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Microeconomics

- Fall 2007

Scarcity and Social Choice

- The problem for society is a scarcity of

resources - Labor
- Capital
- Human capital
- Physical Capital
- Land/natural resources
- Entrepreneurship
- Technology

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.

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

Invisible hand theory

Adam Smith

1776 book An Inquiry into the Nature and Causes

of the wealth of Nations

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.

- Microeconomics
- is the study of individual choice, and how that

choice is influenced by economic forces - Macroeconomics
- Study of the economy as a whole

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.

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.

- 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

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

Economists disagree

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

Economic Models

- Economists do it with models
- What is a model
- Abstract representation of reality

Economics

Clever faces

- )
- (

More

- -Q

More

- O-)

More

- Q-)

More

- O

More

- C-)

More

- d-)

More

- -)

More

- 5-)

More

- -.)

More

- ltO)

More

- -B

More

- )-)

More

- lt-(

More

- -

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

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

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

GRAPHISH THE LANGUAGE OF GRAPHS

Presenting Information Visually

(a) Line graph

(c) Pie chart

(b) Bar graph

(No Transcript)

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

Number Lines

40

30

20

B

10

A

0

- 3

- 2

- 10

- 20

Horizontal number line

- 30

- 40

Vertical number line

Coordinate Geometry

Y

4 3 2 1

(X, Y)

X

-4 -3 -2 -1 1 2 3 4

O

-1 -2

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.

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)

Coordinate System

40

30

B

(1, 20)

20

A

10

(4, 5)

0

1

2 3

4

5

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

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

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.

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

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

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

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

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

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

- Y 2 0.5 X

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

Example on advertising and sales

Table A.1 Advertising and Sales at Len Harrys

Example on advertising and sales

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

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