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Introduction to Microeconomic
Lecture 1 & 2:
January 11, 2011
Based on material in Chapters 1 and 2
Curtis, Irvine and Begg
Dr. William McCarten
Department of Economics
Trent University
Room 343 Peter Gzowski College
Evaluation
This will be as follows:
Quizzes (3)
Assignments (best 5 of 8)
Mid-Term Test
Final Examination
15%
28%
21%
36%
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Learning Outcomes
4
By the end of this chapter you should learn:
Resource allocation and scarcity
The what, how and for whom issues
 Dynamic aspects of resource allocation

Production possibilities and opportunity costs
The roles of markets and governments in the
allocation problem
Positive economics and normative economics
The economist’s belief system
Distinctions between Micro and Macro
economics
©2010 McGraw-Hill
Ryerson Ltd.
Chapter 1 - Curtis, Irvine & Begg
What is Economics?
5
ECONOMICS ...
is the study of how society decides:


What goods and services should be produced and in what
quantity
How to go about producing them


Which techniques of production to employ
For whom should they be produced

The distribution of the wealth and income
Chapter 1 - Curtis, Irvine & Begg
©2010 McGraw-Hill Ryerson Ltd.
Exploring the What, How and for
Whom
©2010 McGraw-Hill Ryerson Ltd.
Chapter 1 - Curtis, Irvine & Begg
6
An Increase in the Price of Oil
Affects
7
What to produce by firms

less oil-intensive products
How to produce

less oil-intensive techniques (example wind, Nuclear
stations)
For whom to produce

oil producers have more purchasing power (that is
command over global resources) power, importers have
less
Chapter 1 - Curtis, Irvine & Begg
Ch 1.1
©2010 McGraw-Hill Ryerson Ltd.
Resource Allocation
based on World Bank Statistics
Table 1.1 World Population and Income 2005
Country Group
Nearlyper
80%capita
of the(Can
world’s
Income
$)
output of goods and services
is consumed by 15% of its
population
Percentage
of World
Population
Percentage of World
Income
Poor
Middle
Rich
580
2640
35131
37
48
15
3
18
79
Ch 1.2
8
Dynamic Resource Allocation
Resources allocated unequally around the world
Developed countries endowed with much more
physical capital and human capital
High-growth economies are usually
characterized by two key patterns



Save and invest
Foster institutions and property rights
However many poor countries in Asia (China, India,
Indonesia have increased saving , investment and growth
in last 25 years. Ex India growth 8-9% per year
Chapter 1 - Curtis, Irvine & Begg
©2010 McGraw-Hill Ryerson Ltd.
The Production Possibilities
Frontier
We wish to introduce the Production
Possibilities Frontier

better known as the PPF.
The PPF is a basic workhorse in economics.
Important for understanding some basic issues in
economics.
The PPF shows for each output of one good, the
maximum amount of the other good that can be
produced with given resources and a given state
of technology.
The Production Possibility
Frontier - What Is It?
The description of the best possible
combinations of two goods to produce using all
of the available resources.
Shows the trade-off between more of one good
in terms of the other.
Assumes: input endowments given, technology
given, time given and efficient production.
The Production Possibility
Frontier (PPF)
12
12
The PPF is a two dimensional graphical device
designed to illustrate:
 Scarcity
 Tradeoffs (negative slope)
 Opportunity cost
 Longer-term economic growth
 Tradeoffs can be linear or reflect increasing
opportunity cost (concave). Why increasing
opportunity?
©2010 McGraw-Hill Ryerson Ltd.
Chapter 1 - Curtis, Irvine & Begg
The Production Possibility Frontier
13
For each level of the output of one good, the
production possibility frontier shows the
maximum amount of the other good that can
be produced
Concave - increasing opportunity cost
Linear --constant opportunity cost
Illustrated…
Chapter 1 - Curtis, Irvine & Begg
Ch 1.3
©2010 McGraw-Hill Ryerson Ltd.
Linear Production Possibility Frontier
14
The opportunity cost of providing
additional doctors is constant = 4/1
peacekeepers
aircraft
4000
A
Unattainable
Aircraft
H
NOT Efficient
G
PPF
Doctors
Chapter 1 - Curtis, Irvine & Begg
Ch 1.3
1000
All
points
on the
PPF are
efficient
©2010 McGraw-Hill Ryerson Ltd.
The Production Possibility Frontier
15
The opportunity cost of providing an
additional 250 doctors is increasing
4000
A
B
Jet Aircraft
-300
C
+250
-400
+250
D
H Unattainable
Efficient
G
NOT Efficient
PPF is always negatively
slopped
PPF
Doctors
Chapter 1 - Curtis, Irvine & Begg
Ch 1.3
1000
This PPF has a concave
shape
©2010 McGraw-Hill Ryerson Ltd.
Opportunity Cost
The opportunity cost of an activity is the value of the
resources used in that activity when they are
measured by what they would have produced when
used in their next best alternative.
The slope of the Production Possibility Frontier
measures the marginal opportunity cost of producing
one good in terms of the amount of the other good
foregone.
A Typical PPF Picture
The marginal
opportunity cost of
guns in terms of
butter is
increasing as we
move down the
PPF!
Butter
just attainable
inefficient
unattainable
just attainable
The PPF is
typically bowedout or linear.
It is not bowed-in
Guns
PPF Gymnastics
Butter
PPF new
PPF old
The PPF is also useful for
many other types of
questions.
Questions about
efficiency.
Questions about equity.
Questions about tax and
transfer policy.
Questions about
composition of output.
Questions about growth
and productivity.
Guns
Lecture separation
Stop Lecture Micro Jan 11
Start Lecture Micro January 12
The Production Possibility
Frontier
20
Expanding the Production Possibilities
 Canada’s economy has grown for two reasons
 Greater quantity of productive capital and
labour (inputs)
 Technological improvements

much of technology is sourced from foreign
countries and used knowledge created in
foreign countries.
©2010 McGraw-Hill Ryerson Ltd.
Chapter 1 - Curtis, Irvine & Begg
Ch 1.3
Opportunity Cost, Comparative
Advantage & Gains21 from Trade (Text)
Penelope the plumber and Gordon the gardener are neighbors
Each can perform both task with differing efficiencies
How can society organize
itself in order to gain from
such specialization?
By using markets
Without specialization they expend 11 hours on tasks
With
specialization
Chapter
1 - Curtis,
Irvine & Beggthey expend 8 hour on tasks
©2010 McGraw-Hill Ryerson Ltd.
Comparative Advantage
The person with the lower marginal
opportunity cost of an activity has the
comparative advantage at that activity.
This means that the person with the comparative
advantage can produce the activity by giving up
the smallest amount of the alternative activity.
The Role of Markets
23
Markets bring together buyers and sellers of
goods and services
Price adjustment is the key to ensuring that
scarce resources are used to supply goods and
services that society wants
Chapter 1 - Curtis, Irvine & Begg
Ch 1.4
©2010 McGraw-Hill Ryerson Ltd.
Resource Allocation
24
Resource allocation is crucial for a society
It is handled in different ways in different societies,
e.g.:
 Command economy
 Centrally planned
 All producers and consumers act only on orders
 Invisible hand (free market ) idea from Adam
Smith Wealth of Nations
 Mixed economy
Chapter 1 - Curtis, Irvine & Begg
Ch 1.4
©2010 McGraw-Hill Ryerson Ltd.
Market Orientation
Sweden
Canada
USA
Cuba 2011
Cuba
Command
economy
Chapter 1 - Curtis, Irvine & Begg
Relatively free
Market economy
©2010 McGraw-Hill Ryerson Ltd.
The Invisible Hand of the
Marketplace and “signalling”
26
• High prices characterize goods and services that are
relatively scarce
• These high prices may induce greater supply over
time
•
•
They signal that it may be profitable to produce goods
If entrepreneurs direct their resources correspondingly, then
the marketplace causes resources to be used where they are
highly valued
• Self interested suppliers are led by the Invisible
Hand of the marketplace Adam Smith terminology
Chapter 1 - Curtis, Irvine & Begg
Ch 1.4
©2010 McGraw-Hill Ryerson Ltd.
Invisible Hand
The invisible hand, Adam Smith’s
phrase (1776) , is the assertion that
the individual pursuit of self interest
within free markets will allocate
resources efficiently (move to
production possibilities frontier) from
society’s viewpoint (p11)
Positive and Normative Economics
28
Positive economics deals with objective explanation and predictions
e.g. if a tax is imposed on a good, then its price will tend to rise, all
other factors held constant
Normative economics offers prescriptions based on value judgements
e.g. a tax should be imposed on tobacco to discourage smoking
Often concerns equity issues (fairness)
Story in press on Newfoundland oil and gas eligibility for an federal
Atlantic Canada Tax Credit. Issues of impact on investment
allocation (efficiency) versus “fairness”. Press journalist reach for
normative vocabulary when the right first question to ask is what are
the positive economic impacts.
Chapter 1 - Curtis, Irvine & Begg
Ch 1.5
©2010 McGraw-Hill Ryerson Ltd.
Box 1.4 Public Policy on Kyoto Protocol
Global Warming
Does microeconomics have anything to offer in
designing public policy to deal with global
warming?
Stern (Nick Stern ex-World Bank chief
Economist ) Review , written for UK
Government argues yes. See page 15
We will explore role of welfare economics in
evaluating alternative policy instruments to
achieve carbon abatement in Chapter 5
Preview More Box 1.4 Public Policy on
Kyoto Protocol Global Warming




1)
2)
Canada committed itself to a 6 percent reduction in greenhouse gas
(GHGs) , but by 2008 Canada had increased its emissions by 1/4
above its 1990 level, despite the reducing the GHG intensity of
GDP i.e is the amount of GHG emitted per unit of output produced.
Big problem. Tragedy of Commons (page 15 column 1) ) Also
Benefits from GHG reduction are spread around the world .
Normative Issues Fairness Across Countries . Developing counties
often claim that it is the responsibility of the rich economies to take
measures to reduce GHGS
Two Options proposed. Discussed in chapter 5 pages 104 - 108.
carbon tax
system of pollution permits that could be traded among polluters
permits in the market. By restricting the number of permits, the
permitted level of pollution could meet a given lower level.
An Economist’s Credo (Irvine)
31
Incentives matter
Markets and Trade Play a Key Role in Improving Economic WellBeing
 Most of society is better off than in a non-market economy
 Most economists believe that even the poor benefit from trade and
globalization
Property Rights Are Vital to Development
 Gives an incentive to work and produce
Public Policy can Improve Well-Being
 In cases of market failure, which will come up later in this course
Marginal Thinking (Incremental)
Most economic choices are not made on an all-or-nothing basis, but
rather at the margin
A little more of a little less? Atlantic Tax Credit impact on
Investment (∆%)on East Coast©2010
OffMcGraw-Hill
Shore Oil
andLtd.
ChapterIncremental
1 - Curtis, Irvine & Begg
Ryerson
Gas.
Micro and Macro Economics
32
Microeconomics…
Offers detailed treatment of individual economic
decisions about particular commodities

The pricing of public transportations is a microeconomic
issue
Macroeconomics…
Emphasizes the interactions in the economy as a
whole

Gross domestic product, the aggregate price level and
unemployment are all macroeconomic issues
Chapter 1 - Curtis, Irvine & Begg
©2010 McGraw-Hill Ryerson Ltd.
Chapter 1 Summary
Economics analyzes what, how, and for whom society produces
in the context of scarcity
The allocation of resources to competing needs is also a dynamic
problem
 Save and invest today for higher economic growth in the future
The production possibility frontier shows the maximum amount
of one good that can be produced for a given output of the other
 It shows the productive capacity of the economy
The PPF reflects the law of increasing opportunity cost and
production efficiency requires that economy produce at a point on
the PPF
Production efficiency require that an economy produce at a point
on the PPF
Chapter 1 - Curtis, Irvine & Begg
©2010 McGraw-Hill Ryerson Ltd.
Chapter Summary
34
Economies rely heavily on markets to allocate
resources
The concept of comparative advantage is central
to determining the economic problem
The command economy, free market economy
and mixed economy
Positive economics and normative economics
Economists have a set of guiding beliefs or a
credo
Microeconomics and Macroeconomics
©2010 McGraw-Hill Ryerson Ltd.
Chapter 1 - Curtis, Irvine & Begg
Chapter 2
Curtis, Irvine & Begg
The Tools of Economic Analysis
Microeconomic
Principles
Learning Outcomes
Topics
Theories, models, and reality
Data and data types
Index numbers
Models and data
Testing, accepting, and rejecting theories
The Canadian data hunt
Criticisms of economics: Is it a science like
physics because it follows the scientific
method?
©2007 McGraw-Hill Ryerson Ltd.
Chapter 2 - Curtis, Irvine & Begg
Models and Theories
37
A theory is a logical view of the world
Theories should have predictions that could be
disproved .
Famius comparison
A model formalizes the theory
Both help to organize our economic thinking and
understand empirical relationships
 Are frameworks based on simplifying assumptions?
 Map on a scale of 1 to 1 would be of no use.
 Economic Models are like maps drown to useful scales.
Chapter 2 - Curtis, Irvine & Begg

Ch 2.1
©2007 McGraw-Hill Ryerson Ltd.
DATA
Data are pieces of evidence about behaviour


They help us quantify theoretical relationships
They help us test our models or our beliefs. How do we test.
Types of data

Time-series data



Cross-section data



A one-to-one correspondence between values and chronological time
A sequence of values at different point of time
A one-to-one correspondence between values and a set of individuals
or groups at one point in time
A “snapshot”
Longitudinal data


Follow the same individuals or groups over time Ex: corporate return
Involves both time-series data and cross-sectional data
Chapter 2 - Curtis, Irvine & Begg
Ch 2.2
Examples…
©2007 McGraw-Hill Ryerson Ltd.
Time-Series Data
39
Table 2.1 House Prices and Price Indexes in North Vancouver
Consistency in Time Series is Vital
Chapter 2 - Curtis, Irvine & Begg
Ch 2.2
©2007 McGraw-Hill Ryerson Ltd.
Graphical Representation of Data
40
Always inspect the axes to determine patterns





Different values on the axes can have very different visual
impacts
Consider the following two representations of the data
from table 2.1, Col. 2
Horizontal X axis
Vertical Y axis.
Logorithmic scale on Y Vertical axis has property?
Chapter 2 - Curtis, Irvine & Begg
Ch 2.2
©2007 McGraw-Hill Ryerson Ltd.
Graphical Representation of Data
41
Figure 21.a: North Vancouver House Prices 1999-2009 in Thousands of Dollars
Chapter 2 - Curtis, Irvine & Begg
Ch 2.2
©2007 McGraw-Hill Ryerson Ltd.
Graphical Representation of Data
42
Figure 2.1b: North Vancouver House Prices 1999-2009 in Thousands of Dollars
Chapter 2 - Curtis, Irvine & Begg
Ch 2.2
©2007 McGraw-Hill Ryerson Ltd.
Cross-Sectional Data
43
Table 2.2 Unemployment by Country (%)
Defined by year Data
Chapter 2 - Curtis, Irvine & Begg
Ch 2.2
©2007 McGraw-Hill Ryerson Ltd.
Index Number
44
An index number expresses data relative to a given
base value

Employed to show % changes realized over a time period
Example…
Choose reference point
Set the price value equal to 100
 Table 2.1, use 1999 as base year
Base year index value:
= $330,000 x (100/$330,000) = 100
Index value in 2003
= $395,000 x (100/$330,000) = 119.7
Percentage change 1999 to 2003
= (119.7-100)/100 = 19.7%
Ch 2.3
Chapter 2 - Curtis, Irvine & Begg

©2007 McGraw-Hill Ryerson Ltd.
Index Number
11
Index numbers as average
Weighted average of the component price indexes
Example:
Fuel price index
= oil price index x 0.5 +
natural gas price index x 0.3 +
coal price index x 0.2
Chapter 2 - Curtis, Irvine & Begg
©2007 McGraw-Hill Ryerson Ltd.
45
Index Number
Consumer Price Index (CPI)

Constructed to measure changes in the overall cost of living – the inflation
rate
Nominal and real variables
Nominal variables reflect the dollar price of a good or service
 Real variables are nominal variables adjusted for inflation
 Real price index shows how much the price has risen or fallen relative to the
overall rate of inflation
Percentage change in real house price index
= (Nominal Index/CPI – 1) x 100
Apply the data from 1999 - 2004 (Table 2.1)
= (131.52/110.01 – 1) x 100
= 19.55%

Quality and Technological Change
Measuring Change in Economic Variables
Chapter 2 - Curtis, Irvine & Begg
Ch 2.3
©2007 McGraw-Hill Ryerson Ltd.
Economic Models and Analysis
47
Example:
Health Canada: Model of the Effect of Smoking
Focusing on key elements
Smoking = f(price of cig., peer pressure,
messages, price of the “patch”)
Sale of Cable Services = f (price of cable services,
price of substitute satellite dish, price of computer and
internet and downloads, income of purchasers)
Evidence…
Chapter 2 - Curtis, Irvine & Begg
Ch 2.4
©2007 McGraw-Hill Ryerson Ltd.
Scatter Diagrams so Scatter Plot
or First Step to Identifying Causal Relations
Each point is an observation on x and y for a particular
time period. With x on the vertical axis and y on the
horizontal axis
The reason that economists often use a scatter diagram
in their analysis is that it reveals whether there may be
an obvious relationship between two variables.
But because Economists can’t conduct laboratory
experiments by holding other variables constant
caution is important in determining the exact nature of
the relationship .
An Economic Model in
Graphical Form
49
Table 2.3: Tobacco Sales and Prices, Canada 1996-2006
Note that at
higher prices,
quantity
smoked is
lower
Chapter 2 - Curtis, Irvine & Begg
Ch 2.4
©2007 McGraw-Hill Ryerson Ltd.
An Economic Model in
Graphical Form
50
Data can be represented graphically…
Figure 2.3: Price and Quantity of Cigarettes, Canada 1996-2005
The line that has been fitted
through these points suggests an
empirical association (on
average) between the two
variables
• Called a regression line
• Indicates a negative or inverse
relationship
Chapter 2 - Curtis, Irvine & Begg
Ch 2.4
©2007 McGraw-Hill Ryerson Ltd.
Scatter diagram with Video
Life expectancy and Gross Domestic Product per
capita
How can scatter diagrams help us in analyzing
economic relations and developing models?
In 1809 all countries of the world had a life
expectancy under 40 years and an income per
person (capita) less than 3.000 dollar per year.
Since then the world has changed but it was not
until after the second world war that most
countries started to improve. Only in 1970 to
1990 to Asian countries begin to move
dramatically to high life expectancy Gapminder
100
Sweden
60
40
(years)
Life expectancy
81 years
80
1
Population
(millions) 100
20
1000
0
200 $
2000 $
20 000 $
Income per person (comparable dollars per year)
Interpreting Linear Relationship
Intercept
Slope = 280/70 = -4.0
Price Index
Define the line:
P =280-4Q
Intercept reflects the value
of P when Q is zero
P = 280 - 4 x 0 = 280
Slope shows the effect of 280
change in Q on change in P
1 unit change in Q
4 units change in P
Downward, negatively
sloped
Ch 2.4
Chapter
2 - Curtis, Irvine & Begg
Sales in Billions
70
©2007 McGraw-Hill Ryerson Ltd.
Testing understanding of linear
relationship
Consider a negatively sloped linear line in a graph where the
vertical axis represents variable Y and the horizontal axis
represents variable X.
If the vertical intercept is 10 and the slope is -0.5,
the correct equation is:
A)
B)
C)
D)
Y = 20 – 2X
X = 20 – 2Y
X = 10 – 0.5Y
Y = 10 – 2X
Non-Linear Relationships
driving deaths by age55 groups (grouped data)
Related Driver Fatality Rate by Age, Canada 2006
Chapter 2 - Curtis, Irvine & Begg
©2007 McGraw-Hill Ryerson Ltd.
Other Things Equal
Other things equal assumption…
• Graphs are simple two dimensional representations
• Economic behaviour is influenced by many variable not in the
two dimensions
• Example:
• Smoking bans in public places
Chapter 2 - Curtis, Irvine & Begg
Ch 2.4
©2007 McGraw-Hill Ryerson Ltd.
Theories and Evidence:
Accepting and Rejecting Theories
Scatter diagrams help us to confront
economic theory with empirical reality
Econometrics takes this further using
statistical techniques
Evidence may allow us to reject a theory
Or to accumulate support for it
but not what Economists can not conduct
laboratory experiments like the natural
sciences (physics )
Chapter 2 - Curtis, Irvine & Begg
2.5
©2007 McGraw-Hill Ryerson Ltd.
The Great Canadian Data Hunt
58
CANSIM database



Canadian Socio-economic Information Management
System
CHASS is gull database
E-STAT is the user friendly version
Chapter 2 - Curtis, Irvine & Begg
Ch 2.6
©2007 McGraw-Hill Ryerson Ltd.
E-STAT
∑ -STAT is an education resource
designed by Statistics Canada and
made available to Universities. Uses
450,000 current CANSIM time series .
Lets you build graphs and charts.
Popular Criticisms of Economics and
Economists
Frequent critiques of the profession include the
following…
‘No two economists ever agree’
‘Models in economics are too simple to be
considered realistic’
‘People are not as mercenary as economists
portray them’
‘Actions of human beings cannot be reduced to
scientific laws’
Chapter 2 - Curtis, Irvine & Begg
Ch 2.7
©2007 McGraw-Hill Ryerson Ltd.
Learning Outcomes
61
By the end of this chapter you should learn:
Theories, models, and reality
Data and data types
Index numbers
Models and data
Testing, accepting, and rejecting theories
The Canadian data hunt
Criticisms of economists
Chapter 2 - Curtis, Irvine & Begg
©2007 McGraw-Hill Ryerson Ltd.
Chapter Summary
62
A theory is a logical view of the world
A model is a simplified framework
DATA are essential for economic analysis
The three primary types of data are:



Time-series data
Cross-section data
Longitudinal data
Index numbers:

Express data values relative to a given base value
CPI is a broad index of cost of living Basket of good &
services
Nominal and real price variables
Scatter diagrams show the relationship between two variables.
The regression line summarizes the average relationship
between the two variables . Linear regression =straight line
Chapter 2 - Curtis, Irvine & Begg
©2007 McGraw-Hill Ryerson Ltd.
Chapter Summary
Econometrics is the science of developing and
understanding the precise relationship between
variables
Other things being equal assumption
Latin Term Ceterus paribus
A straight-line equation is completely
characterized by an intercept and a slope
To understand how the economy works we need
theories and facts

Theories consist of generalizations
©2007 McGraw-Hill Ryerson Ltd.
Economists are subject to criticisms
Chapter 2 - Curtis, Irvine & Begg