Welcome to Econ 110Welcome to Econ 110
Econ 110
Introduction to Economic Theory
Section 2
Professor Tanya Rosenblat
Fall 2007
What is EconomicsWhat is Economics
Economics is a
1 Social Science
2 A Business Tool
As a Social Science Exploration of the consequences of - Rationality
- Selfishness
- Equilibrium
As a Business Tool Subject that studies the market forcesthat govern the creation and distribution
of value in the marketplace
EXAMPLESEXAMPLES
1 Water Diamonds what determines value
2 Why so many new textbook editions
3 Renting or Selling what is better
4 Why is popcorn in theaters so expensive
5 Which auction maximizes revenue
6 To Lead or to Follow what is better
PRINCIPLESPRINCIPLES
1 People face Tradeoffs No ldquoFree Lunchrdquo
2 The Cost of Something is what you give up to get it
3 Rational People think at the Margin
4 Rational People react to Incentives
Econ 110Econ 110 Grade Components Grade Components
Homework (individual or team)10
(8 best out of 10)
Final examination 40
(December 10 )
Midterms 20 each
(Oct 17 and Nov 14)
More information on exams will be provided as the dates of exams approach
No homework due the first week No homework due the weeks of
midterms
+ Class Participation
10
GradingGrading
Final course average is determined according to the following formula
[01 homework] + [02 midterm1] +[02 midterm2] +
[04 final]+ [01 class participation]
bull Upward trend in performance will be rewarded I will weigh final more if your perform substantially better on the final
bull Students who do poorly in Econ 110 tend to be those who donrsquotcome to class and donrsquot do the reading and problems sets
bull Class participation and attendance ndash Not Compulsory but appreciated Please let me know if you cannot
attendbull Course readings
ndash Stiglitz and Walsh Economicsndash Additional readings distributed through course website
bull Problem sets ndash Individual or Group homework assignments to be turned in (no more
than 4 persons)bull Review session Review sessions weekly on Tue at 7 pm in PAC 004
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
What is EconomicsWhat is Economics
Economics is a
1 Social Science
2 A Business Tool
As a Social Science Exploration of the consequences of - Rationality
- Selfishness
- Equilibrium
As a Business Tool Subject that studies the market forcesthat govern the creation and distribution
of value in the marketplace
EXAMPLESEXAMPLES
1 Water Diamonds what determines value
2 Why so many new textbook editions
3 Renting or Selling what is better
4 Why is popcorn in theaters so expensive
5 Which auction maximizes revenue
6 To Lead or to Follow what is better
PRINCIPLESPRINCIPLES
1 People face Tradeoffs No ldquoFree Lunchrdquo
2 The Cost of Something is what you give up to get it
3 Rational People think at the Margin
4 Rational People react to Incentives
Econ 110Econ 110 Grade Components Grade Components
Homework (individual or team)10
(8 best out of 10)
Final examination 40
(December 10 )
Midterms 20 each
(Oct 17 and Nov 14)
More information on exams will be provided as the dates of exams approach
No homework due the first week No homework due the weeks of
midterms
+ Class Participation
10
GradingGrading
Final course average is determined according to the following formula
[01 homework] + [02 midterm1] +[02 midterm2] +
[04 final]+ [01 class participation]
bull Upward trend in performance will be rewarded I will weigh final more if your perform substantially better on the final
bull Students who do poorly in Econ 110 tend to be those who donrsquotcome to class and donrsquot do the reading and problems sets
bull Class participation and attendance ndash Not Compulsory but appreciated Please let me know if you cannot
attendbull Course readings
ndash Stiglitz and Walsh Economicsndash Additional readings distributed through course website
bull Problem sets ndash Individual or Group homework assignments to be turned in (no more
than 4 persons)bull Review session Review sessions weekly on Tue at 7 pm in PAC 004
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
EXAMPLESEXAMPLES
1 Water Diamonds what determines value
2 Why so many new textbook editions
3 Renting or Selling what is better
4 Why is popcorn in theaters so expensive
5 Which auction maximizes revenue
6 To Lead or to Follow what is better
PRINCIPLESPRINCIPLES
1 People face Tradeoffs No ldquoFree Lunchrdquo
2 The Cost of Something is what you give up to get it
3 Rational People think at the Margin
4 Rational People react to Incentives
Econ 110Econ 110 Grade Components Grade Components
Homework (individual or team)10
(8 best out of 10)
Final examination 40
(December 10 )
Midterms 20 each
(Oct 17 and Nov 14)
More information on exams will be provided as the dates of exams approach
No homework due the first week No homework due the weeks of
midterms
+ Class Participation
10
GradingGrading
Final course average is determined according to the following formula
[01 homework] + [02 midterm1] +[02 midterm2] +
[04 final]+ [01 class participation]
bull Upward trend in performance will be rewarded I will weigh final more if your perform substantially better on the final
bull Students who do poorly in Econ 110 tend to be those who donrsquotcome to class and donrsquot do the reading and problems sets
bull Class participation and attendance ndash Not Compulsory but appreciated Please let me know if you cannot
attendbull Course readings
ndash Stiglitz and Walsh Economicsndash Additional readings distributed through course website
bull Problem sets ndash Individual or Group homework assignments to be turned in (no more
than 4 persons)bull Review session Review sessions weekly on Tue at 7 pm in PAC 004
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
PRINCIPLESPRINCIPLES
1 People face Tradeoffs No ldquoFree Lunchrdquo
2 The Cost of Something is what you give up to get it
3 Rational People think at the Margin
4 Rational People react to Incentives
Econ 110Econ 110 Grade Components Grade Components
Homework (individual or team)10
(8 best out of 10)
Final examination 40
(December 10 )
Midterms 20 each
(Oct 17 and Nov 14)
More information on exams will be provided as the dates of exams approach
No homework due the first week No homework due the weeks of
midterms
+ Class Participation
10
GradingGrading
Final course average is determined according to the following formula
[01 homework] + [02 midterm1] +[02 midterm2] +
[04 final]+ [01 class participation]
bull Upward trend in performance will be rewarded I will weigh final more if your perform substantially better on the final
bull Students who do poorly in Econ 110 tend to be those who donrsquotcome to class and donrsquot do the reading and problems sets
bull Class participation and attendance ndash Not Compulsory but appreciated Please let me know if you cannot
attendbull Course readings
ndash Stiglitz and Walsh Economicsndash Additional readings distributed through course website
bull Problem sets ndash Individual or Group homework assignments to be turned in (no more
than 4 persons)bull Review session Review sessions weekly on Tue at 7 pm in PAC 004
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Econ 110Econ 110 Grade Components Grade Components
Homework (individual or team)10
(8 best out of 10)
Final examination 40
(December 10 )
Midterms 20 each
(Oct 17 and Nov 14)
More information on exams will be provided as the dates of exams approach
No homework due the first week No homework due the weeks of
midterms
+ Class Participation
10
GradingGrading
Final course average is determined according to the following formula
[01 homework] + [02 midterm1] +[02 midterm2] +
[04 final]+ [01 class participation]
bull Upward trend in performance will be rewarded I will weigh final more if your perform substantially better on the final
bull Students who do poorly in Econ 110 tend to be those who donrsquotcome to class and donrsquot do the reading and problems sets
bull Class participation and attendance ndash Not Compulsory but appreciated Please let me know if you cannot
attendbull Course readings
ndash Stiglitz and Walsh Economicsndash Additional readings distributed through course website
bull Problem sets ndash Individual or Group homework assignments to be turned in (no more
than 4 persons)bull Review session Review sessions weekly on Tue at 7 pm in PAC 004
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
GradingGrading
Final course average is determined according to the following formula
[01 homework] + [02 midterm1] +[02 midterm2] +
[04 final]+ [01 class participation]
bull Upward trend in performance will be rewarded I will weigh final more if your perform substantially better on the final
bull Students who do poorly in Econ 110 tend to be those who donrsquotcome to class and donrsquot do the reading and problems sets
bull Class participation and attendance ndash Not Compulsory but appreciated Please let me know if you cannot
attendbull Course readings
ndash Stiglitz and Walsh Economicsndash Additional readings distributed through course website
bull Problem sets ndash Individual or Group homework assignments to be turned in (no more
than 4 persons)bull Review session Review sessions weekly on Tue at 7 pm in PAC 004
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
bull Class participation and attendance ndash Not Compulsory but appreciated Please let me know if you cannot
attendbull Course readings
ndash Stiglitz and Walsh Economicsndash Additional readings distributed through course website
bull Problem sets ndash Individual or Group homework assignments to be turned in (no more
than 4 persons)bull Review session Review sessions weekly on Tue at 7 pm in PAC 004
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Classroom Etiquette Responsibilities and Classroom Etiquette Responsibilities and ExpectationsExpectations
bull My responsibility I will be on-time for every class (indeed I will usually be 5 minutes early)
ndash My reciprocal expectation you will try to be in your seats and ready to go at the beginning of the hour
bull My responsibility I will remain in the classroom intensely focused on your learning for the duration of the class
ndash My reciprocal expectation please do not get up from the class and then return later
bull My responsibility To surprise you with ideas and insights
ndash To do this I need to ask that you not read ahead in the chapters especially when we are doing an experiment
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Last Warning What Economics Last Warning What Economics Offers and Does Not OfferOffers and Does Not Offer
bull Economics does NOT offerndash Simple recipes for dealing with every conceivable
problembull Economics does offer
ndash Frameworks of enduring value that can enable your intuition harness your creativity and help you think through a broad range of issues
ndash A honing mechanism that helps you identify the data that is most relevant for dealing with complex ambiguous problems
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
What is Economics
bull Economics in general is about the allocation of scarce resources
bull What is produced bull How is it produced bull Who produces and gets paid for it What does it cost bull Who buys it and whybull You canrsquot have it all ldquoTradeoffsrdquo ldquoThe Dismal Sciencerdquo Real life
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Macro and Micro
bull Macro Aggregate economic behavior and performance of economy Inflation unemployment exchange rates wealth interest rates income distribution
bull Micro Focus on individual economic decision-makers and behavior and performance of markets for goods services and productive inputs (price of gasoline wages of consultants innovation in computer technology)
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
What is Microbull Economic behavior of individual consumers and
producers (firms)bull Interactions between consumers and firms in markets
for goods and services the role of prices and the ldquolaws of supply and demandrdquo
bull Behavior and performance (prices costs efficiency) of markets for goods and services including labor and capital
bull Perfectly competitive markets monopoly imperfect competition
bull Analyze effects of public policies sales taxes price controls antitrust information and disclosure government subsidies environmental regulations on costs prices social welfare consuming and producing groups
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Consumers Producers Markets
bull In this course we examine consumers producers and how they interact in markets
bull Consumers choose what goods and services to buy by maximizing their utility or satisfaction subject to their scarce income or budget constraint Consumers are rational given their information
bull Producers (firms) are constrained by technology prices for inputs (labor capital raw materials) production from competing firms and what consumers are willing to pay (demand) for their products
bull Firms choose output and prices (supply) to maximize profits subject to these constraints
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Consumers Producers Markets
bull Consumers (demand) and producers (supply) interact in markets to trade money for goods and services
bull Markets determine prices assigned to goods and services and to scarce productive inputs (labor capital raw materials)
bull Prices play a central role in microeconomics and determine how scarce resources are allocated what is produced how is it produced and who gets it The central questions of economics
bull Prices are signals that convey information to consumers and firms and ultimately link millions of consumers and thousands of firms
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Consumers Producers Markets
bull Prices tell consumers how much different goods and services cost and allow them to decide whether to consume more or less of a good or service (demand) given how much they value them (utility or preferences) and their budget constraints
bull Prices tell producers how much consumers are willing to pay for what they produce and how much revenue they will receive if they producer alternative quantities (supply)
bull Prices for inputs (wages capital) indicate what it will cost to produce so firms can decide whether to produce more or less and how to produce the products to reduce costs and increase profits (revenues ndash costs)
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Economic Modelsbull We try to approach these economic problems
scientifically but individual human behavior is complicated driven by many factors and cannot be fully explained by simple precise mathematical relationships (eg E = mc^2 )
bull We rely on simple theoretical models to understand consumer and producer behavior and price formation in markets of different kinds A model is any description of a relationship between two or more economic variables (eg prices and quantities sold)
bull These models are based on many assumptions which may sometimes seem unrealistic (eg consumers have good information about product prices and qualities offered by competing firms)
bull We then relax these assumptions to see how market behavior and performance change
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Theoretical vs Empricalbull Theoretical economics is the process of building
models to explain economic relationships (when prices rise consumers buy less ndash the law of downward sloping demand)
bull Empirical economics is the process of testing models and measuring the parameters of established economic relationships (eg (if the prices of gasoline rises does consumption fall and by how much -- elasticity of demand for gasoline)
bull Some economic phenomena are hard to explain empirically
bull Why do people wait in line for four hours for a Britney Spears concert and why can scalpers charge 5 times the face value of the tickets
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Perfect vs Imperfect Competitionbull One of the key sets of assumptions that must be made in
micro theory is to characterize the nature of competition in various markets
bull We always start with ldquoperfectly competitiverdquo markets Perfect competition relies on many assumptions that may all be satisfied for only a few products (eg wheat) Students find this annoying
bull But perfect competition is a good starting point and many economic relationships can be understood well even in markets that donrsquot satisfy all of the assumptions
bull We will go on to examine alternative markets structures (eg monopoly cartels) and many other market imperfections
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Positive vs Normativebull Positive economics focuses on explaining economic
phenomena without making judgments about whether they are good or bad
bull Why is Wesleyanrsquos tuition $36536year Why is it almost identical to Williamsrsquo and Brownrsquos tuition
bull What happened to oil prices before and after the war in Iraq started on March 20 2003
bull Normative economics seeks to evaluate whether market outcomesare good bad or could be improved upon with changes in market structures or with the application of government policies that affect market outcomes (eg controls on pollution) Normative economics uses phrases like efficiency social welfare consumer welfare equity etc that reflect specific normative criteria which may or may not themselves be controversial
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Policy AnalysisMicroeconomics is often used to examine the effects of
various government policies- minimum wage (ldquoliving wagerdquo)- sales taxes- antitrust policies (Microsoft)- farm subsidies (wheat butter milk etc)- safety standards (pharmaceuticals)- pollution regulations (global warming)- price controls (electricity prices)- information disclosure (Enron)- patent and copyright policies
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Economics Can Be Funbull Economics is about real life decisions made by
individuals as consumers and producers It can be applied to many phenomena that we encounter in every day life and care about as citizens It is of enormous value in public policy analysis
bull By the end of this course you should be able to think and speak intelligently about issues like the following
- raising the minimum wage- alternative approaches to controlling pollution- government restrictions on Microsoftrsquos behavior- behavior of oil prices and effects of price controls- how to make investment decisions- how to evaluate insurance policies- why did Enronrsquos CEO earn 100 times more than Michael
Roth
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Production Functionbull Production refers to the conversion of inputs the factors of
production into desired output A production function for a particular good or service is often written as follows
Xi = f(LKMR) bull where Xi is the quantity produced of a particular good or
service andbull 1048698 L represents the quantity and ability of labor input
available to the production processbull 1048698 K represents capital input machinery transportation
equipment and other types of intermediate goodsbull 1048698 M represents land natural resources and raw material
inputs for production andbull 1048698 R represents entrepreneurship organization and risk-
taking
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Example 1 One Good Only Labor Input Variable
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Example 1 One Good Only Labor Input Variable
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Production function with diminishing marginal productivity of labor
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Two Goods Labor Supply = 7
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
MRT (of good 1 for good 2) ndash How much can output of good 1 increase if the firm decreases the output of
good 2 by one marginal unit
bull Marginal Rate of Transformation = the slope of the transformation frontier
bull This ratio measures the opportunity cost of using resources in producing one good in terms of the alternative use of those resources used in the production of the other good Given diminishing marginal productivity as resources are allocated away from good Y towards good X the opportunity cost (|MRT|) of producing more of good X increases
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
Examples
bxay
MRT = |yrsquo| = b
cyx 22
0)()( 212212 xcxxcxy
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