Week 1 Introduction To Microeconomics

MAE101 Economic Principles
Week 1: Introduction to Microeconomics

Reading:
Chapters 1, 2 Gans et al. (2018)
What is Economics?
 Economics is the study of how people, firms, and society
make choices under conditions of scarcity.
 Scarcity means that society has limited resources and

therefore cannot produce all the goods and services people
want.
 However, our economic wants far exceed the productive

capacity of our limited resources.
What is Economics?
In our definition of economics, we mentioned that resources
were scarce.
Resources are all inputs that can be combined in many

different ways to produce goods and services to help satisfy
people’s unlimited needs and wants.
Often referred to as the factors of production.
Resources include land, capital, labour and enterprise.

What is Economics?
• Making decisions in the face of scarcity involves making
choices. Here are some of the choices householders,
producers and governments might make.
Reading 1: Choices about how to use our limited resources
Microeconomics and macroeconomics
Economics is divided into 2 subfields:
• Microeconomics focuses on the individual parts of the

economy.
– How households and firms make decisions and how
they interact in specific markets.
• Macroeconomics looks at the economy as a whole or

large aggregated sectors.
– Economy-wide phenomena, including inflation,
unemployment, and economic growth.
Why study microeconomics?
An understanding of economics will enable you to:
-Determine the true costs of making alternative choices in daily life
-Appreciate the role and operation of markets and the price
mechanism
-Appreciate the diverse range of behavioural characteristics of firms
that trade in the economy
-Evaluate the efficiency of government policy applied to specific
markets.
Principles of economics
There are a number of fundamental principles in economics.
1.People face trade-offs

Making choices in the face of scarcity involves sacrifices. As such, we usually
have to give up something in pursuit of something else.
2.The cost of something is what you have to give up to get it

The true cost of a choice we make is the value of the next best alternative we
had to sacrifice.
3. Rational people think at the margin
Decision making of often made by comparing the marginal
(incremental) costs and benefits of an action, such as
your nightly study.
4. People respond to incentives

Incentives such as taxes or subsidies induce changes in
behaviour but altering marginal costs and benefits.
Consider the impact of a baby bonus on the birth rate.
5.Trade can make everyone better off
Self-sufficiency limits us to our own capabilities, while trading with ours
allows for specialisation and exchange with others of different talents.
6.Markets are usually a good way to organise economic activity

The pursuit of rational self-interest by many buyers and sellers, maximises the
wellbeing of society as a whole.
7. Governments can sometimes improve market outcomes

Free-markets can at times fail to deliver what’s in society’s
best interests. Government policy is sometimes
necessary to create incentives to improve free-market
outcomes.
Economics as a social science
• Our definition of economics stated that economics is the

science of choice.
• Economics is a branch of the social sciences because it

deals with human behaviour and it follows a scientific
methodology.
Scarcity and Economics
2 concepts are used to demonstrate and illustrate the

basic economic problem of scarcity :
•Opportunity Cost
•The Production Possibility Frontier Model [PPF]

Opportunity Cost
 When we make decisions, we forgo (or give up) other
choices. The best alternative sacrificed is the
opportunity cost.
 Opportunity cost applies to individual, group, company

and national decision-making and is central to
economics.
 It represents the needs and wants that are sacrificed -

or cannot be satisfied - because resources are used to
satisfy a particular need or want.
 Opportunity cost is linked closely to scarcity.

The production possibilities frontier (PPF)
• The PPF is a simple economic model which demonstrates

relationship between:
 scarcity
 choice
 opportunity cost
The PPF shows:
 The maximum output and consumption levels of the economy
 The alternative production combinations available to the

economy
 The opportunity cost of various production combinations
 That to produce more of 1 good generally means producing

less of another good
• This model can be used to depict the behaviour of an
individual household, a firm or an entire economy.
The production possibilities frontier
• What can we say about points A, B, C & D?
- Point B is attainable but inefficient as available resources

are unused or misallocated.
- Points A and C (as are any points on the frontier) are

efficient, as they use all the available resources.
- Point D is unattainable as there are insufficient resources

available.
Opportunity Cost and the PPF
-What is the opportunity cost of producing 100 additional

cars when the economy moves from point C to A?
-Between points C to A: +100 Cars = - 200 PCs
-Hence, +1 Car = - 2 PCs between points C to A

Opportunity Cost and the PPF
- The opportunity cost of producing more cars or PCs does
not stay the same as we move along the frontier?
- A bowed outward (concave) PPF reflects increasing

opportunity costs
- This is because resources are not equally productive in

both activities.
Shifts in the PPF
• It is possible to achieve points that were previously outside the
PPF though improvements in technology and/or capital
accumulation (physical or human).
Positive versus normative analysis
• Economics is a social science because it applies the
scientific method to the study of the interactions
between individuals.
• While economics is based on facts and theories it is not

always used in a purely scientific way.
• Sometimes it can be hard to separate fact from biased

opinion on various economic statements and policy.
In general, economic statements can take on two broad
types.
Statements about what is and statements about what ought

to be.
• Positive statements are claims that attempt to describe

the world as it is.
– Called descriptive analysis.
• Normative statements are claims that attempt to describe
how the world should be.
– Called prescriptive analysis.
• The key difference between positive and normative

economic statements relates to how we judge their validity.
• Positive statements – can be settled by examining evidence,

collecting data, etc.
• Normative statements – are difficult to settle claims as they

involve values as well as facts.
• Consider the following example and decide whether they
are positive or normative statements.
1. An increase in the price of cigarettes will lead to less

people smoking cigarettes.
2. Because cigarettes kill many people every year, the

government should increase the price of cigarettes to
reduce the number of people that smoke.
3.Carbon taxes reduce environmental pollution.
4.The government should impose carbon taxes to reduce

environmental pollution.
5. In my opinion, interest rates will rise next month.
6.Tiger Woods is a better golfer than George W. Bush.

Resource Allocation
 Scarcity is the basic economic problem faced by all societies
The basic economic problem is: How does society choose to

allocate its scarce resources to the production of goods and
services in order to satisfy unlimited wants
Resource Allocation
The three fundamental economic questions that every

society faces are:
What to produce - Scarcity imposes restrictions on

what things can be produced
How to produce - What production technique should

be used
For whom to produce - Which people receive the

wealth that is produced
Centrally Planned Economies
• The former Soviet Union and today, counties like Cuba

and North Korea centrally plan their economies.
• Decisions involving what will be produced, how these

goods will be produced and for whom these goods are to
be produced for, are decided by the government.
Centrally Planned Economies
• The key shortcoming of this system of allocation is that it

lacks the incentives necessary to produce goods and services
that are most highly valued by consumers, or encourage
producers to offer the highest quality products and use the
lowest-cost production methods.
• Please review Reading 2 which discusses resource allocation

in centrally planned economies.
The market mechanism
•In essence, a market is an arrangement that allows people

to trade with one another. It brings buyers and sellers
together to enable the voluntary exchange of goods and
services.
The market mechanism
• We will study the role of markets in Chapter 4 and

carefully examine how markets allocate goods and
services by coordinating the decisions of buyers and
sellers through the price mechanism.
Tutorial Question 1
Here is a production possibilities table for watches and bags in
Consumer Land.
Production Alternatives
Type of product A B C D E
Watches (in millions) 10 9 7 4 0
Bags (in millions) 0 5 10 15 20
35
Tutorial Question 1
• If the economy is currently at production alternative D:
i. What is the opportunity cost of five million more bags?
ii. What is the opportunity cost of three million more watches?
• Where would the economy be operating if a recession in

Consumer Land resulted in 2 million people losing their jobs?
• Suppose improvement occurs in the technology of producing

watches but not in the production of bags. Illustrate the impact on
the original production possibilities frontier
Very Important Note
Each week there will be tutorial questions which will help you
understand the concepts that we have covered and help you
practice answering economics exam questions.
I STRONGLY ENCOURAGE you to do the tutorial questions and

to pay close attention when your lecturer is going through the
questions in class.
The final exam will consist of VERY SIMILAR questions to those

that we do in class each week.
37
• Scarcity and Choice
• Key economic resources
• The 2 economic subfields
• The 10 economic principles/lessons
• Economics as a social science and the scientific
method
• Economics models and the PPF
• Trade-offs and Opportunity Cost
• Positive v Normative economic analysis
• Resource allocation – centrally planned or
market based.
Next Week
Topic 2 - Interdependence and the Gains

from Trade

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MAE101 Economic Principles

Week 1: Introduction to Microeconomics

 Scarcity means that society has limited resources and

 However, our economic wants far exceed the productive

Resources are all inputs that can be combined in many

Often referred to as the factors of production.

Resources include land, capital, labour and enterprise.

• Microeconomics focuses on the individual parts of the

• Macroeconomics looks at the economy as a whole or

1.People face trade-offs

2.The cost of something is what you have to give up to get it

4. People respond to incentives

6.Markets are usually a good way to organise economic activity

7. Governments can sometimes improve market outcomes

• Our definition of economics stated that economics is the

• Economics is a branch of the social sciences because it

2 concepts are used to demonstrate and illustrate the

•The Production Possibility Frontier Model [PPF]

 Opportunity cost applies to individual, group, company

 It represents the needs and wants that are sacrificed -

 Opportunity cost is linked closely to scarcity.

• The PPF is a simple economic model which demonstrates

 The maximum output and consumption levels of the economy

 The alternative production combinations available to the

 The opportunity cost of various production combinations

 That to produce more of 1 good generally means producing

• What can we say about points A, B, C & D?

- Point B is attainable but inefficient as available resources

- Points A and C (as are any points on the frontier) are

- Point D is unattainable as there are insufficient resources

-What is the opportunity cost of producing 100 additional

-Between points C to A: +100 Cars = - 200 PCs

-Hence, +1 Car = - 2 PCs between points C to A

- A bowed outward (concave) PPF reflects increasing

- This is because resources are not equally productive in

• While economics is based on facts and theories it is not

• Sometimes it can be hard to separate fact from biased

Statements about what is and statements about what ought

• Positive statements are claims that attempt to describe

• The key difference between positive and normative

• Positive statements – can be settled by examining evidence,

• Normative statements – are difficult to settle claims as they

1. An increase in the price of cigarettes will lead to less

2. Because cigarettes kill many people every year, the

3.Carbon taxes reduce environmental pollution.

4.The government should impose carbon taxes to reduce

5. In my opinion, interest rates will rise next month.

6.Tiger Woods is a better golfer than George W. Bush.

 Scarcity is the basic economic problem faced by all societies

The basic economic problem is: How does society choose to

The three fundamental economic questions that every

What to produce - Scarcity imposes restrictions on

How to produce - What production technique should

For whom to produce - Which people receive the

• The former Soviet Union and today, counties like Cuba

• Decisions involving what will be produced, how these

• The key shortcoming of this system of allocation is that it

• Please review Reading 2 which discusses resource allocation