Download Microeconomics Essay Research Paper Microeconomics Outline

Microeconomics Essay, Research Paper
Microeconomics
Outline Thesis Statement: Microeconomic mechanisms can predict future technology impacted
economic outcomes. I. What is Economics? A. What do economics tell us? B. The science of
economics 1. defining microeconomics 2. some terms and definitions II. Using Microeconomic
models A. Theory 1. practical application 2. household choices III. Economic Growth A. The
cost of economic growth B. Capital accumulation C. Technological change IV. Individual and
Market Demand A. Household Consumption Choices 1. Constraints 2. Preferences 3. Marginal
utility a. an analogy 4. Utility maximization V. Predictions Based on Marginal Utility Theory A.
Price increases B. Increases of income VI. In Conclusion This paper will attempt to examine
microeconomic structures in relation to technological advances. The impact of increasingly
available technology is a major economic force. Prior to 1975, for example, viewing a first run
movie at home was technically possible but economically infeasible. Only the wealthy chose to
view moves at home. VCR’s became available in 1976, with a typical price tag of $2000.00
Even at such a high price, that invention slashed the price of home viewing. Today a VCR can be
purchased for $200.00, a fraction of its’ initial cost. Videos can be rented for approximately a
dollar or purchased for around $20.00. Home viewing has become common in a few short years,
where formerly it had been available only to the very rich. In what other ways has technology
changed the way of life and can microeconomic mechanisms accurately predict future economic
outcomes? What is Economics? The simple answer to the question, “What is the economy?” is to
state that the economy is the means by which resources are allocated. A more accurate portrayal
of economic process is to view it as a machine that produces three distinctly different results: 
First, the economy determines what goods and services will be produced and in what quantities.
 Secondly, it indicates how various goods and services will be produced.  Thirdly, it resolves
the question of distribution. Markets for goods and services, and markets for production of those
goods and services – command mechanisms –directly correlate with the choices made by
households, firms and governments. The US economy relies mainly on markets but to a degree
on command mechanisms. The US economy is an open economy and has become highly
integrated with the global economy. This is a fairly recent development, with foreign investment
into US business outstripping US investments in foreign enterprises shifting the balance in the
mid-1980s. Economists study these financial movements in order to determine the underlying
principles driving the economy. This approach utilizes the same rigor and objectivity of natural
scientists. Economic science, like natural science, is an attempt to discover a body of laws. All
sciences use the same criteria in the investigative process: careful and systematic observation and
measurement, and the development of a body of theory to direct and interpret observations. That
theory is a general rule or principle that allows economists to understand and predict the
economic choices that people make. Theories are derived from building and testing economic
models. Economic models are built on four key premises. These basic assumptions are:  People
have preferences  People have a fixed amount of resources and a technology that can transform
resources into goods and services.  People choose how to use resources and technology to
increase economic well-being.  People’s choices are coordinated – buyers choose what sellers
offer and vice versa. The implications of such models are that the values of various prices and
quantities result in “equilibrium”. That is, situations in which everyone has made the best
possible choices, given their own preferences, information, resources, and technologies, and that
those choices are coordinated and compatible with the choices of everyone else. Equilibrium is
the solution or outcome of an economic model. Economic models fall into two categories:
Microeconomics and macroeconomics. Microeconomics is the branch of economics that studies
the choices of individual households and firms. Because it analyzes the behavior of economic
units, microeconomics is a most important social science. Microeconomics theory is used to
analyze various circumstances and outcomes from decision making. In addition, microeconomics
provides foundations for scientists of other social disciplines. Microeconomics is a highly useful
tool in business management, aiding in planning, finance, and marketing. However,
microeconomics is not limited to business applications. Government administration, political
science, history, social- behavior, and much more can be viewed through the lens of
microeconomics. What do microeconomics tell us? Careful analysis using microeconomic
models answer those questions dealing with technological change, production and consumption,
wages and earnings. Economic concerns involving unemployment, inflation, and the differences
in wealth among nations are macroeconomic. A major cog in the microeconomic machinery is
the concept of “scarcity”. This is easily summed up as the universal state in which wants exceed
resources. Scarcity fuels “production”, the conversion of land, labor, and capital into goods and
services. Services are made up of intangible commodities such as haircuts, phone calls and cab
rides. Goods are tangible – cars, socks, VCRs, and bread. Goods are classified as either capital
goods, i.e., those goods with long term use such as buildings cars, computers, etc., or
consumption goods. Consumption goods are items that can be used one time only, such as
pickles and toothpaste. Finite resources and the available technologies limit what can be
produced in terms of goods and services. The boundary between what can and cannot be
produced is referred to as the production possibility frontier (PPF). Using Microeconomic
Models Understanding the PPF as applied to real life is critically important. To make that
concept easier to grasp a model economy can be devised that, while simpler than real life
situations, provides enough accurate information to draw viable conclusions and make feasible
predictions. To build this model, features essential to understanding the real economy must be
incorporated, but copious details are eliminated. The model will be simplified by establishing
three important criteria: 1. Everything in this model that is produced is also consumed,
stabilizing capital resources so that they neither grow nor shrink. 2. There are only two goods
rice and cloth. 3. There is a single individual involved with this economy, “Joe”. Joe’s setting is
a deserted island, with no outside contact. Joe uses all the resources available to him to produce
rice and cloth. It requires Joe to labor 10 hours a day. The amount of cloth and rice produced
relies on how many hours are devoted to the activity. producing them. If Joe does no work,
nothing is produced. To produce six pounds of rice in a month, Joe must work two hours a day.
Devoting more hours to rice increases monthly output, but the return rate diminishes as Joe has
to use increasingly unsuitable land in that production. Initially, Joe plants in fertile wet land. As
the best quality land is put into production, remaining available land becomes drier and less
productive. Eventually, all workable land is used and time and effort must now be devoted to
reconditioning other types of land. To produce cloth, Joe gathers wool from sheep on the island.
As he devotes more hours to gathering wool and weaving fiber, cloth output increases. If Joe
devotes all his time to raising rice, he can produce twenty pounds of corn a month. He cannot,
however, produce any cloth. Conversely, if Joe devotes all of his time to making cloth, he can
produce five yards a month but will have no time for the rice crop. He can vote some of his time
to rice and some to cloth but not more than ten hours total. Thus he can spend two hours a day
producing rice and eight hours producing cloth, or any combination of hours equaling ten hours.
This clearly illustrates the production possibility frontier as a boundary identifying what is
obtainable and what is not. Calculate Joe’s PPF by using the information in Table 1. These
calculations are summarized in Figure 1 and graphed as Joe’s PPF. To understand these
calculations, first examine the data found in Figure 1. Possibility A shows an entire working day
devoted solely to rice production. In this case 20 pounds of rice per month is the forecasted yield,
while no cloth is produced. Possibility B demonstrates two hours daily in cloth production and
eight hours producing rice, yielding a total of eighteen pounds of rice and one yard of cloth
monthly. The pattern continues onto F, showing an entire working day devoted to cloth
production. The work day is defined as two hour blocks of time in Table 1, however, any
feasible allocation of a day hour work day will
________________________________________________________________________demon
strate the potential various combinations of rice and cloth along the line joining points A, B, C,
D, E, and F. in Figure 1. This indicates the Production Possibility Frontier. Production can be
maintained at any point on or within the attainable frontier – the area discerned as yellow inside
Figure 1. Points outside that frontier are unattainable. To produce at points beyond the frontier,
there would have to be more time allotted to the working day. A ten hour work day allows for
various combinations of rice and cloth production at the PPF. A work day less than ten hours
will allow for production only at a point inside the frontier. Table 1 Production Possibilities
Hours Worked Rice Grown Cloth Produced (per day) ( lbs. per month) (yards per month) 0
either 0 or 0 2 either 6 or 1 4 either 11 or 2 6 either 15 or 3 8 either 18 or 4 10 either 20 or 5
_____________________________________________________________________________
_________________ If Joe performs no labor no rice or cloth are produced. If Joe labors for 2
hours daily and devotes all that time on corn production he will produce 6 pounds of rice per
month. If that same time is used for cloth production, 1 yard of cloth is produced but no rice. The
last four rows of the table indicate the amount of rice or cloth that can be produced per month as
more hours are devoted to those activities.
_____________________________________________________________________________
_________________ _____________________________________ Production Possibility
Frontier Figure 1 Rice 20 A in lbs. 18 B per month 16 C Unattainable 14 12 Z D 10 8 6 E
Attainable 4 Production possibility 2 frontier F 0 1 2 3 4 5 6 7 8 9 Cloth in yards per month Rice
Cloth in in lbs. yards per per Possibility month month A 20 and 0 B 18 and 1 C 15 and 2 D 11
and 3 E 6 and 4 F 0 and 5 The graph lists six points on Joe’s production possibility Frontier. Row
E tells us that if Joe produces 6 pounds of rice, the maximum cloth production that’s possible is 4
yards. These same points are graphed as A, B, C, D, E, and F in the figure. The line passing
through these points is the production possibility frontier, which separates the attainable from the
unattainable. The attainable area contains all the possible production points. Joe can produce
anywhere inside the area or on the production possibility frontier. Points outside the frontier are
unattainable. Models such as these provide a structure for understanding how production works
and aids in decision making by demonstrating what opportunities exist and what is required to
take advantage of those opportunities. But having more of one means having less of another.
This is referred to as opportunity cost. Opportunity cost is measured by evaluating the PPF. How
much cloth has to be given up to get more rice and vice versa are the questions requiring answers
using the rice and cloth model. If all allotted monthly working hours are used to grow rice, there
are twenty pounds of rice but no cloth. How much rice is given up to produce one yard of cloth?
Figure 1 shows that a single yard of cloth will cost two pounds of rice to produce. If an
additional yard of cloth is produced, the progression from point B to point C indicates that it will
cost three pounds of rice to produce the second yard of cloth. The next yard of cloth costs six
pounds of corn. It has been learned from the model that the opportunity cost of cloth increases as
more cloth is produced. This is also true in reverse. The first six pounds of rice costs one yard of
cloth to produce. The next five pounds of rice costs an additional yard of cloth, and so on. The
opportunity cost of rice also increases. Contributing to this phenomenon is the factor of
inequality; not all scarce resources are equally useful in all activities. For example, while some
of the land on Joe’s hypothetical island is extremely suitable for high yield rice crops, the
remaining landscape may be rocky and barren. The sheep on the island, however, prefer rocky
and barren land. Obviously, the optimum use of this island resource is to use the most fertile, wet
land to grow rice and the most rocky and barren land to raise sheep. Only if a larger rice yield is
desired will it be necessary to attempt to cultivate the less desirable land. If all allocated time is
devoted to cultivating rice then it becomes necessary to use unsuitable low yielding land.
Devoting some of the time to making cloth and reducing some of the time spent growing rice
produces a small drop in crop yield but a large increase in the output of cloth. Conversely, if all
allocated time is used to make Seal Straugh cloth, a small reduction in woolgathering leads to a
large increase in rice production. What has been learned from the model provides fundamental
lessons in real world economy. The world has a fixed number of people endowed with a given
amount of limited time and human capital. These limited resources can be utilized, using the
available but limited technology to produce goods and services. But there is a limit to the goods
and services that can be produced, a boundary between what’s attainable and unattainable. For
example, the political candidate who offers better education and human services must
simultaneously be prepared to increase taxes or reduce services in another sector such as road
maintenance or fire protection. On a much smaller but equally important scale, each time an
individual rents a video, that same individual must determine where to expend remaining cash
resource, be it popcorn, soft-drinks or something else entirely. The cost of one more video is one
less of something else. It is impossible to escape from scarcity and opportunity costs. Given the
limited resources available to any individual, the more of one thing always means less than
another and the more of anyone service or product, the higher its opportunity cost. Economic
Growth The PPF defines a clear boundary between what is and is not attainable. However, that
boundary is not static. It is constantly changing. At times the PPF moves inward, reducing
production possibility. Other times, it moves outward. Using the “Joe’s Island” analogy for
example, excellent growing and harvesting conditions would have the effect of pushing the
production possibility frontier outward. Expansion of production possibilities is termed
economic growth. Over the last 100 years, the PPF has expanded exponentially. The question at
hand for the new millennium appears to be how far can the economic envelope be pushed? The
cost incurred in economic growth involves two key factors: capital accumulation, the growth of
capital resources; and technological progress, new and better methods of producing goods and
services. As a result of these factors in the nation’s current economic profile, there are an
enormous quantity of trains, planes, and automobiles, producing far more available
transportation than was experienced when only horses and buggies were available as transport.
Satellites make transcontinental communications possible on a scale much larger than what
could have been predicted using cable technology. However, accumulating capital and
developing new technology are costly. Economic growth wears a cloak of trade-off. If all
resources are devoted to the production of food, clothing, houses, entertainment, and other
consumer goods, and none to research, development, and accumulating capital, there will be no
more capital and no better technologies in the future than exist at present. Production
possibilities in the future will be exactly as they are today. Future economic expansion requires
that fewer goods are produced for future consumption. Resources that are freed up today allow
for the accumulation of capital. In turn, better technologies for the production of consumption
goods can be developed in the future. The cut in output of consumer goods today is the
opportunity cost of economic growth. Household Consumer Choices Individuals determine what
goods and services they will consume. The total quantity of those desired goods and services is
called market demand. The relationship between the quantity of a good or service by a single
individual and its price is called individual demand. Market demand is the sum of all individual
demands. These demands are better understood by examining the mechanism used by
households in making consumer choices. Consumption choices made by households are
determined by two factors: constraints and preferences. Consumer choices made by any
household are limited by that household’s income and the price of the desired goods or services
purchased. Marginal utility theory assumes that a household has a given income to spend and
that it has no influence on the prices of goods or services it purchases. A representation of this
theory follows: House A has a monthly income of $100.00 and is constrained by that limit.
House A spends its dollar resources on only two items – books and beverages. Books cost $6.00
each. Beverages cost .50 each or $3.00 a six pack. House A can purchase as many as ten six
packs a month or five books a month. There are many other purchase combinations conceivable.
Consumption possibilities can be visualized similar to the PPF, and the structure of Figure 1 is an
excellent representation of such a consumption possibilities model. House A must decide how to
divide the monthly income between books and beverages. The likes and dislikes of the members
of that household drive those purchasing decision. This is referred to as preference. Marginal
utility theory uses the highly abstract concept of utility to describe those preferences. The
concept of utility can best be explained with an analogy. Take, for example, the concept of
temperature. It’s easy to understand the difference between feeling hot and cold, but hot and cold
are not something observable. Water turns into steam when hot enough or ice when cold enough
and those are observable phenomena. In order to predict when such changes will occur an
instrument can be constructed. Such an instrument is called a thermometer. The scale on the
thermometer is the essence of temperature. The units used to measure that temperature are
arbitrary. That is, the weight and value assigned to those units are subject to the judgment of the
designer of the scale. An accurate prediction of water turning to ice can be made when a
thermometer using a Celsius scale reaches 0. But the units of measure themselves are
meaningless because this same events takes place when a Fahrenheit thermometer shows a
temperature of 32. The concept of utility allows for predictions about consumption choices in
much the same way. It must be pointed out, however, that marginal utility theory is not as
accurate as the theory that allows us to predict when water will turn to ice. Total utility refers to
the total benefit, or pay out, derived from the consumption of goods or services. The level of
consumption determines the quantity of total utility. This concept can be illustrated by using the
consumption possibilities of House A. Table 2 shows House A’s total utility from consuming
different quantities of books and beverages. If no books are purchased in a month, there is no
utility from books. If one book is purchased monthly 50 units of utility are assigned. Total Utility
from Books and Beverages Table 2 Books Beverages___ Monthly Quantity Total Utility
Monthly Quantity Total Utility 0 0 0 0 1 50 1 75 2 88 2 117 3 121 3 153 4 150 4 181 5 175 5 206
6 196 6 225 7 214 7 243 8 229 8 260 9 241 9 276 10 250 10 291 As the number of book
purchases increase, total utility increases. If ten books are purchased 250 units of utility are
awarded. The other part of the table shows the total utility of beverage consumption. As
beverages are consumed total utility rises. Marginal utility is that change in total utility resulting
from a one-unit increase in the quantity of consumed goods or services. When consumption of
books moves from four to five monthly, total utility from books increases from 150 to 175 units.
Thus, for House A marginal utility of procuring a fifth book each month is 25 units. Marginal
utility appears midway between the quantities consumed. The change in consumption from four
to five is what produces the marginal utility of 25 units. The more books House A purchases a
month the more total utility it gets. However the marginal utility decreases, with each purchase.
For example, marginal utility from the first book is 50 units. The second book has a marginal
utility of 38 units and the third, 33 units. This decrease in marginal utility as the consumption of
a good increases is the principle of diminishing marginal utility. Marginal utility is positive but
diminishes as consumption increases. These two features come about in this way: The members
of House A enjoy reading so benefit from the purchase of books. That casts marginal utility in a
positive light. Marginal utility diminishes as more books are purchased due in part to opportunity
cost and in part to lessening benefit. Those readers still enjoy a good book but the 30th is not
quite as satisfying as the first. Utility maximization is the attainment of the greatest possible
utility. A household’s income and the prices that it faces limit the utility that it can obtain. The
model in Table 3 is used to examine the allocation of spending to establish the maximum total
utility. Assume that Household A has $30.00 per month book and beverage budget. When House
A consumes two books and six beverages a month it receives 313 units of total utility. This is the
best that can be done within the Any other combination of books and beverages generates less
than 313 units of total utility. In maximizing total utility, that is, allocating income to achieve the
most total utility units, consumer equilibrium is created. Books and Beverages UtilityMaximization Combinations Table 3
________________________________________________________________________ Books
Total Utility from Beverages Quantity Total Utility Books & Beverages Total Utility Beverages
0 0 291 291 10 1 50 310 260 8 2 88 313 225 6 3 121 302 181 4 4 150 267 117 2 5 175 175 0 0
_____________________________________________________________________________
________ Predictions Based on Marginal Utility Theory This information allows for economic
prediction. This is relevant because income and prices are not stagnant. What happens to House
A’s consumption of books and beverages when their prices and House A’s income changes?
Determining the effect of a change in price on consumption involves three steps: 1 Determine the
combinations that can be purchased at new prices. 2 Calculate the new marginal utilities per
dollar spent. 3 Determine the maximum utility resulting in consumer equilibrium. This process
demonstrates that if, for example, the price of books falls but beverages remain constant in
pricing, House A will most likely increase consumption of books and indulge in fewer
beverages. If house A does not adjust it’s consumer habits it losses consumer equilibrium. A rise
in income, however, brings about an increase in consumer goods. Should House A increase it’s
books and beverages budget to $42.00 consumer equilibrium is reached when seven books and
seven beverages are purchased monthly. Marginal utility theory is used by economists to answer
a wide range of questions. An example of this can be found in it’s application in determining the
fluctuations in popularity between wooden and aluminum baseball bats. Another example is the
ability of the theory to answer questions about patterns of consumer spending. But as well as
explaining consumption choices, it can be used to explain all household choices. The allocation
of time as well as capital can be decided using marginal utility theory. And it’s often been stated
that time equates to money. In Conclusion What does all this mean to the modern consumer?
There becomes a point for consumers when all resources, intangible capital such as time as well
as tangible dollars, goods and services, has to be factored into the cost/benefit analysis of
consumption and production. Making intelligent consumer choices requires a clear
understanding of the opportunity cost and an applied strategy for maximizing total utility. When
that takes place a window for technological advancement is opened. New technologies enable
producers to eliminate some of those factors that drive up production costs and therefore prices.
For example, the development of new technology for the manufacture of tape by companies such
as 3M has lowered the cost of producing tapes and increased the available supply. Technology
advances in the area of sticky products is now available and affordable to the masses. However,
that technology has also made obsolete other goods and services. Tape sales may be up due to
market demand created by new tape technology, but the market for library paste is drying up.
Makers of library paste may or may not be able to hold enough market share to continue
production. But until it is no longer economically feasible to produce library paste, consumers
have choices beyond tape when considering sticky products. Basically, consumers are faced with
more choices than at any time ever before. In a spiraling effect, these consumer choices have
created the opportunity for increasing technology. And that technology has changed every aspect
of day to day life and all human transactions. We live in a style that previous generations could
not have imagined. Goods such as home videos and microwave popcorn now appear on the
average shopping list. Advances in medicine have cured previously fatal diseases. Homes are
more spacious, people eat better, grow taller, and are even born larger than in past generations.
Economic growth and technological change have made the current generation richer than the
generations of our parents and grandparents. But we have not created Utopia. As a society we
experience opportunity cost with each new technological advancement. The extent of that cost
can be measured with the tools of microeconomics that have been examined in this paper.
Possible production frontier graphs can be employed in the planning and decision making stage
prior to production. Determining how an item is priced, and therefore its’ profitability, is a
function of marginal utility theory. All of this helps industry to decide if and how to go about
introducing new products and technology. That’s critically important simply because just
because we can, it doesn’t always mean we should. Seal Straugh Notes
Bibliography
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