
efficiency and equity is often
heated.
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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.
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PRINCIPLE 2
The Cost of Something Is
What You Give Up to Get It
Examples:
The opportunity cost of…
…waiting in line for “free” event.
…studying at university – not only tuition fee and
living costs but also foregone wages.
Question:
What are “best things” that are “free”? Are they
really free?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
PRINCIPLE 3
Rational People Think at the Margin
Rational people
▪ 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.
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17
During rush hour some drivers will switch into and out of lanes if they
perceive one lane is moving faster than another. This is a marginal
adjustment. The same is true of lines in a supermarket. People are
constantly weighing the marginal benefits and marginal costs of changing
lanes and/or lines.
Vyshnya/Shutterstock.com
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PRINCIPLE 3
Rational People Think at the Margin
Other 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.
▪ VS.
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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.
▪ When cigarette taxes increase,
teen smoking falls.
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A C T I V E L E A R N I N G 1
Applying the principles
You are selling your old car. You have already spent
15,000 CZK on repairs.
At the last minute, the transmission dies.
You can pay 10,000 CZK to have it repaired, or sell
the car “as is.”
In each of the following scenarios, should you have
the transmission repaired? Explain.
A. The value of the car is 40,000 CZK if the
transmission works and 25,000 CZK if it doesn’t
B. The value of the car is 45,000 CZK if the
transmission works and 38,000 CZK if it doesn’t
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A C T I V E L E A R N I N G 1
Answers
Cost of fixing transmission = 10,000 CZK
A. If transmission works, the value of the car is
40,000 CZK and is 25,000 CZK if it doesn’t
Benefit of fixing transmission = 15,000 CZK
(40,000 – 25,000).
Get the transmission fixed.
B. If transmission works, the value of the car is
45,000 CZK and is 38,000 CZK if it doesn’t
Benefit of fixing the transmission is only 7,000
CZK.
Do not pay 10,000 CZK to fix it.
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A C T I V E L E A R N I N G 1
Observations
▪ The 15,000 CZK you previously spent on repairs
is irrelevant. What matters is the cost and benefit
of the marginal repair (the transmission).
▪ The change in incentives from scenario A
to scenario B caused your decision to change.
The principles of
HOW PEOPLE
INTERACT
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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 and
specialization:
▪ Get a better price abroad for goods they
produce
▪ Buy other goods more cheaply from abroad
than could be produced at home
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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
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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.
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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.
▪ In many cases better option than centralized
economy.
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PRINCIPLE 7
Governments Can Sometimes
Improve Market Outcomes
▪ Important role for government: enforce
property rights
(with police, courts)
▪ People are less inclined to work, produce,
invest, or purchase if large risk of their property
being stolen.
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PRINCIPLE 7
Governments Can Sometimes
Improve Market Outcomes
▪ Market failure: when the market fails to allocate
society’s resources efficiently
▪ Causes of market failure:
▪ 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)
▪ Public policy may promote efficiency.
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PRINCIPLE 7
Governments Can Sometimes
Improve Market Outcomes
▪ Govt may alter market outcome to
promote equity.
▪ If the market’s distribution of economic well-being
is not desirable, tax or welfare policies can
change how the economic “pie” is divided.
The principles of
HOW THE
ECONOMY
AS A WHOLE
WORKS
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PRINCIPLE 8
A Country’s Standard of Living Depends on Its
Ability to Produce Goods & Services
▪ Huge variation in living standards across
countries and over time:
▪ Average income in rich countries is more than
ten times average income in poor countries.
▪ The U.S. standard of living today is about
eight times larger than 100 years ago.
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PRINCIPLE 8
A Country’s Standard of Living Depends on Its
Ability to Produce Goods & Services
▪ The most important determinant of living
standards: productivity, the amount of goods
and services produced per unit of labor.
▪ Productivity depends on the equipment, skills,
and technology available to workers.
▪ Other factors (e.g., labor unions, competition from
abroad) have far less impact on living standards.
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PRINCIPLE 9
Prices Rise When the Government Prints Too
Much Money
▪ Inflation: increases in the general level of prices.
▪ In the long run, inflation is almost always caused
by excessive growth in the quantity of money,
which causes the value of money to fall.
▪ The faster the govt creates money,
the greater the inflation rate.
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PRINCIPLE 10
Society Faces a Short-run Tradeoff Between
Inflation and Unemployment
▪ In the short-run (1–2 years),
many economic policies push inflation and
unemployment in opposite directions.
▪ Other factors can make this tradeoff more or less
favorable, but the tradeoff is always present.
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The Economist as 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.
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The Economist as Scientist
▪ Working with data
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The Economist as Scientist
▪ Providing explanations by building up models.
▪ Not these ones ☺
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Assumptions & Models
▪ Model: a highly simplified representation of
a more complicated reality.
Economists use models to study economic
issues.
▪ 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.
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The Role of Assumptions
▪ Assumptions
▪ Can simplify the complex world
▪ Make it easier to understand
▪ The art in scientific thinking: deciding which
assumptions to make
▪ Different assumptions
▪ To answer different questions
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Some Familiar Models
A road map
©wavebreakmedia/Shutterstock.com
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Some Familiar Models
A model of human
anatomy from high
school biology class
©Accord/Shutterstock.com
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Some Familiar Models
A model airplane©Olga Rosi/Shutterstock.com
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Some Familiar Models
The model teeth at the
dentist’s office Don’t forget
to floss!
©ittipon/Shutterstock.com
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Effective Models
▪ Includes characteristics that are essential to
explore research question.
▪ Simplifies reality to increase our understanding –
neglects redundant dimensions of reality.
Most economic models
▪ Diagrams and equation
Ceteris Paribus analysis – concentrating in change
only one variable fixing all others.
Summary
The principles of decision making are:
• People face tradeoffs.
• The cost of any action is measured in terms of
foregone opportunities.
• Rational people make decisions by comparing
marginal costs and marginal benefits.
• People respond to incentives.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Summary
The principles of interactions among people are:
• Trade can be mutually beneficial.
• Markets are usually a good way of coordinating
trade.
• Govt can potentially improve market outcomes if
there is a market failure or if the market outcome
is inequitable.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Summary
The principles of the economy as a whole are:
• Productivity is the ultimate source of living
standards.
• Money growth is the ultimate source of inflation.
• Society faces a short-run tradeoff between
inflation and unemployment.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Next Lecture
▪ Demand and Supply Analysis
▪ Readings: Mankiw, Chapter 1; Production Possibility
Frontier part and Appendix from Chapter 2
50
The PPF
• Production possibilities frontier
–A graph: combinations of output that the
economy can possibly produce
–Given the available
• Factors of production and technology
–Example:
• Two goods: computers and wheat
• One resource: labor (measured in hours)
• Economy has 50,000 labor hours per month
available for production
51
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
PPF Example
Producing one computer requires 100 hours labor.
Producing one ton of wheat requires 10 hours labor.
52
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
5,0000
4,000100
2,500250
1,000400
50,0000
40,00010,000
25,00025,000
10,00040,000
0500050,000
E
D
C
B
A
WheatComputersWheatComputers
Production
Employment of
labor hours
PPF Example
53
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
Point
on
graph
Production
Com-
puters
Wheat
A 500 0
B 400 1,000
C 250 2,500
D 100 4,000
E 0 5,000
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Wheat
(tons)
Computers
A
B
C
D
E
Active Learning 1 Points off the PPF
On the graph above, find the point that
represents (100 computers, 3000 tons of
wheat), label it F.
– Would it be possible for the economy to
produce this combination of the two goods?
Why or why not?
Next, find the point that represents (300
computers, 3500 tons of wheat), label it G.
– Would it be possible for the economy to
produce this combination of the two goods?
54
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
Active Learning 1 Answers
• Point F: 100
computers, 3000
tons wheat
• Requires 40,000
hours of labor
• Possible but not
efficient: could
get more
of either good
without
sacrificing any of
the other
55
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Wheat
(tons)
Computers
F
Active Learning 1 Answers
• Point G: 300
computers, 3500
tons wheat
• Requires 65,000
hours of labor.
• Not possible
because the
economy only
has 50,000
hours
56
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Wheat
(tons)
Computers
G
The PPF: What We Know So Far
• Points on the PPF (like A – E): possible
–Efficient: all resources are fully utilized
• Points under the PPF (like F): possible
–Not efficient: some resources are
underutilized (e.g., workers unemployed,
factories idle)
• Points above the PPF (like G)
–Not possible
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
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57
The PPF
• Moving along a PPF
–Involves shifting resources from the
production of one good to the other
• Society faces a tradeoff
–Getting more of one good requires
sacrificing some of the other
• The slope of the PPF
–The opportunity cost of one good in terms
of the other
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58
The PPF and Opportunity Cost
The slope of a line
equals the “rise
over the run.”
Opportunity cost of
1 computer =
10 tons of wheat.
59
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Wheat
(tons)
Computers
–1000
100
slope = = –10
Active Learning 2 PPF and Opportunity Cost
In which country is the opportunity cost of
cloth lower?
60
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
ENGLAND
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
FRANCE
Active Learning 2 Answers
England, because its PPF is not as steep as France’s
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
ENGLAND
0
100
200
300
400
500
600
0 100 200 300 400
Cloth
Wine
FRANCE
Economic Growth and the PPF
With additional
resources or an
improvement in
technology,
the economy can
produce more
computers,
more wheat,
or any combination in
between.
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
0
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Wheat
(tons)
Computers
Economic
growth shifts
the PPF
outward.
The Shape of the PPF
• Shape of the PPF
–Straight line: constant opportunity cost
• Previous example: the opportunity cost of 1
computer is 10 tons of wheat
– Bowed outward: increasing opportunity
cost
• As more units of a good are produced, we
need to give up increasing amounts of the
other good produced
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
63
Why the PPF Might Be Bowed Outward
As the economy
shifts resources
from beer to
mountain bikes:
PPF becomes
steeper
and the opportunity
cost of mountain
bikes increases.
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
Mountain
Bikes
Beer
Why the PPF Might Be Bowed Outward
At point A, most
workers are
producing beer,
even those who
are better suited to
building bikes.
So, do not have to
give up much beer
to get more bikes.
65
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
Mountain
Bikes
Beer
A
At A, opportunity cost
of mountain bikes is
low.
Why the PPF Might Be Bowed Outward
At B, most workers
are producing bikes.
The few left in beer
production are the
best brewers.
Producing more
bikes would require
shifting some of the
best brewers away
from beer production
causing a big drop in
beer output.
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
Mountain
Bikes
Beer
A
B
At B, opportunity
cost of mountain
bikes is high.
Why the PPF Might Be Bowed Outward
• The PPF is bowed outward when:
–Different workers have different skills
–Different opportunity costs of producing
one good in terms of the other
–There is some other resource, or mix of
resources with varying opportunity costs
• E.g., different types of land suited for different
uses
67
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
The Economist as Policy Adviser
• Positive statements: descriptive
–Attempt to describe the world as it is
–Confirm or refute by examining evidence:
“Minimum-wage laws cause
unemployment”
• Normative statements: prescriptive
–Attempt to prescribe how the world should
be: “The government should raise the
minimum wage”
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
68
Active Learning 3 Positive vs. Normative
Which of these statements are “positive” and
which are “normative”? How can you tell the
difference?
a. Prices rise when the government increases the
quantity of money.
b. The government should print less money.
c. A tax cut is needed to stimulate the economy.
d. An increase in the price of burritos will cause an
increase in consumer demand for music
downloads.
69
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
Active Learning 3 Answers
a. Prices rise when the government increases
the quantity of money.
Positive – describes a relationship, could use
data to confirm or refute.
b. The government should print less money.
Normative – this is a value judgment, cannot be
confirmed or refuted.
70
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
Active Learning 3 Answers
c. A tax cut is needed to stimulate the
economy.
Normative – another value judgment.
d. An increase in the price of burritos will cause
an increase in consumer demand for music
downloads
Positive – describes a relationship.
Note that a statement need not be true to be positive.
71
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
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