ECONOMICS 103. Dr. Emma Hutchinson, Fall 2018

Transcription

1 ECONOMICS 103 Dr. Emma Hutchinson, Fall Reminder: familiarize yourself with all course policies by reading the course outline and all posted info. Today s class: Introductions and reminders; Start of Topic 1: Introductory Concepts & Models Introductory Concepts - positive v normative statements, scarcity, trade-offs, benefits, costs, opportunity cost, sunk costs, marginal analysis, marginal benefit, marginal cost, marginal net benefit. Models - binary and non-binary decision making; marginal analysis.

2 WHAT IS MICRO? 2

3 WHAT IS MICRO? ISN T 3

4 WHAT IS MICRO? ISN T This isn t a course about: - Money - The stock market - Personal finance. - Etc. 4

5 WHAT IS MICRO? ISN T Nor is this course about: - Unemployment - Inflation - Recessions etc. - Etc. That s all macroeconomics (Econ 104) 5

6 WHAT IS MICRO? Principles of Microeconomics Macro deals with large scale phenomena. Micro begins at a much smaller scale. We start by thinking about things from the perspective of individuals. In particular, micro is the study of: - Decision-making at the level of the individual person, household, or firm; We call these decision-makers economics agents - The societal outcomes that arise from those decisions. Do we get good or bad outcomes? 6

7 WHAT IS MICRO? Principles of Microeconomics Micro is the study of decision-making at the level of the individual person, household, or firm, and the societal outcomes that arise from those decisions. Another way to describe micro: - The study of how scarce resources are distributed in society and an evaluation of the desirability of such distributions. In order to assess desirability, we need a normative criterion. In economics, that criterion is called efficiency. 7

8 MICRO AND MARKETS Principles of Microeconomics Often (though not always), interactions between economics agents occur in the context of markets. - Market: any environment in which buyers and sellers make exchanges. Exchanges often (though not always) those of goods for money. Why we will often focus on market exchanges: - Markets are important; they are a vital part of our modern society (like it or not). - Also, under certain conditions, mkts also do a pretty good job of allocating scarce resources across competing uses. 8

9 MICRO AND MARKETS Key questions of interest to us this term: What are those certain conditions under which market outcome are good for society? Do we believe such conditions hold (IRL), or not? This is a question of market success versus market failure. Note that using the phrase good for society requires us to have a rigorous way to distinguish good from bad. - In economics, we use the concept of efficiency for this. Another key goal this term is to develop a deep understanding of economic efficiency. 9

10 PUBLIC POLICY DESIGN Principles of Microeconomics Micro is also about public policy. When markets don t do such a great job, policy can be used to improve societal outcomes. Another key goal for 103 (and hopefully for every other Econ class you take...): - To understand how public policy can improve societal outcomes in the case of where market outcome are not so good for society. 10

11 WHAT IS MICRO? Principles of Microeconomics Recall: micro is the study of: - Decision-making at the level of the individual person, household, or firm; - The societal outcomes that arise from those decisions Problem: statement doesn t distinguish economics much from other social sciences. Where economics tends to differ from (say) sociology, poli sic, etc. is in terms of methodology. Methodology: how do we study what we study? 11

12 METHODOLOGY How is econ different from other policy-oriented social sciences? Two important aspects/assumptions: 1) Methodological individualism. We assume: - Social outcomes are best understood by analyzing the individual actions that underly them. - Individual actions motivated largely by a desire to be happy. - Doesn t mean people are selfish, horrible, hedonistic, etc. (That typically doesn t make us happy, right?) 12

13 METHODOLOGY How is econ different from other policy-oriented social sciences? Two important aspects/assumptions: 2) Rationality. We assume: - For the most part, people take actions that they believe will further their objectives (like being happy). - Doesn t mean people don t make mistakes/screw up. We ll talk more throughout the term about these assumptions. 13

14 WHAT IS MICRO? Recall: micro is the study of: Decision-making at the level of the individual person, household, or firm; and - we call these decision-makers economics agents The societal outcomes that arise from those decisions. How do we study this? More about our methodology. 14

15 A BIT MORE ON METHODOLOGY In economics we use formal models to think about the decision-making behaviour of different economic agents. Models allow us to take basic concepts and assumptions and analyze them rigorously and logically. Can also use models to make predictions about behaviour and behavioural changes. Models also allow us to make (and distinguish between) normative and positive statements. 15

16 METHODOLOGY OF ECONOMICS Positive statement: a state about what is. - Descriptive analysis. - Ex: The carbon tax in BC is currently $30/tonne of CO2. Normative statement: a state about what should be. - Prescriptive analysis. - Ex: The carbon tax in BC should be higher. To make normative statements we need a normative criterion. - More (much more) on this soon. 16

17 MODELS IN ECONOMICS Recall: models allow us to take basic concepts and analyze them rigorously and logically. Models begin with assumptions and use deductive logic to arrive at conclusions. Models are: - Necessarily simplifications - not replications - of reality. - Only as good as the assumptions on which they are built. One aim of Topic 1 is to develop a couple of basic models to understand some key concepts in economics. - Initial context: a simple example of individual decision-making. 17

18 Reminders/announcements: 1. Labs begin next week. Principles of Microeconomics - If you are still having lab reg. problems next week, turn un to any lab that works with your schedules, and contact Nick via economics103@uvic.ca. - Always check Lab section of course website over the weekend prior to the lab, to see what (if anything) you should be doing to prep for lab. 2. There is a form posted on the Exam Info section of the website for students with a class conflict (etc.) for midterm Topic 1 lecture slides are posted. 4. Bring iclickers to every lecture starting tomorrow. 5. We will finish Topic 1 and begin Topic 2 this week. 18

19 Recall from last class: Principles of Microeconomics - Micro is the study of individual decision making and the social consequences of such decisions. - We will judge desirability of social outcomes using criterion of economic efficiency. - We began examining intuition re efficiency using in-class example of resource allocation problem. I m skipping the next few posted slides. - Read over that material after class. Today, we will work through an example to develop a way of thinking about decision-making. - That is, we will begin to develop a model of decision-making. 19

20 Bruce Springsteen announces a concert date in Victoria. - I love Springsteen. How do we measure love? Principles of Microeconomics MAKING DECISIONS: AN EXAMPLE - By how much I am willing to pay (WTP) for the concert. Before ticket prices are announced, I figure out that the MOST I am WTP is $ This is a dollar value of the happiness I will get from concert. Suppose ticket prices are then listed at $160. Question: do I buy a Springsteen ticket? 20

21 MAKING DECISIONS: AN EXAMPLE Going to Springsteen buys me $200 of happiness at cost $ I get a net gain ( happiness profit?) of $40. Seems like a pretty good deal. But.. What else might I do with my time and money that night? There are lots of things I could do: - Study econ 103, go to a movie, work a shift in my job, etc. What matters to us is what I would do, absent the Springsteen concert. - I need to identify the next best alternative use of of my time and money, in order to make a decision. 21

22 MAKING DECISIONS: AN EXAMPLE Let s assume that (bizarrely) U2 is also holding a concert in Victoria on the night of the Springsteen concert. - If I don t go to Springsteen, I will go to U2. - I love U2 also, (not as much as I love Springsteen, though). Suppose I am WTP (at most) $150 for a U2 ticket. I m WTP more ($50 more) for Springsteen than U2. Does that mean I ll choose Springsteen over U2? - No - it depends on the cost of the U2 ticket as well. Assume that a U2 ticket costs $80. 22

23 MAKING DECISIONS: AN EXAMPLE Springteen U2 WTP $200 $150 Ticket cost $160 $80 Net gain $40 < $70 23

24 MEASURING COSTS PROPERLY Looking only at the direct monetary cost of Springsteen misses an important component of true cost. If I go to Springsteen give up the opportunity to go to U2. The true cost of Springsteen includes the ticket price and a measure of what I lose by passing on U2. Economists use the term opportunity cost to describe this true cost. We will define opportunity cost as the explicit costs of an activity plus the implicit costs of that activity. 24

25 OPPORTUNITY COST Principles of Microeconomics Explicit cost of Springsteen is ticket price: $160. Implicit cost of Springsteen is the net gain from U2: $70. Opportunity cost of Springsteen is $160 + $70 = $230. Whenever an economist uses the term cost, they mean opportunity cost. To calculate opportunity cost (OC): - Figure out the direct monetary cost (simple). - Identify the next best alternative activity and calculate the forgone value of that activity (requires a little more thought). 25

26 SCARCITY & TRADE-OFFS Concert example illustrates importance of OC. It also makes clear two other key ideas for the term. 1. Scarcity. The only reason we have to choose one thing over another is because our resources are scarce. In reality, all resources are scarce. - Scarcity means choices must be made about how to allocate resources across competing uses. 2. Trade-offs. - Allocating more resources to one activity requires allocating fewer resources to some alternative activity. - To make choices, we trade-off the relative costs and befits of difference options. 26

27 MAKING BINARY DECISIONS: A RULE Binary decisions are yes or no decisions. Generalizing from Springsteen U2 example gives us a basic model of binary decision-making: - When faced with 2 mutually exclusive options, choose the one with the greatest net gain. - This will maximize my happiness; give me the greatest happiness bang for my buck. 27

28 MAKING DECISIONS: A RULE Alternative characterization of decision rule. - Should you take action A? - Decision steps: 1. Identify what you would do, if not A. 2. Calculate the net gain from this next best alternative action. 3. Add to this the explicit costs of action A. 4. Now you have calculated the the OC of action A. 5. Compare OC to your WTP for action A. 6. Only take action A if WTP > OC of action A. 28

29 MAKING DECISIONS Principles of Microeconomics Definition that we will pick up in Topic 3: - Consumer surplus (CS) is the formal term for the NB from a decision to buy, when OC is accounted for. - Consumer surplus (CS) = The benefits from a buying choice minus the opportunity cost associated with that buying choice. CS = WTP - OC. 29

30 SUNK COSTS One more key point about costs. Economists makes a distinction between costs that are sunk, and costs that are not. Sunk costs are those that cannot be recovered, no matter what decision you make. We need to understand that sunk costs should not influence your decision-making, since you incur them anyway. 30

31 SUNK COSTS Back to the concert example. We know I have (or should have) bought a ticket for U2. Now suppose on the day of the concert, a friend offers me a free Springsteen ticket. - Assume that there isn t time for me to sell the U2 ticket. What should I do? - Is it relevant that I have already paid for the U2 ticket? 31

32 SUNK COSTS Do the cost-benefit analysis. If I go to Springsteen: - I gain $200 of happiness at the concert. - I m out the $80 I paid for U2. - I forgo the $150 of U2-related happiness. If I go to U2: - I gain $150 of happiness at the concert. - I m out the $80 I paid for U2. - I forgo the $200 of Springsteen-related happiness. 32

33 SUNK COSTS Do the cost-benefit analysis. If I go to Springsteen: - I gain $200 of happiness at the concert. - I m out the $80 I paid for U2. - I forgo the $150 of U2-related happiness. If I go to U2: - I gain $150 of happiness at the concert. - I m out the $80 I paid for U2. - I forgo the $200 of Springsteen-related happiness. 33

34 SUNK COSTS No matter what choice I make, I m out the $80. - I can t get that back, no matter what. - It is unrecoverable; sunk. Because it is sunk it should not influence my choice. On the day of the concert, all that s relevant is who I like most. - Everything else is in the past. 34

35 NON-BINARY DECISIONS Principles of Microeconomics So far, we have looked just at binary decision-making. Not all decisions are yes or no choices Many decisions (most decisions?) are how much choices. - We model how much decisions using marginal analysis. Marginal analysis involves imagining decision making as if they occur a little bit at a time. We effectively break down how much decisions into lots of little yes or no decisions. 35

36 ICLICKERS Principles of Microeconomics (45 seconds) Suppose you value Springsteen at $140, tickets cost $80, and if you didn t go to Springsteen you would work that evening and be paid a total of $90. Then the opportunity cost to you of Springsteen is: a) $90. b) $80 c) $170. d) $

37 ICLICKERS Principles of Microeconomics (Answer) Suppose you value Springsteen at $140, tickets cost $80, and if you didn t go to Springsteen you would work that evening and be paid a total of $90. Then the opportunity cost to you of Springsteen is: a) $90. b) $80 c) $170. d) $140. OC = Implicit + explicit costs OC = $80 + $90 OC = $170 37

38 ICLICKERS Principles of Microeconomics (Answer) Suppose you value Springsteen at $140, tickets cost $80, and if you didn t go to Springsteen you would work that evening and be paid a total of $90. Then the opportunity cost to you of Springsteen is: a) $90. b) $80 c) $170. d) $140. OC = Implicit + explicit costs OC = $80 + $90 OC = $170 38

39 MARGINAL ANALYSIS Principles of Microeconomics Example: how many beers should I drink at the University Club on Friday evening? Note that this how much decision will literally be a series of yes or no decisions. - I don t need to buy all the beer at once; my purchases will be sequential over the course of the evening. Assuming that my aim is to maximize my happiness, all we need to do is think about happiness gained from each beer versus cost of each beer. 39

40 MARGINAL ANALYSIS Principles of Microeconomics How happy will beer make me on Friday evening? - 1st beer is worth: $20-2nd beer is worth: $12-3rd beer is worth: $6-4th beer is worth: $2 Think about why each additional beer worth less than the last. - Does this have to be true? Suppose beer costs $5 per pint, and no other costs are relevant. How much should I drink? 40

41 MARGINAL ANALYSIS Principles of Microeconomics How happy will beer make me on Friday evening? - 1st beer is worth: $20-2nd beer is worth: $12-3rd beer is worth: $6-4th beer is worth: $2 It is optimal to drink three beers. WTP > cost WTP > cost WTP > cost WTP < cost 41

42 MARGINAL ANALYSIS Principles of Microeconomics The beer decision is an example of marginal analysis. - We are taking small steps - pushing out the margin of our choice - and asking: Was that step worth it? Should we take the next step? Each step is what we call a marginal choice. - Each step requires us to compare the marginal benefit (MB) of that step to the marginal cost (MC) of that step. 42

43 MARGINAL ANALYSIS Principles of Microeconomics Definitions. Given an activity: - The marginal benefit (MB) is the additional benefit gained by doing one more unit of that activity. - The marginal cost (MC) is the additional cost incurred by doing one more unit of that activity. - The marginal net benefit (MNB) = MB - MC. 43

44 MARGINAL ANALYSIS Principles of Microeconomics Can rewrite slide 40 as: - MB of 1st beer = $20. - MB of 2nd beer = $12. - MB of 3rd beer is worth = $6. - MB of 4th beer = $2. MC of beer = $5. 44

45 MARGINAL ANALYSIS Marginal analysis decision rule: - Take an additional step if and only if the MB > MC. (if the MB = MC, we assume the step is taken.) - Equivalently, take an additional step whenever the MNB > 0. All how much decisions are analyzed in this way. - In each different choice environment, weigh up MB v MC. - All that changes as choice environment changes is what makes up the MB and MC terms. - Every model in 103 (all of econ) is about weighing MB & MC. 45

46 MARGINAL ANALYSIS We will be doing marginal analysis all term. Make sure you understand this material fully. We will return again to the beer example in Topic 3, so make sure you are clear on its relevance now. 46

47 ICLICKERS Principles of Microeconomics Q (45 secs) Marginal benefit of beer, to me: - MB of 1st beer: $20 - MB of 2nd beer: $12 - MB of 3rd beer: $6 - MB of 4th beer: $2 Suppose beer costs $8 per pint. How many will I buy? a) 4 beers. b) 3 beer. c) 2 beers. d) 1beer. 47

48 ICLICKERS Principles of Microeconomics A (45 secs) Marginal benefit of beer, to me: - MB of 1st beer: $20 - MB of 2nd beer: $12 - MB of 3rd beer: $6 - MB of 4th beer: $2 Suppose beer costs $8 per pint. How many will I buy? a) 4 beers. b) 3 beer. c) 2 beers. d) 1beer. 48

49 ICLICKERS Principles of Microeconomics A (45 secs) Marginal benefit of beer, to me: - MB of 1st beer: $20 - MB of 2nd beer: $12 - MB of 3rd beer: $6 - MB of 4th beer: $2 Suppose beer costs $8 per pint. How many will I buy? a) 4 beers. b) 3 beer. c) 2 beers. d) 1beer. 49

50 ROUND UP Topic 1, we have looked at two simple ways to model decisionmaking: - For binary decisions, choose the action with the highest net benefit. - For how much decisions, keep doing more of an action as long at the MB is at least as great as the MC. - Remember to fully account for all costs and benefits. This is the approach we will use throughout the term, looking at decision-making in a variety of different context. Now return to slide 1, and make sure you understand the meaning and relevance of each of the terms and phrases listed. 50