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ABSE 101 Introduction to Microeconomics Our entire life is a set of activities, which are making us a part of the world of economics. On the one hand, we are continually faced with our own economic problems: what should I buy in the supermarket? Should I go to university, or should I try to find a job now? Shell I go for a summer vacation, or should I work to earn some money for the university tuition? On the other hand, we are affected by the local, national, and international economic issues: price increases, interest rate changes, etc. So just what is economics about? One does not need going to university to guess that economics is about economic problems. But which problems are economic? Is there anyone who does not have economic problems? Why do we have economic problems? Why is it impossible to solve all economic problems and live without them for the rest of our lives? Economics tries to find the answers to all these questions. However, it will not give us a set of facts and theories to be memorized. Studying economics will give you a way of thinking about the economic problems. This means, that economics will offer us an organized way of identifying and analyzing economic problems. This is why we will try to organize and arrange the questions and the answers that we are looking for. 1. Sources of economic problems Ask people if they would like more money, and most of them will answer “yes”. They want more money so that they can buy more goods and services. This applies not only to poor people, but also to most wealthy people too. The point is that human wants are unlimited. Yet the means of fulfilling human wants are limited. At any one time the world can only produce a limited amount of goods and services. This is because the world only has a limited amount of resources. These resources, or factors of production, are of three broad types: - Human resources: labor (L). The labor force is limited both in number and skills. - Natural resources: land and raw materials (N). The world’s natural resources are limited. - Manufactured resources: capital (K). Capital consists of all those inputs that have been produced by people. The world’s capital resources are limited too. People put together these resources and create output (goods and services). The quantity and the quality of output depend on the available resources and on the technology. A technology is the way of putting resources together. Since resources are limited, people cannot have all they want. The excess of human wants over what can actually be produced is called scarcity of resources. Therefore, scarcity is a relationship between unlimited human wants and scarce resources. Because of scarcity, people have to make choices. Of course, people do not face the problem of scarcity to the same degree, but both the poor and the rich want more, than they can afford. Scarcity is the major source of economic problems. The second source of economic problems is the technological change. When resources increase in quantity, when their quality is improved, and when technologies change, people can produce more and better goods and services. However, their wants still exceed their ability to produce. With technological changes the problem of scarcity has to be solved in a new way. The third source of economic problems is the change in taste and preference. People just learn how to balance with the scarce resources, and their wants change. Now they need different goods and services and the problem of scarcity has to be solved in a new way. 2. The three economic questions The three sources of economic problems raise three questions that should be answered. Scarcity means that people cannot have as much as they want of everything. Therefore, they have to make a choice what and how much goods and services to produce. This is the first economic question. On the other hand, scarcity of resources means that people should not waste them. They should find ways to produce maximum output with their scarce resources. Technological change improves the ability to produce, but at the same time, it raises again the question “how to use scarce resources” in order to produce as much as possible. The third economic question is “for whom to produce”. People are never satisfied by the way in which goods and services are distributed and the change of taste and preferences raises this question again and again. Economics is the study of how people make decisions what to produce, how to produce, and for whom to produce. In economics, we call people economic agents, or economic decision makers. According to the problems they solve, economic agents can be divided into two big groups: households and firms. Households own resources (labor, land and capital). They sell these resources to the firms. The firms put resources together and produce goods and services, which they sell to the households. The third economic agent is government. It solves economic problems when the society decides that the government can make more efficient decisions of some problems, than households and firms. 3. Microeconomics and macroeconomics We study economics because we want to know how to make our lives better. This means, that we are interested in the impact of our decisions on our on life. Microeconomics studies the impact of economic decisions on the individual households and firms. It is interested in the operation of individual markets for goods and services, where the prices of these goods and services are determined. For example, microeconomics studies the prices of gasoline, vegetable oil, chicken, transportation, etc. Microeconomic studies the markets for labor services, too. For example, it studies why football players are paid better than engineers, how the wages of doctors, and waters are are determined, etc. All these issues affect our individual lives as households. At the same time, microeconomics studies the costs and the profits of the firms and how firms set the prices of goods and services that they buy and sell. Macroeconomics studies the impact of economic decisions on the national economy as a whole. It studies what is the total output produced in the country and how it increases over time. It studies the causes and sources of economic growth and economic recessions. It is interested in the overall use of resources in the country. This means that it studies the rate of employment and the rate of unemployment in general. While microeconomics is interested in the prices in individual markets, macroeconomics studies the average price level and its increase (inflation) or decrease. 4. Positive and normative economics In thinking about economic questions, we must distinguish questions of fact from questions of fairness. Positive economics presents want is, what was, and what will be. The conclusions of positive economics can be proved with facts. We can assess them whether they are true, or false. However, there are many cases, when we cannot check whether the answers to economic questions are true or false. For example: should the government raise taxes on the rich and redistribute the money to the poor? Is it better to have a higher inflation but a lower unemployment, than a lower inflation but higher unemployment? There are no right or wrong answers to these questions. The answers depend on ethical values rather than facts. These are questions of normative economics. Normative economics deals with what should be now and in the future, and what should have been in the past. In relies on logical solutions of the questions. 5. Society’s technological possibilities When economists study how people solve economic questions, they try to present a simple picture of the economy and ignore all the factors that are not important for the particular problem. Such pictures are called economic models. The economy can be presented on a scheme. Government Final goods and services Households L, N, K Firms The above picture is a schematic model of the economy. It presents the economic agents and the main decisions that they make. It ignores all the details which are not important for the identification of economic agents. We can present economic problems on schedules (tables) or on graphs. We can also use mathematical equations to present the relationships in the economy.