Chapter One

Introduction

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What is Microeconomics?

• Economics– The study of the allocation of scarce

resources among alternative uses

• Microeconomics– The study of the economic choices

individuals and firms make and how those choices create markets

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Economic Models

• Simple theoretical descriptions that capture the essentials of how the economy works– Used because the “real world” is too complicated

to describe in detail– Models tend to be “unrealistic” but useful

• While they fail to show every detail (such as houses on a map) they provide enough structure to solve the problem (such as how a map provides you with a way to solve how to drive to a new location)

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Economic Models

• Simplifications by assumption– Regardless of how the model is described, an

economic model is a simplification of reality that contains only its most important features.

• Testing theories– Economic theory is the development and use

of a model to test hypotheses, which are predictions about cause and effect.

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• Positive versus normative– positive statement

• testable hypothesis about cause and effect.

– normative statement• conclusion as to whether something is good

or bad

Economic Models

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The Production Possibility Frontier

• A graph showing all possible combinations of goods that can be produced with a fixed amount of resources

• Figure 1.1 shows a production possibility frontier where the goods are food and clothing produced per week– At point A, 10 units of food and 3 units of clothing

can be produced

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FIGURE 1.1: Production Possibility Frontier

Amountof food

per week

4

10A

B

Amountof clothing

per week

0 3 12

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The Production Possibility Frontier

– At point B, 4 units of food can be produced and 12 units of clothing

• Without more resources, points outside the frontier are unattainable– This demonstrates a basic fact that

resources are scarce

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Opportunity Cost

• The cost of a good or service as measured by the alternative uses that are foregone by producing the good or service

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FIGURE 1.1: Production Possibility Frontier

Amountof food

per week

4

9.510

A

B

Opportunity cost ofclothing = ½ pound of food

Opportunity cost ofclothing = 2 poundsof food

2

Amountof clothing

per week

0 3 4 1213

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Uses of Microeconomics

• While the uses of microeconomics are varied, one useful way to categorize is by types of users– Individuals making decisions regarding

jobs, purchases, and finances– Businesses making decisions regarding

the demand for their product or their costs– Governments making policy decisions

regarding laws and regulations

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APPLICATION 1.2: Is It Worth Your Time to Be Here?

• The typical U.S. college student pays about $18,000 per year in tuition, fees, and room and board charges. One might conclude then, that the “cost” of 4 years of college is about $72,000.- A number of studies have suggested that

college graduates earn more than those without such an education.