Reynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 1 Chapter 1 The Nature of Economics At a physiological level, human existence requires

es food and shelter Other goods and services give pleasure or utility and meaning to individual's lives In Neoclassical economics wants are considered as unlimited We live in a finite world where resources, time and technology are limitedReynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 2 Economics as a Study of Allocation As a decision science, economics is the study of how individuals and societies choose alternatives that best achieve an objective. Must know objective, all feasible alternatives and have a criteria to evaluate alternatives with respect to (wrt) objective Tools used are opportunity cost, Marginal cost (MC), Marginal Benefit (MB), supply, demand, costs,. . . Reynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics

3 Five Basic Questions of Allocation What goods and services should be produced? (requires ranking, valuation or prioritization) How many of each good (and service) should be produced? How should those goods be produced? When should those goods be produced? Who should get the goods that are produced? These 5 questions are interrelated.Reynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 4 Economics as a Study of Provisioning Society must have a system of institutions, allocative mechanisms, beliefs, knowledge and social infrastructure to perform the allocation processes; it is the rules of the game Institutions are habitual patterns of behavior Social institutions include such things as: property rights, law, markets, religion, marriage, ... The infrastructure may evolve overtime or be engineeredReynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 5

Role of Individual in Society In social sciences there is an ongoing debate about the appropriate role of the individual to the society or community How can the freedom or liberty of the individual be maintained and at the same time provide for the commonweal? Social mechanisms for coordinating behavior of individuals; Cooperation, Conscription and CompetitionReynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 6 Cooperation, Conscription and Competition There are two tools that individuals have to dealing with the problem of scarcity; the use of technology and social interaction Cooperation and Conscription are opposite ends of a continuum Competition can be structural or rivalry Modern economy is a mixture of cooperation, conscription and competiton Reynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 7 Important Terms Agents an individual who has the ability and

authority to make a decision and act on it An agent may act for a principal Contract an agreement between two or more agents Institutions are habitual patterns of behavior that are embedded in society Technology is the knowledge about individuals relationships to the natural and built environmentReynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 8 Definitions of Economics Current the social science concerned with the efficient use of limited resources or scarce resources to achieve maximum satisfaction of human material wants (McConnell, p3, 2004) Marshall, 1920 economics is the study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing. Heilbroner the process by which society marshals and coordinates the activities required for its provisioning. Samuels economy is a process of valuation That to behave and to choose is to engage in valuation and thereby to participate in the social, socioeconomic, valuation process.Reynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 9

Microeconomics The study of the behavior and interactions among various individuals, organizations and society within an economic system What forces shape the behavior of agents? What is the nature of the interactions among agents? Neoclassical economics focuses on; Individual behavior (reductionism) Mechanical methodology of cause and effect Market orientationReynolds - Fall 05 Chapter 1 Introduction Principles of Microeconomics 10 Economic Decisions Rules implicit, explicit Intuition Reason and rational behavior Objective, alternatives, best alternative wrt objective Information and market behavior Incentives Chapter One Why study Economics? To learn a way of thinking,to understand society, to understand Global Affairs To be an informed voter EconomicsThe study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided Opportunity cost: That which we for go, or give up, when we make a choice or a decision Sunk cost:Costs that can not be avoided, regardless of what is done in the future, because they have already been incurred. Efficient Market: A Market in which profit opportunities are eliminated almost instantaneously. Industrial

Revolution: The period in England during the late eighteenth and early nineteenth centuries in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to ht cities. Microeconomics:The branch of economics that examines the functioning of individual industries and the behavior of individual decision-making units that is, fussiness firms and households. Macro economics:The branch of economics that examines the economic behavior of aggregates- income, employment, output , and so on- on a national scale. Positive economics:an approach to economics that seeks to understand behavior and the operation of systems without making judgments. It describes what exists and haw it works. Normative Economics: an approach to economics that analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action, also called policy economics. Descriptive economics: the compilation of data that describe phenomena and facts Economic theory: A statement or set of related statements about cause and effect, action and reaction. Model: A formal statement of a theory. Usually a mathematical statement of presumed relationship between two or more variables. Variable: A measure that can change from time to time or from observation to observation. Ockhams razor: The principle that irrelevant detail should be cut away. Ceteris paribus or all else equal:A device used to analyze the relationship between toe variables while the values of other variables are held unchanged. Post hoc, ergo propter hoc: Literally after this (in time), therefore because of this, A Common error made in thinking about causation: If Event A happens before Event B, it is not Necessarily Tue That a Caused B. Fallacy of composition: the erroneous belief that what is true for a part is necessarily true for the whole. Empirical Economics: The collection and use of data to test economics theories. Efficiency: In Economics, a locative efficiency. An efficient economy is one that produces what people want at the least possible cost. Equity: Fairness. Economics growth: an increase in the total output of an economy. Stability: A condition in which output is steady or growing, with low inflation and full employment of resources. Chapter 2 Production: the process by which resources are transformed into useful forms. Resources or inputs: anything provided by Nature or previous generations that can be used directly or indirectly to satisfy human wants. Capital: things that have already been produced that are in turn used to produce other goods and services. Produces: those people or groups of people, whether private or public, who transform resources into usable products. Output: usable product. Three

basic questions: the questions that all societies must answer: 1- What will be produced? 2- How will it be produced? 3- Who will get what is produced? Opportunity Cost: that which we give up, or forgo, when we make a choice or a decision. Theory of comparative advantage:Ricardos theory that specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers. descriptive economics

Descriptive Economics, or Positive Economics, is the branch of economic inquiry that analyzes and explains economic phenomena as they are, without making any statements about how they ought-to be. Economic Theory provides an outlet for research in all areas of economics based on rigorous theoretical reasoning and on topics in mathematics that are supported by the analysis of economic problems. Published articles contribute to the understanding and solution of substantive economic problems.

Among the topics addressed in the journal are classical and modern equilibrium theory, cooperative and non-cooperative game theory, macroeconomics, social choice and welfare, uncertainty and information, intertemporal economics (including dynamical systems), public economics, international and developmental economics, financial economics, money and banking, and industrial organization.

In addition to original research articles, Economic Theory publishes surveys for particular areas of research that clearly set forth the basic underlying concepts and ideas, the essential technical apparatuses, and the central open questions. The Scope and Method of Economics Descriptive Economics versus Economic Theory

Descriptive economics involves compiling data about the economy; economic

theory involves attempts to generalize about the data and interpret them.

Theories and Models

Economists try to explain social and economic behavior by observing what goes on in the world, noticing some regular patterns that appear to be operative, and trying to explain those patterns. Our observations about the world are the facts. But facts by themselves don't really tell us anything!

Facts are nothing more than disconnected bits of data. It's up to us to link some of them together while discarding the rest. The process of going from specific observations to making generalized explanations about the observed regularities is known as inductive reasoning. It is the same reasoning used by all sciences, including economics.

Hypothesis

A hypothesis is a possible explanation for the regularities or patterns we've observed. In science, we focus on hypotheses that can be tested to see if they work. After a hypothesis has been tested, and it seems to provide a reasonable connection between the cause and effect of what we've observed, we can then call the explanation a theory.

Economic theory

Economic theory is a set of related statements about the cause and effect of economic and social phenomena. The way we test economic theories is by making predictions. For example, an economic theory would be "if the price of something goes up, people will buy less of it." We could test that theory by observing whether or not cigarette sales decline after a price increase.

Model

A model is a more formal statement of a theory. It often takes the form of stating the presumed relationship between two or more factors in a precise way. The factors included in a model are called variables because they are things that can change over time. In our earlier example, the price of cigarettes is a variable, and the quantity of cigarettes purchased is another variable. A theory links these two variables together in such a way that explains the causal relationship between them in a testable way.

Occams Razor

It's often important to dispense with less relevant aspects of an issue so that we can focus on specific issues. We do this all the time. For example, when trying to determine the cause of an upset stomach, we focus on things like what we ate earlier, the presence of a fever, and so on. We don't usually include factors such as the strength of sunspots or the weather in Brazil. Similarly, when economists try to explain social phenomena, they key in on the factors that seem most relevant. This practice comes from the principle known as Occam's razor, which instructs us to strip away extraneous detail in order to expose the important aspects of a question.

Ceteris paribus: all else equal

When making predictions in order to test our models and theories, we often focus on the relationship between just two variables. In the example given above, we focused on the relationship between the price of cigarettes and how many cigarettes people will buy.

But a whole host of other factors are involved in determining the number of cigarette purchases. For instance, income makes a difference, as does the amount of advertising, styles, the age of the population, the findings of health research, and so on.

In order to focus on the relationship between price and the amount of cigarettes purchased, we need to hold all those other factors constant. To

isolate those other factors, we employ the idea of ceteris paribus, which is Latin for all else equal. We can then say that, if all other factors remain constant, an increase in the price of cigarettes will cause a decrease in the number of cigarettes sold.