Microeconomics

Microeconomics Microeconomics Outline Thesis Statement: Microeconomic mechanisms can predict future technology impacted economic outcomes. I. What is Economics? A. What do economics tell us? B. The science of economics 1. defining microeconomics 2.

some terms and definitions II. Using Microeconomic models A. Theory 1. practical application 2. household choices III. Economic Growth A.

The cost of economic growth B. Capital accumulation C. Technological change IV. Individual and Market Demand A. Household Consumption Choices 1. Constraints 2.

Preferences 3. Marginal utility a. an analogy 4. Utility maximization V. Predictions Based on Marginal Utility Theory A.

Price increases B. Increases of income VI. In Conclusion This paper will attempt to examine microeconomic structures in relation to technological advances. The impact of increasingly available technology is a major economic force. Prior to 1975, for example, viewing a first run movie at home was technically possible but economically infeasible. Only the wealthy chose to view moves at home.

VCR’s became available in 1976, with a typical price tag of $2000.00 Even at such a high price, that invention slashed the price of home viewing. Today a VCR can be purchased for $200.00, a fraction of its’ initial cost. Videos can be rented for approximately a dollar or purchased for around $20.00. Home viewing has become common in a few short years, where formerly it had been available only to the very rich. In what other ways has technology changed the way of life and can microeconomic mechanisms accurately predict future economic outcomes? What is Economics? The simple answer to the question, “What is the economy?” is to state that the economy is the means by which resources are allocated.

A more accurate portrayal of economic process is to view it as a machine that produces three distinctly different results: ? First, the economy determines what goods and services will be produced and in what quantities. ? Secondly, it indicates how various goods and services will be produced. ? Thirdly, it resolves the question of distribution. Markets for goods and services, and markets for production of those goods and services – command mechanisms – directly correlate with the choices made by households, firms and governments. The US economy relies mainly on markets but to a degree on command mechanisms. The US economy is an open economy and has become highly integrated with the global economy. This is a fairly recent development, with foreign investment into US business outstripping US investments in foreign enterprises shifting the balance in the mid-1980s. Economists study these financial movements in order to determine the underlying principles driving the economy.

This approach utilizes the same rigor and objectivity of natural scientists. Economic science, like natural science, is an attempt to discover a body of laws. All sciences use the same criteria in the investigative process: careful and systematic observation and measurement, and the development of a body of theory to direct and interpret observations. That theory is a general rule or principle that allows economists to understand and predict the economic choices that people make. Theories are derived from building and testing economic models. Economic models are built on four key premises. These basic assumptions are: ? People have preferences ? People have a fixed amount of resources and a technology that can transform resources into goods and services. ? People choose how to use resources and technology to increase economic well-being.

? People’s choices are coordinated – buyers choose what sellers offer and vice versa. The implications of such models are that the values of various prices and quantities result in “equilibrium”. That is, situations in which everyone has made the best possible choices, given their own preferences, information, resources, and technologies, and that those choices are coordinated and compatible with the choices of everyone else. Equilibrium is the solution or outcome of an economic model. Economic models fall into two categories: Microeconomics and macroeconomics.

Microeconomics is the branch of economics that studies the choices of individual households and firms. Because it analyzes the behavior of economic units, microeconomics is a most important social science. Microeconomics theory is used to analyze various circumstances and outcomes from decision making. In addition, microeconomics provides foundations for scientists of other social disciplines. Microeconomics is a highly useful tool in business management, aiding in planning, finance, and marketing. However, microeconomics is not limited to business applications. Government administration, political science, history, social- behavior, and much more can be viewed through the lens of microeconomics. What do microeconomics tell us? Careful analysis using microeconomic models answer those questions dealing with technological change, production and consumption, wages and earnings.

Economic concerns involving unemployment, inflation, and the differences in wealth among nations are macroeconomic. A major cog in the microeconomic machinery is the concept of “scarcity”. This is easily summed up as the universal state in which wants exceed resources. Scarcity fuels “production”, the conversion of land, labor, and capital into goods and services. Services are made up of intangible commodities such as haircuts, phone calls and cab rides.

Goods are tangible – cars, socks, VCRs, and bread. Goods are classified as either capital goods, i.e., those goods with long term use such as buildings cars, computers, etc., or consumption goods. Consumption goods are items that can be used one time only, such as pickles and toothpaste. Finite resources and the available technologies limit what can be produced in terms of goods and services. The boundary between what can and cannot be produced is referred to as the production possibility frontier (PPF).

Using Microeconomic Models Understanding the PPF as applied to real life is critically important. To make that concept easier to grasp a model economy can be devised that, while simpler than real life situations, provides enough accurate information to draw viable conclusions and make feasible predictions. To build this model, features essential to understanding the real economy must be incorporated, but copious details are eliminated. The model will be simplified by establishing three important criteria: 1. Everything in this model that is produced is also consumed, stabilizing capital resources so that they neither grow nor shrink.

2. There are only two goods rice and cloth. 3. There is a single individual involved with this economy, “Joe”. Joe’s setting is a deserted island, with no outside contact. Joe uses all the resources available to him to produce rice and cloth.

It requires Joe to labor 10 hours a day. The amount of cloth and rice produced relies on how many hours are devoted to the activity. producing them. If Joe does no work, nothing is produced. To produce six pounds of rice in a month, Joe must work two hours a day. Devoting more hours to rice increases monthly output, but the return rate diminishes as Joe has to use increasingly unsuitable land in that production.

Initially, Joe plants in fertile wet land. As the best quality land is put into production, remaining available land becomes drier and less productive. Eventually, all workable land is used and time and effort must now be devoted to reconditioning other types of land. To produce cloth, Joe gathers wool from sheep on the island. As he devotes more hours to gathering wool and weaving fiber, cloth output increases. If Joe devotes all his time to raising rice, he can produce twenty pounds of corn a month.

He cannot, however, produce any cloth. Conversely, if Joe devotes all of his time to making cloth, he can produce five yards a month but will have no time for the rice crop. He can vote some of his time to rice and some to cloth but not more than ten hours total. Thus he can spend two hours a day producing rice and eight hours producing cloth, or any combination of hours equaling ten hours. This clearly illustrates the production possibility frontier as a boundary identifying what is obtainable and what is not. Calculate Joe’s PPF by using the information in Table 1. These calculations are summarized in Figure 1 and graphed as Joe’s PPF.

To understand these calculations, first examine the data found in Figure 1. Possibility A shows an entire working day devoted solely to rice production. In this case 20 pounds of rice per month is the forecasted yield, while no cloth is produced. Possibility B demonstrates two hours daily in cloth production and eight hours producing rice, yielding a total of eighteen pounds of rice and one yard of cloth monthly. The pattern continues onto F, showing an entire working day devoted to cloth production. The work day is defined as two hour blocks of time in Table 1, however, any feasible allocation of a day hour work day will demonstrate the potential various combinations of rice and cloth along the line joining points A, B, C, D, E, and F.

in Figure 1. This indicates the Production Possibility Frontier. Production can be maintained at any point on or within the attainable frontier – the area discerned as yellow inside Figure 1. Points outside that frontier are unattainable. To produce at points beyond the frontier, there would have to be more time allotted to the working day. A ten hour work day allows for various combinations of rice and cloth production at the PPF. A work day less than ten hours will allow for production only at a point inside the frontier. Table 1 Production Possibilities Hours Worked Rice Grown Cloth Produced (per day) ( lbs.

per month) (yards per month) 0 either 0 or 0 2 either 6 or 1 4 either 11 or 2 6 either 15 or 3 8 either 18 or 4 10 either 20 or 5 If Joe performs no labor no rice or cloth are produced. If Joe labors for 2 hours daily and devotes all that time on corn production he will produce 6 pounds of rice per month. If that same time is used for cloth production, 1 yard of cloth is produced but no rice. The last four rows of the table indicate the amount of rice or cloth that can be produced per month as more hours are devoted to those activities. Production Possibility Frontier Figure 1 Rice 20 A in lbs.

18 B per month 16 C Unattainable 14 12 Z D 10 8 6 E Attainable 4 Production possibility 2 frontier F 0 1 2 3 4 5 6 7 8 9 Cloth in yards per month Rice Cloth in in lbs. yards per per Possibility month month A 20 and 0 B 18 and 1 C 15 and 2 D 11 and 3 E 6 and 4 F 0 and 5 The graph lists six points on Joe’s production possibility Frontier. Row E tells us that if Joe produces 6 pounds of rice, the maximum cloth production that’s possible is 4 yards. These same points are graphed as A, B, C, D, E, and F in the figure. The line passing through these points is the production possibility frontier, which separates the attainable from the unattainable. The attainable area contains all the possible production points.

Joe can produce anywhere inside the area or on the production possibility frontier. Points outside the frontier are unattainable. Models such as these provide a structure for understanding how production works and aids in decision making by demonstrating what opportunities exist and what is required to take advantage of those opportunities. But having more of one means having less of another. This is referred to as opportunity cost.

Opportunity cost is measured by evaluating the PPF. How much cloth has to be given up to get more rice and vice versa are the questions requiring answers using the rice and cloth model. If all allotted monthly working hours are used to grow rice, there are twenty pounds of rice but no cloth. How much rice is given up to produce one yard of cloth? Figure 1 shows that a single yard of cloth will cost two pounds of rice to produce. If an additional yard of cloth is produced, the progression from point B to point C indicates that it will cost three pounds of rice to produce the second yard of cloth.

The next yard of cloth costs six pounds of corn. It has been learned from the model that the opportunity cost of cloth increases as more cloth is produced. This is also true in reverse. The first six pounds of rice costs one yard of cloth to produce. The next five pounds of rice costs an additional yard of cloth, and so on.

The opportunity cost of rice also increases. Contributing to this phenomenon is the factor of inequality; not all scarce resources are equally useful in all activities. For example, while some of the land on Joe’s hypothetical island is extremely suitable for high yield rice crops, the remaining landscape may be rocky and barren. The sheep on the island, however, prefer rocky and barren land. Obviously, the optimum use of this island resource is to use the most fertile, wet land to grow rice and the most rocky and barren land to raise sheep. Only if a larger rice yield is desired will it be necessary to attempt to cultivate the less desirable land.

If all allocated time is devoted to cultivating rice then it becomes necessary to use unsuitable low yielding land. Devoting some of the time to making cloth and reducing some of the time spent growing rice produces a small drop in crop yield but a large increase in the output of cloth. Conversely, if all allocated time is used to make Seal Straugh cloth, a small reduction in woolgathering leads to a large increase in rice production. What has been learned from the model provides fundamental lessons in real world economy. The world has a fixed number of people endowed with a given amount of limited time and human capital.

These limited resources can be utilized, using the available but limited technology to produce goods and services. But there is a limit to the goods and services that can be produced, a boundary between what’s attainable and unattainable. For example, the political candidate who offers better education and human services must simultaneously be prepared to increase taxes or reduce services in another sector such as road maintenance or fire protection. On a much smaller but equally important scale, each time an individual rents a video, that same individual must determine where to expend remaining cash resource, b …