ECON 103 Microeconomics

• Dr. Malcolm Rutherford

• Office: BEC 340

• Office hours: Tuesday 10:30-11:30 and Wednesday 11:30-12:30, or by appointment.

• Office phone: 721-6481

• E-mail: rutherfo@uvic.ca

Econ 103 Microeconomics

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Part 1Basic Concepts and

Models

• Interest in economic problems• But specific problems and issues

change over time• General analytic framework—how

to think about any economic problem

• Abstraction and model building• Simplified models that capture key

general characteristics• Empirical testing of models• Economics and policy• Positive and normative

Economics

• Economics is about “the economy”• The way in which individuals and

social groups “make a living”• Provides the material well being of

individuals and society• Economics can also be defined in

terms of technique—choice in the face of scarcity

• Techniques of economic analysis sometimes applied to non-economic subject matter

The Market Economy

• Production and distribution result largely from individuals pursuing their own self interest, in the institutional context of markets

• Specialization and exchange• Decentralized• Complex and interdependent• How does this complex and

decentralized system work, rather than becoming chaotic?

• Markets provide information and incentives (prices, profits) and coordinate economic decisions

The Market Economy

• Markets allocate resources BUT:

• Markets and the distribution of income

• Markets and market power

• Markets in everything?

• Constraints on market activity

• Misbehaving markets?

• Market failures

• Government and markets

Basic Concepts:Scarcity

• Limited resources—land, labour, capital, and entrepreneurship

• Unlimited wants• Scarcity of resources relative to

wants• Need for choice between

alternative uses of resources• This leads to the next important

concept: cost

Basic Concepts: Opportunity Costs

• Cost derives from scarcity and the need to make choices

• The cost of doing one thing is what is foregone

• Explicit costs and implicit costs

• The economists’ and the accountants’ definition of cost

• The implicit cost of capital and economic profit

Basic Concepts:Decisions at the Margin

• Some decisions involve all or nothing choices

• Many decisions involve decisions at the margin

• How much of something should I consume or produce?

• Marginal cost and marginal benefit

• Optimal point where MC=MB

Decisions at the Margin

Optimal rounds of golf per week for Dr. R.

Q

$

Q*

MC

MB

Basic Concepts:Efficiency

• Productive efficiency—production at least cost

• Allocative efficiency is where resources are allocated to their highest valued use

• Marginal benefit=Marginal cost• At the margin people value this

good (in terms of willingness to forego other things) just what it costs to produce (in terms of opportunity costs)

• All costs and benefits must be included

Efficient Use of Resources

MC

MB

Q of good X

Cost exceeds benefitsBenefit exceeds cost

What must be foregone for an additional unit

What people will forego for an additional unit

Q*

$

Basic Concepts:Incentives

• People tend to respond to economic incentives

• Price changes

• Opportunities to increase income or reduce debts

• Changes in incentives vs moral suasion

• Incentives in the longer term

• Unintended consequences and incentives

Some Basic Models:Production Possibilities

• Production possibility curve gives a simplified representation of an economy

• Two goods

• Given resources and technology

• Can use this model to think about opportunity cost and concepts of efficiency

Production Possibility Frontier

With given resources and technology

QuantityofMilitarygoods

Quantity of Civilian goods

Attainable

Unattainable

PPF

Opportunity Cost

• Productive efficiency—on the PPF

• Tradeoffs along the frontier

• Opportunity cost

• Constant opportunity cost

• Increasing opportunity cost

• Allocative efficiency—where on the PPF?

Economic Growth

• Economic growth can be represented as an outward shift in the PPF due to accumulation of capital or technological change

X

Y

Some Basic Models:Gains from Trade

• Without trade a person or nation is limited to their own domestic production possibilities curve

• Gains from trade• Absolute advantage—based on

different costs• Comparative advantage—based on

different relative costs• An example of two individuals with

different abilities or endowments and two activities—hunting for meat or collecting plants and berries—each with constant marginal opportunity costs

Gains from Trade

Meat (kgs)

Plants (kgs)

Person 1

Person 2

10

20

10 Plants (kgs)

20

1 kg meat costs 2 kgs plants1 kg plants costs .5 kg meat

1 kg meat costs .5 kg plants1 kg plants costs 2 kgs meat

Meat (kgs)

Absolute Advantage

Gains from Trade

Plants (Kgs)2010

10

20

a

b’

b

cPerson 1’s ppf

Person 2’s ppf

Trade line

Meat (kgs)

The trade line drawn here assumes terms of trade of 1:1 and equal division of the gains from trade

Gains from TradeComparative AdvantageMeat

Plants

Meat

Plants

40

30

10

20

1M=1.33P

1M=0.5P

Person 1

Person 2

Gains From Trade• Comparative Advantage

Assume trade at 1P=1M

30

40

20

10

30

10

10

P

P

M

M

Person 1 produces 40P andtrades 10

Person 2 produces 20 M and trades 10

Some Basic Models: Circular Flow

Circular Flow Diagram

Goods marketsFactor markets

Households

Firms

sales revenues

expendituresincomes

Factor payments

factors

inputs

goods

outputs

The Market Economy• Individual and households choose

what factors to supply for income and what goods to spend that income on

• Firms choose what goods to produce and what factors to buy in order to produce them

• Interdependence• Choice and constraints on choice • Incentives• Markets and efficiency• Market failures