Introduction to Microeconomics
Chapter 1, Acemoglu
Chapter 1, Acemoglu
Economics is a decision making science
Three important questions that we try to answer in Economics
a. What to produce
b. How to produce
c. For whom to produce
What to produce: Goods and services that people want to consume
How to produce: The concept of appropriate technology
For whom to produce: The difference between selling and distributing
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▪ What is science
▪ Although there is no clear and conclusive answer of this question we
try to get some idea about what are the common attributes of
disciplines that are called science
▪ We can identify two attributes, like
A) Measurability and
B) Repeatability
These two also brings preciseness in calculations and analysis
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▪ It takes decision about human production and consumption which is difficult to
ignore for any society
▪ So it needs to be objective, methodical and analytical, so that we have to accept
the outcome even we do not like the outcome
▪ That is called optimization and typically with a constraint
▪ Economics involves far more than money. Economists study all human behavior,
from a person’s decision to lease a car, to her decision not to wear a seat belt, to
the speed the new driver chooses as she rounds a hairpin corner. These are all
choices, and they are all fair game to economists.
▪ Choice - not money - is the unifying feature of all the things that economists’
study.
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▪ Another discipline that talks about these two ideas like Finance. The difference
between Finance and Economics is in the degree in which money and choice are
mixed together. Finance puts lot of emphasis on money and little on choice. On the
other hand Economics treats money almost unimportant
▪ Economists think of almost all human behavior as the outcome of choices.
▪ Economic Agents
▪ An economic agent is an individual or a group that makes choices.
▪ A consumer chooses which cell phone to purchase. A parent chooses whether and
how to reward their teenager for good behavior. A student chooses to attend classes
or skip them. A citizen chooses whether or not to vote, and if so, which candidate
to support. A worker chooses to do her job or slack off. A criminal chooses to sell
meth or opioids (or neither or both).
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▪ A business leader chooses where in the world to open a new production
facility.
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▪ Scarcity of economic resources is another important factor in economic decision
making
▪ Economists consider that resources are limited and that’s why they are sold in the
market and not free
▪ So its use has to be useful and beneficial for the society
▪ Economics is the study of how agents choose to allocate scarce resources and how
those choices affect society.
▪ Economics is the science of managing unlimited demands with limited resources
▪ What happens if there is no scarcity and no shortage of resources
▪ Potentially scarcity free resources
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▪ Positive Economics and Normative Economics
▪ Positive economics is analysis that generates objective descriptions or predictions,
which can be verified with data.
▪ Normative economics is analysis that recommends what an individual or society
ought to do.
▪ In the mind of most economists, it is legitimate for the worker to choose any level
of risk, as long as she understands the implications of that risk for her average rate
of return—less risk implies a lower average rate of return. When economic analysis
is used to help individual economic agents choose what is in their personal best
interest, this type of normative economics is referred to as prescriptive economics.
▪ Frequently normative decisions are based on pure philosophical arguments and
positive decisions are logical decisions based on collected data
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▪ Normative Analysis and Public Policy
▪ Normative analysis also generates advice to society in general. For example,
economists are often asked to evaluate public policies, like taxes or
regulations. When public policies create winners and losers, citizens tend to
have opposing views about the desirability of the government program. One
person’s migratory bird sanctuary is another person’s mosquito-infested
swamp. Protecting a wetland with environmental regulations benefits
bird-watchers but may harm a landowner who would like to develop that
land.
▪ Data don’t lie, they need to be explained, story of Russian pandemic
▪ Difference in values, perception, black slavery issue
▪ Difference in objective
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▪ Ethical judgments are usually unavoidable when economists think about
government policies because there are few policies that make everyone
better off. Deciding whether the costs experienced by the losers are justified
by the benefits experienced by the winners is partly an ethical judgment.
▪ Microeconomics and Macroeconomics
▪ Microeconomics is the study of how individuals, households, firms, and
governments make choices, and how those choices affect prices, the
allocation of resources, and the well-being of other agents.
▪ Macroeconomics is the study of the economy as a whole. Macroeconomists
study economy-wide phenomena, like the growth rate of a country’s total
economic output, the inflation rate, or the unemployment rate.
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▪ Three Principles of Economics
▪ Optimization: We have explained economics as the study of people’s
choices. The study of all human choices may initially seem like an
impossibly huge and diverse topic.
▪ Optimization means trying to pick the best feasible option, given whatever
limited information, knowledge, experience and training an economic agent
has.
▪ Economists do not believe that people always succeed in picking the best
feasible option. Rather, economists believe that people try to pick the best
feasible option. People don’t always succeed because we are not perfect,
all-knowing decision makers. We certainly do not know the future.
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▪ Decisions aren’t made with a crystal ball. People try to do as well as they
can, given the limited information, knowledge, experience, and training that
they have.
▪ Any decision can depend only on the information available at the time of the
choice. For example, if you choose to drive from San Diego to Los Angeles
and your car is hit by a drunk driver, you are unlucky, but you haven’t
necessarily failed to optimize. Optimization means that you weigh the
information that you have, not that you perfectly foresee the future.
However, if you decide to let a friend drive you from San Diego to Los
Angeles and you know that your friend is drunk, this is likely a case in
which you are not choosing the best feasible option.
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▪ The COVID-19 crisis is a good example of the complexity of optimization. If
governments were simply trying to maximize total economic output, firms and
employees would have kept working through the pandemic despite the health
consequences. Instead, almost all countries adopted aggressive public health measures
during the crisis, including lockdowns and shelter-in-place rules, causing economies to
contract. Accordingly, the policy response to the COVID-19 crisis involved a trade-off
between health and economic output. Almost all countries accepted a sharp drop in
economic output as the price for partially reducing illness and deaths—morbidity and
mortality—resulting from the pandemic. You can think of this as the first recession
that was equivalent to intentionally putting the economy into a coma.
▪ The problem of objective, Chinese zero COVID policy
▪ Rationality: Doing something systematically and methodically with some objective in
mind
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▪ All optimization problems involve trade-offs. Trade-offs arise when some
benefits must be given up to gain others.
▪ Economists use budget constraints to describe trade-offs. A budget
constraint is the set of things that a person can choose to do (or buy) without
breaking her budget.
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▪ Opportunity Cost
▪ We are now ready to introduce another crucial tool in the optimization
toolbox: opportunity cost. Social media provides an illustration of the
concept. The time that we spend on social media is time that we could have
spent in some other way. In the illustrative example just discussed, the only
two alternative activities were social media and working at a part-time job.
▪ The cost of best alternative forgone. Evaluating trade-offs can be difficult
because so many options are under consideration. Economists tend to focus
on the best alternative activity. We refer to this best alternative activity as
the opportunity cost.
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▪ Assigning a Monetary Value to an Opportunity Cost Economists sometimes
try to put a monetary value on opportunity cost. One way to estimate the
monetary value of an hour of your time is to analyze the consequences of
taking a part-time job or working additional hours at the part-time job you
already have.
▪ A student spends three hours and $20 at the movie the night before an exam.
The opportunity cost is time spent studying and that money to spend on
something else.
▪ A student spends three hours and $20 at the movie sometime during his
leisure time
▪ A farmer chooses to plant wheat; the opportunity cost is planting a different
crop, or an alternate use of the resources (land and farm equipment).
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▪ Opportunity cost of Padma bridge
▪ The road section of Padma bridge costs 30000 crore taka
▪ What else we could do with this 30000 crore taka
▪ May be we could built ICU facility in every Upazila health complex
▪ May be we could built lots of road or schools
▪ Suppose according to some criteria Padma bridge became our first choice
and building ICU facility is our second choice.
▪ In that case ICU facility is the opportunity cost of Padma bridge
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▪ Is Facebook free
▪ Facebook doesn’t charge you a monthly fee, so it’s tempting to say “it’s
free.”
▪ By now we know that Facebook has an opportunity cost—the best
alternative use of your time. We now estimate this cost. To do this, we’re
going to need some data.
▪ U.S. adults are estimated to spend 56 minutes per day on social media
platforms in 2019, which includes sites like Facebook, TikTok, Instagram,
Snapchat, Twitter, Pinterest, Tumblr, and LinkedIn. To simplify our
calculation, let’s round this up to 1 hour per day. Even if we pick a relatively
conservative opportunity cost of time of $13/hour, this amounts to $4,745
per year per U.S. adult
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▪ What can an average US citizen do with this 4745 dollars of extra income
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▪ Cost-Benefit Analysis
▪ Let’s use opportunity cost to solve an optimization problem. Specifically,
we want to compare a set of feasible alternatives and pick the best one. We
call this process cost-benefit analysis. Cost-benefit analysis is a calculation
that identifies the best option by summing benefits and subtracting costs,
with both benefits and costs denominated in a common unit of measurement,
like dollars. Cost-benefit analysis is used to identify the alternative that has
the greatest net benefit, which is the sum of the benefits of choosing an
alternative minus the sum of the costs of choosing that alternative.
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▪ To see these ideas in action, suppose that you and a friend are going to
Miami Beach from Boston for spring break. Imagine that the only question
is whether you should drive or fly. Your friend argues that you should drive
because splitting the cost of a rental car and gas “will only cost $200 each.”
He tries to seal the deal by pointing out “that’s much better than a $300
plane ticket.”
▪ ($100 reduction in out of pocket costs) – (40 hours of additional travel time)
* (13/hour) = +100 - 520 = - 420.
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▪ The Second Principle of Economics: Equilibrium
▪ A situation where no economic agent will have any incentive to move out of
his/her decision, that is they will not be better off by choosing something else
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▪ Economics got this idea (most probably) from physics and quickly grabbed
this as it makes decision making more mathematical
▪ Equilibrium sounds good but sometimes it can give false impression. The
government agency that oversees New York City’s mass transit system
released a report in December 2018 estimating that each day, 208,000
people take the subway without paying and 350,000 people take the bus
without paying.
▪ Free rider problem
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▪ The Third Principle of Economics: Empiricism
▪ Economists test their ideas with data. We call such evidence-based analysis
empirical analysis or empiricism. Economists use data to determine whether
our theories about human behavior—like optimization and
equilibrium—match actual human behavior. Economists also use data to
determine what is causing things to happen in the world.
▪ Economists are also interested in understanding what is causing things to
happen in the world. We can illustrate what causation is—and is not—with a
simple example. Hot days and crowded beaches tend to occur at the same
time of the year. What is the cause and what is the effect here? It is, of
course, that high temperatures cause people to go swimming. It is not that
swimming causes the outside air temperature to rise.
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▪ But there are some cases when cause and effect are hard to untangle. Does
being relatively smart cause people to go to college, or does going to college
cause people to be relatively smart? Perhaps both directions of causation
apply. Or perhaps some other factor plays the causal role—for instance, a
love for reading might cause people to become smarter and cause them to go
to college.
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▪ Problem:
▪ You are thinking about buying a house in London. You find one you like
that costs £1,000,000. You learn that, based on the value of the house and
your wages, your bank will give you a mortgage for 20 years in the region of
£600,000. This means that you must make a down payment of £400,000.
What are some of the monetary and non-monetary opportunity costs of this
purchase?
▪ Think about what are the opportunities that you are missing for this
transaction
▪ Like, you could buy a car or take vacation with £400,000
▪ Throughout next 20 years you will certainly have less money to spend which
will restrict your future consumption, of course you won’t have to pay rent
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