[In these lectures we reviewed some microeconomic principles, starting
with the economic way of thinking and then moving on to demand. The corresponding
chapters of Case & Fair's textbook are Chapters 2 and 4.
-- Yes, these lectures follow a slightly different sequence from
the one on the course syllabus; still, by the end of week three (by Fri.,
Feb. 11), we will have covered the first six chapters.
-- Note: this class did not meet on Wed., Feb. 2, 2000, owing to
a snafu on my part. I will hand out makeup lecture notes at some future
date.]
WEEK 2, LECTURE 4
Mon., Jan. 31, 1999
0. IMPEDIMENTA
* Get Problem Set 1 (review of micro).
* Today: Review of microeconomics,
Part I
I. The economic way of thinking: scarcity
and tradeoffs
II. The economic way of thinking: rationality
and marginal analysis
III. Scarcity, tradeoffs, and efficiency
IV. Demand (begin)
I. THE ECONOMIC WAY OF THINKING: SCARCITY AND TRADEOFFS
SCARCITY (A resource is scarce if...)
-- Most resources have more than one use.
----> The use of a scarce resource has an OPPORTUNITY COST, which
is the (forgone) value of its next best alternative use.
------ What is the opportunity cost of going to class? Probably
sleeping.
------ "no free lunch" (other uses of that time: shopping a class,
going to the gym, buying your course books...)
------ tradeoffs (if you want more of one thing, you have to settle
for less of another)
II. THE ECONOMIC WAY OF THINKING: RATIONALITY AND MARGINAL ANALYSIS
How people (are assumed to) behave:
* Economic reasoning (cost-benefit analysis): For any decision,
people compare the costs and benefits.
-- If benefits > costs, do it.
-- If costs > benefits, don't do it.
* Optimization (a bit stronger than merely saying people
compare costs and benefits): Individuals (and firms) make the best decisions
for themselves. People know ~what's best for themselves, and that's what
they do. (No $500 bills on the sidewalk.)
-- Obviously not the most realistic model of human behavior, but it
is about the simplest, because you don't have to worry about people's errors.
Modeling mistakes is hard.
---- "You're here because you have nothing better to do."
---- What is it that people optimize?
------ People maximize "utility" (happiness/satisfaction)
------ Firms maximize profits (revenues - costs)
--> Marginal analysis (not a separate assumption, but rather something
that can be deduced from the assumption that everyone optimizes): "optimal,"
"rational" decisions are generally made at the margin (e.g.,
in cost-benefit analysis, does marginal benefit exceed marginal cost?)
---- Ex.: selling a house in Oswego: Do I wait for prices to rise back
up to what I paid for the house, so that I can break even (or, better yet,
sell it at a profit)? Or do I just sell the house now, cut my losses, and
move on? If you don't expect prices to rise anytime soon, you cut your
losses and move on. What you paid for the house is a sunk cost --
it cannot easily be recovered. A rational decision about whether to sell
it now or later is not affected by what you paid for the house, but where
prices are now and where they'll be in the future.
---- Ex.: airlines' student travel discounts. One such discount was
student round-trip tickets to the West Coast for $189, which is a small
fraction of what those tickets normally go for. Suppose the average cost
is about $300. Why would the airlines go along with a program like that?
------ A: For a plane that's about to take off with some seats empty,
the MC of another passenger is essentially zero (or whatever the Coke and
peanuts are worth); the total cost of the trip is essentially unchanged
by an extra passenger.
--------> Setting aside a few seats for discounts (incl. standby) can
be profitable even if the fare for those seats is far below the AC per
seat. As long as the MR ($189) > MC ($0), setting aside an extra seat is
profitable.
III. SCARCITY, TRADEOFFS, AND EFFICIENCY
Scarcity and opportunity costs imply ...
"tradeoffs" (if you want more of one thing,
you have to settle for less of another)
--> PRODUCTION POSSIBILITY FRONTIER
(PPF): a graph that shows all the combinations of goods (in a 2-good
economy) that can be produced if all of society's resources are used efficiently
(i.e., no waste)
-- [We saw an overhead of a PPF in
class. A very similar PPF appears on p. 31 (Figure 2.3) of Case & Fair's
textbook. I also drew a point inside the PPF, which corresponds to point
D in Case & Fair's diagram.]
---- Efficiency: producing at
the least possible cost (no waste)
---- Q: What's wrong with the point inside
the PPF?
---- A: It's inefficient - it's possible
to have more of both goods, so why not just produce more of both?
---- Along the PPF, the slope (rise
over run, Dy/Dx)
is negative, because there is a ...
------ TRADEOFF: more of one good means
less of the other
------ slope = opportunity cost (of producing
one more unit of the good on the horizontal axis)
The PPF is curved this way ("convex") because
of
DIMINISHING RETURNS: as you produce
more and more of a good, the cost of producing that good increases.
That is, producing an extra unit of output requires more inputs than it
did before.
-- Why: Production generally exhibits
diminishing returns in the short run because some factors (capital,
land) tend to be fixed in the short run.
A PRODUCTION FUNCTION shows the
relationship between labor and output, and also illustrates the "law" of
diminishing returns. It is curved in such a way ("concave") that its slope
becomes flatter and flatter as you move from left to right. What that means
is that as you add an extra unit of labor, the resulting addition to output
becomes smaller and smaller. In other words, production is subject to diminishing
returns.
-- [We saw an overhead of a typical
production function in class. Case & Fair's book unfortunately does
not have a picture of a production function, so at some point I will add
a link to a picture of a production function that I've drawn myself.]
So now we've seen scarcity, in a picture. Now,
Q: How do we allocate all those
scarce resources?
A: MARKETS and PRICES.
Microeconomic theory is often called PRICE THEORY, because in a free-market system the basic coordinating mechanism is price.
On a related note, you might think about
the canned tuna fish that you buy at the supermarket. Some of it is marked
"dolphin-safe," whereas some of it is not. Most of us naturally recoil
at the thought of cute, intelligent dolphins being routinely slaughtered
in tuna nets just because they happen to swim with tuna. Virtually nobody
is completely indifferent to the plight of those poor dolphins. Yet tuna
that is "dolphin-unsafe" continues to be sold, and in fact there is a type
of tuna that has always been dolphin-safe: albacore tuna, because those
tuna don't swim with dolphins.
--> So why wasn't everyone eating dolphin-safe
tuna all along?
---- A: Non-albacore tuna is a lot cheaper.
While everybody likes dolphins, a great many people are not willing
to pay a bit more for their tuna in order to prevent dolphins from being
killed. So "dolphin-unsafe" tuna is still on the supermarket shelves.
This brings us to the "Law" of Demand.
IV. DEMAND
Someone once said an economist is nothing more than a trained parrot that says "Supply and demand... Supply and demand..." over and over again. But, there are worse things you could teach a parrot to say, and we hear them every day.
Let's start with demand, which is really the simpler of the two concepts.
DEMAND CURVE: a graph showing how much
of a given product people will be willing to buy at different prices.
-- "Law" of Demand: As the price
of a good goes up, the quantity demanded of that good goes down
----> demand curves slope downward
-- [We saw an overhead of a demand
curve, much like the demand curve in Case & Fair's Figure 4.2 (page
72).]
-- [I drew a second demand curve, for
potato chips, using real numbers on the P and Q axes.]
Parting question: Why is it that when the price of a bag of potato chips is reduced from $1.50 to $1.25, people will buy more? There are two reasons - what are they?
***
[Wed., Feb. 5 - LECTURE CANCELED - I arrived more than 15 minutes late.]
***
WEEK 2, LECTURE 5
Fri., Feb. 4, 2000
0. IMPEDIMENTA
* Today: Micro review, Part II: Demand (finish)
* QUIZ (answers will be posted on the WWW
at a later date)
DEMAND (finish)
Where we left off:
Q: Why do demand curves slope downward? If the price of potato chips falls from $1.50 to $1.25 a bag, why is it that people will buy more?
Why demand curves slope downward:
(1) INCOME EFFECT: As the price
of a good falls, your real income (in terms of that good) rises; you can
now afford to buy more of it, and so you do.
(2) SUBSTITUTION EFFECT: As the
price of a good falls, its relative price (i.e., its price relative
to other goods' prices) falls, causing you to buy less of other goods (especially
close substitutes) and more of that good.
These two effects reinforce each other.
Note well:
CHANGES IN DEMAND (shifts of the demand
curve)
are different from
CHANGES IN QUANTITY DEMANDED (occur
in response to price; movements along the demand curve).
-- [I illustrated this in class with
an overhead of two demand curves. Case & Fair's Figure 4.4 (p. 78)
tells a similar story.]
-- The same goes for supply curves.
To repeat: A change in a good's price causes a movement along the demand curve for that good. What causes the demand curve to shift?
Things that cause demand to increase
(demand curve shifts out, people are willing to pay more for the good,
and want more of it):
(1) Higher incomes (for normal
goods, as people get richer, they buy more of the good)
(2) Increased population
(3) Increased popularity of a good
(from changes in people's tastes)
(4) Increases in the price of other,
substitute goods
---- Ex.: If CD's become more expensive,
the demand for tapes will go up.
(5) Decreases in the price of complementary
goods (goods that are used together
with the first good)
---- Ex.: If tape decks become cheaper,
the demand for tapes will go up.
Exs.
| Enrollment at SUNY-Oswego is up, so there
is more demand for economics textbooks.
--> demand curve shifts up;
|
The College Store cut the price of new
textbooks, so more economics textbooks are being sold.
--> movement along the demand curve;
|
-- [The graphs that accompanied these
examples were again similar, though not identical, to two of the graphs
in Case & Fair's Figure 4.4 (page 78).]