ECONOMICS SESSION ONE

Fall ‘ 97 Principles of Microeconomics Slide 1

This is a PowerPoint presentation on some basic ideasand concepts that are used in principles of economics.

A left mouse click or the enter key will add an element to a slide or move you to the next slide. The backspace key will take you back one element or slide. The escape key will get you out ofthe presentation.

R. Larry Reynolds


Principles of Microeconomics

· Instructor: r. larry reynolds· office: B-311· phone: 208.426.1469· e-mail: [email protected]

Internet students pleas use [email protected]

© R. Larry Reynolds 1997


Objectives in EC202

· To learn the nomenclature used to describe economic events and relationships

· To learn the methodology used in mainstream [Neoclassical] economics

· To understand limitations of Neoclassical economics· To Become aware of the role of ideology our

perceptions· To learn to ask relevant questions about events and

values· What do I know? How do I know? · What do I believe? Why?


A University is a community of Scholars

· Student and faculty are members of community· Your are participant not a customer

· read material in text and on the syllabus· awareness of related material in press and other

sources· thinking about how material in course is related to

historical and current events· questioning the analysis and position of others


Introduction to Economics

· A finite world· Unlimited wants· Relative Scarcity· Choices must be made

· individual choices· social choices


Finite world

· individuals and society are confronted by limited resources · inputs or factors of production· time· budgets· information / knowledge / technology


Resources

· Typical taxonomy· land / natural resources· labor· Capital· Entrepreneurial ability

· Alternative view· Matter· Energy· Time· Technology


Scarcity

· Because of Scarcity, individuals and societies must make choices

· All Choices in a finite world have “opportunity costs”· alternative uses of finite resources· Opportunity cost is the value of the next

best alternative sacrificed· Can institutional structure create or

increase scarcity?


Definition of Economics

· economics is a social science that studies human behavior and institutional arrangements in societies that influence the processes by which relatively scarce resources are allocated to alternative uses --

· social science and decision science components of economics


Fundamental Economic Questions

· What should be produced?· How many?· How should these goods (and services)

be produced?· When should these goods be produced?· Who gets the goods (and services) that

were produced?


“THE BIG QUESTION”

· HOW CAN SOCIETY BE ORGANIZED IN SUCH A WAY THAT THE LIBERTY AND AUTONOMY OF THE INDIVIDUAL CAN BE PROTECTED YET AT THE SAME TIME PROVIDE FOR THE COMMONWEAL?


Economics as a Social Science

· Human behavior is influenced by a matrix of complex forces· Psychology· Sociology· Anthropology· Economics· Political Science· Religion, ...


Economics as Social Science [cont ...]

· Need for integration of social sciences· deductive, historical and empirical

[statistical] approaches· Philosophical and Historical Context

· To speculate about where you are going, you need to understand where you are

· To fully understand where you are, you need to know where you came from


Economics as Social Science[cont ...]

· As a social science economics has a foundation based on a system of ethics

· Ethics· consequentialist [“Utilitarianism”]· deontological· ontological


Economics as a Decision Science

· Optimization· Maximization of an objective· Minimization of an objective

· Objectives· preferences

· individual, · firm, [organization]· social


“Scientific Method”

· Scientific method is a subset of Epistemology· General approach is:

· aware of problem· develop hypothesis [model]· gather data to test hypothesis· test hypothesis· accept or reject hypothesis· when hypothesis gathers general

acceptance it becomes a “Theory”


Models

· A model is a representation of reality, it necessarily abstracts form the “real world”

· case of two models: Paper and clay. You model an airplane. Do the models look alike? No? Which model is “best?” Which is “best” to demonstrate the principle of lift and flight? Which model would be “best” in a wind tunnel at 700kph?

· What you build your model from determines to some extent the nature of your model.

· What you want to use the model for determines the process.


Goals of Science

· to predict: On the basis of information currently known and theories, science would like the ability to estimate with some degree of probability, future events.

· to explain: The process by which the causal processes of an event can be identified. [The identification of causal relationships.]

· Story telling: Story telling is the process by which most societies pass on the cultural values, organizing myths and traditions that determine values and guide behavior.


Steps to Economic analysis

· Identify the Objective· Identify all feasible alternatives

· Alternatives are determined by technology · other constraints [finite resources, law,

custom,...]

· Develop Criteria to evaluate each alternative with respect to the objective


Objectives

· The objective is the goal or desired outcome of a choice· Individuals may try to maximize utility given

the constraints of income, time, prices, etc.· Firms may have objectives such as the

maximization of profits, sales, market share, etc. or the minimization of costs per unit

· Social objective, maximize the well being of the members of society


Social Objectives

· The philosophical foundation of Neoclassical

economics is “Utilitarianism”· Jeremy Bentham [1748-1832]· “The greatest good for the greatest number.” We

want the greatest welfare for the members of a community.

· Individual and Community· How can we maintain the autonomy of

the individual and at the same time provide for the commonweal?


A fundamental question

· What is the welfare of the society?· One view is the the welfare of the

community is the sum of the welfare of each individual.

· An alternative view is that social welfare is not the sum of the individual’s welfare. There is a symbiotic relationship between the welfare of individuals.


Economics as a Decision Science

· Economics to analyze choices· At the margin· Marginal Benefits [MB] · Marginal Costs [MC]

· MC is the same as opportunity cost· It is the value of what you sacrifice as a

result of the choice

· MB = MC as basic rule of optimization


MB = MC

· Individuals optimize welfare when MB = MC

· Neoclassical economics holds that when each individual maximizes their utility, the utility of society is also maximized.

· This requires that individuals’ utilities can be summed, i.e. individual utilities are additive

· Heterodox economists hold other views


Individualism

· Neoclassical economics starts with the individual

· Individual preferences are primary· “voluntary” Individual action · market exchange is the focus of

neoclassical economic analysis


Coordination and Integration

· Individual choices must be coordinated and integrated by social institutions

· Integrating / coordinating mechanisms in society· householding· redistribution· reciprocity· market exchange


Householding

· each individual household or familial unit produces all the items they consume

· subsistence type of economy· not prevalent in modern, industrial

societies· largely ignored in Neoclassical

economics


Redistribution

· Redistribution occurs when a society’s recourses are distributed by an authority

· Central organizing authority takes resource and allocates them by some criteria

· Authority based on religion, political power, military strength, etc.


Reciprocity

· Defined in anthropology as “obligatory gift giving”

· I do something for you and through social convention you are obliged to do something for me

· Reciprocity requires a society that includes members who have a continuing relationship


Reciprocity [cont. . .]

· When I help you harvest your crop as a member of a community, you have obligations to help me do something

· Should you choose to ignore your social responsibilities often enough, you will eventually be ostracized. Reciprocity requires a sense of community

· If I pay you for goods or services, it may substantially alter the good or service


Market Exchange

· A market exchange is a “quid pro quo” mechanism. It is a contractual arrangement were we specify exactly what you will receive in return for a good or service rendered.

· “I will give a yellow, #2 pencil for $.50“· We both know exactly what we are

getting in the exchange


Market exchange [cont. . . ]

· market exchange may occur between strangers. I do not need to know the shopkeeper where I buy a soft drink.

· market exchange works best were exchanges are voluntary· this assures that one or both parties to an

exchange benefit and no one is made “worse” off. Concept of Pareto Efficiency

· “nonattenuated property rights” are required for markets to produce optimal results


Pareto Efficiency

· Pareto efficiency is the primary criteria used in Neoclassical economics to evaluate alternatives

· Pareto efficiency is a condition such that there are no alternatives that will improve the welfare of any person(s) without making some one else (or others) “worse off”


Pareto Efficiency [cont. . . ]

· Clearly, if there is an alternative that will improve the welfare of at least one person and no one is any worse off, that alternative would improve the welfare of society. This is a Pareto improvement

· If the utility of at least one person can be increased, but some one else (or others) is made worse off, it is not a Pareto improvement

· Benefit/cost analysis is based on the Pareto criterion {rate of return on investment and others are also based on the Pareto criterion


Pareto Efficiency and Voluntary Exchanges

· Market exchanges that are voluntary are said to be Pareto Optimal

· It is believed that no one would voluntarily enter into a voluntary exchange and make themselves “worse off”

· Therefore, one or both parties to a voluntary exchange is believed to be better off and no one is any worse off


Nonattenuated property rights

· To “attenuate” is a legal term that means to “weaken”

· Nonattenuated property rights are “strong property rights”· exclusive· transferable · enforceable


Exclusive property rights

· Exclusive property rights means that all the benefits and costs fall on the “owner.” Third parties do not benefit nor are there costs imposed on them

· When property rights are not exclusive, externalities, public goods, common property resources are said to exist.”

· “Market Failures” and property rights failures


Enforceable property rights and transferability

· Markets do not work well when property rights are not enforceable. Many early political philosophers argue that enforcement of property right is the principle function of government

· Copyrights, patents, etc. are examples of attempts to create, assign and enforce property rights


Summary of Intro

· Relative scarcity of inputs, unlimited wants· Choices by individuals within societies· opportunity cost is the value of the next best

alternative that was sacrificed· Analysis is individual behavior, at the margin,

that optimizes an objective within a set of constraints

· use of “scientific method.” Hypotheses are tested with empirical data to develop “theories”

· goals are to predict, explain, story telling

Documents

ECONOMICS SESSION ONE