MICROECONOMICS

Topic 1
Introduction to
Economics

What is Economics?
Definition of Economics
Scarcity and Choice
The Economic Questions
Production Possibilities
Frontier
Opportunity Cost
The Difference Between
Microeconomics and
Macroeconomics
Key Terms

Definition of Economics
Economics is a social science that studies the choices
that individuals, businesses, governments, and entire
societies make as they cope with scarcity and the
incentives that influence and reconcile those choices.
Choices - To choose among the available alternatives
Scarcity our inability to satisfy all our wants; faced
with scarcity we must choose among the available
alternatives.

Definition of Economics
Scarcity forces us to make choices among a limited
set of possibilities
Study the logic of rational choice among competing
alternatives
Under scarcity, deciding to have more of one good or
service means deciding to have less of something
else. The relevant cost of a decision is the value of
the best alternative foregone

Needs vs. Wants

Needs what people
must have to live.
Food
Clothing
Shelter

Wants the things

we would like to
have, but can live
without.

The Difference Between

Microeconomics and Macroeconomics
Microeconomics:
The study of the choices that individuals and
businesses make, the way these choices interact in
markets, and influence of governments
Macroeconomics:
The study of the performance of the national
economy and the global economy

Macroeconomics vs. Microeconomics

MICROECONOMIC QUESTION MACROECONOMIC QUESTION
Go to business school or take
a job?

How many people are

employed in the economy as a
whole?

What determines the salary

What determines the overall
offered by Citibank to Cherie
salary levels paid to workers
Camajo, a new Columbia MBA? in a given year?

Macroeconomics vs. Microeconomics

MICROECONOMIC QUESTION MACROECONOMIC QUESTION
What determines the cost to a What determines the overall
university or college of offering level of prices in the economy
a new course?
as a whole?

What government policies

should be adopted to make it
easier for low-income students
to attend college?
What determines whether
Citibank opens a new office in
Shanghai?

What government policies

should be adopted to promote
full employment and growth in
the economy as a whole?
What determines the overall
trade in goods, services and
financial assets between the
US and the rest of the world?
8

The Economic Questions

What, How and For Whom?
What goods and services get produced and how
much?
How to get those goods and services produced?
For whom the goods and services produced?

What goods and services get produced and

how much?
Goods and services:
Are objects (tangible and intangible) that people
value and produce to satisfy human wants
Goods: physical objects. E.g. books, pen
Services: tasks performed for people. E.g. car wash,
hair cut
What goods and services get produced?
Agriculture product?
Manufacturing product?
More cars, less clothes?
More hand phones, less corn?

What goods and services get produced and

how much?
How much the quantities of goods and services get
produced?
A small number?
A large number?

How to get those goods and services

produced?
Goods and services are produced by using productive
resources that called factors of production
4 grouped of factors of production:
Land
Labor
Capital
Entrepreneurship

How to get those goods and services

produced?
Land
Refers as natural resources
It includes land in the everyday sense together
with oil, gas, coal, water and air.
The amounts are limited and nonrenewable

How to get those goods and services

produced?
Labor
The work time and work effort that people devote
to producing goods and services is called labor.
It includes the physical and the mental efforts.
The quality of labor depends on human capital i.e.
the knowledge and skill that people obtain from
education, training, and work experience.

How to get those goods and services

produced?
Capital
Human made resources
Examples are tools, instruments, machines, buildings,
offices, plants and other constructions that businesses
now use to produce goods and services.

How to get those goods and services

produced?
Entrepreneurship
The human resource that organizes labor, land and
capital.
Come up with new ideas about what and how to
produce, make business decisions and bear the risks
that arise from these decisions.

For whom the goods and services produced?

Who gets the goods and services that are produced
depends on the income that people earn.
A large income enables a person to buy large quantities
of goods and services.
A small income leaves a person with a few options and
small quantities of goods and services.

For whom the goods and services produced?

People earn their incomes by selling the services of the
factors of production they own:
Land earns rent.
Labor earns wages/salaries.
Capital earns interest.
Entrepreneurship earns profit.

Production Possibilities Frontier

Quantities of goods and services that we can produce
are limited by both our available resources and by
technology.
And if we want to increase our production of one good,
we must decrease our production of something else
we face tradeoffs.

Production Possibilities Frontier

Definition of PPF:
A graph that shows the maximum combinations of goods
that can be produced when resources and technology
are used efficiently
To illustrate the PPF, we focus on two goods at a time
and hold the quantities produced of all the other goods
and services constant.
For simplicity, lets take a world with only 2 products

The Production Possibility Curve

for an Individual
The production possibility curve demonstrates
that:
There is a limit to what you can achieve,
given the existing institutions,
resources, and technology.
Every choice made has an opportunity
costyou can get more of something
only by giving up something else.

Production Possibilities Frontier

Possibility

Fish
(hundreds)

Coconuts
(hundreds)

A
B
C

0
1
2

15
14
12

D
E
F

3
4
5

9
5
0

Production Possibilities Frontier

The PPF for CDs and cars shows the limits to the
production of these two goods, given the total resources
available to produce them.
The table lists some combinations of the quantities of
fish and coconuts that can be produced in a month given
the resources available.

Production Possibilities Frontier Graph

The curve has a
Coconuts (hundreds)

Unattainable

15 A

negative slope.
The curve is
concave to the
origin.

C
D

10
Attainable
Z

PPF
F

Fish (hundreds)

Production Possibilities Frontier

Production Efficiency
At a point on the PPF the production is efficient.
All points on the curve correspond to full use of
resources.
Production Not Feasible
Points outside the PPF are not feasible /
unattainable with existing resources.
It is feasible / attainable only when we add more
resources to the existing amount.

Production Possibilities Frontier

Tradeoff Along the PPF
Every choice along the PPF involves a tradeoff
Tradeoff is a situation where we must give up
something to get something else.
All tradeoffs involve a cost an opportunity cost.

Opportunity Cost
Definition of opportunity cost
Is the highest-valued alternative forgone.
Along the PPF, there are only two goods, so there is
only one alternative forgone: some quantity of the
other good.
The opportunity cost of any alternative is defined as
the cost of not selecting the "next-best" alternative.
The opportunity cost is a ratio:
It is the decrease in the quantity produced of one
good divided by the increase in the quantity produced
of another good as we move along the PPF.

Opportunity Cost Examples

Woman who is considering whether to stay
home and take care of her children or work at a
job paying $9.50 per hour and hire a baby sitter
Seamstress who chooses to make blue shirts
instead of striped shirts
A landowner decides to farm his own land
instead of renting it to a neighbor

Opportunity Cost
All economic decisions taken by individuals or society
are costly
If we want a missile defense system, we have to have
less of other goods
If an individual wants to have a higher level of
consumption during working years, then the person will
have to give up something
Have a lower level of consumption in retirement
Work harder and have less leisure
Get more education or training

Measuring Opportunity Cost

Table 1:
Possibility

Fish
(millions)

Coconuts
(millions)

A
B
C

0
1
2

15
14
12

D
E
F

3
4
5

9
5
0

Measuring Opportunity Cost

Example:
Refer to Table 1:
From C to D, the opportunity cost of a fish is 3
coconuts. The inverse of 3 is 1/3, so if we decrease
the production of fish and increase the production of
coconuts by moving from D to C, the opportunity cost
of a coconut must be 1/3 of a fish.

Rightward shifts in PPFs

Increase in resources
Increased productivity
Improved technology

32

Technological Change
What would happen to the PPF if a new and
improved variety of corn became available to
the Jonsons. It would not affect the
possibilities when only soybeans were being
produced but it would shift the curve outward
and to the right.
If an improved fertilizer became available it
could shift the PPF out in all directions.

Commodity-specific technological
change

Changing the PPF: Other Factors

If the Jonsons became better informed about crop
husbandry that could also shift the PPF outward
If the became more experienced at growing these crops,
that could also shift the PPF outward
What would happen if they had more land?

Economic growth
Economic growth indicates
an increase in the total
output of an economy.

Can a PPF shift inward (to the left)?

YES!! For just the opposite reasons as an outward shift
such as a loss of resources

37

Application to the Economy

The amounts of goods and services that can
be produced in any given year is limited by the
amount and productivity of the land, labor,
and capital goods available.
Choices have to be made regarding the
composition of output. How much national
defense, food, clothing, automobiles,
education, drugs, health care, capital goods,
etc. The PPF can be used to capture the
choices.

The End
Next Topic:
Demand and Supply