chapter 1 preliminaries. ©2005 pearson education, inc.chapter 12 introduction what are the key...
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Chapter 1
Preliminaries
©2005 Pearson Education, Inc. Chapter 1 2
Introduction
What are the key themes of microeconomics?
What is a Market?What is the difference between real and
nominal pricesWhy study microeconomics?
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Themes of Microeconomics
Microeconomics deals with limits Limited budgets Limited time Limited ability to produce
How do we make the most of limits?How do we allocate scarce resources?
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Themes of Microeconomics
Workers, firms and consumers must make trade-offs Do I work or go on vacation? Do I purchase a new car or save my money? Do we hire more workers or buy new
machinery?
How are these trade-offs best made?
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Themes of Microeconomics
Consumers Limited incomes Consumer theory – describes how
consumers maximize their well-being, using their preferences, to make decisions about trade-offs.
How do consumers make decisions about consumption and savings?
©2005 Pearson Education, Inc. Chapter 1 6
Themes of Microeconomics
Workers Individuals decide when and if to enter the
work-forceTrade-offs of working now or obtaining more
education/training What choices do individuals make in terms of
jobs or work places? How many hours do individuals choose to
work?Trade-off of labor and leisure
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Themes of Microeconomics
Firms What types of products do firms produce?
Constraints on production capacity & financial resources create needs for trade-offs.
Theory of the Firm – describes how these trade-offs are best made
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Themes of Microeconomics
Prices Trade-offs are often based on prices faced
by consumers and producers Workers made decisions based on prices for
labor – wages Firms make decisions based on wages and
prices for inputs and on prices for the goods they produce
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Themes of Microeconomics
Prices How are prices determined?
Centrally planned economies -governments control prices
Market economies – prices determined by interaction of market participants
Markets – collection of buyers and sellers whose interaction determines the prices of goods.
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Theories and Models
Economics is concerned with explanation of observed phenomena Theories are used to explain observed
phenomena in terms of a set of basic rules and assumptions.
The Theory of the Firm The Theory of Consumer Behavior
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Theories and Models
Theories are used to make predictions Economic models are created from theories Models are mathematical representations
used to make quantitative predictions
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Theories and Models
Validating a Theory The validity of a theory is determined by the
quality of its prediction, given the assumptions.
Theories must be tested and refined Theories are invariably imperfect – but gives
much insight into observed phenomena
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Positive & Normative Analysis
Positive Analysis – statements that describe the relationship of cause and effect Questions that deal with explanation and
predictionWhat will be the impact of an import quota on
foreign cars?What will be the impact of an increase in the
gasoline excise tax?
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Positive & Normative Analysis
Normative Analysis – analysis examining questions of what ought to be Often supplemented by value judgments
Should the government impose a larger gasoline tax?
Should the government decrease the tariffs on imported cars?
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What is a Market?
Markets Collection of buyers and sellers, through their
actual or potential interaction, determine the prices of products
Buyers: consumers purchase goods, companies purchase labor and inputs
Sellers: consumers sell labor, resource owners sell inputs, firms sell goods
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What is a Market?
Market Definition Determination of the buyers, sellers, and
range of products that should be included in a particular market
Arbitrage The practice of buying a product at a low
price in one location and selling it for more in another location
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What is a Market?
Defining the Market Many of the most interesting questions in
economics concern the functioning of markets
Why are there a lot of firms in some markets and not in others?
Are consumers better off with many firms?Should the government intervene in markets?
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Types of Markets
Perfectly competitive markets Because of the large number of buyers and
sellers, no individual buyer or seller can influence the price.
Example: Most agricultural markets Fierce competition among firms can create a
competitive market
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Types of Markets
Noncompetitive Markets Markets where individual producers can
influence the price.Cartel – groups of producers who act
collectivelyExample: OPEC dominates with world oil
market
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Market Price
Transactions between buyers and sellers are exchanges of goods for a certain price Market price – price prevailing in a
competitive market.Some markets have one price: price of goldSome markets have more than one price: price
of Tide versus Wisk
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Market Definition
Market Definition Which buyers and sellers should be included
in a given market This depends on the extent of the market –
boundaries, geographical and by range of products, to be included in it
Market for housing in New York or IndianapolisMarket for all cameras or digital cameras
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Market Definition
Importance of market definition In order to set price, make budgeting
decisions, etc., companies must know Their competitors Product-characteristic and geographic
boundaries of the market Important for public policy decisions
Should government allow a merger between companies in same market?
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Real Versus Nominal Prices
Comparing prices across time required measuring prices relative to some overall price level Nominal price is the absolute or current dollar
price of a good or service when it is sold. Real price is the price relative to an
aggregate measure of prices or constant dollar price.
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Real Versus Nominal Prices
Consumer Price Index (CPI) often used as a measure of aggregate prices. Records the prices of a large market basket
of goods purchased by a “typical” consumer over time
Percent changes in CPIU measure the rate of inflation
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Real Versus Nominal Prices
Calculating Real Prices
yearcurrent yearcurrent
yearbase Price Nominal x CPI
CPI RealPrice
100baseyear
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Real Price of College
Year Nom. Price
CPI Real Price
1970 $2,530 38.8
1990 $12,018 130.7
2002 $18,273 181.0
$3,569$12,018*130.738.8
$3,917$18,273*181.038.8
$2,530$2,530*38.838.8
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Real Price of Wages
Observations The minimum wage has been increasing in
nominal terms since 1940.From 1930 at $0.25 to 2003 at $5.15
The 1999 real minimum wage was no higher in 1999 than 1950.
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The Minimum Wage: Figure 1.1
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Why Study Microeconomics?
Microeconomic concepts are used by everyone to assist them in making choices as consumers and producers.
Examples show the numerous levels of microeconomic questions necessary in many decisions
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Ford SUV’s
Built Ford Explorer in 1991, Ford Expedition in 1997 and the Ford Excursion in 1999
In each of these cases, Ford had to consider many aspects of the economy to ensure their introduction was a sound investment
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Ford SUV’s
Questions How strong in demand and how quickly will it
grow?Must understand consumer preferences and
trade-offs What are the costs of manufacturing
Given all costs of production, how many should be produced each year?
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Ford SUV’s
Questions (cont.) Ford had to develop pricing strategy and
determine competitors reactions? Risk analysis
Uncertainty of future prices: gas, wages Organizational decisions
integration of all divisions of production Government regulation
Emissions standards
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Emission Standards
1970 Clean Air Act imposed emissions standards and have become increasingly stringent Questions
What are the impacts on consumers?What are the impacts on producers?How should the standards be enforced?What are the benefits and costs?