Introductory Microeconomics

Transcription

1 Introductory Microeconomics January 7 lecture Economics Definition: The social science concerned with the efficient use of scarce resources to achieve the maximum satisfaction of economic wants. Efficient: walking to school on one s feet is more efficient than walking on ones hands. Why? You get to school faster using less energy. Scarce: 24 hours in one day. Time is limited and we always want more. Therefore it is scarce. Resources: That which is available for us to use: time, own energy, oil, earth/soil, etc. Economic Wants: things we desire such as food, leisure time, cares, etc. Economic Perspective: a viewpoint that believes individuals and institutions make rational decisions by comparing the marginal benefits and marginal costs associated with their actions. That is, we always want more than we have the resources to obtain. Therefore, we make a choice based on the costs and benefits of each course of action. The economic perspective is that people and institutions make the choice that will give them the greatest satisfaction. (examples) Scarcity and Choice We can t have it all We must decide what we want and need the most. What did you have for breakfast? What did you consider when you decided what to eat? (time(making and eating), taste/flavour, money, availability?) Simple example: one can think of the scarcity of time and money and how you decide what to eat for breakfast. Suppose it takes you 1 hour to cook, eat, and clean the dishes if you make scrambled eggs. The eggs cost $0.25 for two. Alternatively, you can buy a banana bread muffin for $1.00 and it takes you 15 minutes to buy and eat the muffin. Which one you choose depends on:

2 1. How much money you have 2. Whether you are in a rush 3. How much you like eggs versus muffins Opportunity Costs that which you give up when you chose one course of action over another. In our breakfast example, if I choose eggs over the muffin, I give up ¾ hour, and I save 75 cents. Suppose I have an exam that day. Then ¾ hour is probably more valuable to me in study time, therefore, the opportunity cost of eggs is high. Another way to think of opportunity costs with respect to time is by considering the schoolwork decision. Suppose I have the choice to go to school or not. What costs do I take into account when I make that decision? Consider, the following: Go to School: 1. Pay $2,000 in tuition 2. Work part time and earn $4,000 for a semester 3. Learn and improve skills and earn credits 4. May have more leisure time and flexible schedule Work: 1. Earn $10,000 for a semester 2. Pay taxes of $2,000 (leaving $8,000 net earnings) 3. Obtain work experience What is the opportunity cost of school? Forego $6,000 and work experience (gain education and leisure time) Although the opportunity cost of school is high, the future benefits of an education are also high, and therefore, it is rational that many people chose to go to school. What is Rational Behavior? Individuals choose that action which will gain them the maximum satisfaction. Rational behavior may result in different actions under different circumstances (i.e. I have an exam today so I grab a muffin for breakfast, but tomorrow is a holiday, so I will make eggs. Rational behavior or rational self-interest is different for different people. Ex/ Anna hates eggs but loves muffins, so she always buys muffins. Joe loves eggs, so he usually chooses eggs.

3 Rational decisions may change as costs or benefits change. Ex/ price of muffin rises to $2 (increase cost), size of muffing decreases (decreases benefit). So I may decide muffin is not worth it. Marginal Analysis The comparison of marginal (extra/additional) benefits and marginal costs, usually for decision-making. Ex/ if I am doing 2 loads of laundry, the marginal cost of doing one more load of laundry is relatively small since I am already going to the laundry mat and using up my time. Suppose $20/hr is worth of my time 0 loads = 0 hours + $0.00 = $0 1 load = 2 hours + $2.50 = $ loads = 2 hours + $5.00 = $ loads = 2 hours + $7.50 = $47.50 The marginal cost of the first load of laundry is $ The marginal cost of the third load of laundry is $2.50, the marginal benefit is having more of my clothes clean. If the marginal benefit is greater than the marginal cost, then I do the third load. Another example with food: If I buy ½ rack of ribs, I pay $ If I buy full rack of ribs, I pay $ The marginal cost of a full rack of ribs versus a ½ rack is $10. If the value of more ribs is worth more than $10.00 to me, I will order the full rack. Of course, there can be too much of a good thing. The more I eat, the less I am likely to want to eat more. So we might expect my marginal benefit to be lower with each added unit. Suppose the first ½ rack gives me a lot of happiness (say 50 units of happiness if we could quantify it). The next ½ rack gives me some happiness (20 units), but not as much as the first ½ rack. The third ½ rack only gives me 5 units of happiness, because I m starting to get full. By the fourth ½ rack I m feeling ill, and stuffing any more ribs into me will make me throw up and actually have negative happiness(-10 units).

4 We can put this in a table as follows: # of racks of ribs Extra units of happiness per ½ rack (Marginal Benefit - MB) Marginal Cost (MC) of added ½ rack ½ 50 $ $10 1 ½ 5 $ $10 How many racks of ribs should I buy? (1) Given what we have learned so far, why would we expect someone who generally eats very little at a standard restaurant, become a glutton at an all-you-can-eat (single price) restaurant? For example, if you go to an all you can eat ribs restaurant with a fixed price of $25, the marginal cost of any additional ribs is $0. You want to maximize your happiness. You eat until your MC = MB. Therefore, you want to choose 1 ½ racks of ribs (75 units >70 units) What do economists and businesses do? They try to figure out how and why people make the choices that they do. Restaurant owners know that if they make their meals one price, all you can eat, then people will eat more. Therefore, they must price the buffet according to how much they think people will pay for what they expect to eat. Economic Methodology Economists, like other social scientists, rely on the scientific method. The Scientific Method is a term used to mean: The systematic pursuit of knowledge through 1. The formulation of a problem 2. The collection of data 3. The formulation and testing of hypotheses Key elements in the process are: a. observation of real world data b. based on this data, we form a guess (hypothesis) of cause and effect. c. we test our guess by making predictions and comparing these predictions to real life outcomes d. we accept or reject our hypothesis based on how close our predictions are to the real life outcomes.

5 If many tests result in the acceptance of our hypothesis, it evolves into a theory (or model). Very well tested and widely accepted theories are called laws or principles. Lets do an example: a. People with more education earn more (fact from data) b. Guess/hypothesis: obtaining a degree causes one s salary to increase c. Test: compare salaries of (otherwise similar) people who obtained additional education versus those who have not. (Prediction: salary will increase by 20%) d. Reject guess/hypothesis if salary increased by less than 10% Economists develop models of behavior of individuals and institutions by gathering facts/data & by forming and testing hypothesis Well tested and widely accepted generalizations are called principles or laws. The process of deriving theories and principles is called Theoretical Economics. Economic theories and principles are statements about economic behavior that enable predictions of the probable effects of certain actions. (ex. If a restaurant owner raises the price of his/her buffet, (s)he knows that fewer customers will eat there, and those that do are likely to eat more. Good theories are those that do a good job of predicting and explaining and are supported by facts Facts change over time (behavior changes over time), so even good theories much be checked again and again. Clarifying Terminology Hypothesis: a guess that needs initial testing (has not yet been tested) Theory: hypothesis that has been tested, but requires further analysis (testing) Law/Principle: has been tested over and over and has proved very accurate Generalization: theories, laws and principles are generalizations relating to economic behavior. Generalizations are tendencies or typical behavior. i.e. if I say men earn more than women, it is a generalization. Not every man earns more than every women, but typically men do earn more. Ceteris Paribus other things equal assumption Economists use this assumption to arrive at generalizations. It means that all factors except the one we will test are assumed to be constant.

6 Ex/ if we hypothesize that more educated people earn more, we are testing education and wages. We assume, therefore, that things like work experience, gender, age, and all other factors are held constant. Ex2/ if a restaurant owner raises the price of food, but keeps the quality the same, we expect the number of customers to decrease. Comparing price and quantity, we assume quality remains constant. Abstractions: Economic theories are abstractions. They simplify by abstracting from (omitting) details. Our choices are, of course, very complex. To consider all the components of our decision making process would be very time consuming, therefore we just consider the most influential elements: Ex/ Breakfast: time, money, taste (omit: affinity/ability to cook, availability of foods, roommates/family preferences, number of clean dishes, etc) Graphs: many models are expressed graphically because it is easier to show many details quickly with a graph, whereas, describing them in words would be harder. One can think of graphs like road maps. We will discuss this in more detail next class, but keep in mind that this class will rely heavily on graphical analysis. Policy Economics Theories and data are used to formulate policies that aim to resolve a specific economic problem or to achieve an economic goal. Ex/ Bank of Canada may reduce interest rates in order to increase spending & prevent a recession Basic Steps in Policy Making 1. State the Goal (ex/ full employment, what does this mean? Everyone has a job, or all those who wish to have jobs?) 2. Determine Policy Options (ex/ fiscal policy gov t spending and taxes: decrease payroll tax which will increase demand for labour, monetary policy increase supply of money which will increase employment) 3. Implement and Evaluate (after policy is implemented, determine how well it worked. Ex/ did employment increase?)

7 Many countries have similar economic goals, such as: Economic growth Full employment Economic efficiency Price level stability Economic Freedom Equitable distribution Economic Security Balance of trade Etc. What do you think of these goals? Good/Bad/problematic Sometimes the goals of a country (or an individual) conflict: ex/ equitable distribution & economic efficiency, or economic growth and price stability. When goals conflict, we must prioritize and determine which are most important. In doing so, we consider the tradeoffs of each goal. Tradeoffs: the sacrifice of some or all of one economic goal or good or service to achieve some other goal or good or service. A country s economic goals usually are in the realm of macroeconomic goals. Macro versus Micro Macroeconomics that part of economics which is concerned with the economy as a whole, or basic subdivisions in aggregate. (an aggregate is a collection of specific economic units treated as one: ex/ total consumption = the amount consumed by every individual summed together. I might consume 1 apple per day, but Canadians consume a total of 10 million apples a day) Microeconomics that part of economics which is concerned with individual units such as firms and households. Microeconomists look at the decisions and choices of the individual and examine the individual s specific problem. There is much overlap between the two, because in determining aggregate behaviour, we consider the sum of individual behaviors. Another issue when considering economic goals, economic analysis, and so forth, is the nature of the discussion. Is the analyst looking at the economic problem with a specific socio-political view?

8 Normative Versus Positive Positive Economics analysis of facts/data to establish scientific generalizations about economic behavior (ex/ employers pay men a higher wage than they pay women) Normative Economics involves judgments about what the economy should be like. (ex/ employers should pay men a higher wage than they pay women) Economists try to look at issues objectively, so as to provide accurate analysis. However, most are motivated by policy concerns and, thus, include a judgment on what the economy should or could be like. It is fine to be motivated by potential improvements in the economy, but we must be cautious to distinguish between what we know to be a fact, and what we believe to be good. We must also be cautious not to let our analysis be flawed by the common errors listed below. Pitfalls to Objective Thinking Biases preconceptions we may have because we do not think an issue through or because we do not look at the data closely. Until issues are analyzed with theories and data, biased thinking could cloud objective analysis. Loaded Terminology descriptive words that are used to get an emotional reaction Ex/ Newspapers may call low wages exploitative wages. To objectively analyze economic issues, one should avoid or reject the use of such terminology. Definitions In economics, definitions are sometimes different than those used in everyday language. Ex/ investment in general terms means purchases of stocks or bonds, etc. In economics, it means purchases of newly created physical capital assets. (machinery/equipment) Fallacy of Composition - Incorrectly reasoning that what is true for the individual is necessarily true for the whole. Ex/ If I am at a hockey game, and I stand up, I can see better. But, if everyone at the game stands up, it is NOT true that everyone can see better.

9 Causation Fallacies Correlation versus Causation two events may often occur together in some dependable way, but that does not mean that one causes the other. Ex/ people who have high income also tend to have high levels of education. Does high income cause one to study more? We can t simply assume so. Post Hoc ergo Propter hoc (after this, therefore because of this) incorrectly assuming that when one event precedes another, the first must have caused the other. Ex/ today I had black cat cross my path and this afternoon it snowed. Did seeing the cat cause the snow? Probably not.