Microeconomics

Week 1 - Course Notes for Microeconomics

Learning Outcomes

Upon completion of this chapter, you will be able to:

• Explain how scarcity affects decisions of households, firms, and government

• Apply the economic way of thinking to make choices

• Understand fundamental economic concepts and terminology

• Distinguish between positive and normative statements

1. What is Economics?

Definition

Economics = The study of choice under conditions of scarcity

Key Characteristics

• Social Science: Studies people and their behavior

• Scientific Approach: Uses systematic methods to investigate choices

• Universal Application: Applies to all areas of human experience

Why Study Economics?

• Helps understand news and current events

• Improves decision-making skills

• Provides analytical tools for various careers

• Explains how societies organize economic activity

2. The Fundamental Economic Problem: Scarcity

Core Concept

Scarcity = The condition of having unlimited wants but limited resources

The Scarcity Equation

Unlimited Wants + Limited Resources = SCARCITY = Need to Make Choices

Examples of Scarcity

• Personal: Limited time, money, energy

• Business: Limited capital, labor, raw materials

• Government: Limited tax revenue, competing priorities

• Society: Limited natural resources, productive capacity

Important Note

• Even "free" goods can become scarce (e.g., clean air, outer space)

• Abundance doesn't eliminate scarcity if alternatives exist

3. The Three Fundamental Economic Questions

Every society must answer these questions due to scarcity:

1. WHAT to Produce?

• Which goods and services should be created?

• How much of each?

• Examples: More schools or more hospitals? More cars or more public transit?

2. HOW to Produce?

• What production methods to use?

• What combination of resources?

• Examples: Labor-intensive vs. capital-intensive production? Domestic vs. foreign production?

3. FOR WHOM to Produce?

• Who gets the goods and services?

• How should output be distributed?

• Examples: Based on income? Need? Merit? Government allocation?

4. Opportunity Cost

Definition

Opportunity Cost = The value of the best alternative forgone when making a choice

Key Points

• Not the same as money cost

• Always the BEST alternative given up

• Applies to all choices (time, money, resources)

Examples

Choice

Opportunity Cost

Study economics for 2 hours

Value of best alternative use of those 2 hours

Buy a $20 textbook

Value of best alternative purchase with $20

Attend college

Income forgone from working full-time

Government builds hospital

Value of best alternative use of those resources

Formula

Opportunity Cost = Value of Best Alternative Not Chosen

5. Types of Goods

Scarce Goods

• Definition: Goods where choosing one use prevents another

• Characteristic: Have alternative uses

• Examples: Land, money, time, skilled labor

Free Goods

• Definition: Goods where one person's use doesn't prevent another's

• Characteristic: No alternative uses

• Examples: Gravity, sunlight (in most cases)

• Note: Very few truly free goods exist

6. The Economic Way of Thinking

Three Key Features

1. Emphasis on Opportunity Costs

• Always ask: "What am I giving up?"

• Consider alternatives before making decisions

• Recognize that every choice involves trade-offs

2. Assumption of Maximizing Behavior

• People make choices to maximize their satisfaction

• Businesses seek to maximize profits

• Self-interest ≠ Selfishness

• Can include helping others, charitable giving

3. Choices Made at the Margin

• Margin = Current level of activity

• Marginal analysis = Comparing benefits and costs of small changes

• Most decisions involve "a little more" or "a little less"

Marginal Thinking Example: Water Conservation

• Question: Will higher prices reduce water consumption?

• Common response: "No, because water is a necessity"

• Economic thinking: "Will people use slightly less water if prices rise?"

• Result: Even small price increases can reduce consumption

7. Microeconomics vs. Macroeconomics

Microeconomics

• Focus: Individual decision-making units

• Studies: Consumers, firms, individual markets

• Questions:

  • Why do concert tickets cost so much?

  • How does global warming affect coastal real estate?

  • Why do women do more housework?

Macroeconomics

• Focus: Aggregate (total) economic activity

• Studies: Entire economy, national indicators

• Questions:

  • What causes unemployment?

  • Why do economies grow?

  • What determines inflation rates?

8. The Scientific Method in Economics

Models

• Purpose: Simplify complex reality

• Characteristics: Based on assumptions, necessarily unrealistic

• Use: Generate hypotheses about economic behavior

Hypotheses

• Definition: Testable statements about relationships

• Requirement: Must be possible to prove false

• Example: "Higher prices reduce quantity demanded"

Testing Challenges

1. Ceteris Paribus Problem

• Meaning: "All other things being equal"

• Problem: Other things don't remain constant

• Solution: Statistical methods to isolate effects

2. Fallacy of False Cause

• Problem: Assuming correlation implies causation

• Example: "People wearing shorts cause warm weather"

• Solution: Careful analysis of cause-and-effect relationships

9. Positive vs. Normative Statements

Positive Statements

• Definition: Factual claims that can be tested

• Characteristics: Can be proven right or wrong

• Examples:

  • "Unemployment rose to 7% last month"

  • "Higher taxes reduce consumer spending"

Normative Statements

• Definition: Value judgments or opinions

• Characteristics: Cannot be tested, based on personal values

• Examples:

  • "Unemployment is too high"

  • "Taxes should be reduced"

Why the Distinction Matters

• Economists can agree on positive statements through testing

• Disagreements often stem from different normative views

• Policy debates mix both types of statements

10. Key Formulas and Concepts

Scarcity Relationship

Scarcity = Unlimited Wants ÷ Limited Resources

Opportunity Cost Calculation

Opportunity Cost = Value of Best Alternative Forgone

Marginal Analysis

Marginal Benefit vs. Marginal Cost

If MB > MC → Do more

If MB < MC → Do less

If MB = MC → Optimal level

11. Real-World Applications

Personal Decision Making

• Choosing a major: Consider opportunity costs of alternatives

• Time management: Allocate time to highest-value activities

• Spending decisions: Compare marginal benefits of purchases

Business Applications

• Production decisions: What to produce, how much

• Resource allocation: Optimal use of limited capital and labor

• Pricing strategies: Understanding consumer responses

Government Policy

• Budget allocation: Competing priorities with limited resources

• Regulation: Balancing costs and benefits

• Economic policy: Understanding incentive effects

12. Common Economic Fallacies to Avoid

1. Sunk Cost Fallacy

• Error: Considering past costs in current decisions

• Correct approach: Focus only on future costs and benefits

2. Zero-Sum Thinking

• Error: Believing one person's gain requires another's loss

• Reality: Economic activity often creates mutual benefits

3. Composition Fallacy

• Error: Assuming what's true for individuals is true for groups

• Example: If everyone saves more, the economy might actually shrink

13. Study Tips and Review

Key Terms to Master

• Scarcity

• Opportunity cost

• Marginal analysis

• Ceteris paribus

• Positive vs. normative statements

• Microeconomics vs. macroeconomics

Practice Questions

1. What is the opportunity cost of attending this class?

2. Give an example of a normative statement about education policy

3. Why do economists focus on marginal changes rather than total amounts?

4. How does scarcity affect government decision-making?

Application Exercises

• Analyze a personal decision using opportunity cost

• Identify positive and normative statements in a news article

• Apply marginal thinking to a consumption decision

• Explain how scarcity affects your daily choices

14. Chapter Summary

Main Points

1. Economics studies choice under scarcity

2. Scarcity forces all economic actors to make trade-offs

3. Opportunity cost is the key concept for understanding choice

4. Economists think at the margin and emphasize self-interest

5. Economic analysis uses scientific methods despite challenges

6. Positive statements can be tested; normative statements cannot

Connection to Course Learning Outcomes

• ✓ Understand how scarcity affects household, firm, and government decisions

• ✓ Apply economic thinking to personal and policy choices

• ✓ Distinguish between different types of economic statements

• ✓ Prepare for analysis of production possibilities and economic systems

Next Chapter Preview: Production Possibilities and Economic Systems