Chapter 1

Introduction

McGraw-Hill/Irwin

Copyright 2008 by The McGraw-Hill Companies, Inc. All

Rights Reserved.

Main Topics
What is microeconomics?
Tools of microeconomics
Themes of microeconomics
Uses of microeconomics

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The Focus of Economics

Scarcity forces societies to confront three
critical issues:
What to produce
How to produce goods
Who gets what

Economics examines how societies

address these three issues: allocation of
scarce resources
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What is Microeconomics?
Microeconomics: concerns individual
decision making and its collective effect
on allocation of a societys resources
Macroeconomics: concerns aggregate
phenomena
Much of modern macroeconomics
involves applications of microeconomics
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Institutions for Allocation

Resources
Institutions, including laws and customs,
define a societys procedures for
allocating resources
In a capitalist economy:
Means of production are owned and
controlled by and for the benefit of private
individuals
Resources are allocated by voluntary
trading among businesses and consumers
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Institutions for Allocation of

Resources
In a communist economy:
Economic decisions are highly centralized
The state owns and controls the means of
production and distribution

No economy is completely centralized or

decentralized; all economies are a combination
of both.
Examine statistics on the size of government
for a rough measure of centralization
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Markets
Markets are the most common form of
economic decentralization
Markets are economic institutions that
provide people with opportunities and
procedures for buying and selling goods
and services
May be governed by explicit rules (e.g.,
NYSE) or by custom (e.g., open bazaar)
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What is a Market?
In microeconomics, a market is:
Associated with a single group of closely
related products
Offered for sale within particular geographic
boundaries

Products belong to the same market

when they are highly interchangeable
Some markets may be worldwide
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Characteristics of Markets
Markets include buyers and sellers
Often, but not always, sellers are companies
and buyers are individuals
Trade in modern markets is usually governed
by price, the rate at which someone can swap
money for a good
Markets can function only if a system of
transferable property rights is established and
enforced
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Economic Motives
Need to understand individual motives to
determine what choices they will make
Assume people are motivated by self-interest:
Desire for goods and services
Can include possibility that someone might care
about someone elses well-being

Same motivation even if acting as consumer,

firm, or employee

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Positive Economic Analysis

Positive economic analysis: addresses factual
questions, typically about economic choices or
market outcomes
What did happen? What will happen? What would
happen?
Historical fact-finding
Forecasting
Cause-and-effect analysis of actions and their
consequences

Stick to objective facts and avoid value

judgments
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Normative Economic Analysis

Normative economic analysis: addresses
questions that involve value judgments
concerning the allocation of resources
What ought to happen?

Turn normative questions into positive

questions using the principle of individual
sovereignty

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Scope of Microeconomics
Broad definition of resources, not just about
money (time, for example)
Range of topics is extremely wide:
Marriage
Crime
Addiction
Environment

Many ways decisions by many individuals

combine to produce social outcomes
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Tools of Microeconomics
Economists use the scientific method:
Initial observation
Theorizing
Identification of additional implications
Further observation and testing
Refinement of the theory

A useful theory must have broad

application but also specific implications
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Models and Mathematics

Model: a simplified representation of a
complex phenomenon
Economists use models to provide an
account of cause and effect, to help us
understand how the world works
Some economic models are quantitative
(mathematical) so that they are more
precise
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Simplifying Assumptions
All scientists build models based on
assumptions, so do economists
This allows the model to focus on the
most important explanations for a
particular phenomenon
No economic model is literally true
Some assumptions are easy to criticize
The test of a model is its usefulness
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Data Analysis
Scientific method requires models to be tested
with data, e.g., from:
Records (financial accounts, customer databases)
Surveys (Consumer Expenditure Survey, other
government or private sources)
Experiments

Econometrics: application of statistical

methods to empirical questions in economics

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Why Economists Disagree

Even with scientific method, still room to
disagree
Differences in scientific judgment lead to
disagreements on positive questions
e.g. Look at the same data but come to a different
conclusion
Likely began from different assumptions; may be
able to resolve by empirically testing assumptions

Cant resolve normative disputes that arise

from differences in values
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Themes of Microeconomics:
Decisions
Theme 1: Trade-offs are unavoidable
Theres no such thing as a free lunch

Theme 2: Good choices are made at the

margin
Most decisions are a matter of degree

Theme 3: People respond to incentives

Theme 4: Prices provide incentives
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Themes of Microeconomics:
Markets
Theme 5: Trade can benefit everyone
Theme 6: The competitive market price
reflects both value to consumers and
cost to producers
Theme 7: Markets have advantages
Theme 8: Sometimes governments can
improve on free-market resource
allocations
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Uses of Microeconomics
Why study microeconomics? Its useful!
Tools for understanding and evaluating
the effect of public policies
Help make important personal and
business decisions
Stresses thinking at the margin,
importance of trade-offs
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Uses of Microeconomics
Applications of microeconomics:
Business investments
Portfolio management
Replacing an old car
Environmental policy
.and many others

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