Microeconomic Principles

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Chapter 1 Ten Principles of Economics

1-1 How People Make Decisions

There is no mystery about what an economy is. Whether it encompasses Los Angeles, the United States, or the entire planet, an economy is just a group of people dealing with one another as they go about their lives.

That seems like an odd definition. I don’t think they intend for it to be the primary definition of economics, but its the first one you’re offered. Are teams (groups) who play sports against each other considered economies here?

The first four principles below are concerned with individual decisions.

1-1a Principle 1: People Face Trade-Offs

Life has trade-offs. The time I’m spending reading this textbook right now could be used to read something else, play games, eat, nap, run, lift weights, etc. By choosing one thing you give up on the other things. The other things you gave up are the trade-offs for what you chose to do.

A common societal trade-off is between efficiency and equality.

Efficiency means that society is getting the greatest benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society’s members. In other words, efficiency refers to the size of the economic pie, while equality refers to how evenly the pie is sliced.

1-1b Principle 2: The Cost of Something Is What You Give Up To Get It

Opportunity Cost - “Whatever must be given up to obtain some item”

The cost of college is not just the cost of tuition, books, dorming, food, and gas. Its also the time you could be spending doing other things including activities that would make you money.

Hmm. I guess opportunity costs focus on realistic options? I think there are nearly infinitely many things you’re giving up by choosing something. I order food from my local chinese place. The opportunity cost would technically be every restaurant (and all the other things I could do with the money). Right? That’s so vast. I think this is more meant to focus on realistic options? So the “actual” opportunity cost would be reasonably close restaurants that you like eating at.

1-1c Principle 3: Rational People Think at the Margin

Economics assume rational individuals.

Rational People - “people who systematically and purposefully do the best they can to achieve their objectives”

You don’t (usually) decide between not eating all day and eating all day, or not studying all day and studying all day. You’re more likely to make smaller decisions such as studying for an extra hour, eating just a little bit more cake, etc.

Economists use the term marginal change to describe an incremental adjustment to an existing plan of action.

Lets say you pay $30 a month for a streaming service with unlimited movies. The marginal cost of watching another movie is $0. It doesn’t cost you anything (at least not cash wise) to watch another movie.

1-1d Principle 4: People Respond to Incentives

An incentive is something that gets people to act. It can either be rewards or punishments.

One economist went so far as to say that the entire field could be summarized as simply, “People respond to incentives. The rest is commentary.”

1-2 How People Interact

The next three principles will deal with interactions between individuals.

1-2a Principle 5: Trade Can Make Everyone Better Off

Trade between two countries can make each country better off. Even when trade in the world economy is competitive, it can lead to a win–win outcome for the countries involved.

Countries that compete still benefit from trade between each other.

Trade allows for specialization.

1-2b Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

In a market economy the decisions of a central planner are replaced by those of millions of firms and households. Firms decide whom to hire and what to make. Households decide where to work and what to buy with their incomes.

As you study economics, you will learn that prices are the instrument with which the invisible hand directs economic activity.

This makes prices sound very important. That makes sense. I remember hearing about Von Mises debunking planned economies because they can’t price correctly or something.

1-2c Principle 7: Governments Can Sometimes Improve Market Outcomes

Most importantly, market economies need institutions to enforce property rights so individuals can own and control scarce resources.

Economists use the term market failure to refer to a situation in which the market does not produce an efficient allocation of resources on its own. One possible cause of market failure is an externality, which is the impact of one person’s actions on the well-being of a bystander. The classic example of an externality is pollution.

Hmm. So their saying its a failure of the market to calculate the costs of what you’re doing to other people? Mmm. I can see that. I can see how this is a “failure” of the market. WIthout the government getting involved I can believe many businesses would just harm people through pollution and not take the costs of what they’re doing into account.

Another market “failure” are monopolies.

The above are things the government can address to make the economy more efficient. The government can also address things to make the economy more equal.

1.3 How the Economy as a Whole Works

First part covered individuals, second part covered interactions between individuals, third part will cover the whole economy now.

1.3a Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

People/countries with higher average incomes have better qualities of life. From access to food, medicine, technology, etc.

Almost all variation in living standards is attributable to differences in countries’ productivity—that is, the amount of goods and services produced by each unit of labor input.

The relationship between productivity and living standards is simple, but its implications are far-reaching. If productivity is the main determinant of living standards, other explanations must be less important.

1.3b Principle 9: Prices Rise When the Government Prints Too Much Money

In January 1921, a daily newspaper in Germany cost 0.30 marks. Less than two years later, in November 1922, the same newspaper cost 70,000,000 marks. All other prices in the economy rose by similar amounts. This episode is one of history’s most spectacular examples of inflation, an increase in the overall level of prices in the economy.

What causes inflation? In almost all cases of large or persistent inflation, the culprit is growth in the quantity of money. When a government creates large quantities of the nation’s money, the value of the money falls.

1.3c Principle 10: Society Faces a Short-Run Trade-Off between Inflation and Unemployment

Most economists describe the short-run effects of money growth as follows:

  • Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services.

  • Higher demand will, over time, cause firms to raise their prices, but in the meantime, it encourages them to hire more workers and produce a larger quantity of goods and services.

  • More hiring means lower unemployment.

So in the short-term people get hired. Long-term prices go up.

1.4 Conclusion

How People Make Decisions

    1. People face trade-offs.
    1. The cost of something is what you give up to get it.
    1. Rational people think at the margin.
    1. People respond to incentives.

How People Interact

    1. Trade can make everyone better off.
    1. Markets are usually a good way to organize economic activity.
    1. Governments can sometimes improve market outcomes.

How the Economy as a Whole Works

    1. A country’s standard of living depends on its ability to produce goods and services.
    1. Prices rise when the government prints too much money.
    1. Society faces a short-run trade-off between inflation and unemployment.
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Incentives (video lecture)

The subject is about understanding rational decision making.

People respond in a systematic way to the incentives put in front of them.

A favorite example of incentives from the professor:

When Australia was the penal colony of Britain they ran into an issue where prisoners were dying on the way to Australia. The crown(?) came up with a simple solution. Instead of paying ship captains by the number of prisoners they took, they instead paid them by the number of alive prisoners that got to Australia. That, apparently, fixed the problem and drastically reduced the prisoners deaths.

It doesn’t matter what you want people to do. It matters what you incentivize them to do.

Interesting:

The professor asked students what they’d prefer. Would they prefer to pull up to a gas station, in the middle of a natural disaster or whatever, and be “overcharged” for gas, but still be able to get gas. Or would they rather pull up to a gas station with cheaper gas prices, but with no gas.

I thought the second option was obviously better, but apparently quite a few students thought that the high gas prices were unjustifiable regardless of whether they’d have gas or not.

Prices can force people to conserve.

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Opportunity Cost (video lecture)

Economics is based heavily on the concept of opportunity cost.

Opportunity cost, here, is being defined as looking at the next best alternative.

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So we focus on things we would do, instead of just anything. Ok.

A story about opportunity cost:

There aren’t many (63 in 100 years) left handed catchers in baseball. That’s because many of the qualities that would make you good at catching are also good for pitching. A left handed pitcher is way more valuable then a left handed catcher. If you were to become a catcher there would be a high(?) opportunity cost paid from not becoming a pitcher.

Uhh we swtiched to supply and demand:

Rules/laws that interfere with supply and demand are not good. They will have unwanted consequences.

Economists are interested in describing the world around them accurately. This is referred to as positive analysis. It is objective.

Normative economics is opinion based, its subjective. Its what we should do.

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Do you have questions or some sort of feedback you want?

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You appear to have a typo. I think you liked the first opinion.

I think one of the reasons people don’t like the first option is because they don’t want to support real life price gouging. This scenario is meant to bring up real life situations. The real life situations are different than the hypothetical (which omits tons of context) and people give their answer partly based on what they’d want in those real situations and their opinions about issues that aren’t explicitly discussed in the hypothetical. Does that make sense to you for what’s going on? It’s not purely an abstract question about a hypothetical scenario for people.

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Oh. Woops. Yes.

~yea.

I guess what I found odd was based on how the professor, apparently, presented it. I think the initial knee-jerk reaction to price gouging makes sense. Also, in general, I just kinda assume most price gouging is bad (gouging sounds bad, is there a term for when its good?). However, the professor presented it as:

  • You have an emergency scenario where you need to drive away. Hurricane, tornado, something.

  • You pull up to a gas station and either:

    • Gas prices stay cheap and you can get no gas because people over consumed.
    • Gas prices go up but you can get gas.

A fair number of people would prefer no gas to overpaying for gas.

The professor did make a comment about how if I pull up to a gas station and see how prices I will get mad or whatever versus if I pull up to one that has no gas I’m just whatever about it. If it has no gas I’ll drive to a different one.

Maybe that’s something people subconsciously assumed?

I do think those people may have preferred a different, third, option: rationing. Idk if he presented that to his class.

Idk. I just thought it was odd that if he explained it as he did. that you would rather have no gas versus paying a lot

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One thing people are assuming is if there is gas, it’s because someone else didn’t get it previously, which they see as an unfair system that harmed someone during a crisis.

If you just imagine the gas magically appears or disappears for the out-of-context hypothetical, that’s different.

Yes lots of them would want rationing and also would expect that, with low prices, most people would voluntarily ration during a crisis. So they see high prices, not as conserving gas, but as preventing some people who need it from getting enough.

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Today, we live in a high trust society where people generally don’t act like this. The policies appropriate for a low trust society or a high trust society are different.

We do have problems where bad actors take advantage of high trust society policies. However, most people are decent and changing everything to low trust systems has huge downsides.

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Read the section “Critique of the Opportunity-Cost Doctrine” in Capitalism: A Treatise on Economics by George Reisman. Compare it to what your course says and see if you can reach a conclusion about which ideas are correct.

Also from the book:

Both the classical and the Austrian schools study economic phenomena from the point of view of their effects on all members of the economic system, not just on those directly involved. In contrast, Marshall advanced the doctrine known as “partial equilibrium,” which is the attempt to study the behavior of individual consumers, individual firms, and individual industries divorced from the rest of the economic system. His approach was one of disintegration, resulting in the present-day existence of two allegedly separate branches of economics: “microeconomics” and “macroeconomics”—the first studying the actions of individuals apart from their relationship to the rest of the economic system, and the second studying the economic system as a whole, apart from the actions of individuals.

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Ohh. So like if there are high gas prices in an emergency instead of seeing it like some sort of rationing out of gas, they see it as someone couldn’t get gas because its too expensive for them.

Hmm. That makes sense.

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Scarcity (video lecture)

Scarce resources are those resources where we don’t have enough to fulfill everyone’s needs/wants of that resource.

Is salt water scarce?

No. The transportation to move it and store it probably is. Also its debatable whether salt water is a desirable resource/a good.

Is pollution scarce?

No, but its also not a resource. Its something we try to get rid of.

Scarcity and choice are two of the most fundamental concepts in economics.

Scarcity is what leads us to have prices. If something is scarce, limited and insufficient, and its a good, a resource that has value, then it has a price. If its a resource that may have a value but is not limited and insufficient, such as possibly salt water, then it does not have a price?

If the price of a good goes up then that is communication to you that it is relatively more scarce now.

Exchange happens because we value things unequally. You value the gallon of milk more than your dollar, the retailer values your dollar more than the gallon of milk.

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Taking a quiz. I can check if my answers are correct before submitting. I’m a bit confused.

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Externality is “the impact of one person’s actions on the well-being of a bystander”. So you’re doing something and it has an effect on third parties.

I initially choose education since I don’t see how the regular things involved in teaching, such as lecturing, reading, would lead to an externality. I then guessed inoculations against disease because you getting protected means other will be fine. I chose food last.

When dealing with food you can create waste (both scraps and human body waste). That to me seems like an obvious possible externality. Idk.

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I think this question is unanswerable. E.g. one might say that selling sugar or red dye 40 to children causes negative externalities for their parents and school systems to deal with. Or maybe people commit more murders while hungry.

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Chapter 2 Thinking Like an Economist

Introduction

Before delving into the substance and details of economics, it is helpful to have an overview of how economists look at the world. This chapter discusses the field’s methodology.

2.1 The Economist as Scientist

Economists try to address their subject with a scientist’s objectivity. They approach the study of the economy much as a physicist approaches the study of matter and a biologist approaches the study of life: They devise theories, collect data, and then analyze the data to verify or refute their theories.

The essence of science, however, is the scientific method—the dispassionate development and testing of theories about how the world works.

2.1a The Scientific Method: Observation, Theory, and More Observation

Because Newton’s theory has been so successful at explaining what we observe around us, it is still taught in physics courses.

Idk much about economics, but I don’t think economics has the same track record as the physical sciences. I think I’ve heard it said that “An economist is someone who sees something is possible in practice and verifies if its possible in theory” and “The field of economics has made a lot of intellectual progress and yet there has been no improvement in the world.” The reputation of economists in the sciences seems poor.

Although economists use theory and observation like other scientists, they face an obstacle that makes their task challenging: Conducting experiments is often impractical.

That makes sense. I think being able to get reliable results from not that great experiments (or no experiment) is important.

To substitute for laboratory experiments, economists pay close attention to the natural experiments offered by history. When a war in the Middle East interrupts the supply of crude oil, for instance, oil prices skyrocket around the world.

2.1b The Role of Assumptions

Assumptions can simplify the complex world and make it easier to understand

But by assuming the world has only two countries and two goods, we can focus on the essence of the problem. After analyzing international trade in this simplified imaginary world, we are in a better position to understand trade in the more complex world in which we live.

Its also important that we make the right assumptions.

2.1c Economic Models

All models—in physics, biology, and economics—simplify reality to improve our understanding of it. And all models are subject to revision when the facts warrant it. The key is to find the right model at the right time.

So models are based on the assumptions that we think is necessary to answer a given question.

2.1d Our First Model: The Circular-Flow Diagram

Circular-Flow Diagram - “a visual model of the economy that shows how dollars flow through markets among households and firms”

In a circular-flow diagram we are only considered with two decision makers in the economy: firms and households.

In the market for goods and services firms are the producers and households are the consumers. In the market for the factors of productions firm are consumers and households are the producers/seller.

2.1e Our Second Model: The Production Possibilities Frontier

Most economic models, unlike the circular-flow diagram, are built using the tools of mathematics. Here, we use one of the simplest of these models, called the production possibilities frontier, to illustrate some basic economic ideas.

Production Possibilities Frontier - “a graph that shows the combinations of output that the economy can possibly produce with the available factors of production and production technology”

Although real economies produce thousands of goods and services, consider an economy that produces only two goods—cars and computers. Together, the car and computer industries use all of this economy’s factors of production.

So a production possibilities frontier graph (is the frontier the part that refers to a graph?) is a graph that shows possible production of goods in an economy given the factors of production in the economy.

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An outcome is said to be efficient if the economy is getting all it can from the scarce resources it has available. Points on (rather than inside) the production possibilities frontier represent efficient levels of production.

Once an economy reaches an efficient point on the frontier, the only way to produce more of one good is to produce less of the other. When the economy moves from point A to point B, for instance, society produces 100 more cars at the expense of producing 200 fewer computers.

Ok so one things that confusing here: they make it sound like its easy just to move along that line. Besides things like supply and demand dictating where production is on the curve I don’t get why we’re talking about moving along the curve.

If we move from point A to point B and produce more cars and less computers that assumably means less people working at a computer manufacturing job. Also how are the production possibilities being compared here. I think human resources are probably transferrable between many industries, but I don’t know about transferability of pc manufacturing technology to car manufacturing technology.

Notice that the opportunity cost of a car equals the slope of the production possibilities frontier.

How do I do that?

When the economy is using most of its resources to make computers, the resources best suited to car production, such as skilled autoworkers, are being used in the computer industry.

Really? Do job transfers in the economy happen just like that?

2.1f Microeconomics and Macroeconomics

Economics is also studied on various levels. We can examine the decisions of individual households and firms. We can focus on the interaction of households and firms in markets for specific goods and services. Or we can study the operation of the economy as a whole, encompassing all these activities in all these markets.

Economics is traditionally divided into two broad subfields. Microeconomics is the study of how households and firms make decisions and how they interact in specific markets. Macroeconomics is the study of the overall economy.

2.2 The Economist as Policy Advisor

When economists are trying to explain the world, they are scientists. When they are giving guidance on how to improve it, they are policy advisers. Even if you never become a professional economist, you may find yourself using both sides of your economic brain in daily life: analyzing the world as you find it and devising solutions to make things better. Both approaches are indispensable, but it’s important to understand how they differ.

2.2a Positive versus Normative Analysis

Prisha:

Minimum-wage laws cause unemployment.

Noah:

The government should raise the minimum wage.

Ignoring for now whether you agree with these claims, notice that Prisha and Noah differ in what they are trying to do. Prisha is speaking like a scientist: She is describing how the world works. Noah is speaking like a policy adviser: He is talking about how he would like to change the world.

Positive statements describe the world. Normative statements talk about how the world ought to be.

2.2b Economists in Washington

Truman was right that economists’ advice is not always straightforward. This tendency is rooted in one of the Ten Principles of Economics: People face trade-offs.

An economist who says that all policy decisions are easy is an economist not to be trusted.

Hmm. I wonder if this desire for straightforward answers plays a part in why economists fail at being influential. Or maybe straightforwardness is not the issue, but they want “clean” answers that let them have their cake and eat it too.

Since 1946, the president of the United States has received guidance from the Council of Economic Advisers, which consists of three members and a staff of a few dozen economists.

(The author of this textbook was chair of the Council of Economic Advisers from 2003 to 2005.)

Huh. So we are seeing the writing/thought process of someone who played a huge part in shaping the economy.

2.2c Why Economists’ Advice Is Often Not Followed

This section just talks about all the various things that can prevent a policy from being implemented. From media misrepresentation to political disagreements.

2.3 Why Economists Disagree

Why do economists so often appear to give conflicting advice to policymakers? There are two basic reasons:

  • Economists may disagree about the validity of alternative positive theories of how the world works.

  • Economists may have different values and, therefore, different normative views about what government policy should aim to accomplish.

2.3a Differences in Scientific Judgements

Economists disagree with each other because they have different views on the validity of certain theories. They may also disagree with each other on how certain variables are related. For example, economists may disagree on whether tax revenue will go up if we had a consumption tax versus an income tax.

2.3b Differences in Values

Economists disagree in their normative prescriptions because they have different values.

2.3c Perception versus Reality

Economists agree with one another more often than is sometimes understood.

Consider the proposition, “A ceiling on rents reduces the quantity and quality of housing available.” When economists were polled about it, 93 percent agreed. Economists believe that rent control—a policy that sets a legal maximum on the amount landlords can charge for their apartments—adversely affects the supply of housing and is a costly way of helping the neediest members of society. Nonetheless, many city governments ignore economists’ advice and place ceilings on the rents that landlords may charge their tenants.

2.4 Let’s Get Going

We will be drawing on multiple intellectual skills in our study of economics.

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Took a quiz on chapter 2 (I have one more chapter after this, ended up doing hw last second because of a lot of stuff going on).

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Is money not capital?

I originally picked e.

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FYI I don’t recommend arguing with your teacher or mentioning Reisman in class. I’m just bringing stuff up for intellectual curiosity and forum discussion.