ECON2011

Basic
Microeconomics
Introduction

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Contact Information

Instructor
Dr. Cheuk Yin HO
Office: ELB1002
Email: [email protected]
 What Economics Is All About
Scarcity: resources are limited
Individuals have to make
Choices/Decisions because resources
are limited but wants are unlimited
Economics: the study of choices, e.g.
how CONSUMERS decide what to buy,
how much to work, save, and spend
how FIRMS decide how much to produce,
how many workers to hire
how the GOVERNMENT decides how to
divide its resources between national
defense, public healthcare, and
environment protection, etc
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 How did you make your college
major choice?
Your wants are unlimited - you want to
choose a major that
(1) is interesting
(2) will land you a well-paid job
(3) provide easy grades, etc.
Admission exam results are your limited
resources

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in part, except for use as permitted in a license distributed with a certain product or service or
The principles of
HOW PEOPLE
MAKE DECISIONS

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 People Face Tradeoffs

All decisions involve tradeoffs because of

scarce resources. Examples:
Going to a party the night before your exam
leaves less time for studying (time is
scarce).
Spending more income on food leaves less
income on clothing (income is scarce).
Allocating more workers in the
manufacturing industry leaves fewer
workers in the agricultural industry (human
resources are scarce).
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 People Face Tradeoffs

Society faces an important tradeoff:

efficiency vs. equality
Efficiency: when society gets the most
from its scarce resources
Equality: when income is distributed
equally among society’s members
Tradeoff: To achieve greater equality, the
government could redistribute income
from wealthy to poor. But this reduces
efficiency as people have less incentive to
work and produce.
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 The Cost of Something Is What You
Give Up to Get It

Making decisions requires comparing the

costs and benefits of alternative choices.
The opportunity cost of any item is
whatever must be given up to obtain it.
Example: The benefit of going to college is
to acquire knowledge. The opportunity
cost of going to college are the tuition fee
plus the income forgone in the labor
market.
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 The Cost of Something Is What You
Give Up to Get It

Examples: The opportunity cost of…

…going to college for a year is not just the

tuition, books, and fees, but also the foregone
wages.
…seeing a movie is not just the price of the
ticket, but the value of the time you spend in
the theater.
… working as a construction worker are not just
the time and effort, but also the risk of getting
injuries.
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 Rational People Think at the Margin

Rational people

Do the best they can to achieve their

objectives.
Examples: firms want to maximize profits;
students want to maximize test scores.
make decisions by evaluating costs and
benefits of marginal changes (incremental
adjustments) to an existing plan.
Example: to have 1 cup of coffee or none.
Not true that 3 cups of coffee or none.
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 Rational People Think at the Margin

When the existing plan changes, there are

marginal benefits (changes in benefits) and
marginal costs (changes in costs). Examples:
You change your study plan by increasing
weekly study hours from 10 to 11.
Marginal benefits are increases in test scores
by 10 marks and marginal costs are decreases
in leisure by 1 hour.
You plan to change your lifestyle by taking a
part-time job: marginal benefits are extra
income and marginal costs are study time
foregone.
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 Rational People Think at the Margin

Examples:
When a student considers whether to study
for an additional year, he compares the
fees & foregone wages (marginal costs)
to the extra knowledge (marginal
benefits) he could get.
When a manager considers whether to
increase an additional output, she
compares the cost of the needed labor and
materials (marginal costs) to the extra
revenue (marginal benefits).
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 People Respond to Incentives

Incentive: something that induces a person to

act, or something that affects marginal benefits
or marginal costs.
Rational people respond to incentives.
When gas prices rise, people drive less and
walk more. (marginal cost of driving increases)
When cigarette taxes increase, teen smoking
falls. (marginal cost of smoking increases)
When hourly wages increase, people sleep less.
(marginal cost of sleeping increases)

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 ACTIVE LEARNING 1 Applying the principles

You are selling your car. You have already spent

$1,000 on repairs.
At the last minute, the car does not work. You can
pay $600 to have it repaired, or sell the car directly.
In each of the following scenarios, should you
repair the car? Explain.

A. Blue book value (what you could get for the

car) is $6,500 if the car works, $5,700 if it
doesn’t
B. Blue book value is $6,000 if the car works,
$5,500 if it doesn’t
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in part, except for use as permitted in a license distributed with a certain product or service or
 ACTIVE LEARNING 1 Applying the principles

You are selling your car. You have already spent

$1,000 on repairs.
At the last minute, the car does not work. You can
pay $600 to have it repaired, or sell the car directly.
In each of the following scenarios, should you
repair the car? Explain.

A. Blue book value (what you could get for the

car) is $6,500 if the car works, $5,700 if it
doesn’t
B. Blue book value is $6,000 if the car works,
$5,500 if it doesn’t
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in part, except for use as permitted in a license distributed with a certain product or service or
 ACTIVE LEARNING 1 Answers
Marginal cost of fixing the car = $600

A. Blue book value is $6,500 if the car works,

$5,700 if it doesn’t
Marginal benefit of fixing = $800($6,500 –
$5,700)> marginal cost = $600.
It’s worthwhile to fix the car.
B. Blue book value is $6,000 if the car works,
$5,500 if it doesn’t
Marginal benefit of fixing is only $500
($6,000-$5,500)< marginal cost = $600.
Paying $600 to fix the car is not
worthwhile.
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 ACTIVE LEARNING 1 Observations

The $1,000 you previously spent on repairs

is irrelevant (sunk). What matters is the
marginal cost and marginal benefit of the
current repair.
The incentives (i.e., the change in marginal
benefit) from scenario A to scenario B
caused your decision to change.

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 Absolute Advantage
Absolute Advantage: a higher productivity
than others.
Higher outputs with the same inputs
Or
Lower inputs with the same outputs

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 Comparative Advantage
Comparative Advantage: the ability to do the
thing at a lower opportunity cost in comparison
to others.
The idea was developed by David Ricardo
(1817).
This concept is applied in
international trade, migration,
occupational choice, etc.

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 Example of International Trade

France: produce 5 clothes or 10 wines with 1

worker.
US: produce 20 cloths or 20 wines with 1 worker.
US has absolute advantages in producing both
goods.

France (US) has a comparative advantage in the

production of wine (cloth).
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 Example of Elective Course Selection

Advanced Calculus is more demanding than

History
Passing grade (D) = GPA of 1.0 for both subjects

Smart student has absolute advantages in

taking History and Advanced Calculus.

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 Example of Elective Course Selection

Smart student has a comparative advantage in

taking a demanding subject, i.e., Advanced
Calculus.
Mediocre student has a comparative advantage
in taking a less demanding subject, i.e. History

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 Summary
People face tradeoffs.
The opportunity cost of any item is
whatever must be given up to obtain it
Rational people make decisions by
comparing marginal costs and marginal
benefits.
People respond to incentives.
People act according to their comparative
advantages.

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in part, except for use as permitted in a license distributed with a certain product or service or
 Question 1
(a) You were planning to spend Saturday
working at your part-time job, but a friend
asks you to go swimming. What is the true
cost of going swimming?

(b) Now suppose you had been planning to

spend the day studying at the library.
What is the cost of going swimming in this
case? Explain.

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 Question 2
Water is more important than a diamond
in our life. Why is a diamond more
expensive than a cup of water?

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in part, except for use as permitted in a license distributed with a certain product or service or
 Question 3
Gary and Diane must prepare a presentation for their
marketing class. As part of their presentation, they
must do a series of calculations and prepare 50
PowerPoint slides. It would take Gary 10 hours to do
the required calculation and 10 hours to prepare the
slides. It would take Diane 12 hours to do the
calculations and 20 hours to prepare the slides.
(a) How much time would it take the two to complete
the project if they divide the calculations equally and
the slides equally?
(b) How much time would it take the two to complete
the project if they use comparative advantage and
specialize in calculating or preparing slides?
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in part, except for use as permitted in a license distributed with a certain product or service or