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Principles of the
Microeconomics
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MC
Dr. Weimin Ma
[email protected]
A903 New Main Building
School of Economics and Management
Beihang University
Thinking Like
An Economist
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MC
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Introduction

What is the Optimal Class Size?
To maximize learning without consideration
of cost?
z How would considering costs change our
answer?
z
A
personal tutorial course in economics might
cost $40,000
A class of 300 students might cost
$200/student
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 3
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Introduction

What is the Optimal Class Size?
z
What trade-offs must university
administrators and students consider when
choosing class size?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 4
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Economics: Studying
Choice In a World of Scarcity
The Scarcity Principle
Boundless wants cannot be satisfied with
limited resources.
z Therefore, having more of one thing
usually means having less of another.
z Because of scarcity we must make choices.
z
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 5
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Economics: Studying
Choice In a World of Scarcity
Wants vs. Resources
Scarcity
Choices
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 6
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Economics: Studying
Choice In a World of Scarcity
Economics
z
The study of how people make choices
under conditions of scarcity and of the
results of those choices for society.
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 7
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Economics: Studying
Choice In a World of Scarcity
The Cost-Benefit Principle
z
An individual (or a firm or a society) should
take an action if, and only if, the extra
benefits from taking the action are at least
as great as the extra costs
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 8
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Economics: Studying
Choice In a World of Scarcity
Choosing the Optimal Class Size
Revisited
z
Assumptions:
Two
class sizes: 100 and 20
Introductory economics classes currently have
100 students
z
Question
Should
the class size be reduced to 20
students?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 9
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Economics: Studying
Choice In a World of Scarcity
Observations
The “best” class from an economic point of
view will generally not be the same as the
“best” size from the point of view of an
educational psychologist.
z People will feel differently about the value
of smaller classes.
z
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 10
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Economics: Studying
Choice In a World of Scarcity
Application
z
What other examples of scarcity and
trade-offs can we identify?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 11
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Economics: Studying
Choice In a World of Scarcity
Choosing the Optimal Class Size
z
Assume:
The
cost of a class with 20 students is $1,000
per student more than a class of 100 students
z
What do you think:
Would
it be a good idea to reduce the class
size?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 12
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Applying The Cost-Benefit Principle

Rational Person
z
Someone with well-defined goals who tries
to fulfill those goals as best he or she can
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 13
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Applying The Cost-Benefit Principle

Should you walk downtown to save $10
on a $25 computer game?
The benefit of going downtown = $10
z The cost of going downtown is the dollar
value of everything you give up to go
downtown
z
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 14
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Applying The Cost-Benefit Principle

Should you walk downtown to save $10
on a $25 computer game?
z
Estimating the cost:
How
much would someone have to pay you to
walk downtown?
If you would walk downtown for $9; the trip’s
cost is $9
z
The benefit ($10) exceeds the cost of ($9)
of buying the game downtown
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 15
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Applying The Cost-Benefit Principle

Question
z
Will everyone choose to buy the computer
game downtown?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 16
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Applying The Cost-Benefit Principle

Economic Surplus
The benefit of taking any action minus its
cost
z The goal of economic decision makers is to
maximize their economic surplus
z
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 17
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Applying The Cost-Benefit Principle

Opportunity Cost
z
The value of the next-best alternative that
must be forgone to undertake an activity
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 18
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Applying The Cost-Benefit Principle

Question
z
What is the opportunity cost of buying the
game downtown?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 19
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Applying The Cost-Benefit Principle

Assume
The benefit of buying the game downtown
is $10
z The cost of making the trip is $12
z

Questions
What is your economic surplus from buying
the game downtown?
z Where should you buy the game?
z
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 20
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Applying The Cost-Benefit Principle

The Role of Economic Models
Economic models are abstract (simplified
descriptions) models that allow us to
analyze situations in a logical way
z Other examples of abstract models
z
A
computer model of climate change
A road map
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 21
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Applying The Cost-Benefit Principle

Observation
z
The cost-benefit principle suggests that we
take only those actions that create
additional economic surplus.
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 22
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Four Important Decision Pitfalls

Pitfall 1: Measuring cost and benefits as
proportions rather than
absolute dollar amounts
Examples:
Should you walk downtown to save $10 on
a $2,020 laptop computer?
z Which is more valuable, saving $100 on a
$2,000 plane ticket to Tokyo or saving $90
on a $200 plane ticket to Chicago?
z
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 23
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Four Important Decision Pitfalls

Pitfall 2: Ignoring Opportunity Costs
z
Example:
Should
you use your frequent-flyer coupon to
fly to Fort Lauderdale for spring break?
z
Assume:
Round
trip airfare is $500 and is equal to your
frequent flyer coupon
Other costs equal $1,000
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 24
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Four Important Decision Pitfalls

Pitfall 2: Ignoring Opportunity Costs
z
Assume (cont):
The
most you are willing to pay for the Fort
Lauderdale trip is $1,350
Alternate use for the frequent flyer coupon is to
attend a wedding in Boston the week after
spring break and the Boston airfare is $400
(coupon expires just after the wedding)
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 25
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Four Important Decision Pitfalls

Pitfall 2: Ignoring Opportunity Costs
z
Example:

z
Should you use your frequent flyer coupon to fly to Fort
Lauderdale for spring break?
Without the coupon:
Benefits = $1,350
Cost = $1,400 ($400 opportunity cost + $1,000
other costs)

z
Question

What would you do if the coupon expires just after spring
break?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 26
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Four Important Decision Pitfalls

Pitfall 2: Ignoring Opportunity Costs
z
The key to using the concept of opportunity
cost correctly lies in recognizing precisely
what taking a given action prevents us
from doing.
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 27
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Four Important Decision Pitfalls

Pitfall 3: Failure To Ignore Sunk Costs
z
The only costs that should influence a
decision about whether to take an action
are those that we can avoid by not taking
the action
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 28
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Four Important Decision Pitfalls

Pitfall 3: Failure To Ignore Sunk Costs
z
Sunk cost
A
cost that is beyond recovery at the moment a
decision must be made
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 29
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Four Important Decision Pitfalls

Pitfall 3: Failure To Ignore Sunk Costs
z
Example
How
much should you eat at an all-you-can-eat
restaurant?
z
Assume:
Price
= $5
20 randomly selected guests will get lunch on
the house
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 30
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Four Important Decision Pitfalls

Pitfall 3: Failure To Ignore Sunk Costs
z
Example
How
much should you eat at an all-you-can-eat
restaurant?
z
Question:
If
all diners are rational, will there be any
difference in the average quantity of food
consumed by these two groups?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 31
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Four Important Decision Pitfalls

Pitfall 4: Failure To Understand the
Average-Marginal Distinction
z
Marginal Benefit
The
increase in total benefit that results from
carrying out one additional unit of an activity
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 32
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Four Important Decision Pitfalls

Pitfall 4: Failure To Understand the
Average-Marginal Distinction
z
Marginal Cost
The
increase in total cost that results from
carrying out one additional unit of an activity
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 33
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Four Important Decision Pitfalls

Pitfall 4: Failure To Understand the
Average-Marginal Distinction
z
Example
Should
NASA expand the space shuttle
program from four launches per year to five?
Benefits
o $24 billion (average of $6 billion/launch)
Costs
o $20 billion (average of $5 billion/launch)
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 34
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Four Important Decision Pitfalls

Pitfall 4: Failure To Understand the
Average-Marginal Distinction
z
Average Cost
The
total cost of undertaking n units of an
activity divided by n
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 35
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Four Important Decision Pitfalls

Pitfall 4: Failure To Understand the
Average-Marginal Distinction
z
Average Benefit
The
total benefit of undertaking n units of an
activity divided by n
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 36
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Four Important Decision Pitfalls
# of Launches
Total Cost
Average Cost
Marginal Cost
($ billion)
($ billion/launch)
($ billion/launch)
0
0
0
1
3
3
2
7
3.5
3
12
4
4
20
5
5
32
6.4
3
4
5
8
12
What is the optimal number of launches?
Assume: Average Benefit = Marginal
Benefit = $6 billion
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 37
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Normative Economics
vs. Positive Economics
Normative Economic Principle
z
One that says how people should behave
Example:

Cost-benefit principle
Positive Economic Principle
z
One that predicts how people will behave
Example:
The incentives matter principle
o A person (or a firm or society) is more likely to take
an action if its benefit rises and less likely if its cost
rises)
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 38
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Economics: Micro and Macro

Microeconomics
z
The study of individual choice under
scarcity and its implications for the
behavior of prices and quantities in
individual markets
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 39
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Economics: Micro and Macro

Macroeconomics
z
The study of the performance of national
economies, and of the policies that
governments use to try to improve that
performance
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 40
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The Approach of This Text

Focus on core economic concepts
Scarcity principle
Cost-benefit principle
Incentive principle
Learning economics through
applications
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 41
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Economic Naturalism

Using insights from economics to help
make sense of observations from
everyday life
Copyright c 2007 by The McGraw-Hill
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Chapter 1: Thinking Like an Economist
Slide 42
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Economic Naturalism

Question
z
Why do so many computer hardware
manufacturers include more than $1,000
worth of “free” software with a computer
selling for only slightly more than that?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 43
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Economic Naturalism

Questions
Why don’t automobile manufacturers make
cars without heaters?
z Why do the keypad buttons on drive-up
automatic teller machines have Braille dots?
z
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Chapter 1: Thinking Like an Economist
Slide 44
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Economic Naturalism

Applications
z
Use cost-benefit analysis to explain some
pattern of events or behavior you have
observed in your own environment
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 1: Thinking Like an Economist
Slide 45
End of
Chapter
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