Microeconomics

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Microeconomics

• Fall 2007

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Scarcity and Social Choice

• The problem for society is a scarcity of
  resources
• Labor
• Capital
• Human capital
• Physical Capital
• Land/natural resources
• Entrepreneurship
• Technology

3
Coordination in Economics three big Problems

• Any economic system must solve three coordination
  problems
• What, and how much, to produce.
• How to produce it.
• For whom to produce it.

4

• Economics Reasoning
• People are rational
• People respond to Economic Incentives
• Optimal Decisions are made at margins

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Invisible hand theory
Adam Smith
1776 book An Inquiry into the Nature and Causes
of the wealth of Nations
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The Invisible Hand Theory

• Price has a tendency to fall when the quantity
  supplied is greater than the quantity demanded.
• Price has a tendency to rise when the quantity
  demanded is greater than the quantity supplied.

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• Microeconomics
• is the study of individual choice, and how that
  choice is influenced by economic forces
• Macroeconomics
• Study of the economy as a whole

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Positive economics vs. Normative economics

• Positive economics
• A statement can be tested, proven or proven
  false.
• The scientific study of what is among economic
  matters.
• A positive economics can be true or false.

• Normative economics
• Judgments about what ought to be in economic
  matters.
• Cannot be proved false, because they are based on
  opinion.
• A normative economics can be true or false.

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Economists Fight

• "Economics is the only field in which two people
  can share a Nobel Prize for saying opposing
  things."
• Specifically, Myrdal and Hayek shared one.

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• 18981987, Swedish economist, sociologist, and
  public official
• His wife, Alva Myrdal won the Nobel Peace Prize
  in 1982.

• Friedrich von Hayek born May 8, 1899, Vienna,
  Austriadied March 23, 1992, Freiburg, Germany

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Why Economists Disagree

• In some cases, the disagreement may be positive
  in nature because
• Our knowledge of the economy is imperfect
• Certain facts are in dispute
• In most cases, the disagreement is normative in
  nature because
• While the facts may not be in dispute
• Differing values of economists lead them to
  dissimilar conclusions about what should be done

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Economists disagree
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The Methods of Economics

• Economics relies heavily on modeling
• Economic theories must have a well-constructed
  model
• While most models are physical constructs
• Economists use words, diagrams, and mathematical
  statements

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Economic Models

• "Economists do it with models"
• What is a model?
• Abstract representation of reality

Economics
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Clever faces

• )
• ? ?
• (
• ? ?

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More

• -Q

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More

• O-)

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More

• Q-)

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More

• O

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More

• C-)

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More

• d-)

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More

• -)

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More

• 5-)

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More

• -.)

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More

• ltO)

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More

• -B

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More

• )-)

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More

• lt-(

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More

• -

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Example on model

• A map is a model.
• If your purpose is to find the best way to drive
  from Lexington to Cincinnati.
• A highway map is needed
• If you purpose is to find how to get to Keeneland
  from B.E. building
• A city map is needed

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The Art of Building Economic Models

• Guiding principle of economic model building
• Should be as simple as possible to accomplish its
  purpose
• Level of detail that would be just right for one
  purpose will usually be too much or too little
  for another
• Even complex models are built around a simple
  framework

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Assumptions and Conclusions

• Types of assumptions in an economic model
• Simplifying assumptions
• Way of making a model simpler without affecting
  any of its important conclusions
• Critical assumptions
• Affect conclusions of a model in important ways
• If critical assumptions are wrong model will be
  wrong
• All economic models have one or more critical
  assumptions

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GRAPHISH THE LANGUAGE OF GRAPHS
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Presenting Information Visually
(a) Line graph
(c) Pie chart
(b) Bar graph
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(No Transcript)
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Graphing A brief review

• Variables a quantity that is free to take a
  range of different values. E.g. Xs and Ys
•  Functions (Equations) a mathematical expression
  that describes the relationship between two or
  more variables.
• Yf(X)
•  
• Y is a function of X
•  Y dependent (endogenous) variable
•   a variable in an equation whose value is
  determined by the value taken by another variable
  in the equation
• X independent (exogenous) variable.
• a variable in an equation whose value determines
  the value taken by another variable in the
  equation
• Constant (parameter) a quantity that is fixed
  in value

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Number Lines
40
30
20
B
10
A
0

- 3
- 2
- 10
- 20
Horizontal number line
- 30
- 40
Vertical number line
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Coordinate Geometry
Y
4 3 2 1
(X, Y)
X
-4 -3 -2 -1 1 2 3 4
O
-1 -2
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Coordinate Geometry

• The figure above shows the (rectangular)
  coordinate plane. The horizontal line is called
  the x-axis and the perpendicular vertical line is
  called the y-axis. The point at which these two
  axes intersect, designated O, is called the
  origin. The axes divide the plane into four
  quadrants. 1,2 ,3 and 4, as shown.

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Coordinate Geometry

• Each point in the plane has an x-coordinate and a
  y-coordinate. A point is identified by an ordered
  pair (x, y) of numbers in which the x-coordinate
  is the first number and the y-coordinate is the
  second number.
• (4,5) means that the point is 4 units to the
  right of the y-axis ( that is x4) and 5 units
  above the x-axis ( that is y5). The origin has
  coordinates (0,0)

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Coordinate System
40
30
B
(1, 20)
20
A
10
(4, 5)
0
1
2 3
4
5
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From Table to Graph
Quantity of pens
3.00
2.50
2.00
Price of pens (in dollars)
1.50
1.00
.50
0
1 2 3 4 5 6 7 8
Quantity of pens bought
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Linear and Nonlinear Curves
6
5

4
Price (in dollars)
Price (in dollars)
3
2
1
0
10
20
30
40
Quantity
Quantity
Linear Curve
Nonlinear Curve
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Linear Equation

• Linear Equations
• Y a bX
• a is called vertical intercept, it determines the
  graph position.
• b is called the slope. It can be positive,
  negative or 0.

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Slope

• Y a bX
• Slope (straight-Line Graphs)
• tells how much Y will change every time X changes
  by one unit
• slope of a straight line
• change in vertical variable/change in
  horizontal variable.
• rise / run ?Y/ ?X

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Example telephone bills

• Let Ycost of an international phone call
• Let Xlength of call in minutes 
• 2 initial connection fee
• 50 cents per minute
• functional relationship between X and Y
•  
• Y f(x) 2 .5 X

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From Table to Graph
Quantity of pens
3.00
2.50
2.00
Price of pens (in dollars)
1.50
1.00
.50
0
1 2 3 4 5 6 7 8
Quantity of pens bought
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Slopes of Curves
c
10
Slope 1
9
d
Rise 1
A
8

Slope 4
Run 1
Slope - 4
7
Rise 4
6
Rise - 4
5
B
4
Run 1
Run 1
e
Slope -0.5
3
L
a
Rise -1
2
Slope 1
Run 2
E
b

1
Rise 1
e
Run 1
0
1 2 3 4 5 6
7 8 9 10 11
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Positive relationship v.s. Negative relationship

• Suppose YGPA
• Xnumber of hours spent
  studying per week
•  
• As X increases, what do you expect to happen to
  Y?
• As X increases, Y increases.
• positive (or direct) relationship
• Suppose YGPA
• Xnumber of hours spent
  watching TV
•  
• As X increases, what do you expect to happen to
  Y?
• As X increases, Y decreases.
• negative (or indirect) relationship

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Inverse and Direct Relationships
positive relationship When X goes up, Y goes
up When X goes down, Y goes down
negative relationship When X goes up, Y goes
down When X goes down, Y goes up
X
X
Y
Y
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• Y 2 0.5 X

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Solve for the linear equation

• Step (1) Pick any two points.
• (X2,Y2) (1, 2.5) (X1,Y1) (0, 2)
• Step (2)  Plug into formula
• slope ?Y/?X
• (Y2 - Y1)/(X2 - X1)
• (2.5 2)/(1 0)
• .5/1
• .5
• INTERPRETING THE SLOPE
• Slope tell us what happens to Y as X increases by
  ONE unit.
• Equation of a line Y a bX ? Y a .5X
• Substituting any point value, say, (0, 2) ?2 a
  .5 x 0 ?a2
• So, Y 2 .5 X

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Example on advertising and sales
Table A.1 Advertising and Sales at Len Harrys
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Example on advertising and sales
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Solve for the straight line function

• First, calculating slope
• Step 1, pick up 2 points
• (X1,Y1)(2,46), (X2,Y2)( 6,58)
• Step 2, plug into formula
• Slope (Y2 - Y1)/ (X2 X1)
• (58-46)/(6-2)
• 12 / 4
• 3
• b
• So Y a 3X, plug in any point value for X
  and Y. e.g. (2,46)
• 46 a 3x2,
• So a 46 6 40,
• And Y 40 3X