Chapter 1 Preliminaries What is microeconomic theory Micro

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Chapter 1: Preliminaries • What is microeconomic theory? • Micro theory is about the

Chapter 1: Preliminaries • What is microeconomic theory? • Micro theory is about the allocation of scarce resources with a focus on individual economic units like consumers and firms. • It focuses on trade-offs or opportunity costs. • Using economic jargon: individuals maximize utility subject to a budget constraint.

Economics as a Social Science • Tries to explain observed behavior and make predictions

Economics as a Social Science • Tries to explain observed behavior and make predictions about the future. • Develops theories to explain observed phenomena. • A model is a mathematical representation of a theory; no theory is perfect. • Models are simplifications of the real world.

Positive versus Normative • Positive: explanation and prediction (deals with actual observed phenomena); can

Positive versus Normative • Positive: explanation and prediction (deals with actual observed phenomena); can be proven right or wrong. • Normative: what ought to be (deals with opinions and recommendations); reflects value judgements. • The two can be hard to disentangle.

Describing Markets • Identify who is the supplier and who is the demander •

Describing Markets • Identify who is the supplier and who is the demander • Define the extent of the market • Describe units in which the output is measured. • How competitive is the market?

Real versus Nominal Prices • KEY: Real prices reflect influence of inflation so can

Real versus Nominal Prices • KEY: Real prices reflect influence of inflation so can make meaningful comparison of real prices across time. • Real price: price of a good relative to an aggregate measure of prices (adjusts for inflation); must pick a base year. • Nominal price: actual dollar price, not adjusted for inflation (price actually see) • Aggregate measure of prices: CPI— Consumer Price Index

Formula to Calculate Real Price in Year X • Real Price in Year X

Formula to Calculate Real Price in Year X • Real Price in Year X = • (Nom. P in Year X) * (CPI base year/CPI Year X). • Real PX = • Nom. PX (CPIB/CPIX) • Homework: Exercises #2 and # 3 on page 18 in textbook.

Examples • Information given: Nominal price of college education = $15, 212 in 1993.

Examples • Information given: Nominal price of college education = $15, 212 in 1993. CPI values: 1985: 107. 6 1990: 130. 7 1993: 144. 0 • Calculate the real price of a college education in 1993 in terms of 1985 dollars: Use: Nom P ’ 93 * (CPI 85/CPI 93) $15, 212 * (107. 6/144. 0) = $11. 366. 74.

Exercise YEAR Gas Price Per gallon CPI (base year 1982 = 100) 1970 0.

Exercise YEAR Gas Price Per gallon CPI (base year 1982 = 100) 1970 0. 28 38. 8 1977 0. 58 60. 6 1989 1. 10 124. 0

Exercise (cont. ) • Calculate the real price of gasoline for 1977 and 1989

Exercise (cont. ) • Calculate the real price of gasoline for 1977 and 1989 using 1970 dollars. • How did gasoline prices changed from 1977 to 1989?

Exercise Solution • 1. Real price in 1977, expressed in terms of 1970 dollars:

Exercise Solution • 1. Real price in 1977, expressed in terms of 1970 dollars: 1977 nom. P * (CPI 70 / CPI 77) = $0. 58 * (38. 8 / 60. 6) = $0. 37. • 2. Real price in 1989, expressed in terms of 1970 dollars: 1989 nom. P * (CPI 70 / CPI 89) = $1. 10 * (38. 8/124. 0) = $0. 34.