Introduction to Advanced Microeconomics.ppt

These slides provide an introduction to Advanced Microeconomics. It covers important economic concepts like scarcity, opportunity cost, demand and supply, which factors cause shifts in these curves.

1. Microeconomics and Its
Application
Introduction and Recap
Slide Presentation

2. 1.0 Introduction
Economic
Models

3. 3
What is Microeconomics?
Economics
–The study of the allocation of scarce resources
among alternative uses
Microeconomics
–The study of the economic choices individuals and
firms make and how those choices create markets

4. 4
Economic Models
Simple theoretical descriptions that capture the
essentials of how the economy works
–Used because the “real world” is too complicated to
describe in detail
–Models tend to be “unrealistic” but useful
While they fail to show every detail (such as houses on a
map) they provide enough structure to solve the problem
(such as how a map provides you with a way to solve how
to drive to a new location)

5. 5
The Production Possibility Frontier
A graph showing all possible combinations of
goods that can be produced with a fixed
amount of resources
Figure 1.1 shows a production possibility
frontier where the good goods are food and
clothing produced per week
–At point A, 10 units of food and 3 units of clothing
can be produced

6. 6
Amount
of food
per week
4
10
A
B
Amount
of clothing
per week
0
3 12
FIGURE 1.1: Production Possibility
Frontier

7. 7
The Production Possibility Frontier
–At point B, 4 units of food can be produced and 12
units of clothing
Without more resources, points outside the
frontier are unattainable
–This demonstrates a basic fact that resources are
scarce

8. 8
Opportunity Cost
The cost of a good or service as measured by
the alternative uses that are foregone by
producing the good or service

9. 9
Opportunity Cost Example
As shown in Figure 1.1, if the economy
produces one more unit of clothing beyond the
10 that it produces at point A, the amount of
food produced decreases by 1/2 from 10 to 9.5
–Thus, the opportunity cost of one unit of clothing is
1/2 unit of food at point A

10. 10
Amount
of food
per week
9.5
10
A
Opportunity cost of
clothing = ½ pound of food
Amount
of clothing
per week
0
34
FIGURE 1.1: Production Possibility
Frontier

11. 11
Opportunity Cost Example
Figure 1.1 also shows that the opportunity cost
of clothing is much higher at point B (1 unit of
clothing costs 2 units of food)
–The increasing opportunity costs of producing even
more clothing is consistent with Ricardo’s and
Marshall’s ideas of increasing marginal cost

12. 12
Amount
of food
per week
4
B
Opportunity cost of
clothing = 2 pounds
of food
2
Amount
of clothing
per week
0
1213
FIGURE 1.1: Production Possibility
Frontier

13. 13
Amount
of food
per week
4
9.5
10
A
B
Opportunity cost of
clothing = ½ pound of food
Opportunity cost of
clothing = 2 pounds
of food
2
Amount
of clothing
per week
0
34 1213
FIGURE 1.1: Production Possibility
Frontier

14. 14
APPLICATION 1.1: Do Animals
Understand Economics?
Nature provides examples of where animals
have scarcity affect their choices
–Birds of prey recognize a trade-off between
spending time and energy in one area and moving
to another location
–To avoid using too much energy, animals will leave
an area before the food supply is exhausted

15. 15
Uses of Microeconomics
While the uses of microeconomics are varied,
one useful way to categorize is by types of
users
–Individuals making decisions regarding jobs,
purchases, and finances
–Businesses making decisions regarding the
demand for their product or their costs
–Governments making policy decisions regarding
laws and regulations

16. 16
APPLICATION 1.2: Is It Worth Your
Time to Be Here?
•The typical U.S. college student pays about
$18,000 per year in tuition, fees, and room
and board charges. One might conclude
then, that the “cost” of 4 years of college is
about $72,000.
-A number of studies have suggested that college
graduates earn more than those without such an
education.

17. 17
The Basic Supply-Demand Model
A model describing how a good’s price is
determined by the behavior of the individuals
who buy the good and the firms that sell it.
–Economists argue that market behavior can
generally be explained by this model that captures
the relationship between consumers’ preferences
and firms’ costs.

18. 18
David Ricardo and Diminishing
Returns
David Ricardo (1772-1823) believed that labor
and other costs would rise with the level of
production
–for example, as new less fertile land was cultivated,
it would require more labor
This increasing cost argument is now referred
to as the law of diminishing returns

19. 19
Marginalism and Marshall’s Model
of Supply and Demand
In Figure 1.3, the amount of a good purchased
per period is shown on the horizontal axis and
the price of the good is shown on the vertical
axis
The demand curve shows the amount people
want to buy at each price and is negatively
sloped reflecting the marginalism principle

20. 20
Marginalism and Marshall’s Model
of Supply and Demand
The upward sloping supply curve reflects the
idea of increasing cost of making one more unit
of a good as total production increases
Supply reflects increasing marginal costs and
demand reflects decreasing marginal
usefulness

21. 21
Price
Demand
Supply
Quantity
per week
0
FIGURE 1.3: The Supply-Demand
Curves

22. 22
Market Equilibrium
In Figure 1.3, the demand and supply curve
intersect at the market equilibrium point P*,
Q*
P* is the equilibrium price: The price at which
the quantity demanded by buyers of a good is
equal to the quantity supplied by sellers of the
good

23. 23
Price
Demand
Supply
Equilibrium pointP*
Quantity
per week
0
Q*
FIGURE 1.3: The Supply-Demand
Curves
.

24. 24
Market Equilibrium
Both demanders and suppliers are satisfied at
this price, so there is no incentive for either to
alter their behavior unless something else
happens
Marshall compared the roles of supply and
demand in establishing market equilibrium to
the two blades of a pair of scissors working
together in order to make a cut

25. 25
Nonequilibrium Outcomes
If something causes the price to be set above
P*, demanders would wish to buy less than Q*
while suppliers would produce more than Q*
If something causes the price to be set below
P*, demanders would wish to buy more than
Q* while suppliers would produce less than Q*

26. 26
Change in Market Equilibrium:
Increased Demand
Figure 1.4 shows the case where people’s
demand for the good increases as represented
by the shift of the demand curve from D to D’
A new equilibrium is established where the
equilibrium price has increased to P**

27. 27
Price
D
S
P*
Quantity
per week
0
Q*
FIGURE 1.4: An increase in Demand Alters
Equilibrium Price and Quantity

28. 28
Price
D
D’
S
P*
P**
Quantity
per week
0
Q*Q**
FIGURE 1.4: An increase in Demand Alters
Equilibrium Price and Quantity

29. 29
Change in Market Equilibrium:
decrease in Supply
In Figure 1.5 the supply curve has shifted
leftward reflecting a decrease in supply brought
about because of an increase in supplier costs
(say an increase in wages)
At the new equilibrium price P** consumers
respond by reducing quantity demanded along
the Demand curve D

30. 30
Price
D
S
P*
Quantity
per week
0
Q*
FIGURE 1.5: A shift in Supply Alters
Equilibrium Price and Quantity

31. 31
Price
D
S’
S
P*
P**
Quantity
per week
0
Q**Q*
FIGURE 1.5: A shift in Supply Alters
Equilibrium Price and Quantity

32. 32
How Economists Verify Theoretical
Models
Two methods are used
–Testing Assumptions: Verifying economic models by
examining validity of the assumptions on which they
are based
–Testing Predictions: Verifying economic models by
asking if they can accurately predict real-world
events

33. 33
Testing Assumptions
One approach would be to determine if the
assumptions are reasonable
–The obvious problem is that people have differing
opinion regarding reasonable
Empirical evidence can also be used
–Results of such methods have had problems similar
to those found in opinion polls

34. 34
Testing Predictions
Economists, such as Milton Friedman argue
that all theories require unrealistic assumptions
The theory is only useful if it can be used to
predict real-world events
–Even if firms state they don’t maximize profits, if
their behavior can be predicted by using this
assumption, the theory is useful

35. 35
The Positive-Normative Distinction
Distinction between theories that seek to
explain the world as it is and theories that
postulate the way the world should be
–To many economists, the correct role for theory is to
explain the way the world is (positive) rather than
the way it should be (normative)
–Positive economics is the primary approach of the
text

36. 36
APPLICATION 1.6: Do Economists
Ever Agree?
Many jokes and popular opinion suggest that
economists do not agree on many issues
This belief arises primarily because people fail
to distinguish between positive and normative
issues
As Table 1 shows, there is much agreement
regarding positive issues but much less
agreement with normative issues

37. 37
TABLE 1: Percentage of Economists Agreeing with Various
Propositions in Three Nations
Proposition U.S.A.
Switzer-
landGermany
Tariffs reduce economic
welfare 95 87 94
Flexible exchange rates are
effective for international
transactions
94 91 92
Rent controls reduce the
quality of housing 96 79 94
Government should
redistribute income 68 51 55
Government should hire the
jobless 51 52 35