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Summary Microeconomics
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Summary of Microeconomics for BA1 Business Economics at the VUB.
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MicroeconomicsCHAPTER 1: WHAT IS ECONOMICS?
What is economics about?
- A study of human action
o How people make choices
o How people respond to incentives (An incentive is something that motivates an
individual to perform an action)
- An economist is much broader than someone who manages money and invests in
the stock market
Economics: A quick journey through time
- Xenophon: Oeconomicus (c. 362 BC)
o Economics comes from the Greek word “oikonomos”, which means “the one
who manages a household”
o A treatise on the (sexual) division of labor in agriculture
- Plato: The Republic (c. 370 BC)
o Discussion of justice and the ideal society
o Discussion on an important economic question “What goods and services
should be produces in the society?”
o Importance of specialization
o “a society starts to be formed, I suppose, when individual human beings find
that they aren’t self-sufficient, but that each of them has plenty
requirements which he can’t fulfil on his own” … “we have lots of needs”
- Richard Cantillon: essay on the nature of the trade in general (1755), posthumously
(after the death of the originator)
o The price of a good or service is the amount of land and labor required to
produce it.
o Notion of entrepreneurship: “the farmer is an entrepreneur who, without
any certainty about what advantages he will derive from his enterprise,
promises to pay the owner a fixed sum of money for his farm or land
o Notion of trade-offs: “the sun of a laborer can…
• Learn a certain trade or craft (ex. Tailor or cabinetmaker)
• Remain carrying out rural works that require neither art or skill
(ex. Digging earth)
- Adam Smith: The Wealth of Nations (1767)
o The invisible hand – a landmark in economics
§ Individuals are usually best left to their own devices, without the
government guiding their actions.
• Participants in the economy are motivated by self-interest
• Invisible hand in the market guides this self-interest into
promoting general economic well-being
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,Microeconomics
• Markets are a good way to organize economic activity because
self-interested individuals’ actions produce socially desirable
results
- William Stanley Jevons: Theory of Political Economy (1871)
o Importance of the use of mathematics
o Introduction of the concept “utility”
§ Total utility: the satisfaction gained from the consumption of a good
§ Marginal utility: the addition to the total utility as a result of
consuming one extra unit of a good
o Contrast between Cantillon (1755) and Jevons (1871)
§ Cantillon: price of a good or service depends on labor and land
§ Jevons: price of a good or service depends entirely on utility
- Alfred Marshall: Principles of Economics (1890)
o For several decades the most important book in the propagation of
economics. Its influence on modern mainstream economics is profound.
o Price of a good depends on both the utility from its consumption and the
costs of production ( see chapter 3-6 )
o Consumer surplus: a buyer’s willingness to pay minus the amount the buyer
actually pays (see chapter 7)
o Producer surplus: the amount a seller is paid minus the seller’s cost (see
chapter 7)
Economics today
- Society’s resources (production factors)
o Land: all the natural resources of the earth
o Labor: the human effort both mental and physical that goes in to production
o Capital: the equipment and structures used to produce goods and services
o Scarcity: the limited nature of society’s resources
- Economics: the study of how society manages its scarce (insufficient for the demand)
- Microeconomics: the study of how households and firms make decisions and how
they interact in markets
- Macroeconomics: the study of economy-wide phenomena, including inflation,
unemployment and economic growth
- Market: a group of buyers and sellers of a particular good or services (or production
factor)
Microeconomics: how people make decisions
- Some principles
o People face trade-offs
o Opportunity cost
o Thinking at the margin
o People respond to incentives
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,Microeconomics
- People face trade-offs
o To get one thing, we usually have to give up another thing
o Making decisions requires trading off one goal against another
§ Examples:
• Food v. no clothing
• Study v. leisure
• Investment possibility 1 v. investment possibility 2
• Learning a craft versus remaining carrying out rural works
(Cantillon, 1755)
- Opportunity cost: whatever must be given up to-obtain some item
o Making decisions requires individuals to compare the benefits and costs of
alternatives
§ Whether to go to university or to start working?
§ Whether to study or to go on a date?
§ Whether to go to class or to sleep in?
- Thinking at the margin
o People make decisions by comparing benefits and costs at the margin
(incremental decisions)
o Marginal changes: small incremental adjustments to plan of action
§ Examples
• Should I take another course this semester?
• Should I study an additional hour for the exam?
• Should I study for a master degree after having completed my
undergraduate studies?
• Marginal utility: the addition to total utility as a result of
consuming one extra unit of a good ( Jevons, 1871)
- People respond to incentives
o Rational people make rational decisions by weighing costs and benefits
o Marginal changes in costs or benefits motivate people to respond
o Public policies can create incentives or disincentives that alter behavior
o Sometimes policymakers fail to understand how policies may alter behavior
§ Examples of incentives
• Prisoners transport (see video)
• Putting a price on the use of plastic bags in the supermarkets
• Sports club: membership incentives
Microeconomics: how people interact
- Microeconomics: the study of how households and firms make decisions and how
they interact in markets
o Markets
o Governments
o Non-profit organizations
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, Microeconomics
- Market: a group of buyers and sellers (household and firms) of a particular good or
service (or production factor)
o Markets can be a good way to organize economic activity
- Market failure: a situation where scare resources are not allocated to their most
efficient use
o Public goods and common resources
o Externalities
o Asymmetric
o Monopoly
- Government: government and public agencies can sometimes improve market
outcomes
- Government failure: a situation where political power and incentives distort
decision-making so that decisions are made which conflict with economic efficiency
o Political process can be imperfect:
§ Made by well-intentioned leaders who are not fully informed
§ Designed to reward the politically powerful
§ Focused on providing public foods only at the level that satisfies the
median voter
- Non-profit organizations: are characterized by the non-distribution constraint: “the
prohibition of distributing profits to owners” (a signal of trustworthiness to potential
consumers)
o Examples:
§ Hospitals
§ Nursing homes
§ Schools
§ Universities
§ Museums
§ …
- Non-profit failure
o Philanthropic insufficiency: lacking sufficient and reliable resources
o Philanthropic particularism: forcing on particular group of clients while
ignoring others
o Philanthropic paternalism: serving donors’ interests instead of wider social
needs
o Philanthropic amateurism: inefficiently managed, without professional
workforce
SUMMARY
1. Microeconomics studies how households and firms make decisions and how they
interact in markets
2. When individuals make decisions, they face trade-offs among alternative goals
3. The costs of any action are measured in terms of foregone opportunities
4. People often make decisions by comparing marginal costs and marginal benefits
5. People change their behavior in response to the incentives they face
6. Markets are usually a good way of coordinating trade among people
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