Oct 19, 2015
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
CHAPTER 1
INTRODUCTION THE BIG IDEAS
Microeconomics
Curtis & Irvine, 2013
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Learning outcomes
By the end of this chapter you should understand
The nature and objective of economics
The role of theory, models, hypotheses and data
The centrality of government
How microeconomics differs from macroeconomics
Opportunity cost, productivity advantage and efficiency
Specialization, exchange and markets
The production possibility frontier
Full employment, booms, recessions and economic growth
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
A Working Definition of Economics
Economics, at its best, is a set of ideas and methods for the improvement of society. It is not, as so often seems the
case today, a set of ideological rules for asserting why we
cannot face the challenges of stagnation, job loss and
widening inequality.
Christopher Sims,
Nobel Laureate in Economics, 2011
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Ideas and Methods
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Economics is a social science
It is concerned with ideas that may improve society
It is scientific in its approach
Use of mathematics Use of models Use of data and statistical methods
Translation of ideas into formal models through mathematics, and
testing of the ideas/models through the use of statistical methods
(more in chapter 2)
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Challenges for todays society
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Unemployment rates among young people are at historic highs
Government balance sheets are in disarray
Inequality is on the rise.
In addition, the world simultaneously faces
structural upheaval:
overpopulation climate change political instability globalization
These issues challenge us to understand and
formulate policies
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
But there is Good News too
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Literacy rates rising dramatically in the developing world
Child mortality has plummeted
Family size is a fraction of what it was 50 years ago
Prosperity is on the rise in much of Asia
Life expectancy is increasing universally
Deaths through wars are in a state of long term decline.
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Microeconomics and Macroeconomics
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Macroeconomics studies the economy as a system in which feedbacks among sectors
determine national output, employment and prices
Microeconomics is the study of individual behavior in the context of scarcity
In a mixed economy goods and services are supplied both by private suppliers and government
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Government
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Government is not an add-on to our economy.
It plays an integral role in regulating, redistributing and enforcing contracts.
Without this legal structure the private sector could decline into a state of Hobbesian anarchy
Example: Congo in the modern era
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Understanding Economics through the Use of Models
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A model is a formalization of theory that facilitates scientific enquiry
A theory is a logical view of how things work, and is frequently formulated on the basis of observation
Frequently we transform theories into models and test the theories in this way by confronting them with data and statistical analysis .
Examples below
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Markets, Trading and Opportunity Cost
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Markets are central to our economic lives
they permit us to trade, work efficiently and improve our living standards
Example of Gardner and Plummer who are neighbors:
Trading skills == market place
Let us take a numerical example that we can develop into a
model of production and exchange.
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Each producer has a time allocation of 36 hours
By allocating total time to one activity, Amanda can produce 12F or 18V
Zoe can produce 18F or 9V
By splitting their time each person can also produce a combination of the two
Table 1.1 Production Possibilities in a Two-Person Economy
Hours/fish Hours/vegetable Fish production Vegetable production
Amanda 3 2 12 18
Zoe 2 4 18 9
A Model of Exchange and Specialization
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Opportunity Cost
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The opportunity cost of a choice is what must be
sacrificed when a choice is made
Zoes opportunity cost is 1:2 (1 unit of V for 2 units of F)
Amandas opportunity cost is 3:2 (18 units of V for 12 units of F)
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Specialization
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Amanda specializes in Vegetable Zoe specializes in Fish
We are about to develop our first graphical model
Lets now see what can happen as a result of each individual specializing in the production of the good
where their opportunity cost dictates:
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Absolute Advantage - Production
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18
9
12 18
* 6,9
9,4.5 *
Vegetable
Fish
Zoes PPF
Amandas PPF
Amandas initial consumption is {6, 9} and
Zoes is {9, 4.5}. With specialization they can
produce a greater total
{18, 18} than when
operating individually.
Hence, if they trade, after
specializing, they each
have the potential to
consume more.
Amanda
specializes
Zoe specializes
Amandas assumed initial
consumption
Zoes assumed initial consumption
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
From Production to Consumption
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Let us see how specialization, that produces more output can
translate into more consumption. It is consumption rather than
production which is of ultimate interest
First they must decide upon a rate at which to exchange the
two goods:
If each individual is to benefit this rate should lie between their individual rates of transformation.
To illustrate: suppose they exchange at a rate of 1:1
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Absolute Advantage - Consumption
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18
18
8,10
10,8
Vegetable
Fish
Zoes initial consumption = {9, 4.5}
Amandas initial consumption = {6, 9}
If Amanda trades 8V to Zoe in return for
8F Amanda moves to
the point {8, 10} and
Zoe to {10, 8}.
Both consume more
after specialization,
relative to pre-
specialization
Amanda
specializes
Zoe
specializes
Amandas assumed final
consumption
Zoes final consumption
With specialization, and trade at 1:1, they consume
along the line joining the specialization points
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
From Individuals to the Economy
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Can we represent the production possibilities of the
whole economy by aggregating the production capabilities of each individual?
The economy-wide PPF
is the set of products combinations that can be
produced in the economy when all available productive
resources are in use.
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
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9
18 12
Vegetable
Fish
Zoes PPF
Amandas PPF
c 18,18
PPF for whole economy
a 0, 27
e 30, 0
With complete specialization this
economy can produce 27V or 30 F
From a, to produce Fish it is more efficient
to use Zoe because
her opportunity cost is
less (segment ac).
When Zoe is completely specialized
Amanda is used
(section ce)
Economy-wide PPF
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Vegetable
Fish
a
b
c
d
e
The PPF for the whole economy abcde, is obtained
by allocating productive resources most efficiently.
The opportunity cost in the economy of
producing more fish is the amount of
vegetable that must be foregone.
Opportunity cost depends upon how
much of the economys productive resources (individuals) are already
producing F and V. The opportunity
cost along bc differs from along cd
With many individuals
the PPF is the concave
envelope of the
individual capabilities
A Multi-person PPF
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Services
Goods
a
B b
Economic growth or an
increase in the available
resources can be
envisioned as an outward
shift in the PPF from
PPF0 to PPF1. With PPF1
the economy can
produce more in both
sectors than with PPF0.
A
Gmax Gmax
Smax
Smax
S0
G0
X0
X1 S1
G1
PPF1
PPF0
Growth and the PPF
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Recessions and Booms
In an economic recession output
falls below the economys capacity output
A boom is a period of high growth
that raises output above normal
capacity output.
illustrate through the PPF
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Services
Goods
a
b
Economic recessions leave the
economy below its normal
capacity; the economy might be
driven to a point such as Z.
Gmax
Smax
S0
G0
X
W
PPF Z
Economic expansions, or
booms, may drive capacity
above its normal level, to a
point such as W.
Booms and Recessions
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Productivity of the Economy
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The productivity of labour, defined as output per worker,
depends on:
the skill, knowledge and experience of the labour force
the capital stock: buildings, machinery, equipment, and
software the labour force has to work with
the current technology embodied in the labour force and
the capital stock.
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Full Employment and the PPF
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When everyone who is willing to work at current wage rates and normal hours of work is actually working, the economy is a full employment
In this state the economys actual output is also termed its capacity output or full employment output
In 2012 the actual unemployment was 7.3% in Canada. Economists believe that full employment corresponds to approximately 6%
unemployment
Hence the PPF in Canada has an associated unemployment rate of 6%!
Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Chapter Summary
Economics: methods and ideas for the improvement of society
Economists use models to test theories with data
Markets improve the economys efficiency
Opportunity cost reflects the alternative possibilities
Production possibility frontier represents the capabilities of the
economy when functioning efficiently
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Chapter 1 - Microeconomics, Curtis & Irvine, 2013
Chapter Summary
Absolute advantage refers to greater absolute efficiency
Specialization increases consumption possibilities
With many individuals the PPF may be concave
Economic growth shifts the PPF
Booms and recessions see increases and decreases in output
beyond what is normal
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