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ECON 102.004 – Principles of Microeconomics

Introduction and S&W, Chapter 1Instructor:

Mehmet S. Tosun, Ph.D.Department of Economics

University of Nevada, Reno

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Microeconomics is the study of decisions made by individuals, firms and government and how those decisions determine prices in

the market.

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Five Core Ideas

• Trade-offs: scarcity of resources, no free lunch

• Incentives: benefits that motivate a decision• Exchange: voluntary exchange in markets

lead to efficient use of resources• Information: informed choices require

information• Distribution: how markets distribute wealth

matters

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Trade‑offs• All choices involve trade‑offs:

– What should you spend your weekly budget on—pizza, CDs, movies, books, and so on?

• More of one of these means you can spend less on another.

• There is no such thing as a free lunch.

• Trade‑offs stem from scarcity.– You have limited money and time.– Society has limited resources.

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Incentives

• Incentives are the rewards and costs that stem from making choices.– Prices reflect incentives: rewards and costs.– All decision makers, consumers, businesses,

and governments respond to incentives.

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Example: Superstar Economics!!!

• Was it a good idea for Viacom to let Tom Cruise go?

• Does a superstar guarantee success?• Do you see a movie for its cast?

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Exchange• Exchange is the trade of goods and services.• Voluntary exchange in markets is how modern economies like the United

States determine which goods and services to produce to satisfy the vast number of consumers.

• Voluntary exchange means both parties get something they want; a worker wants income and a firm wants a certain job done, for example.

• A market is any situation in which an exchange takes place.– A market need not be a physical location.– With competition, consumers have a choice of alternatives.– The United States is a mixed economy where most exchanges take

place in a market but the government plays a critical role in other aspects of the economy.

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Information• Making informed choices requires information.• Information is like any other good or service.

– There are firms and institutions that specialize in the purchase and sale of information.

– The seller of a car lets you test drive it, but a seller of information cannot let you see the information.

• In some markets information is so crucial it shapes the whole market:– Market for used cars– Stock market and other security markets– Insurance

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Distribution• Markets determine who gets which goods according to the

demand and supply of goods, labor, and capital.• Some view the uneven distribution of wealth with unease.• Government programs attempt to even out the distribution.

– However, efforts to soften the distributional impact of markets often blunt economic incentives.

• That is, there is a trade‑off between equity and efficiency.

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The Three Major Markets

• The product market: where final goods and services are exchanged

• The labor market: where workers sell labor and firms hire workers

• The capital market: where households, firms, and government save and raise funds

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The Three Major Markets

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Microeconomics and Macroeconomics

• Two branches of Economics: microeconomics and macroeconomics

• Macroeconomics (study of the large) studies behavior of the whole economy or aggregates like– Inflation– Unemployment– Output

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From NYTMacroeconomic Issues:“The American economy grew more quickly in the

second quarter than the government had initially estimated, and inflation was slightly lower, the Commerce Department reported today.”

“The gross domestic product, a measure of all goods and services produced in the United States, increased at an annual rate of 2.9 percent, up from an earlier estimate of 2.5 percent, while a closely watched measure of prices that excludes food and energy rose 2.8 percent, rather than 2.9 percent.”

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• Microeconomics (study of the small) studies how people make decisions

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The Science of Economics

• Economics is a social science.– Economic theory is composed of:

• Assumptions or hypotheses and the conclusions derived from them.

• Theories are logical exercises that lead from assumptions to conclusions.

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Economic Modeling

• Economists use models to test theories.• Models are abstractions.

– They are oversimplified to stress the essentials of a complex social reality.

• Engineers do not put the "Fasten Seat Belts" sign on a model of an airliner to test it in a wind tunnel for aerodynamics.

– Economists use the theory of perfect competition even where it only holds approximately.

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Discovering and Interpreting Relationships

• Economists seek to understand the relationships among economic variables that can be measured and may change.

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Causation and Correlation• Correlation – when one variable changes another tends

to change.• Causation – when changing one variable “causes”

another variable to change then changing the first necessarily changes the second.– In the 1970s imports of cars from Japan rose while U.S. auto

production fell• These variables are correlated, but was there causation?• No; both events were related to a third event:

– Higher oil prices pushed U.S. consumers away from “gas-guzzling” U.S. cars toward more fuel efficient Japanese cars.

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Example: Migratory Birds and Inflation

• When birds migrate south in winter, inflation gets higher

• Does bird migration cause higher inflation?• Correlation does not mean causation• What is the third external factor here?

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Why Economists Disagree• Economists often disagree about public policy.• Their differences usually fall into one of two categories.

– Positive Economics: differences about how the economy operates• These differences stem from differences over which model to use.

– Normative Economics: differences about how to evaluate the consequences of policies

• These differences stem from different assessments of the quantitative magnitudes of the analysis.

– Economists have different values which may lead them to disagree about policies.