Microeconomic Principles ECON 103
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Date Created: 09/28/15
Economics 103 Microeconomic Principles 7201000 PM Monday Evening George Mason University Fall 2012 EC Holt Instructor George Mason Rich in Economic Excellence 0 GMU has two Nobel Laureates both in Economics only VA University with two 0 Professor James Buchanan in 1986 for his work in Public Choice 0 Professor Vernon Smith in 2002 for his work in Experimental Economics What is Economics Economics is the social science dealing with the allocation of scarce resources among unlimited wants Key Words social science allocation scarce resources and unlimited wants Economic is a Social Science As a social science it means that it deals with people as in humans homo sapiens Dealing with humans is what makes economics interesting relevant and practical but at the same time complex Relevant since it deals with realworld situations or as in the title of Ludwig von Mises famous book HUMAN ACTION Complex since humans are all different and any given person is not the same every day throughout their life Allacatian 0f Scarce Resaurces There is not enough of most things to satisfy all the needs of all the individuals Goods and services for which there is not enough to meet all such needs are classi ed as scarce goods or economic goodsquot Since there is not enough to go around individuals must make must make choices These Scarce Resources Come in Two Forms 0 Human and NonHuman Human resources are all types of skilled and unskilled labor including the special categories of management amp entrepreneurship Nonhuman resources include land natural resources oil coal water etc and capital machines tools etc that are used to produce other goods and services Resources Also Referred to as Factors of Production Land including natural resources Labor unskilled skilled professional clerical etc Capital machines equipment technology including the nancial resources necessary to acquire machines engage in research and development etc Entrepreneur special category of labor that identi es a previously unrecognized pro t opportunity More than just a manager A risk taker Capital The stuff used to make other stuff Capital can be de ned as aides to productionquot There is no doubt that a person can dig a hole in the ground with their hands To make the process faster and easier a piece of capital could be employed in the form of a stick To the extent the situation could justify the utilization of more sophisticated capital a shovel backhoe or other machinery might be applied Capital Does Not Just Happen It Must Be Created In its creation other scarce resources must be utilized For the sherman to create net and thereby shorten the time and effort to catch a given number of sh current scarce resources including the sherman s time when he could have been catching sh must be given up As such the creation or formation of capital requires a decision to forego some current consumption in favor of greater future consumption You Are Making Such a Choice Here Today sitting in this class You have decided to improve your human capital by attending this class As a result of this decision you are incurring certain explicit costs such as the tuition books etc as well as certain implicit costs such as foregoing the opportunity to sleep or work several additional hours each week Your decision to sacri ce this current consumption is motivated by your expectation that with the resultant education will produce a larger future income stream Time Can Be Allocated But It Cannot Be Created No Matter How Wealthy One May Be There Is Always a Shortage of TIME The lowest posted price or the money price may not always be the best bargain when time is factored into the total cost The total cost of anything must include both the explicit outof pocket costs and the implicit nonmonetary cost such as the value of one s time Making Choices Means Incurring Costs Opportunity Costs 1 Life is lled with alternatives What to buy where to work what classes to take whether to go to the movies or stay home and study economics etc On a daily basis we make choices among these various opportunities or alternatives based upon our assessment of their relative costs and bene ts what is best for me at this moment in time Making Choices Means Incurring Costs Opportunity Costs 2 Since you cannot be two places at the same time once you have decided to do one thing you have given up the opportunity to do the other Or in other words you have incurred an opportunity cost This opportunity cost is expressed in terms of the highest valued alternative foregone given up in making any choice Markets Setting for Exchange Range from highly organized markets such as the New York Stock Exchange Where you can literally see What the last person paid for it to the underground economy Where transactions are deliberately dif cult to follow Primary coordinating mechanism in a capitalist democracy Not necessary that goods or services be bought or sold information can be traded Markets The various arrangements people have for trading with one another Good and services may be traded as well as information Some are more organized than others Price is a Re ection of Relative Scarcity All other things equal the less of something you have the more valuable it becomes As oil resources are depleted the price should be expected to rise The value you place on the rst drink of water when you are thirsty versus after consuming a sixteen ounce glass Prices Provide Essential Signals in a Market Economy Prices convey information to producers and resources suppliers that help them determine What and how much to produce As goods sit on store shelves and the price must be lowered Sale this tells signals suppliers to reduce or stop production If goods are bought quickly and prices rise re ecting their increasing scarcity this tells suppliers to reallocate their production capacity to produce more Positive versus Normative Economic Statements Positive one based upon an unemotional assessment of the facts testable for validity through scienti c analysis Raising the minimum wage will increase shortterm unemployment among unskilled labor Normative one based upon value judgment personal preference bias The minimum wage should be raised because at its current level it is unfair to low income citizens Basic Economic Lessons in Life 0 Nothing is ever worth more than the last person paid for it 0 Price is a re ection of relative scarcity 0 Resources ow to their most highly valued use in ef cient markets but most markets are not truly ef cient 0 People are just too human Rational SelfInterest as Expressed by Adam Smith It is not for the benevolence of the butcher the brewer or the baker that we expect our dinner but from their regard to their own interestquot Wealth of Nations Humans Rational SelfInterested Beings Going Through Life Trading Off Benefits Against Costs Looking out for NUMBER ONE This does not make people evil only HUMAN Sometimes we may question another person s actions or Choices as being irrational when in fact this is nothing more than a re ection of the fact that relative values and priorities vary among people Transaction Costs the cost of making a deal Include 1 Information costs 2 Cost of negotiating and contracting 3 Cost imposed by taxes and regulations trade environmental health amp safety etc 4 Transportation costs Returns to Factors of Production 0 Land 0 Rent 0 Labor 0 Wages Capital 0 Interest 0 Entrepreneur 0 Pro t What Do We Hold Constant When Drawing a Demand Curve Taste and preferences can be in uenced by experience advertisement peer pressure etc Income Price of Other Goods Buyer s Expectations WHEN ONE OF THESE CHANGE WE GET A CHANGE IN DEMAND AS SIGNIFIED BY SHIFT IN THE DEMAND CURVE What Do We Hold Constant When Drawing a Supply Curve Cost of inputs including technology if labor costs for a rm go up the supply curve will shift up and to the left if labor costs go down the supply curve will shift down and to the right Price of Other Goods Supplier s Expectations Number of Suppliers WHEN ONE OF THESE CHANGE WE GET A CHANGE IN SUPPLY AS SIGNIFIED BY SHIFT IN THE SUPPLY CURVE Travel Options and Costs Which is the Cheapest 1 Bus Fare 120 Time Required 10 Hours Plane Fare 400 Time Required 2 Hours Clearly if all we were concerned with was the money price the bus is 280 cheaper However that does not account for the 8 hour time difference In other words if I want to save 280 it is going to cost me 8 hours Or if I want to save 8 hours it is going to cost me 280 Week of March 31 Goals 0 Distinguish between private goods and public goods 0 Introduce concept of public choice 0 Understand importance of enforcing property rights Distinguish between private goods and public goods Definition of Public Good 0 The private market does not do very well at providing public goods 0 To understand why we need to be clear on the distinction between private goods and public goods 0 A private good is bought by one person and consumed by one person 0 With a public good one person39s consumption does not reduce the amount of the good available for consumption by others Definition of Public Good 0 the technical term is quotnonrival in consumptionquot 0 with private goods consumers are rivals because what one consumes the other can39t o The most common example of a public good is national defense 0 the protection one citizen receives does not decrease the protection any other citizen receives Definition of Public Good 0 Nonexlusion feature of a public good 0 when provided to one it is provided to all 0 example of movie theater TV broadcast national defense 0 In general whenever there is a cost involved in consuming the public good this degrades the public good character 0 that is a pure public good is free it costs nothing to consume FreeRider Problem 0 Say a private firm produced a public good 0 what could they sell it for 0 Consider the choice facing a potential consumer if you pay a price of 10 you can consume the public good 0 if you pay a price of 5 you can consume the public good 0 if you pay nothing at all you can consume the public good 0 that is you can quotfree ridequot FreeRider Problem 0 Everyone has on incentive to let everyone else pay for the public good 0 result no one pays for it and it doesn39t get produced 0 We can demonstrate this with the prisoner39s dilemmo FreeRider Problem 0 Prisoner39s Dilemma Analysis Pay Free ride Pay 55 410 Free ride 104 00 o If produced at all it will be only at level of the greatest individual demand 0 that individual pays and everyone else free rides FreeRider Problem P Dag1mm 111 an How can the Government Help 0 The government has the power to impose taxes on its citizens 0 payment for the appropriate level can be forced rather than having to rely on voluntary payments Introduce Concept of Public Choice What is Public Choice 0 Public choice is the application of economic tools to the study of government 0 Basic insight People in government are people 0 that is motivated by self interest Voting Rules 0 What is the basic voting rule used in this country 0 Answer Majority rule 0 What other voting rules are in use 0 I39ve got a little exercise for us to play that will reveal some odd things about majority voting 0 it ought to be fun too Voting Rules 0 There are 2 costs involved in maleing collective decisions 0 1 The expense of convincing the required number of people to vote for a proposal decisionmaking cost 0 2 The chance that a proposal you don39t lilee will be approved external cost 0 Both of these costs are affected by the voting rule used Voting Rules Tntal cutst i 1 I I quot III Percent Elf V t I Equired f r pas sag I Voting Rules 0 Xc External cost 0 the majority may decide something you don39t like 0 in effect the lileelihood that you are in the minority 0 DC Decisionmaking cost 0 Tc Total cost 0 The quotbestquot voting rule is the one that minimizes the total cost Special Interest Groups 0 The government has the power to redistribute income 0 They should do so to the extent that the public favors it o How do our elected officials know how much income redistribution and to who the public desires They have to listen to their constituents 0 However there is a problem in the incentives individuals have for making their opinions known to their representatives Special Interest Groups 0 Special interest groups large stalee in the outcome low organization costs 0 General public small individual stake in the outcome high organization costs Don39t seek Seek special special favors favors Don39t seek 1010 215 Seek 152 55 Special Interest Groups 0 This explains organizations such as Common Cause 0 It pays general public to invest in an organization that will represent its interests 0 Explains why bills are presented as if in the public interest 0 with a pure income grab the public could discover what was going on very inexpensively 0 CIOCIIQ the bill in the public interest make it long and complicated and very few people will be willing to incur the expense to discover what the bill will really do Agenda Setting 0 The outcome of a vote depends not just on the voting rule used but also on the way in which a bill is presented for voting 0 an unpopular bill may pass if it is combined with a popular bill 0 a popular bill may fail if it is combined with an unpopular bill 0 Give some examples of how this worles 0 quotChristmas treequot appropriation bills 0 quotKillerquot amendments Agenda Setting 0 The person who decides how bills will come up for voting that is the person who controls the voting agenda has a lot of ability to influence the outcome discuss homeworle 15 Logrolling 0 Congressmen want to pass bills that will benefit their own state Why 0 Answer The only people who can vote for him are people in his state If they approve of him it doesn39t matter how people outside his state feel 0 But why would congressmen from other states vote for a bill which would benefit the citizens of Ohio for example at the expense of the citizens of their own state 0 Answer Logrolling you help me and I39ll help you 0 He votes for your pork barrel bill and in return you vote for his pork barrel bill Logrolling 0 Voters in your state love you because you got that quothelp Ohio a lot hurt everybody else a littlequot bill passed 0 they don39t notice that you helped pass 49 quothelp somebody else a lot hurt Ohio a littlequot bills 0 Can anything be done about this What does public choice tell us 0 First it tells us what won39t worle 0 quotThrow the rascals outquot in general will not worle 0 because the rascals are just people and the next bunch is lileely to be just as rascally Logrolling Which is not to say you don39t want to vote out bad representatives just that you aren39t lileely to malee a substantive change in this way 0 Second it tells us what will work 0 That is changing the incentives changing relative costs and returns 0 Change the rules constitutional economics 0 Unfortunately public choice doesn39t tell us how to change the rules 0 In addition it is often highly unclear if a particular rule change would be good or not Understand Importance of Enforcing Property Rights What Would Things be like if There Were No Government 0 Thomas Hobbes Leviathan o Simplifying model only economic activity is raising sheep 0 Two ways to get additional sheep 1 Work hard take good care of the sheep you have get them good pasture and shelter breed them well and so on 2 Steal your neighbor39s sheep What Would Things be like if There Were No Government 0 Now we have 2 economic activities 0 1 Raising sheep 2 Protecting your sheep against theft 0 Resources invested in protecting against theft cannot be invested in raising sheep society is poorer What Would Things be like if There Were No Government 0 Prisoner39s dilemma illustrates this Don39t steal Steal Don39t steal 1010 018 Steal 180 55 0 Cell AA is preferred but there is no way to get there driven inexorably to cell BB where no one wants to be What Would Things be like if There Were No Government 0 To reach cell AA requires a collective decision but we have assumed that there is no government that is that no decisions are made collectively o Hobbes describes life without government as nasty brutish and short 0 and he39s right ECON 103 April 9 2009 Distribution of Income Ineqaulity 0 Book calls it a market failure which is a huge stretch in reality 0 Even if our markets were completely completive there would still be income and inequality because some folks have more income more than others There is no such thing has having too much income in Inequality The poorthe resources the human capital is not taken good advantage of bad housing bad food reduce the value of human capital that you do have Household Income 0 Income in inequality over the past 40 years have gotten worse 0 Quintiles to o Lorenz s Curve percent of Income 100 Denent 0F Households 0 2o 40 60 E0 100 I Percent of Income Percent Households I 45 degree line I Bows away as it increases 0 Gini Percent of l come OO PercentofIIouseholds 0 20 40 so 30 I00 I The area above the 45 degree and divide by the area beneath the Lorenz s Curve 0 45 degree area creates a triangle I Area 5000 o Worksheet on Income Inequality ECON 103 April 9 2009 1 Wage Earner Arranged in Form quintiles 2 25 5 56 0 Put in lowest to greatest first 0 Group them by quintiles ex Snap shot I Comparing apples to oranges o The Effect of Age 0 Step 1 Step 2 Step 3 Arranged in OldNoung 32 50 Form normalized quintiles order by Prime 3amp1 75 income 1 2 32 3 1 3 45 2 3 32 45 75 3 5 32 75 2quot 75 9 4 6 32 75 165 5 7 32 105 3 1o575 6 1O 34 75 18 7 11 32 115 4th 165 105 8 14 34 105 27 9 18 34 135 5thz155 18 1O 24 34 18 315 0 Changes in Household Compositions I Household C single male I Household D single female 0 Get married I Household F elderly parents of household H I Household E married couple with successful careers 0 Get diyorced I Household B a son with income 4 move out and forms his own household List new Step 2 Step 3 households and Arrange in Order Form quintiles percent of by Income income A 2 1 23 B1 14 C 3 5 B2 4 B2 4 2quot 47
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