Mod 1 Microeco

Specific Defn: Social science that studies and seeks the efficient allocation of
scarce resources to satisfy unlimited human needs and wants
MACROECONOMICS MICROECONOMICS
Studies the behavior of aggregate Studies the behavior of individual

economic variables (national level) economic units (HH, firms)
Economics of the nation Economics of the firm
MICROECONOMICS MACROECONOMICS
Scope Firm/Industry National Economy
Viewpoint Business Manager GovtPolicymaker
What to produce? Needs of customers Of buyers and sellers
How much? Max profit, Max prodn,
utility,quality productivity,employmen
t, equity, stability
How? Available resources + Devtobjectives
For whom? Owners/Shareholders Society at large
Goal Competitiveness Sustained Eco Devt
Microeconomic Agents
Firms
–Produce and sell goods and services
–Buy inputs (labor, capital & raw materials)
Consumers
–Buy goods and services
–Sell inputs (labor services, loanable funds)
Ten Principles of Economics

How People Make Decisions
Principle 1: People Face Trade-offs
Principle 2: The Cost of Something Is What You Give Up to Get It
Principle 3: Rational People Think at the Margin
Principle 4: People Respond to Incentives
How People Interact

Principle 5: Trade Can Make Everyone Better Off
Principle 6: Markets Are Usually a Good Way to Organize Economic
Activity
Principle 7: Governments Can Sometimes Improve Market Outcomes
How the Economy as a Whole Works

Principle 8: A Country’s Standard of Living Depends on Its Ability to
Produce Goods and Services
Principle 9: Prices Rise When the Government Prints Too Much Money
Principle 10: Society Faces a Short-Run Trade-off between Inflation and
Unemployment
Principle 1 People face tradeoffs
•All decisions involve tradeoffs.
•Examples:
Going to a party the night before your DEADLINE for a reportorial
requirement. Leaves less time for analytical work
Having more money to buy stuff requires working longer hours, which leaves
less time for leisure.
Protecting the environment requires resources that could otherwise be used to
produce consumer goods.
ALL decisions involve trade-offs.

The most desirable alternative given up as a result of a decision is known as opportunity
cost.
Trade-offsare all the alternatives that we give up whenever we choose one course of action
over others.
(Examples: going to the movies)
What are trade-offs of deciding to go to college?
What is the opportunity cost of going to college?
•Society faces an important tradeoff: efficiency vs. equality
Efficiency: when society gets the most from its scarce resources
Equality: when prosperity is distributed uniformly among society’s members

Tradeoff: To achieve greater equality, could redistribute income from wealthy
to poor. But this reduces incentive to work and produce, shrinks the size of
the economic “pie.”
PRINCIPLE 2 The Cost of Something Is What You Give Up to Get It
Making decisions requires comparing the costs and benefits of alternative

choices.
The opportunity costof any item is whatever must be given up to obtain it.
It is the relevant cost for decision making.
Opportunity cost is the benefit that is missed or given up when an investor,

individual or business chooses one alternative over another.
PRINCIPLE 3 Rational People Think at the Margin
•Rational people
Systematically and purposefully do the best they can to achieve their objectives.
Make decisions by evaluating costs and benefits of marginal changes, incremental
adjustments to an existing plan.
Marginal Analysis
•Marginal benefit
•Marginal cost
•Marginal means “extra”
•Comparison between marginal benefit and marginal cost
In economics the term marginal = additional

“Thinking on the margin,” or MARGINAL ANALYSIS involves making
decisions based on the additional benefit vs. the additional cost.
For Example:
You have been shopping at the mall for a half hour; the additional benefit of
shopping for an additional half-hour might outweigh the additional cost (the
opportunity cost).
After three hours, the additional benefit from staying an additional half-hour
would likely be less than the additional cost.
PRINCIPLE 4 People Respond to Incentives

•Incentive:
Something that induces a person to act, i.E.The prospect of a reward or punishment.
Rational people respond to incentives.
oRational people make statements, decisions, or judgments using reasoned thinking,

based on facts, and applying rules.
The principles of HOW PEOPLE INTERACT
PRINCIPLE 5 Trade Can Make Everyone Better Off

Rather than being self-sufficient, people can specialize in producing one
good or service and exchange it for other goods.
Countries also benefit from trade and specialization:

Get a better price abroad for goods they produce
Buy other goods more cheaply from abroad than could be produced at home
PRINCIPLE 6 Markets Are Usually A Good Way to Organize Economic
Activity
Market: a group of buyers and sellers (need not be in a single location)
“Organize economic activity” means determining

What goods to produce
How to produce them
How much of each to produce
Who gets them
A market economy allocates resources through the decentralized decisions of

many households and firms as they interact in markets.
Famous insight by Adam Smith in The Wealth of Nations (1776):
Each of these households and firms acts as if “led by an invisible hand”to promote
general economic well-being.
The invisible hand works through the price system:

The interaction of buyers and sellers determines prices.
Each price reflects the good’s value to buyers and the cost of producing the good.
Prices guide self-interested households and firms to make decisions that, in many
cases, maximize society’s economic well-being.
PRINCIPLE 7 Governments Can Sometimes Improve Market Outcomes

•Important role for govt:
•ENFORCE PROPERTY RIGHTS (with police, courts)

People are less inclined to work, produce, invest, or purchase if large risk of their
property being stolen.
Market failure: when the market fails to allocate society’s resources

efficiently
Causes of market failure:
Externalities, when the production or consumption of a good affects bystanders (e.g.
pollution)
Market power, a single buyer or seller has substantial influence on market price (e.g.
monopoly)
Public policy may promote efficiency.
Improve Market Outcomes
oPrice Stability
oIncreaseOutputofProduction
oFull Employment
Economic Goals
1.Economic Freedom
2.Economic Equity
3.Economic Efficiency
4.Economic Security
5.Economic Stability
6.Economic Growth
Economic Freedom
This goal is about the amount of choice people have in where they work and
live, the type of career they have, what they do with their income and what they
buy or sell.
Economic freedom is restricted in some cases to protect the rights of others,
for example there are laws prohibiting the production, sale and purchase of
illegal drugs.
Economic Equity
Means what is fair. This can be seen as an equality of opportunity or an
equality of outcome
This goal centers on fairness. People's beliefs around what is right or wrong
determine how this goal is achieved.
Issues that involve Economic Equity certainly deal with redistribution of
income.
Economic Security
Protecting consumers, producers, and resource owners from risks that exist in
society. Each society must decide from which uncertainties individuals can and
should be protected
Economic Stability
This goal involves three aspects: sustained growth without large swings in
output or consumption; stable rate of employment; and a stable level of prices
without dramatic inflation or deflation. Most nations with economic freedom
allow for some unemployment and inflation.
Full Employment
Full employment does not mean that no one is jobless in a country; rather full
employment refers to the situation when there is no voluntary unemployment in
the country.
There is always a certain level of unemployment in the country due to
economic instabilities and imperfections. Such level of unemployment is called
the natural rate of unemployment.
But the government tries its best to reduce the level of unemployment in a
country as much as it can. It is one of the most important responsibilities of the
government of a country to create job opportunities for its people.
Price Stability
Inflation means a general increase in price level. Increase in price level results
in an unequal and unfavorable distribution of wealth in an economy.
Due to inflation the growth rate also decreases. It reduces purchasing power
and it also causes a deficit in the balance of payment which effects the
international repute of the country.
Therefore, the government of a country takes a serious and effective step to
overcome inflation and to keep the prices of commodities stable.
The balance of payment
A balance of payment is the statistical record of economic transactions with
the rest of the world.
Economic transactions refer to international trade that includes the import
and export of goods and services. Where imports increase the exports the
balance of payment becomes unfavorable.
If the value of imports is greater than the value of exports, then the balance of
payment is in deficit.
On contrary, if the value of export is greater than the value of imports than
the balance of payment is in surplus.
A balance of payment deficit in disadvantageous to the country. It affects the
credibility, repute, and ranking of the country.
In order to keep the balance of payment favorable, the government imposed
duties on imports and provides subsidies on exports.
The principles of HOW THE ECONOMY AS A WHOLE WORKS

Macroeconomics involves the study of aggregate factors such as employment, inflation, and
gross domestic product, and evaluating how they influence the economy as a whole.
The Economy As A Factory

Production has a rated capacity subject to technological constraintsas
well as the scarcest resource/input
Overproduction is possible but only for limited period as costs eventually
increase (Why?)
The scarcest resource for developed countries is labor
The sign that the economy is overheating is a low unemployment rate below
the 4-6 natural rate
The Economy As A Household
oTraditional farm-based HH produces output for itself and possibly other HH as
exports
oExcess output of other HH is exchanged or bought as imports
PRINCIPLE 8 A Country’s Standard of Living Depends on Its Ability to

Produce Goods & Services
Huge variation in living standards across countries and over time:
Average income in rich countries is more than ten times average income in poor
countries.
The Advance economies standard of living today is about eight times larger than 100
years ago.
The most important determinant of living standards:

•Productivity-the amount of goods and services produced per unit of labor.
Productivity depends on the equipment, skills, and technology available to
workers.
Other factors (e.g., labor unions, competition from abroad) have far less impact on
living standards.
PRINCIPLE 9 Prices Rise When the Government Prints Too Much Money
Inflation: increases in the general level of prices.
In the long run, inflation is almost always caused by excessive growth in
the quantity of money, which causes the value of money to fall. (Purchasing
power)
The faster the govtcreates money, the greater the inflation rate.
Department of Economics
The Quantity Theory of Money
Supply of money
•Money Supply
•The amount of money in circulation
•Economists use two basic approaches to define and measure money.

•The transactions approach
•The liquidity approach
Transactions Approach (M1)

•A method of measuring the money supply by looking at money as a medium of
exchange
•Liquidity Approach (M2)
•A method of measuring the money supply by looking at money as a temporary
store of value
PRINCIPLE 10 Society Faces a Short-run Tradeoff Between Inflation and

Unemployment
In the short-run (1–2 years), many economic policies push inflation and
unemployment in opposite directions.
Other factors can make this tradeoff more or less favorable, but the tradeoff
is always present.
The principles of interactions among people are:
Trade can be mutually beneficial.
Markets are usually a good way of coordinating trade.
Govtcan potentially improve market outcomes if there is a market failure or if
the market outcome is inequitable.
The principles of the economy as a whole are:

Productivity is the ultimate source of living standards.
Money growth is the ultimate source of inflation.
Society faces a short-run tradeoff between inflation and unemployment.
The Circular Flow
Our economy is an enormous, constant cycle in which Goods, Services,
Resources, and money flow back and forth.
Economists refer to this as the Circular Flow of Economic Activity
Economic Interdependence
Businesses (Producers), households (Individuals), and the government depend

on each other in order for the economy to run smoothly.
Circular Flow Model

Households are where you find regular people who work and consume in our economy
Households own and control resources and sell them to businesses.
Firms are the businesses that produce, employ us, and purchase in our economy
Businesses use the resources to make finished products.
Businesses take finished products and sell them to households.
Circular Flow Model Slide 152-163
Thinking Like an Economist
The Economist as Policy Advisor
As scientists, economists make positive statements, which attempt to
describe the world as it is.
As
policy advisors, economists make normative statements, which attempt to

prescribe how the world should be.
Positive statements can be confirmed or refuted, normative statements
cannot.
Govt employs many economists for policy advice. E.g., the Phil. President has
a Council of Economic Advisors.
Methodology: Positive v. Normative Economics

Positive econ. --Studies the way the world is.
•How much will a new gasoline tax raise the price of gasoline?
•Will an increase in the minimum wage increase unemployment?
•Why is the price of corn Php4.20 per bushel?
•How much will a drought in the corn belt raise the price of corn? Of Rice?
•What will be the effect on Byron Brown’s Puto consumption if we take Php1000
away from Tom Izzo and give it to Brown?
Methodology: Positive v. Normative Economics

Normative econ. --Studies the way the world should be.
•Should there be a new tax on gasoline?
•Should there be an increase in the minimum wage?
•Should Php1000 be taken from M. Peter McPherson and given to Byron Brown?
•What should the price of corn be?
Pricing/Prices
•Pricing/Prices
the key element in any market system
•Prices –
the amounts of money that are charged for different goods and services in a
market economy
Act as signals that influence the behavior of both consumers and producers
of goods and services
Prices can be output prices or input prices

Output prices –prices of final products sold by a firm
Input prices –prices of inputs, resources used to produce final products or

output (e.g. land cost, building rental cost, raw material, labor cost/wages,
etc.)
Other Microeconomic Influences on Managers

Decisions about –demand, supply, production, and market structure
Factors that affect consumer behavior/demand and the willingness of
consumers to buy your product vs the competition
Relative prices –price of one good over another similar good or another
alternative
A firm/company’s production technology

Prices paid for resources
Basically all demand and cost decisions
these are all the focus of microeconomics
In sum,
How consumer behavior affects their revenue.
How production technology and input prices affect their costs.
How the market and regulatory environment in which managers operate
influences their ability to set prices and to respond to the strategies of their
competitors.
These microeconomic factors exert influence on how managers make
decisions

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Specific Defn: Social science that studies and seeks the efficient allocation of

scarce resources to satisfy unlimited human needs and wants

Studies the behavior of aggregate Studies the behavior of individual

Ten Principles of Economics

How People Interact

How the Economy as a Whole Works

ALL decisions involve trade-offs.

•Society faces an important tradeoff: efficiency vs. equality

Equality: when prosperity is distributed uniformly among society’s members

PRINCIPLE 2 The Cost of Something Is What You Give Up to Get It

Making decisions requires comparing the costs and benefits of alternative

It is the relevant cost for decision making.

Opportunity cost is the benefit that is missed or given up when an investor,

PRINCIPLE 3 Rational People Think at the Margin

In economics the term marginal = additional

PRINCIPLE 4 People Respond to Incentives

oRational people make statements, decisions, or judgments using reasoned thinking,

PRINCIPLE 5 Trade Can Make Everyone Better Off

Countries also benefit from trade and specialization:

“Organize economic activity” means determining

A market economy allocates resources through the decentralized decisions of

The invisible hand works through the price system:

PRINCIPLE 7 Governments Can Sometimes Improve Market Outcomes

•ENFORCE PROPERTY RIGHTS (with police, courts)

Market failure: when the market fails to allocate society’s resources

The principles of HOW THE ECONOMY AS A WHOLE WORKS

The Economy As A Factory

PRINCIPLE 8 A Country’s Standard of Living Depends on Its Ability to

The most important determinant of living standards:

•Economists use two basic approaches to define and measure money.

•The liquidity approach

Transactions Approach (M1)

PRINCIPLE 10 Society Faces a Short-run Tradeoff Between Inflation and

The principles of the economy as a whole are:

Economists refer to this as the Circular Flow of Economic Activity

Businesses (Producers), households (Individuals), and the government depend

Circular Flow Model

policy advisors, economists make normative statements, which attempt to

Methodology: Positive v. Normative Economics

Methodology: Positive v. Normative Economics

Prices can be output prices or input prices

Input prices –prices of inputs, resources used to produce final products or

Other Microeconomic Influences on Managers

A firm/company’s production technology

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