AP Micro Economics Unit 1 Introduction to Economics.

AP Micro EconomicsUnit 1

Introduction to Economics

Micro-Music

It’s a Small World

Rockin’ with the Rolling Stones

Barenaked Ladies

Dancing with Dire Straits

Queen

Chapter Objectives Microeconomics and Macroeconomics Economics Defined Economic Perspective (Economic Way of

Thinking) Role of Economic Theory Scarce Resources

– The Economizing Problem– Budget Lines

Production Possibilities

Let’s Get Started

Economics Defined– Economics is the social science of making the best choices

given scarce resources. It is the process of analyzing how to provide the most goods, services, and satisfaction with the limited resources we have available for use.

Economic Perspective (Economic Way of Thinking)– Scarcity – only a limited number of goods and services can

be produced because we have limited resources available to produce them

– Choice – We must choose how we will use our finite resources to produce the goods and services available in our markets

The Economic PerspectiveScarcity and Choice Opportunity Cost represents what we

give up in exchange for what we obtain when we alter our choices.

Although you may not immediately identify with the concept, in reality you are quite familiar with it. You and I make opportunity cost-based decisions on a daily basis.

– For instance, your opportunity cost in this particular moment is the alternative use of your time. What might you be doing right now instead of experiencing this lecture? Sleeping, eating, exercising? An opportunity cost is best represented as your next best alternative use of money, time, or anything else of value.

Let’s Take a Closer Look…

Upfront – Beef, It’s What’s For Dinner!

Video: The Family Man: Opportunity Cost

Video: Saving Private Ryan. - Opportunity Cost

Video: Along Came Polly- Efficiency, Optimal Behavior

Video: Lost in Translation - Incentives, Comparative Advantage, and Opportunity Cost

Purposeful Behavior Utility represents the satisfaction or benefit we receive from

consuming a good or service. We weigh the costs of our choices by comparing the different

degrees of satisfaction or utility we will receive from each choice. We then seek to make those choices that yield the greatest amount of satisfaction. We go about this process purposefully, or with rational thoughts.

Although the utility maximization process might at first glance suggest that we make selfish choices, in reality, acting in self-interest is not the same as selfishness.

People often make choices that are self-sacrificial and beneficial to others. These people derive pleasure (utility) from these acts of self sacrifice. – For instance, philanthropists give freely to help others because they

gain a greater degree of satisfaction from seeing others better off than they would have if they used their money to purchase more goods and services for themselves. Self-interested behavior maximizes personal satisfaction (utility).

Challenges in measuring utility One significant challenge we face when studying economics is

measuring the satisfaction (utility) we derive from our choices. We are quite capable of detailing whether we personally gain more

satisfaction than we give up when we make choices, but quantifying this satisfaction is another matter.

There is no standard measure of satisfaction. As such we most often study the aggregate behavior (choices) of people and draw broad conclusions from these behaviors about utility.

– For instance, although each of us may say that we gain a lot of satisfaction from owning another pair of brand-name jeans, we have no way of detailing whether our level of satisfaction is the same as someone else who bought the same jeans. However, we can definitively determine in aggregate how much additional satisfaction groups of people receive from owning more of these pairs of jeans because their purchasing decisions within their budget constraints reflect their satisfaction levels (or they vote with their purchases, which can be measured).

Marginal Analysis Marginal – Means additional or change in Marginal Benefits & Marginal Costs

– We compare the cost of providing additional benefits with the additional satisfaction received (utility) from the choice. We select those choices that yield more benefits than costs.

• You and I participate in this process each time we buy something at a store or restaurant. Will our purchase be "worth it"? Will that dessert be worth the calories? Will that new television be worth the cost? We are constantly in the process of refining our choices in the struggle to maximize our satisfaction within our budgetary constraints.

– Marginal analysis also provides another perspective from which to view opportunity costs. We are constantly comparing the satisfaction we might have enjoyed with an alternative choice with the satisfaction derived from our current choice.

Theories Principles and ModelsThe Scientific MethodEconomic Principle

–Generalizations–Other-Things-Equal Assumption

(ceteris paribus)• We assume other things are held equal because a change in one

economic variable will most likely have ripple effects throughout the economy.

• These reverberation effects become secondary causal effects for other variables and so forth and so on. However, by holding the assumption that other things remain constant, we can observe a causal variable and one, or perhaps two effect variables and draw generalizations from their response.

–Graphical Expression

Macro and MicroeconomicsMacroeconomics

–AggregateMicroeconomics

–Individual UnitsPositive EconomicsNormative Economics

How do Macroeconomics and

Microeconomics differ? Macroeconomics examines either the economy as a whole (often referred to as

aggregates). – Aggregates are collections of specific economic units treated as though they were one

unit. • Examples of aggregates include government, household, and business sectors. • Another example is found when we lump our entire national population together

and study them as consumers. – We measure aggregate data such as total output, total employment, total income,

aggregate spending, price levels, et cetera. – Note that we pay very little attention, if any, to the specific units making up the various

aggregates. In a sense macroeconomics looks at the beach and not the grains of sand, rocks, and shells of which it is comprised.

Microeconomics is concerned with individual units such as a household, firm, or industry and their respective challenges and behaviors.

– We look at facets such as measuring the price of a specific product, the number of workers employed by a single firm (or perhaps an industry), the revenue of a particular firm or household, or the expenditures of a specific firm, government entity, or family. In microeconomics, we examine the sand, rocks, and shells, but not the beach in aggregate.

You should realize that the discipline is not so neatly compartmentalized that is affords us the luxury of precisely distinguishing dividing lines between macroeconomics and microeconomics. There are many topics and concepts that share roots in both areas and there is often some degree of confusion regarding exactly how they differ.

So What’s the Difference– Ferris Bueller’s Day Off - Understanding the Difference Between Microeconomics and

Macroeconomics

Individual’s Economizing Problem Limited Income Unlimited Wants A Budget Line Attainable and Unattainable

Combinations Tradeoffs & Opportunity Costs Choice Income Change

Individual’s Economizing Problem

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1012

DVDs$20

Books$10

12

10

8

6

4

2

02 4 6 8 10 12 14

$120 Budget

Income = $120

Pdvd = $20= 6

Income = $120

Pb = $10= 12

Attainable

Unattainable

Quantity of Books

Qu

anti

ty o

f D

VD

s

Society’s Economizing ProblemScarce ResourcesResource Categories

–Land–Labor–Capital

• Investment–Entrepreneurial Ability

Factors of Production

Production Possibilities Model

Full Employment Fixed Resources Fixed Technology Two Goods

– Consumer Goods (Pizzas)– Capital Goods (Industrial Robots)

Three peasants wrestle with how to spend 15 silver coins that they have won in a jousting tournament. One of the peasants (played by Heath Ledger) encourages the other peasants to reinvest their winnings in training and equipment so that they can make more money later. This creates tension between consuming more now and saving more with the hopes of enjoying a higher standard of living later. The three peasants, after an extended argument, decide to spend two coins now and reinvest the other 13 coins in jousting equipment and training. You can use this decision to show how an increase in investment can expand the PPC in the long run. - Production Possibilities Curve

Assumptions in Production Possibilities Models

The following items must be held constant as assumptions for our model.

We are fully employed at the societal level and are using all our available resources.

The quantity and quality of our factors of production are fixed.

The state of our technology (the methods used to produce output) is constant.

The economy is producing two goods: pizza (consumer goods) and industrial robots (capital goods).

Production Possibilities Table

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Plot Points to Create Graph…

Pizzas

Ind

ust

rial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

AB

C

D

E

EconomicGrowth

Now Attainable

A’

B’

C’

D’

E’

Production Possibilities Curve

Production Possibilities Model

Pizzas

Ind

ust

rial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

AB

C

D

E

Law of IncreasingOpportunity Cost

A’

B’

C’

D’

E’

Shape of the Curve

Production Possibilities Model

Pizzas

Ind

ust

rial

Ro

bo

ts

Under or Unemployment

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

A’

B’

C’

D’

E’

U

Production Possibilities Model

15

10

5

0 1 2 3

a

b

c

d

e

MB = MC

MC

MB

Optimal Allocation of Resources

Quantity of Pizza

Mar

gin

al B

enef

it &

Mar

gin

al C

ost

Unemployment Growth and the FutureA Growing EconomyEconomic Growth

–Increasing Resource Supplies

–Increasing Resource Quality

–Technological Advances

Present Choices & Future Present Choices & Future PossibilitiesPossibilities

Goods for the Present

Goo

ds f

or t

he F

utur

e

Goo

ds f

or t

he F

utur

e

Goods for the PresentPresentville Futureville

P

F

CurrentCurve

CurrentCurve

FutureCurve

FutureCurve

Compare Two Hypothetical Economies

Implications of International Trade

Pitfalls to Sound Economic ReasoningBiasesLoaded TerminologyFallacy of CompositionPost Hoc FallacyCorrelation but not Causation

Key Terms economics economic perspective opportunity cost utility marginal analysis scientific method economic principle other-things-equal assu

mption macroeconomics aggregate microeconomics positive economics normative economics economizing problem budget line

economic resources land labor capital investment entrepreneurial ability factors of production consumer goods capital goods production possibilities c

urve law of increasing opport

unity costs economic growth

Let’s Practice Interactive Graphs to Try Problems to Work Key Questions