#### Transcript Econ 281 Chapter01

Econ 281 Intermediate Microeconomics •Consumer Behavior •Theory of Production and Cost •Various Market Structures Lorne Priemaza, M.A. [email protected] Various material courtesy of Katharine Rockette and Wiley & Sons INC. Chapter 1 What is economics? Microeconomics and Macroeconomics Economic Tools Positive and Normative Analysis What Is Economics? • Economics is the science that deals with the allocation of limited resources to satisfy unlimited wants (by examining the choices people make). Limited Resources Choices Unlimited Wants Outcome Microeconomics and Macroeconomics • Microeconomics -from the Greek mikros meaning small -studies economic behavior of individual decision makers (people, firms, etc.) -What price should Apple charge for Iphones? -How much Game of Thrones (GoT) should Kim watch? -How does owning an Iphone and watching GoT affect Jon’s utility? Microeconomics and Macroeconomics • Macroeconomics -from the Greek makros meaning large -studies aggregate economic behavior (nation, world, business cycles, etc.) -What should the tax on MP3 players be? -How does tv shows affect productivity and unemployment? -What is MP3 and tv demand in China? Economics and Models • “Economists work with models.” -Life is too complicated for an economist to analyze all at once -In order to analyze one aspect of life, economists build a simplified model to represent that aspect of life -The results of the model are then tested against real life -Models require assumptions Economics and Assumptions • “Assume there’s a can opener!” -Every economic model relies on assumptions (much like a house relies on foundations) -ie: Assume people are rational; assume firm A understands people’s tastes -If the assumptions are invalid, the model suffers -ie: Assume all students read the text Exogenous and Endogenous Variables • Exogenous Variables -values that are taken as given -values that are decided outside the model Ie: GIVEN that Marble Slab ice cream costs $10 (exogenous variable), how much ice cream should Zhang eat this month? Exogenous and Endogenous Variables • Endogenous Variables -values that are determined within the model Ie: How much ice cream (endogenous variable) should Zhang eat, and how happy (endogenous variable) will this make him? Exogenous and Endogenous Variables • Relationship Model John is trying to woo his sweetheart Jenni. -Jenni’s feelings towards John are exogenous -John’s attempts to woo Jenni are endogenous -Jenni’s reaction is endogenous Mathematical Tools -Economic agents react rationally or irrationally given their available information. -Economists assume agents react rationally to maximize their utility/profit or minimize their work/cost using: Constrained Optimization Equilibrium Analysis Comparative Statics Mathematical Tools • Constrained Optimization “If I had one thing I would be happy – everything.” -Generally, people cannot be satisfied with everything, there are limits to buying power/production, etc. -Constrained Optimization maximizes utility, cost, etc. given a constraint (money, production function, etc) Constrained Optimization Example Jason enjoys playing card games and playing board games. Unfortunately, he cannot do both at the same time. Therefore Jason’s model is: Max U(Card,Board) ->Objective Function Subject to the constraint (s.t.) Hour Per Day = 8 = Card + Board Jason Optimization Example One may say Jason should spend his full 8 hours on card or board games; whichever he likes more. But Jason probably enjoys the first few hours of each game type more than the last few hours. We’re concerned with MARGINAL happiness. (Happiness gained from the last hour’s activity) Jason Example Assume Jason gets the following satisfaction from riding his bike or saving lives: 4 Hours 2 Hours 8 Hours 6 Hours Cards 4 7 9 10 Board Games 3 6 7 8 What should House do to maximize his happiness? (Remember that he’s planning his day 2 hours at a time – marginally) Jason Example 4 Hours 2 Hours 8 Hours 6 Hours Cards 4 7 9 10 Board games 3 6 7 8 What ADDITIONAL happiness does Jason get? 4 Hours 2 Hours 8 Hours 6 Hours Cards 4 3 2 1 Board Games 3 3 1 1 Example: Jason’s Happiness B Card + Board= 8 8 House will pick the mixture games that maximizes his happiness, subject to the fact he only has 8 hours. 4 U2(Card, Board) U1(Card, Board) 0 4 8 C Dealing with the marginal Assume that you bought a lemon car – a 2006 Pontiac Sunfire that has caused you nothing but problems. You paid $8,000 for it and have spent $2000 in repairs over the last year. Your kartoflemonometer just broke and will cost $1000 to fix. After this last job you’ve basically replaced the entire car. On the other hand, you can buy a reliable 2006 Ford Escape for $7000. What do you do? Dealing with the marginal If you fix your Pontiac, it will have cost you a total of $11,000 to buy a car that works, whereas the Ford would have cost you a total of $7000. But right now you already have the Pontiac. To get a car that works, you need an ADDITIONAL $1,000 or an ADDITIONAL $7,000. You will fix the Pontiac. Rational people deal with marginal decisions. Mathematical Tools • Equilibrium Analysis -Equilibrium is a state that will continue indefinitely as long as exogenous factors don’t change -If a variable is higher than equilibrium, market forces will pull it down, -If a variable is lower than equilibrium, market forces will pull it up Price Example: The Market for Iphones Surplus P1 P* • P2 Shortage Supply If price is too high, supply will exceed demand and price will fall. If price is too low, demand will exceed supply and price will rise Demand Q* Quantity Mathematical Tools • Comparative Statistics -In the real world, variables change, which could change the equilibrium -Comparative Statistics aims to measure the effect a change in one exogenous variable on one endogenous variable. Jason - Comparative Statics Example Jason’s hero – Zee – is also playing card games, changing Jason’s enjoyment: 4 Hours 2 Hours 8 Hours 6 Hours Cards 5 9 13 14 Board Games 3 6 7 8 4 Hours 2 Hours 8 Hours 6 Hours Cards 5 4 4 1 Board Games 3 3 1 1 Positive and Normative Analysis • In order to carry out effective policy, the policy maker must understand how the economy works • The is called POSITIVE ECONOMICS; The economics of facts & theory -ie: Minimum wage increase causes unemployment increase Positive and Normative Analysis • In order to conduct policy, the policy maker must have some goals in mind • NORMATIVE ECONOMICS is the study of what the goals of the economy should be -ie: We should lower the minimum wage in order to lower unemployment Positive and Normative Analysis • Positive economics is important to understand the economy • Normative economics is important to policy makers • Classify the following: – “When the price of the Xbox One rises, more people buy the Playstation 4.” – “We should buy Lorne a Playstation 4 to increase his utility.”