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Time to Party…almostTime to Party…almost

Day 1 of MicroSections 1 & 2

Day 1 of MicroSections 1 & 2

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OverviewOverview

◊ Objective today is to review first two sections

◊ Goal is in & out in 30 minutes◊ More concerned with you paying

attention than taking notes

◊ Objective today is to review first two sections

◊ Goal is in & out in 30 minutes◊ More concerned with you paying

attention than taking notes

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Back to square 1Back to square 1

◊ Economics is the study of choices◊ Scarce (limited) resources force us

to decide what to do w/ them◊ In doing so we try to maximize

efficiency (most output/input)

◊ Economics is the study of choices◊ Scarce (limited) resources force us

to decide what to do w/ them◊ In doing so we try to maximize

efficiency (most output/input)

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Case in point…PPCCase in point…PPC

◊ Graph showing different combos of two goods

◊ Want to do as well as possible◊ Assuming full use of resources &

technology

◊ Graph showing different combos of two goods

◊ Want to do as well as possible◊ Assuming full use of resources &

technology

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Producers & consumersProducers & consumers

◊ Doesn’t matter who you are◊ Same goal…get as much as

possible◊ MU versus MP◊ Satisfaction versus profit◊ Get away from “study”◊ Get into “thought”

◊ Doesn’t matter who you are◊ Same goal…get as much as

possible◊ MU versus MP◊ Satisfaction versus profit◊ Get away from “study”◊ Get into “thought”

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Both guided by “invisible hand”Both guided by “invisible hand”◊ Self-regulating nature of market◊ We all do what’s good for us◊ Everyone doing that makes

everything function

◊ Self-regulating nature of market◊ We all do what’s good for us◊ Everyone doing that makes

everything function

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That becomes a problemThat becomes a problem

◊ Diff between command & market economies

◊ Markets are like pretty flowers◊ Command are like gym class◊ All decide What? How? For whom?◊ Command fail due to lack of incentive◊ Markets thrive on private property &

protection of ability to benefit from hard work

◊ Diff between command & market economies

◊ Markets are like pretty flowers◊ Command are like gym class◊ All decide What? How? For whom?◊ Command fail due to lack of incentive◊ Markets thrive on private property &

protection of ability to benefit from hard work

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Markets on auto pilotMarkets on auto pilot

◊ Millions of transactions per day◊ No one pulling strings◊ Products & money flow around the

circular flow model◊ Simplified model

◊ Millions of transactions per day◊ No one pulling strings◊ Products & money flow around the

circular flow model◊ Simplified model

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Factors of ProductionFactors of Production

◊ Stuff flows one way; money the other

◊ Factor market, product market◊ Sell factors of production◊ Buy products◊ Money is used to buy things, but is

not in itself a productive resource

◊ Stuff flows one way; money the other

◊ Factor market, product market◊ Sell factors of production◊ Buy products◊ Money is used to buy things, but is

not in itself a productive resource

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Part 2: S/D InteractionsPart 2: S/D Interactions

◊ We each pursue our own goals◊ Need other party to make it happen◊ Consumers BUY MORE WHEN PRICE

IS LOW◊ Producers SELL MORE WHEN PRICE

IS HIGH◊ Picture worth a million $

◊ We each pursue our own goals◊ Need other party to make it happen◊ Consumers BUY MORE WHEN PRICE

IS LOW◊ Producers SELL MORE WHEN PRICE

IS HIGH◊ Picture worth a million $

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Why demand down?Why demand down?

◊ Substitution Effect: buy cheaper item◊ Income Effect: math side; cheaper

prices mean you can buy more (more REAL buying power…REAL INCOME)

◊ Law of Diminishing MU: more & more gives you less & less• Not the same for everyone

◊ Substitution Effect: buy cheaper item◊ Income Effect: math side; cheaper

prices mean you can buy more (more REAL buying power…REAL INCOME)

◊ Law of Diminishing MU: more & more gives you less & less• Not the same for everyone

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Lots of things changeLots of things change

◊ Don’t worry about the list◊ What matters is effect◊ Think about “who” first◊ If makes us want more or less-Demand◊ If affects cost-Supply◊ Change in demand vs change in Q dem◊ Shift of vs shift along

◊ Don’t worry about the list◊ What matters is effect◊ Think about “who” first◊ If makes us want more or less-Demand◊ If affects cost-Supply◊ Change in demand vs change in Q dem◊ Shift of vs shift along

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Smelling roses on a spring daySmelling roses on a spring day◊ The market is self-correcting◊ Supply & demand never stationary◊ PRICES serve as signal

• Tell us how much to buy; them how much to make

◊ Keeps things in balance as price can adjust to EQUILIBRIUM

◊ The market is self-correcting◊ Supply & demand never stationary◊ PRICES serve as signal

• Tell us how much to buy; them how much to make

◊ Keeps things in balance as price can adjust to EQUILIBRIUM

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Our job is simpleOur job is simple

◊ As a consumer thought never progresses…buy what you want

◊ If it’s worth it, buy it◊ Consider dim MU & how important◊ ELASTICITY OF DEMAND

• Measures how we react to a change in price (how RESPONSIVE we are)

◊ As a consumer thought never progresses…buy what you want

◊ If it’s worth it, buy it◊ Consider dim MU & how important◊ ELASTICITY OF DEMAND

• Measures how we react to a change in price (how RESPONSIVE we are)

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Elasticity of DemandElasticity of Demand

◊ Equation(s)◊ We don’t care…we buy (or not)◊ Inelastic: E < 1; Q < P

• Necessities, few subs, more “important”

◊ Elastic: E > 1; Q > P• Luxuries, many subs, less “important”

◊ Equation(s)◊ We don’t care…we buy (or not)◊ Inelastic: E < 1; Q < P

• Necessities, few subs, more “important”

◊ Elastic: E > 1; Q > P• Luxuries, many subs, less “important”

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We really don’t care…they doWe really don’t care…they do◊ Producers use this to make more $◊ Know when to raise price

(inelastic) or lower (elastic)◊ EVERYTHING ALWAYS FITS BOTH◊ DEMAND CURVE HAS SECTIONS OF

EACH◊ ANALYZE THIS USING GRAPH

◊ Producers use this to make more $◊ Know when to raise price

(inelastic) or lower (elastic)◊ EVERYTHING ALWAYS FITS BOTH◊ DEMAND CURVE HAS SECTIONS OF

EACH◊ ANALYZE THIS USING GRAPH

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Use elasticity for evaluationUse elasticity for evaluation◊ Analytical tool◊ Just like cross-price & income

elasticity◊ C-P: determine comps & subs◊ I: determine normal vs inferior◊ Equations & examples

◊ Analytical tool◊ Just like cross-price & income

elasticity◊ C-P: determine comps & subs◊ I: determine normal vs inferior◊ Equations & examples

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Not our problem but yoursNot our problem but yours

◊ We buy stuff…we are happy◊ They have to sell what we want to

buy (CONSUMER SOVEREIGNTY)◊ Their supply is most based on

costs of production◊ Costs change so does supply◊ Sometimes fast; others slow (TIME)

◊ We buy stuff…we are happy◊ They have to sell what we want to

buy (CONSUMER SOVEREIGNTY)◊ Their supply is most based on

costs of production◊ Costs change so does supply◊ Sometimes fast; others slow (TIME)

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All happy in the endAll happy in the end

◊ SUPPLY & DEMAND HAVE AMAZING ABILITY TO BALANCE

◊ Think about now…what happens when we balance?

◊ Better to stay in happiness◊ Who unhappy w/ high prices?◊ Low?

◊ SUPPLY & DEMAND HAVE AMAZING ABILITY TO BALANCE

◊ Think about now…what happens when we balance?

◊ Better to stay in happiness◊ Who unhappy w/ high prices?◊ Low?

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Sometimes it comes from GovSometimes it comes from Gov◊ Don’t like our price◊ Can use SUBSIDIES or EXCISE TAXES◊ Change market price to “make it better”◊ Also use PRICE CEILINGS & FLOORS

◊ OFFSET THE NATURAL POINT OF EQUILIBRIUM (hurts some; helps others)

◊ Don’t like our price◊ Can use SUBSIDIES or EXCISE TAXES◊ Change market price to “make it better”◊ Also use PRICE CEILINGS & FLOORS

◊ OFFSET THE NATURAL POINT OF EQUILIBRIUM (hurts some; helps others)

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Part III: The simple life (21-27)Part III: The simple life (21-27)

◊ So sweet, so simple◊ Life as a consumer is pretty good◊ All we have to do is buy what we want ◊ If we don’t like the price, we don’t buy

it◊ Whole idea is to maximize utility

• Utility is satisfaction

◊ So sweet, so simple◊ Life as a consumer is pretty good◊ All we have to do is buy what we want ◊ If we don’t like the price, we don’t buy

it◊ Whole idea is to maximize utility

• Utility is satisfaction

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Once doesn’t mean againOnce doesn’t mean again

◊ Our satisfaction is our goal◊ I bought the sweetest minivan on

the market…doesn’t mean I would buy a second one

◊ Law of Diminishing MU: the more you have of something the less MU it adds• At some point this always holds true• Doesn’t mean it has to start that way

◊ Our satisfaction is our goal◊ I bought the sweetest minivan on

the market…doesn’t mean I would buy a second one

◊ Law of Diminishing MU: the more you have of something the less MU it adds• At some point this always holds true• Doesn’t mean it has to start that way

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Big menus make life hardBig menus make life hard

◊ I don’t like restaurants◊ Choices STINK◊ I want it all◊ When I order I usually want what

someone else got◊ Goal is to buy what gives you the

highest MU / $

◊ I don’t like restaurants◊ Choices STINK◊ I want it all◊ When I order I usually want what

someone else got◊ Goal is to buy what gives you the

highest MU / $

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But what do I buy next?But what do I buy next?

◊ The first thing you buy is the one with the highest MU / $

◊ If you are still hungry you get what has the new highest MU / $

◊ Could be the same thing, but after the burger and fries you may desire the milkshake the most

◊ The first thing you buy is the one with the highest MU / $

◊ If you are still hungry you get what has the new highest MU / $

◊ Could be the same thing, but after the burger and fries you may desire the milkshake the most

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Eventually E is reachedEventually E is reached

◊ Consumer equilibrium occurs when MU/$ of each item is equalized

◊ If one thing is best you buy it◊ Continuing buying until MU < $◊ When do it w/ everything end

result is◊ MU1/P1 = MU2/P2 = MU3/P3…

◊ Consumer equilibrium occurs when MU/$ of each item is equalized

◊ If one thing is best you buy it◊ Continuing buying until MU < $◊ When do it w/ everything end

result is◊ MU1/P1 = MU2/P2 = MU3/P3…

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Part IV: Producers (28-47)Part IV: Producers (28-47)

◊ Consumers buy stuff b/c they want it◊ Producers make & sell stuff b/c they

want our money◊ Goal is to maximize profit◊ Total Revenue - Total Costs = PROFIT◊ Goal then is to maximize output while

minimizing costs

◊ Consumers buy stuff b/c they want it◊ Producers make & sell stuff b/c they

want our money◊ Goal is to maximize profit◊ Total Revenue - Total Costs = PROFIT◊ Goal then is to maximize output while

minimizing costs

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They need usThey need us

◊ Can’t make money if we don’t buy it◊ We create demand when we are

willing & able to buy stuff◊ Our demand creates DERIVED

DEMAND for the things they need to make what we want to buy

◊ They want to buy stuff b/c they can sell it to us

◊ Can’t make money if we don’t buy it◊ We create demand when we are

willing & able to buy stuff◊ Our demand creates DERIVED

DEMAND for the things they need to make what we want to buy

◊ They want to buy stuff b/c they can sell it to us

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Lots of stuff CAN workLots of stuff CAN work

◊ I need to make more cookies◊ I could hire more help◊ I could buy another oven◊ I could buy a bigger mixer

◊ Many different inputs can achieve the MB > MC…which one do you buy?

◊ I need to make more cookies◊ I could hire more help◊ I could buy another oven◊ I could buy a bigger mixer

◊ Many different inputs can achieve the MB > MC…which one do you buy?

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The one that does it the bestThe one that does it the best◊ Want to purchase what gives the

highest MP / $◊ Same concept as MU / $ for

consumers◊ Buying what gives highest MP / $

helps you to make more money◊ PRODUCTIVITY: output / input

• Typically per human hour worked

◊ Want to purchase what gives the highest MP / $

◊ Same concept as MU / $ for consumers

◊ Buying what gives highest MP / $ helps you to make more money

◊ PRODUCTIVITY: output / input• Typically per human hour worked

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Result is the same as wellResult is the same as well

◊ Consumer/producer makes no difference

◊ End result is the same◊ MP1/P1 = MP2/P2 = MP3/P3…◊ Least-cost Rule◊ Tells you what to buy first…but

when should you stop buying it?

◊ Consumer/producer makes no difference

◊ End result is the same◊ MP1/P1 = MP2/P2 = MP3/P3…◊ Least-cost Rule◊ Tells you what to buy first…but

when should you stop buying it?

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MRPMRP

◊ Marginal revenue product = value of input = demand = willingness to buy it

◊ Tells you how much it’s worth to you

◊ As long as MB > MC it’s ok to buy it◊ MRP > MC then hire that input

◊ Marginal revenue product = value of input = demand = willingness to buy it

◊ Tells you how much it’s worth to you

◊ As long as MB > MC it’s ok to buy it◊ MRP > MC then hire that input

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Most applicableMost applicable

◊ MRP = MR x MP◊ Marginal revenue x marginal

product◊ If I can hire another worker and get

another 10 dozen per hour and sell them for $3 profit per item, how much is that guy worth?

◊ Hire him as long as wage < $30

◊ MRP = MR x MP◊ Marginal revenue x marginal

product◊ If I can hire another worker and get

another 10 dozen per hour and sell them for $3 profit per item, how much is that guy worth?

◊ Hire him as long as wage < $30

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MR constant, MP changesMR constant, MP changes

◊ For our level, MR usually always kept constant at the one selling price (PC)

◊ MP will change with additional units◊ Law of Diminishing MP: KEEPING

OTHER FACTORS CONSTANT adding additional units of one input will eventually produce less MP

◊ For our level, MR usually always kept constant at the one selling price (PC)

◊ MP will change with additional units◊ Law of Diminishing MP: KEEPING

OTHER FACTORS CONSTANT adding additional units of one input will eventually produce less MP

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Feed the world from a flower potFeed the world from a flower pot

◊ Classical example◊ If diminishing MP didn’t exist◊ One flower pot, some sun, and

endless fertilizer would produce enough food to feed the world

◊ Obviously not true

◊ Classical example◊ If diminishing MP didn’t exist◊ One flower pot, some sun, and

endless fertilizer would produce enough food to feed the world

◊ Obviously not true

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MP vs returns to scaleMP vs returns to scale

◊ MP includes keeping all constant & changing one input

◊ Returns to scale involve changing everything in like quantities• Double everything what happens• Constant, increasing, diminishing

◊ MP would be changing labor but keeping everything else the same

◊ MP includes keeping all constant & changing one input

◊ Returns to scale involve changing everything in like quantities• Double everything what happens• Constant, increasing, diminishing

◊ MP would be changing labor but keeping everything else the same

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Work hard to make $Work hard to make $

◊ Must also consider all costs-both implicit & explicit

◊ Explicit is what normal people think about (stuff you pay for)

◊ Implicit is opportunity cost (stuff you give up)

◊ Economists consider both

◊ Must also consider all costs-both implicit & explicit

◊ Explicit is what normal people think about (stuff you pay for)

◊ Implicit is opportunity cost (stuff you give up)

◊ Economists consider both

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different types of profitdifferent types of profit

◊ Accounting = TR > TC • Ignores implicit

◊ Normal Profit: TR = TC• Considers implicit

◊ Economic Profit: TR > TC• Considers implicit

◊ Accounting = TR > TC • Ignores implicit

◊ Normal Profit: TR = TC• Considers implicit

◊ Economic Profit: TR > TC• Considers implicit

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Love the costsLove the costs

◊ FC, VC, TC, AVC, AFC, ATC, MC◊ FC = capital (output irrelevant)◊ VC = land & labor (based on

output)◊ MC = cost to make one more

◊ Graphs rule!!!

◊ FC, VC, TC, AVC, AFC, ATC, MC◊ FC = capital (output irrelevant)◊ VC = land & labor (based on

output)◊ MC = cost to make one more

◊ Graphs rule!!!

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