Chapter 1
Preliminaries
Chapter 1,Preliminaries Slide 2
Topics to be Discussed
? The Themes of Microeconomics
? What Is a Market?
? Real Versus Nominal Prices
? Why Study Microeconomics?
Chapter 1,Preliminaries Slide 3
Preliminaries
? Microeconomics deals with,
? Behavior of individual units
?When Consuming
? How we choose what to buy
Chapter 1,Preliminaries Slide 4
Preliminaries
? Microeconomics deals with,
? Behavior of individual units
?When Producing
? How we choose what to produce
Chapter 1,Preliminaries Slide 5
Preliminaries
? Microeconomics deals with,
? Markets,The interaction of consumers and
producers
Chapter 1,Preliminaries Slide 6
Preliminaries
? Macroeconomics deals with,
? Analysis of aggregate issues,
?Economic growth
?Inflation
?Unemployment
Chapter 1,Preliminaries Slide 7
Preliminaries
? The Linkage Between Micro and Macro-
economics
? Microeconomics is the foundation of
macroeconomic analysis
Chapter 1,Preliminaries Slide 8
The Themes of Microeconomics
? According to Mick Jagger* & the Rolling
Stones
?“You can’t always get what you want”
*Economics degree from London School of Economics
Chapter 1,Preliminaries Slide 9
The Themes of Microeconomics
? Why Not?
?Limited Resources
Chapter 1,Preliminaries Slide 10
The Themes of Microeconomics
? Microeconomics
?Allocation of Scarce Resources and
Trade-offs
? In a planned economy
? In a market economy
Chapter 1,Preliminaries Slide 11
The Themes of Microeconomics
? Microeconomics and Optimal Trade-offs
1,Consumer Theory
2,Workers
3,Theory of the Firm
Chapter 1,Preliminaries Slide 12
The Themes of Microeconomics
? Microeconomics and Prices
?The role of prices in a market economy
?How prices are determined
Chapter 1,Preliminaries Slide 13
Theories and Models
? Microeconomic Analysis
? Theories are used to explain observed
phenomena in terms of a set of basic rules
and assumptions,
? For example
?The Theory of the Firm
?The Theory of Consumer Behavior
Chapter 1,Preliminaries Slide 14
Theories and Models
? Microeconomic Analysis
? Models,
? a mathematical representation of a
theory used to make a prediction,
Chapter 1,Preliminaries Slide 15
Theories and Models
? Microeconomic Analysis
? Validating a Theory
?The validity of a theory is determined by
the quality of its prediction,given the
assumptions,
Chapter 1,Preliminaries Slide 16
Theories and Models
? Microeconomic Analysis
? Evolving the Theory
?Testing and refining theories is central to
the development of the science of
economics,
Chapter 1,Preliminaries Slide 17
Positive Versus
Normative Analysis
? Positive Analysis
? Positive analysis is the use of theories and
models to predict the impact of a choice,
? For example,
?What will be the impact of an import
quota on foreign cars?
?What will be the impact of an increase in
the gasoline excise tax?
Chapter 1,Preliminaries Slide 18
Positive versus
Normative Analysis
? Normative Analysis
? Normative analysis addresses issues from
the perspective of,What ought to be?”
? For example,
?Consider the equity and efficiency trade-
off of an increase in the gasoline excise
tax versus import restriction on foreign
oil,
Chapter 1,Preliminaries Slide 19
What is a Market?
? Markets
? A geographically defined area where
buyers and sellers interact to determine the
price of a product or a set of products,
Chapter 1,Preliminaries Slide 20
What is a Market?
? Markets vs,Industries
? Industries are the supply side of the
market,
Chapter 1,Preliminaries Slide 21
What is a Market?
? Defining the Market
? The market parameters must be set before
an analysis of the market can take place,
Chapter 1,Preliminaries Slide 22
What is a Market?
? Arbitrage
? Buying a product at a low price in one
location and selling at a high price in
another
Chapter 1,Preliminaries Slide 23
What is a Market?
? Competitive vs,Noncompetitive Markets
? Competitive Markets
?Because of the large number of buyers
and sellers,no individual buyer or seller
can influence the price,
?Example,Most agricultural markets
Chapter 1,Preliminaries Slide 24
What is a Market?
? Competitive vs,Noncompetitive Markets
? Noncompetitive Markets
?Markets where individual producers can
influence the price,
?Example,OPEC
Chapter 1,Preliminaries Slide 25
What is a Market?
? Market Price
? Competitive markets establish one price,
? Noncompetitive markets may set many
prices for the same product,
Chapter 1,Preliminaries Slide 26
What is a Market?
? Market Definition & The Extent of a
Market
?Market Definition
?Which buyers and sellers should be
included in a given market
Chapter 1,Preliminaries Slide 27
What is a Market?
? Market Definition - The Extent of a
Market
?Market Extent
?Defines the boundaries of the market
? Geographic
? Range of products
Chapter 1,Preliminaries Slide 28
What is a Market?
? Examples
?Geographic boundaries
? Gasoline,US vs California
? Housing,Chicago vs a Chicago
neighborhood
Chapter 1,Preliminaries Slide 29
What is a Market?
? Examples
?Range of Products
? Gasoline,regular,super,& diesel
? Cameras,SLR’s,point & shoot,digital
Chapter 1,Preliminaries Slide 30
What is a Market?
? Examples
?Markets for Prescription Drugs
? Well-defined markets - therapeutic drugs
? Ambiguous markets - painkillers
Chapter 1,Preliminaries Slide 31
Real Versus Nominal Prices
? 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,
Chapter 1,Preliminaries Slide 32
Real Versus Nominal Prices
? The Consumer Price Index (CPI) is an
aggregate measure,
?Real prices are emphasized to permit the
analysis of relative prices,
Chapter 1,Preliminaries Slide 33
Real Versus Nominal Prices
? Calculating Real Prices
y e a rc u r r e n t
y e a rc u r r e n t
y e a rb a s e P r i c e N o m i n a l x
C P I
C P I
P r i c e R e a l ?(base year = 100)
Chapter 1,Preliminaries Slide 34
An Example,
Calculating the Real Price of Milk
1970,40 38.8,40 = 38.8/38.8 x,40
1980,65 82.4,31 = 38.8/82.4 x,65
1999 1.05 167.0,24 = 38.8/167.0 x 1.05
Nominal Price Real Price of Milk
Year of Milk CPI in 1970 dollars
Chapter 1,Preliminaries Slide 35
Calculating Real Prices,
An Example - Eggs & College
$ 4,5 7 3$ 1 9,2 1 3x 1 6 3, 03 8, 8 ??
Real Price of a
College Education
1998 (1970 = 100)
1, 0 4x1633 8,8E g g s of P r i c e R e a l 1970 ?1998 (1970 = 100)
Chapter 1,Preliminaries Slide 36
Calculating Real Prices,
An Example - Eggs & College
Consumer Price Index
(1983 = 100) 38.8 53.8 82.4 107.6 130.7 163.0
Nominal Prices
Grade A Large Eggs $0.61 $0.77 $0.84 $0.80 $0.98 $1.04
College Education $2,530 $3,403 $4,912 $8,156 $12,800 $19,213
Real Prices ($1970)
Grade A Large Eggs $0.61 $0.56 $0.40 $0.29 $0.30 $0.25
College Education $2,530 $2,454 $2,313 $2,941 $3,800 $4,573
1970 1975 1980 1985 1990 1998
Chapter 1,Preliminaries Slide 37
An Example,
The Minimum Wage
? Observations
1,The minimum wage has been
increasing in nominal terms since 1940,
2,The 1999 real minimum wage was no
higher in 1999 than 1950,
Chapter 1,Preliminaries Slide 38
An Example,
The Minimum Wage
? What Do You Think?
?What are the positive and normative issues
of raising the minimum wage?
Chapter 1,Preliminaries Slide 39
Why Study Microeconomics?
? Microeconomic concepts are used by
everyone to assist them in making
choices as consumers and producers,
Chapter 1,Preliminaries Slide 40
Why Study Microeconomics?
? Two Examples
?Ford and the development of its SUV’s
?Public Policy Design
?Automobile emission standards for the
21st century
Chapter 1,Preliminaries Slide 41
Why Study Microeconomics?
? Ford and the development of its SUV’s
? Questions
?Consumer acceptance and demand
?Production cost
?Pricing strategy
Chapter 1,Preliminaries Slide 42
Why Study Microeconomics?
? Ford and the development of its SUV’s
? Questions
?Risk analysis
?Organizational decisions
?Government regulation
Chapter 1,Preliminaries Slide 43
Why Study Microeconomics?
? Auto emission standards for the 21st
century
? Questions
?Impact on consumers
?Impact on producers
?How to enforce the standards
?What are the benefits and costs?
Chapter 1,Preliminaries Slide 44
Summary
? Microeconomics is concerned with the
decisions made by small economic
units,
? Microeconomics relies heavily on the
use of theory and models,
Chapter 1,Preliminaries Slide 45
Summary
? Microeconomics is concerned with
positive questions and normative
analysis,
? A market refers to a collection of buyers
and sellers who interact and to the
possibility for sales and purchases that
results from that interaction,
Chapter 1,Preliminaries Slide 46
Summary
? The market price is established by the
interaction of buyers and sellers,
? A market’s geographic boundaries and
range of products must be defined,
? To eliminate the effects of inflation we
measure real prices,rather than
nominal prices,
End of Chapter 1
Preliminaries