Introduction

ECONOMICS
Introduction
Introduction
 What are the key themes of

microeconomics?
 What is a market?
 What is the difference between real and
nominal prices?
 Why study microeconomics?
Themes of Microeconomics
 Microeconomics deals with limits

Limited budgets
Limited time
Limited ability to produce
 How do we make the most of limits?
 How do we allocate scarce resources?
 Workers, firms and consumers must

make trade-offs
Do I work or go on vacation?
Do I purchase a new car or save my money?
Do we hire more workers or buy new
machinery?
 How are these trade-offs best made?
 Consumers
Limited incomes
Consumer theory – describes how
consumers maximize their well-being, using
their preferences, to make decisions about
trade-offs
How do consumers make decisions about
consumption and savings?
 Workers
Individuals decide when and if to enter the
workforce
 Trade-offsof working now or obtaining more
education/training
What choices do individuals make in terms of
jobs or workplaces?
How many hours do individuals choose to
work?
 Trade-off of labor and leisure
 Firms
What types of products do firms produce?
 Constraints
on production capacity and financial
resources create needs for trade-offs
Theory of the Firm – describes how these
trade-offs are best made
 Prices
Trade-offs are often based on prices faced
by consumers and producers
Workers make decisions based on prices for
labor – wages
Firms make decisions based on wages and
prices for inputs and on prices for the goods
they produce
 Prices
How are prices determined?
 Centrally planned economies – governments
control prices
 Market economies – prices determined by
interaction of market participants
Markets – collection of buyers and sellers
whose interaction determines the prices of
goods
Why Study Microeconomics?
 Microeconomic concepts are used by

everyone to assist them in making
choices as consumers and producers
 Examples show the numerous levels of
microeconomic questions necessary in
many decisions
Positive Economics
 The study of economics based on objective analysis. Most
economists today focus on positive economic analysis,
which uses what is and what has been occurring in an
economy as the basis for any statements about the future.
Positive economics stands in contrast to normative economics,
which uses value judgments.
 For example, a positive economic statement would be:
"Increasing the interest rate will encourage people to save."
This is considered a positive economic statement because it
does not contain value judgments and its accuracy can be
tested.
Most of the information we hear in the media today is a
combination of positive and normative economic statements or
theories. Because of this, investors should always be careful to
separate out what is objective and what is subjective analysis.
Normative Economics
 A perspective on economics that incorporates subjectivity
within its analyses. It is the study or presentation of "what
ought to be" rather than what actually is. Normative
economics deals heavily in value judgments and theoretical
scenarios. It is the opposite of positive economics.
 Normative statements are often heard in the media because
they tend to represent a theory or opinion rather than
objective analysis. Normative economics is a valuable way
to establish goals and generate new ideas, but it should
not be used as a basis for policy decisions.
 An example of a normative economic statement would be,
"We should cut taxes in half to increase disposable income
levels". By contrast, a positive (or objective) economic
observation would be, "Big tax cuts would help many
people, but government budget constraints make that option
infeasible.“
(Source: Investopedia)
Production Possibility Frontier –
PPF
 A curve depicting all maximum output possibilities for two or
more goods given a set of inputs (resources, labor, etc.).
The PPF assumes that all inputs are used efficiently.
 As indicated on the chart above, points A, B and C
represent the points at which production of Good A and
Good B is most efficient. Point X demonstrates the point at
which resources are not being used efficiently in the
production of both goods; point Y demonstrates an output
that is not attainable with the given inputs.
 Among others, factors such as labor, capital and technology
will affect where the production possibility frontier lies. The
PPF is also known as the production possibility or
transformation curve.
Production Possibility Frontier –
PPF
Economic System
 Economic system is the sum total of the

devices by which the preference among
alternative purposes of economic activity
is determined and by which individual
activities are coordinated for the
achievement of these purposes. The
central problem of an economic system
is the allocation of resources.
Economic System
 For business, the economic system is a

parameter and the former can do little
about it. In fact, business has no choice
but to adjust itself within the framework of
the given economic system.
Economic System
 The three central problems of an economy
viz. what to produce, how to produce and
for whom to produce are solved in by the
business in a capitalist economy freely in
the framework of market mechanism. As
against this, the role of business is much
less important in a socialist economy
because economic planning occupies the
central stage under it.
Capitalism
 The politco-economic system based on
private property and private profit.
 A concept of economics based on Laissez-
faire where the market forces of supply and
demand determine the allocation of
resources. The role of the government in the
functioning of the economy is minimized.
 However, emergence of big MNCs as
monopolies has necessitated the
intervention of the government to provide a
level playing ground for all manufacturers.
Socialism
 In a socialist economy, the responsibility

of taking all decisions related to
production and economic development
lies with the state. All factors of
production other than labor are owned by
the government. Business has a highly
regulated and limited role to play.
Real Versus Nominal Prices
 Comparing prices across time requires

measuring prices relative to some overall
price level
Nominal price is the absolute or current
dollar price of a good or service when it is
sold
Real price is the price relative to an
aggregate measure of prices or constant
dollar price
 Consumer Price Index (CPI) is often

used as a measure of aggregate prices
Records the prices of a large market basket
of goods purchased by a “typical” consumer
over time
Percent changes in CPI measure the rate of
inflation
 Calculating Real Prices
CPIbase year
RealPrice  x Nominal Pricecurrent year
baseyear CPIcurrent year
Real Price of College
Year Nom. CPI Real Price
Price
1970 $2,530 38.8 38.8

 * $2,530  $2,530
38.8
1990 $12,018 130.7 

38.8
* $12,018  $3,569
130.7
38.8
2002 $18,273 181.0 
181.0
* $18,273  $3,917
Ford SUV’s
 Built Ford Explorer in 1991, Ford

Expedition in 1997 and Ford Excursion
in 1999
 In each of these cases, Ford had to
consider many aspects of the economy
to ensure their introduction was a sound
investment
Ford SUV’s
 Questions
How strong is demand and how quickly will it
grow?
 Mustunderstand consumer preferences and
trade-offs
What are the costs of manufacturing?
 Givenall costs of production, how many should
be produced each year?
Ford SUV’s
 Questions (cont.)
Ford had to develop pricing strategy and
determine competitors’ reactions
Risk analysis
 Uncertainty of future prices: gas, wages
Organizational decisions
 Integration of all divisions of production
Government regulation
 Emissions standards
Emission Standards
 1970 Clean Air Act imposed emissions

standards and have become increasingly
stringent
Questions:
 What are the impacts on consumers?
 What are the impacts on producers?
 How should the standards be enforced?
 What are the benefits and costs?

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ECONOMICS

 What are the key themes of

 Microeconomics deals with limits

 Workers, firms and consumers must

 Microeconomic concepts are used by

 Economic system is the sum total of the

 For business, the economic system is a

 In a socialist economy, the responsibility

 Comparing prices across time requires

 Consumer Price Index (CPI) is often

 Calculating Real Prices

1970 $2,530 38.8 38.8

1990 $12,018 130.7 

 Built Ford Explorer in 1991, Ford

 1970 Clean Air Act imposed emissions

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