Microeconomics and Macroeconomics

FCS 3450Spring 2015

Unit 1

Examples:1. Why do some couples choose to have three children while others elect to have none?2. Why do some families carry life insurance while others do not?3. Why do some families save to purchase major appliances while others buy them on credit?

Microeconomics: focuses on the behavior of individual consumers, households, & businesses.

Macroeconomics: focuses on national economic policy and growth

Concept 1:Nominal Price vs. Relative Price

Nominal PriceReading – “What’s the Difference between Nominal & Real?”

Price paid for a product or service at the time of the transaction.

Nominal prices are those that have not been adjusted to remove the effect of changes in the purchasing power of the dollar.

Nominal Price vs Relative Price

• RPx = relative price of commodity x• NPx = nominal price of commodity x• NPb = nominal price of the base

commodity (base commodity is whatever commodity you choose as the comparison basis).

Constructing Relative Prices Using Average Hourly Wage Rate

Products Nominal Price

Year 1969 1989 2010

Round Steak $1.28 $2.39 $4.30

Bread (loaf) $0.25 $1.00 $1.39

Average wage rate $3.00 $10.00 $18.61

Concept 2: Diminishing marginal Value (Marginal Utility), Demand, and Supply• What is marginal value or marginal utility?• Marginal value or marginal utility is the satisfaction or

pleasure you get from each additional unit or consumption of the same good or service.

• What is declining marginal value or diminishing marginal utility?• We get less pleasure from additional units of a

product or service than from earlier units.

Relative Price of Round SteakRound Steak (1 lb):• 1969: RP = $1.28/$3.00 = 0.427 hour = 26 minutes• 1989: RP = $2.39/$10.00 = 0.239 hour = 14 minutes• 2010: RP = $4.30/$18.61 = 0.231 hour = 14 minutes

Implications of Declining Marginal Value (Marginal Utility)

Implication 1: Consumers buy more of a product or service when its (relative) price falls.• The marginal value is the price you are willing to pay for that unit of product.• Example: If you are very hungry, the marginal value of the first hamburger is

$3,00 to you. However, the marginal value of each hamburger after that decreased until the marginal value may be $0 or close to it.

• So, if the price of a hamburger is $3.00, you will buy 1. If the price of hamburger is $2.00 you will buy 2. If the price of hamburger is $0.80, you will buy 3.

Implications of Declining Marginal Value (Marginal Utility)

Implication 2: Sellers can use quantity discount as a pricing strategy to maximize profit.• In the previous example, if the seller sets the price at $2.00, the consumer will

buy 2 hamburgers. However, because of diminishing marginal utility, the consumer was actually willing to pay $5.00 for 2 hamburgers ($3.00 for the first and $2.00 for the second).

• The seller can package two hamburgers and sell both for $5.00 to maximize profit. This is why sellers often offer quantity discounts.

Demand and Demand Curve

What is demand?• The quantity of a product that a consumer, or a group of consumers, will purchase at a given price.

What is the relationship between demand and price?• Inverse relationship between quantity demand and price:

• Price increases, demand decreases• Price decreases, quantity demand increases

What is a demand curve?• A graph that depicts the relationship between the prices of a product and the quantities of the

product that consumers purchase at these prices.

Demand for Donuts

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Quantity of Donuts (in 1,000’s)

Price/donut

D1

Substitution and Income Effects of a Price Change

When the price of a product goes up, two things happen:1. Substitution effect: The consumer switches to another product as a substitute.

1. The size of the substitution effect varies depending on how readily available substitutes are. For example, the substitution effect for medical care is likely to be small compared to the substitution effect for beef.

2. Income effect: When the price of a product goes up the real value of a consumer’s income decrease.

The total effect of an own-price change = substitution effect + income effect.

Supply and Supply CurveWhat is supply?• The quantity of product that a producer, or a group of producers, will produce at given

prices.

How do producers respond to price changes?• The producers try to maximize their profit, they will keep on producing as long as the cost of

producing one more unit is lower than the market selling price.

What is a supply curve?• A graph depicting the relationship between the prices of a product and the quantities

producers will produce at these prices.

Supply of Donuts

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Quantity of Donuts (in 1,000’s)

Price/donut

S1

Market Equilibrium?

What is market equilibrium?• At equilibrium, quantity demand = quantity supply• Market price is thus determined

Is the market always at equilibrium?• In most cases, prices and quantities are moving towards the equilibrium.

Supply & Demand Intersect to Determine Market Price

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Quantity of Donuts (in 1,000’s)

Price/donut

S1

D1

P1

Q1

E1

Concept 3: Opportunity Cost

What is opportunity cost?• When you spend time or money on anything, you give

up the opportunity to spend that time or money on something else.• Often defined as the cost of doing “the next best

thing.”

Concept 4: The Value of TimeDoes time have value? Why?• Time has value because it is a limited resource.• Time is money

How is the value of time defined?• The theoretical definition uses the opportunity cost approach:• The value of your time in any activity depends on what else you

could do with that time.• With this approach the value of time varies from individual to

individual and from activity to activity• The empirical definition defines the price of an hour as a person’s hourly

wage rate.• With this approach there is uniformity for each person.

• Assumption: the quality of meals is equal, you get no enjoyment from cooking, and you don’t mind doing dishes• Cooking at home: $50 (ingredients) + 6 hours of your time

preparing the meal and dealing with clean-up.• Eating at a restaurant: $120 (including tax and tip), 15

minute drive to the restaurant, 30 minute wait for your table, 15 minute drive back home but no time spent in meal preparation.• The economic answer depends on the rate at which you

value your time:• $20/hr time costs: $50 + ($20/hr * 6 hrs) = $170 > $140 ==> eat

out!• $10/hr time costs: $50 + ($10/hr * 6 hrs) = $110 < $130 ==> eat in!

Example: Housework tradeoffs - Friends are coming to town for the weekend. Should you take them out to dinner or cook for them at home?