Principles of Microeconomics Problem Set

What is microeconomics? How do economists begin to study behavior?

Summary

ECO 105: Principles of Microeconomics Course Introduction

Brian Phelan DePaul University

September 6, 2017

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

What is microeconomics?

Microeconomics is the study of individual and firm behavior (and the resulting collective outcomes that emerge) in the face of scarcity.

Loaded definition:

Behavior → social science Why is studying behavior useful for business? Diff from other SS, Econ considers role of firms

Behavior/Decisions focused around scarcity. What is/isn’t scarce? scarcity → tradeoffs

Aggregation of individual decisions leads to collective outcome

market-level outcomes (in micro) Outcomes of interest: Prices and Quantities

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

What is microeconomics?

This broad definition incorporates many individual and business questions

How many goods to produce? How much income to save vs. spend? How much should you study for your intro micro course?

Essential to each question is: scarcity and tradeoffs

What is scarce in each? What is the tradeoff in each?

How to decide?

simple cost/benefit analysis dismal science?

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

How economists study behavior and outcomes?

To study behavior discipline has put a lot of structure on the problem.

Some structure purely definitional but insightful

Economic activity takes place in markets. All agents either firms or individuals

Other structure is based on stronger assumptions

These assumptions have real implications for interpreting economic models. E.g., market structure They require careful consideration of the relevance of assumptions.

Mankiw example about marble and beach ball.

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

Basic Structure

Who are the participants in the economy? Individuals (aka Consumers or Households) Firms (aka Businesses) Government

What decisions do participants make? On the Product market side:

Individuals decide how much to buy Firms decide how much to produce Government?

On the Factor market side... How do firms and individuals make decisions?

Firms maximize profits Consumers maximize their happiness

What outcomes emerge? A price changed & a quantity produced/consumed

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

How do Economic Agents make decisions?

Scarcity ⇒ tradeoffs, but how do individuals/firms evaluate tradeoffs?

Profit/Utility maximization is consistent a marginal cost/maginal benefit analysis

Optimizing economic agents (consumers/firms) take all actions where marginal benefits exceed marginal costs.

Example: You are selling your 1996 BMW. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car “as is.” Blue book value (what you could get for the car) is $6500 if transmission works, $5700 if it doesn’t.

Should you repair the transmission? Explain using incremental decision making.

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

Marginal Decision Making II

Mark is refinishing an antique china cabinet and has already spent $180 on the restoration. He expects to be able to sell the cabinet for $360. Mark discovers that he needs to do an additional $200 of work to make the cabinet worth $360 to potential buyers. He could also sell the cabinet now, without completing the additional work, for $100. What should he do?

A construction company has built 30 houses so far this year at a total cost to the company of $7.5 million. If the company builds a 31st house, its total cost will increase to $7.76 million. If they can sell these houses for $255,000, should the company build the 31st house?

Mankiw’s example about airline and stand-by tickets.

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

What Costs are Included?

In evaluating costs, economists are different than accountants. Economists think costs include both:

Explicit Costs (aka accounting costs)

Dollar outlays for goods and services

Implicit Costs

Other things one gives up to buy or produce something

In economics, costs are called “opportunity costs,” and include everything one gives up to get something – including BOTH explicit costs and implicit costs).

What are the opportunity costs of:

attending college? working while in college?

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

How do individual decisions aggregate up?

Each individual (optimally) decides how many of a particular good they would purchase at each price

For example, tickets to Cubs playoff game.

The individual decisions are added up and described by the DEMAND CURVE

Similarly, each firm decide how many goods to produce at each price.

The total of all firm-level decisions are added up and described by the SUPPLY CURVE

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

Supply and Demand

Workhorse of Microeconomics

Our basic model of outcomes in markets (prices and quantities) is based upon the interaction of:

All those individual decisions inherent in the demand curve All those firm decisions in the supply curves

In many ways, the purpose of this course is: To show you that prevailing prices and quantities do not come out of nowhere They result from the interaction of many optimal decisions – not some “dark force” Thus, even if we could change prices (or quantities) with government policies, in many/most instances we would not want to do that.

Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Individual & Firm Decisions Aggregating up Individual Decisions

Who gives a #@*& about prices and quantities?

Price/Quantites important in many dimensions.

For Business: Accurately pricing one’s product (and understanding the demand for it) is essential for good business plan. If you can accurately predict changes in prices of stocks, real estate, etc. you can make A LOT of money Understanding prices/quantities essential for business growth – the Southwest Story

For Policy: Why do some workers get paid more than others? How much will increasing the minimum wage (a price), effect the employment levels (a quantity)? How can we encourage college education (a quantity)?

What you learn in this class will be useful in many arenas! Brian Phelan DePaul University ECO 105: Principles of Microeconomics

What is microeconomics? How do economists begin to study behavior?

Summary

Introductory Microeconomics

In this course, we’ll study: The trade-offs economic agents (consumer and firms) face and how they make decisions

thinking at the margin opportunity costs

How all of these individual decisions aggregate up to market level outcomes (prices and quantities)

Supply and Demand Equilibrium

Whether these outcomes that emerge from all of these individual decisions are “good” outcomes from societies point of view.

Efficiency

Is there some role for the government to “improve” upon the outcomes that emerge in free markets.

Brian Phelan DePaul University ECO 105: Principles of Microeconomics