MICROECONOMICS

Subtopic 1: Limits, Alternatives, and Choices

Economics
Ex: Economists say that consumers buy more
➢ A social science concerned with making
of a particular product when its price falls.
optimal choices under conditions of scarcity.
➢ Economic wants exceed society’s productive
➢ Other-things-equal assumption (Ceteris paribus)
capacity.
➢ The assumption that factors other than those
being considered do not change. They assume
The Economic Perspective that all variables except those under immediate
consideration are held constant for a particular
• Scarcity and choice. analysis
• Opportunity cost.
• Purposeful behavior to increase utility. Ex: when considering the relationship
• Marginal analysis. between the price of Pepsi and the amount
of Pepsi that is purchased, economists do not
Scarcity and Choice
take into account all the factors that might
• Resources are scarce. influence the amount of Pepsi purchased.
• Choices must be made.
• Opportunity cost. ➢ Graphical expression
• There is no free lunch

Purposeful Behavior MICRO and MACRO

• Rational self-interest. Microeconomics
• Individuals and utility.
• Firms and profit. ➢ The study of the individual consumer, firm, or
• Desired outcome. market.
➢ Concerned with decision making by individual
Marginal Analysis customers, workers, households, and business
firms.
• Marginal benefit.
➢ Measures the price of a specific product, the
• Marginal cost.
revenue or income of a particular firm or
• Marginal means “extra”.
household, or the expenditure of a specific firm,
• Comparison between marginal benefit and
government entity, or family.
marginal cost.

Macroeconomics
Theories, Principles, and Models
➢ The study of the entire economy or a major
The Scientific Method
aggregate of the economy.
• Observe. ➢ Examines the performance and behavior of the
• Formulate a hypothesis. economy as a whole.
• Test the hypothesis. ➢ Focuses on economic growth, The business
• Accept reject or modify the hypothesis. cycle, interest rates, inflation, and the behavior
• Continue to test the hypothesis, if necessary of major economic aggregates such as the
government, household, and business sectors.

Aggregate – a collection of specific economic units

Economic Principles
treated as if they were one unit.
➢ Generalizations
➢ Economic Principles are generalizations.
➢ Expressed as the tendencies of typical or
average consumers, workers, or business firms.
Positive Economics (what is) Society’s Economizing Problem
➢ Economic statements that are factual. Four categories of economic resources
➢ Focuses on facts and cause-and-effect
relationships. • Land - all natural resources used in the
production process.
Normative Economics (what ought to be)
• Labor - consist of the physical actions and
➢ Economic statements that involve value
mental activities that people contribute to the
judgments.
production of goods and services.
➢ Underlies expressions of support for particular
economic policies.
• Capital – all manufactured aids used in
producing consumer goods and services
The Economizing Problem (factory, storage, transportation, and
distribution facilities as well as tools and
➢ The need to make choices because economic machinery)
wants exceed economic means.
❖ Economist use the term investment to describe
• Limited income and unlimited wants. spending that pays for the production and
accumulation of capital good
• The budget line or budget constraint
- a schedule or curve that shows various • Entrepreneurial ability – driving force behind the
combinations of two products a consumer can production.
purchase with a specific income.
❖ Because land, labor, capital, and
• Attainable and unattainable combinations. entrepreneurial ability are combined to
produce goods and services, they are called
• Trade-offs and opportunity costs. the factors of production or simply “inputs”

• Choice
Entrepreneurs
• Income Changes
• Employ the other factors of production.
• Take initiative.
• Make strategic business decisions.
The Consumer’s Budget Line
• Innovate.
A schedule or curve that shows various • Take risk.
combinations of two products a consumer can
Production Possibilities Model
purchase with a specific income (Page 5)
• Economic model that shows different
combinations of two goods that an economy
can produce.
• Full employment.
• Fixed resources.
• Fixed technology.
• 2-good economy.
• Consumer goods and capital goods.
Production Possibilities Table Increasing Opportunity Costs
➢ Lists the different combinations of two products Law of increasing opportunity costs
that can be produced with a specific set of
• As more of a particular good is produced, its
resources, assuming full employment (Page 9)
marginal opportunity costs increase.

Production possibilities curve

• Concave shape.
• Economic rationale.

Optimal Allocation

Generalization: At any point in time, a fully employed

economy must sacrifice some of one good to obtain
more of another good. Scarce resources prohibit a fully
employed economy from having more of both goods.
Having more of one thing means having less of
something else.

Production Possibilities Graph

This curve displays the different combinations of
goods and services that society can produce in a
fully employed economy, assuming a fixed
availability of supplies of resources and fixed
technology.

REVIEW
❖ The production possibilities curve illustrates
several ideas: (a) Scarcity of resources is implied
by the unattainable combinations of output
lying outside the production possibilities curve;
(b) choice among outputs is reflected in the
❖ Each point on the production possibilities curve
variety of attainable combinations of goods
represents some maximum output of two products if
resources are fully employed. The curve is a “constraint” lying along the curve; (c) opportunity cost is
because it shows the limit of attainable outputs. Points on illustrated by the downward slope of the curve;
the curve are attainable as long as the economy uses all (d) the law of increasing.
its available resources. Points are also attainable, but they
reflect less total output and therefore are not as desirable ❖ A comparison of marginal benefits and
as points o the curve. Points beyond the production marginal costs is needed to determine the best
possibilities curve, like W, represent a greater output than or optimal output mix on a production
the output at any point on the curve. Such points,
possibilities curve
however, are unattainable with the current resources
and tech
Unemployment, Growth, and the Future REVIEW:

❖ Unemployment causes an economy to operate

at a point inside its production possibilities curve.

❖ Increase in resource supplies, improvement in

resource quality, and technology advance
cause economic growth, which shifts the
production possibilities curve outward.

❖ An economy’s present choice of capital and

consumer goods helps determine its future
production curve.
❖ International specialization and trade enable a
nation to obtain more goods than its production
possibilities curve indicates.

(Page 12) International Trade

• Specialization
• Increased production possibilities
Present Choices and Future Possibilities
Subtopic 2: The Market System and the Circular Flow

➢ Turkmenistan, Laos, Belarus, Myanmar,

Economic Systems Venezuela, and Iran (uses mainly command
• Set of institutionalized arrangements. system)
• Coordinating mechanism.
• Determines what goods are produced, how
The Market System
they are produced, who gets them, how to
accommodate change, how to promote ➢ Also known as capitalism or the mixed
technological progress. economy.
Economic systems differ as to:
➢ A mixture of centralized government economic
1. Who owns the factors of production initiatives and decentralized actions taken by
2. The method used to motivate, coordinate, and individuals and firms.
direct economic activity.
➢ Systems found in much of the world.
Differences in systems exist by • Private markets are dominant force.
• Private ownership of resources.
• Degree of decentralized use of markets and
prices in decision-making.
➢ Self-interested behavior.
• Degree of centralized government control.
➢ Offers high potential monetary rewards that
create powerful incentives for existing firms to
Laissez-Faire Capitalism innovate and for entrepreneurs to pioneer new
products and processes.
➢ Pure capitalism, Ideal economy

➢ Government intervention is minimal and Characteristics of the Market System

markets and prices direct nearly all economic Private Property
activity.
➢ The right of private persons and firms to obtain,
➢ Keep the government from interfering with the own, control, employ, dispose of, and bequeath
economy. land, capital and other property.

➢ The government’s role is limited to protecting ➢ Property rights encourage people to cooperate
private property and establishing a legal by helping to ensure that only mutually
environment in which contracts are enforced agreeable economic transactions take place.
and people interact in markets to buy and sell
goods, services, and resources. ➢ Property rights also encourage investment,
innovation, maintenance of property, and
economic growth.
The Command System
➢ known as socialism or communism. Freedom of Enterprise
➢ Ensures that entrepreneurs and private
➢ The government owns most property resources businesses are free to obtain and use economic
and economic decision-making is set and resources to produce their choice and services
enforced by the government. and to sell them in their chosen markets.

➢ Decisions made by a central planning board.

➢ North Korea, Cuba, Myanmar (last prominent

remaining examples of largely centrally
planned economies.)
Freedom of Choice Technology and Capital Goods
➢ Allows owners to employ or dispose of their ➢ Advanced technology and capital goods are
property and money as they see fit. important because the most direct methods of
➢ Allows workers to try enter any line of work for production are often the least efficient.
which they are qualified
➢ Ensures that customers are free to buy goods ➢ Only way to avoid that inefficiency is to rely on
and services that best satisfy their want and that capital goods.
their budgets allow.
➢ More efficient production means much more
Self- Interest output.
➢ Motivating force, simply means that each
economic unit tries to achieve its own particular Specialization
goal.
➢ Means using the resources of an individual, firm,
Competition region, or nation to produce one or a few
➢ Two or more buyers and two or more sellers goods or services rather than the entire range of
acting independently in a particular product or desired goods and services.
resource market.
Division of Labor
➢ Freedom of sellers and buyers to enter or leave
(exit) markets, on the basis of their economic ➢ Human specialization.
self-interest. • Specialization makes use of differences in
ability.
➢ Competition among buyers and sellers diffuses • Specialization fosters learning by doing.
economic power throughout the economy. • Specialization saves time.

Geographic Specialization

Market and Prices ➢ Specialization also works on a regional and

international basis.
➢ Key components of market systems.

➢ Conveys the decisions made by buyers and Use of Money

sellers of products and resources.
➢ A medium of exchange, makes trade easier.
➢ Barter - swapping goods for goods. Requires
➢ The system of markets and prices is the
coincidence of wants.
organizing and coordinating mechanism.

REVIEW:

❖ The market system rests on the private ownership of Active, but limited, Government
property and on freedom of enterprise and freedom
➢ Is the final characteristic of modern market
of choice.
systems.
❖ Property rights encourage people to cooperate and ➢ Government may be needed to alleviate
make mutually agreeable economic transactions. market failures.
➢ Government can increase effectiveness of a
❖ The market system permits consumers, resource market system.
suppliers, and business to pursue their self-interest. ➢ Possible government failure.

❖ Competition diffuses economic power and limits the

actions of any single seller or buyer.

❖ The coordinating mechanism of capitalism is a system

of markets and prices.
REVIEW: Invisible Hand
❖ The market systems of modern industrial economies ➢ Competition leads individuals and firms to
are characterized by extensive use of technologically promote the social interest, as If they were
advanced capital goods.
guided by a benevolent “invisible hand.”
❖ Specialization is extensive in market systems; it
enhances and output by enabling individuals, ➢ 1776 Wealth of Nations by Adam Smith
regions, and nation to produce the goods and • Unity of private and social interest.
services for which their resources are best suited.
➢ Virtues of the market system:
❖ The use of money in market systems facilitates the • Efficiency – encourages the development
exchange of goods and services that specialization and adoption of new and more efficient
requires. production techniques.
Five Fundamental Questions
• Incentives – the market system encourages
❖ What will be produced? skill acquisition, hard work, innovation, and
➢ The goods and services that can be entrepreneurship.
produced at a continuing profit will be
produced. • Freedom – The major noneconomic
➢ Consumer Sovereignty argument for the market system is its
➢ Dollar votes emphasis on personal freedom.
o Method for consumers to determine
which goods will be produced
The Demise of the Command Systems
o Determines which products and
industries survive or fail. ➢ Soviet Union, eastern Europe, and China.
➢ The Coordination Problem
❖ How will the goods be produced? - Set output targets for all goods.
➢ In combinations and ways that minimize the ➢ The Incentive Problem
cost per unit of output. - No adjustments for surplus or shortage.
• Technology
• Prices of the necessary resources.
The Circular Flow Model
❖ Who will get the output?
➢ The dynamic market economy creates
➢ Consumers with the ability and willingness to
continuous, repetitive flows of goods and
pay will get the product.
services, resources, and money.
➢ Ability to pay depends on income.
➢ The circular flow model illustrates how resources
❖ How will the system accommodate change?
flow households to businesses and how
➢ Change in consumer tastes
payments for those resources flow from
➢ Change in technology
businesses to households.
➢ Change in resource prices

❖ How will the system promote progress? Circular flow diagram

➢ Technological advance
• Creative destruction – the creation of new
products and production methods
completely destroys positions of firms that are
wedded to existing products and older ways
of doing business.

➢ Capital Accumulation
Households Shielding Employees and Suppliers from Business
Risk
➢ One or more persons occupying a housing unit.
➢ Because everyone else is legally entitled to get
➢ Household buy the goods and services that paid before the firm’s owners, the firm’s owners
business make available in the product market. are called Residual Claimants
- Owners receive (claim) whatever profit or
➢ Household obtain the income needed to buy loss remains (is residual) after all other parties
those products by selling resources in the have been paid.
resource market.

Businesses
Benefits of Restricting Business risk to Owners
➢ Commercial establishments that attempt to
➢ Attracting Inputs
earn profits
➢ Focusing Attention
• Sole proprietorship – business owned and
managed by a single person.
❖ By focusing risk on owners and investors, the
market system;
• Partnership – two or more individuals agree
a. Creates an incentive for owners and investors to
to own and operate a business together.
hire managerial and entrepreneurial specialist to
prudently manage business risk.
• Corporation – an independent legal entity
that can acquire resources, own assets, b. Encourages the participation of workers, suppliers
produce and sell products, incur debts, and lenders who dislike risk.
extend credit, sue and be sued, and
otherwise engage in any legal business
activity.
Shuffling the deck
➢ Extremely large number of ways to arrange a
deck of cards.
Product Market
➢ Arrangement of economy’s resources is even
➢ Where households purchase the goods and larger.
services produced by businesses. ➢ Avoid random outcomes in market due to.
• Private property.
• Rational decisions about property.
Resources Market

➢ Where households sell resources to business.

How the system deals with risk

➢ Business risks are restricted to owners.

➢ Attracts needed inputs:
• Inputs easier to obtain since many dislike risk.
➢ Focuses attention:
• Owners personally responsible for outcome.
• Will encourage prudent decisions.
➢ Manage risk well and the owners will prosper.

The Profit System

➢ Entrepreneurs have a large financial incentive

to avoid unnecessary risks and make prudent
decisions.