Welcome to Econ 202Principles of Microeconomics

Dr. David Sobiechowski, Instructor

www-personal.umd.umich.edu/~davidski

www-personal.umd.umich.edu/~davidski

What is Economics ? (or why does economics exist)

Problem 1. Human Beings have unlimited wants for goods and services.

Problem 2. Resources (which are used to produce goods and services) are Limited

Example: You have a limited income (your resources), but could always want more goods & services than you do now.

The Economic problem is Scarcity • Scarcity is the imbalance between: the unlimited wants of humans and

the limited means to satisfy those wants• An Economy is: a mechanism through which the use

of land, labor, and capital are organized......in an attempt to satisfy the unlimited wants of it's

members.• Economics is......1. the study of how individuals, groups, and countries

use their limited resources in an attempt to satisfy their unlimited wants.

2. Economics is the study of how people make choices in attempting to satisfy their unlimited wants.

Why make choices?• You can’t ever get everything you

desire because of limited resources...

...(i.e. income, wealth, time, etc.) this implies that one must choose among many different possible alternatives.

…which means that we could have done something something elseelse with our time or with our income…

…in other words we must give up some other we must give up some other alternativealternative to get something else.

This is called: Opportunity cost...... is the cost of making a choice... …it is measured as the sacrifice of the next best

alternative given up by a person, group, or nation.

Opportunity cost is, for the most part, subjective (by the person making the choice).

But it always existsalways exists regardless of person or nation.

This leads to the saying: There is no such thing as This leads to the saying: There is no such thing as a free lunch. a free lunch.

Decision MakingThe question that is fundamental to economics is:How should we use our resources and capabilities?This applies to an individual, a business firm, and a

nation as a whole……because all face the universal problem of scarcity• Economists use the concept of opportunity cost as

a way to make decisions:1. There is an opportunity cost to everything we do2. There must also be a benefit (the opposite of

cost) to everything we do………it is measured by what we are willing to give up.it is measured by what we are willing to give up.

Marginal Analysis• Economists assume that people have objectives they

want to reach, such as getting as much profit as possible from producing goods or services.

• How can a firm or a person make sure they do this?• By comparing the benefits and costs of an action!...…moreover, you will only be concerned with the

additional benefits and additional costs from your current situation…

…because there is nothing you can do about past costs and benefits(Sunk Costs)…

…the decision rule is simple: pursue an action where the additional benefits are greater or equal toare greater or equal to the additional costs of an action.

It is called marginal analysis because this is the name economists give to the words: additional, next, extra.

Example: The choice of going to college. • All of you decided the marginal benefit of going to

college was higher than the marginal cost of going to college.

• I assume you are a rational self-interested person• Rational means you have an objective and will choose

that action that will give you the greatest satisfaction• Choosing the alternative where the

marginal benefit >= marginal cost will do this.• In fact you will choose the amount of that alternative

until the marginal benefit = marginal cost (get the most satisfaction from your action).

How do we study Economics?

A look at a Theories (Models) To explain economic behavior

• Looks closely at how individuals, business firms, and societies make choices.

• It attempts to show how the market-capitalist system answers the following three fundamental questions (every economy faces these because of Scarcity) :

The study of how the choices individuals, businesses and governments affect the aggregate or total economy.

Three large issues of Macroeconomics: 1. Standard of Living - level of consumption of goods and

services people enjoy. Economic growth and Unemployment. Productivity - Total Production / Number employed 2. The cost of Living - number of dollars it takes to buy

goods and services for a given standardgiven standard of living. Inflation and Price Stability : Quantity of Money 3. Economic Fluctuations - the periodic rise and fall of total

production in the economy, the business cycle Recessions and Expansions affecting

Unemployment & Inflation : Fluctuations in total spending

Begins with observing the economy• All Scientific inquiry starts with observations about

what is happening in the world.• Economists gather information and describe the

economy by organizing the data.• This data can be shown with tables of numbers

which we can translate into a picture(graph).• A discussion of how to read and interpret these

observations will be done later in the lecture.• However, this is only the start: Descriptions are not

explanations… …this is why economic models or theories are needed:

To explain the data that is collected

Two types of Scientific inquiry• Positive Economics...making objective statements about

economic phenomena that can be tested and proved right or wrong.

a. Explaining why events occurb. Predicting under what circumstances economic events

will occur in the future Example: An increase in income taxes will cause

consumer spending to go down• Normative Economics...a way of determining the

desirability of outcomes based on some value judgments (opinions)

a. Recommending appropriate courses of actions to take. Example: Taxes should be lowered in order to increase

consumer spending.b. Criteria: 1. Efficiency 2. Equity

Theories or Models• Used to explain how something works.• An Economic model is a simplified way of

expressing how the economy or parts of that economy function.

• It’s main purpose is to explain how the economy (or parts of it) work and to make predictions about what could happen when something changes in the economy.

Theories or models include four steps 1. Identify what you want to study (variables) Example: You may want to study how a congressperson

will vote on bill. Some variables that may be relevant to that vote are: Party affiliation Congressional district (Constituents) Conscience Money received for political campaigns

2. Make assumptions on variable behavior Example: What is the objective of the Congressperson? 1. Reflect constituent views, 2.Vote with Party,

3. Get Re-elected

Theories or models include four steps 3. Make hypothesis or Predictions (In the form of IF... THEN..)• Example: If a Congressman receives money from the

UAW he will vote Yes on raising the minimum wage.......Ceteris Paribus: All other things held constant. (This is an implicit assumption made with all predictions) It means that we only use two variables at a time when

making predictions (in order to isolate how one variable affect one other variable)...

...Everything else is assumed not to change.4. Test your predictions• If wrong you may have to adjust theory

Problems in theory building:1. Fallacy of Composition...what is true for the

individual is true of the group2. Post hoc, ergo Propter Hoc (Post Hoc fallacy) Association does not imply causation

When I stand up at a ballgame, I can see better. Therefore, if everyone stands up, everyone will be able to see better?

If Farmer Jones produces more corn, her revenues will rise. If all farmers produce more corn, their revenues will all rise?

1. The Fallacy of Composition: The often mistaken belief that what is true for a part is necessarily true for the whole.

Many, many examples exist... I went to the beach and it began to rain. It

must have rained because I went to the beach?

We increased our advertising budget and people stopped buying our product. Our advertising must be discouraging consumers?

2. Post Hoc Fallacy: If event A happens before event B, it is not necessarily true that event A caused event B.

Correlation vs. Causation

• Two variables are correlated if one variable changes when the other variable changes.

• This does NOT mean that changes in one variable CAUSE changes in the other.

APPLICATION: Correlation vs. Causation

Cities with high crime rates also have many automobiles. Does this mean that automobiles cause crime?

President Bush took office in 2001 and soon after the economy began to get worse. Does this mean that the Bush inauguration caused the worsening economy?

An Introduction in reading and using Graphs

Graphs• Graphs are pictures that show the relationship

between two variables• A variable is something that can take on more

than one value.• There are two ways that variables can be

related:1) Positive relationship: variables move in the

same direction2) Negative relationship: variables move in the

opposite direction

Example: Positive or Direct relationship

Miles driven in a car and the total amount of gasoline used

As you drive more you will use up more gasoline. Miles Driven Gasoline used (gallons)

200 10 400 20 600 30 800 40

Miles Driven

200

400

600

800

0 Gallons of gasoline used10 20 30 40

A graph always starts with labeling the verticaland horizontal axis with the variables(numbering is usually optional)

Miles Gasoline used Driven (gallons) 200 10 400 20 600 30 800 40

Next, we plot the points from our table...

Then we connect the dots to represent other possible observations and to describe the relationship

The graph is read by moving to the right on the horizontal axis.....

...and then moving vertically until you hit the relationship line.

Miles Driven

Gallons of gasoline used

200

400

600

800

0 10 20 30 40

Miles Gasoline used Driven (gallons) 200 10 400 20 600 30 800 40

If we want more detailed information about this relationship we can calculate the slope of the line

Slope = Change in vertical distanceChange in horizontal distance

= RiseRun

= 200 miles10 gallons

= 20 milesgallon

200 miles10 gallons

This relationship line is constructed ceteris paribus• Are there other variables could affect the amount of

gasoline a car would use for the same amount of miles driven?

Tire inflation Weather conditions a well tuned engine amount of weight in car or towing• If a car is driven is cold weather it will use more gas for

same miles driven• How will this affect the relationship line we have

drawn?

Miles Driven

Gallons of gasoline used

200

400

600

800

0 10 20 30 40 Miles Gasoline used Gasoline used Driven (gallons) (gallons) 200 10 20 400 20 30 600 30 40 800 40 50

Use more gas more same amount of miles driven...Adding the variable driving in cold weather has caused the curve to Shift Position!

When a third(or more) variable is included in a model it causes the entire curve to shift.

This curve also shows a positive relationship, except it is a not a straight line...

...The slope of a curved line changes at every point on that curve...

...you should be able to tell how the slope of the line changes as we move away from the origin.......

Dealing with curves

Production of Cars

Cost of Next car

Any time a line gets steeper, the slope is getting larger

Interpretation:As production gets larger the same increase in production leads to greater increases in costs than before.

Production of Autos

Amount of Workers

Here is a positive relationship where Y increases but at a smaller rate as X increases.

Interpretation:As more workers are added the same increase in workers leads to smaller increases in production.

Dealing with curves

The Difference Between a Line and a Curve

Equal increments in Equal increments in XX lead to diminished lead to diminished increases in increases in YY..

Equal increments in Equal increments in XX lead to constant lead to constant increases in increases in YY..

Negative or Inverse relationship• Two Variables move in the opposite direction• Example: Birthrate and Family income• As Family income increases the Birthrate tends

to decline

Birthrate(averageper family)

Family Income (average per family)0

A negative relationship shows a downwardsloping line (moving to the southeast)

A

B

c

d

e f

When we move to the right on the horizontal axis, the relationship line tells us we must move down the verticalaxis.

Y

XHere is a case of a negative relationship that is not a straight line

Interpretation:As X gets larger the same increase in X leads to Y decreasing in greater amounts than when X was smaller

Dealing with curves

Y

X…as X increases, Y does not changeThis means that Y is independent of X and vice versa.A straight horizontal or vertical line indicate no relationship between the two variables.

A Graph that shows no relationship between the two variables...

20

This is a time series graph. It shows how a variable performs over time. This graph shows Mortgage rates 1978-2008