Chapter 1

Introduction to microeconomics

Great Economists:
- Adam Smith (1723 – 1790)
- David Ricardo (1772–1823)
Nobel Prize:
- Gunnar Myrdal (1898-1987)
- Friedrich Von Hayek (1899-1992)
- Paul A. Samuelson (1915-2009)

Mr. SENG Veyanet

Tel.: 0886816070
1
 What you will learn in this chapter:
1) Concept of micro, macro, economics, and economy

2) Microeconomic principles

3) Three key economic problems

4) Economic resources

5) Economic model

6) Production possibility curve or PPF

7) Economic growth in the context of PPF

8) Sources of Economic growth

9) Transaction and the circular flow diagram

10) Positive and normative economics

2
 I. Concept of micro-, macro-, economics and economy

➢ Microeconomics is the study of how households and firms make

decisions and how they interact in markets. The interaction of
consumers and firms forms the markets and industries.

➢These are some microeconomic issues:

✓Supply and demand
✓ Price and cost

✓ Revenue and profit

✓Input, output, production function

✓ Competition
✓ Profit maximization
✓…
3
➢ Macroeconomics is the study of the economy as a whole. It is
about the indicators of national economies and also government
policies to intervene the country’s economy.

➢ It addresses the issues as below:

✓ Aggregate output (GDP & GNP)
✓ Economic growth
✓ Inflation, unemployment,
✓ Business cycle
✓ Macroeconomic policy
✓ Trade balance, balance of payment

4
➢ Economics is “the study of the behavior of human in producing,
distributing and consuming goods and services for the purpose of
the satisfaction of needs in a world of scarce resources.”

➢ An economy - is the institutional structure through which people

in a society engage in activities in order to satisfy their needs.

5
 II. Uses of Microeconomics

➢ The users of microeconomics

 Individuals make decisions about jobs, purchases, and finances

▪ Students have to make choice on career

▪ Consumers select various bundles of goods up to their own

preferences and budget

 Firms make decisions about the investment , demand , cost

▪ Producers need to decide what to produce, how much price to put

on their product

 Governments making policy decisions about laws and regulations such

as antitrust law, tobacco control law

6
 Is it worth your time to be here?

➢The typical university student pays about $700 - $1000 per year in
tuition and room. So the “cost” of 4 years is about $3000 - $4000.

➢ It has been suggested that university graduates earn more than

those without such an education.

7
ii. Concept vs. theory

* Concept is an abstract idea about the surrounding world

E.g. Economics, Management, Benefit, Cost, RIA,...

* Theory is a meaningful justifiable statement about the interrelationship

b/w socio-economic variables. It is used to predict and explain the socio-
economic phenomena.
Theory  principle  law  rule  norm
some examples:
1. People always respond to incentive
2. People always face options (tradeoffs)
3. Market is a good way to organize economic activity, but sometimes fails.
4. People
Concepts often fall
+ Theory + inpractice
the fallacy
= knowledge
8
 III. Microeconomic principles

➢Economic principles are created through people’s perception

about the surrounding world.
➢ These are phases of creating principles:

Assumption Observation Hypothesis

  
Empirical Test Accept/reject hypothesis Model / Principle
  
Generalization of economic principle into Economy

9
 Ceteris paribus: a special method for economic analysis

A.k.a. Other-things-equal assumption is a method widely used in

microeconomic analysis. It means that all variables other than
the ones being studied are assumed to be constant.

Economists study the following conditions of individual’s behavior.

1. How people make decisions – choice

2. How people interact with each other – individual interaction

3. Understanding economy-wide interactions

Note Choice and interaction are necessary conditions of

forming the economic principles.

10
 CHOICE is the core of economics:
Individual choice is the decision by an individual of what to do,
which necessarily involves a decision of what not to do.

Some principles under the condition of choices (titles):

1) Scarcity

2) Opportunity cost

3) Marginal analysis

4) Incentive

11
 Principle #1: Resources are scarce.

➔ It means that the quantity of resources available is not enough to

satisfy all productive uses.
 Ex.: Land, Petroleum, intelligence.
➔ A resource is anything that can be used to produce something else.

Also called Economic resource

- Land (natural resources)

-Resource, a.k.a.
- Raw material (unprocessed material)
are -Factor of
- Labor (number & skills)
the production
- Capital (buildings, machinery, networks)
same -Input - Entrepreneurship (skills & capability in
creating new business)
12
Principle # 2: To make a choice people always face opportunity cost

➢ Opportunity cost of an item is the value of  Trade-offs  options 

what you give up to obtain that item. It occurs alternatives  choices
because of trade-offs.  For instance, more of 1 thing
➢ Consider: Why study at university? means less of another thing.

Principle #3: Most decisions are made at the margin

➔ Decisions about whether to do a bit more or a bit less of an activity are marginal

decisions. The study of such decisions is known as marginal analysis.

• Ex. Hiring one more worker?

→ To make the decision, we compare the benefit of doing one more unit of one thing with
its cost — we make our choice at the margin
13
 Principle #4: People always respond to incentives.

➢ People usually take advantage of opportunities to make

themselves better off.

➢ An incentive is anything that offers rewards to people who

then change their behaviour.

→ Ex.: If price of gasoline rises, people buy more fuel-efficient cars.

→ Ex.: There are more well-paid jobs available for college graduates with
economics degrees, therefore more students enrol for economics.

14
 ECONOMIC INTERACTION is how an economy works
Interaction — interrelationship between two or more economic units.

Situation of “my choices affect your choices, and vice versa”— is a

feature of most economic situations.

➔Some principles under the interaction:

5. gains from trade

6. Equilibrium

7. Invisible hand of market

8. Government intervention

15
 Principle #5: Trade can make everyone better off.

➔ In a market economy, individuals engage in trade - No Loser,

Only Winner!!: They provide goods and services to others and

receive goods and services in return.

➔ There are gains from trade: people can get more of what they
want through trade than they could if they tried to be self-sufficient.

➔ Gain from trade occurs because of specialization: Each person

specializes in the task that he is good at performing.

➔The economy, as a whole, can produce more when each individual

specializes in a task and trades with others.

16
 Principle #6: Markets always move toward equilibrium.

➔Equilibrium is a situation in which there is the

balance between two or more variables.

➔ Anytime there is a change, the economy will

move to a new equilibrium.

➔Ex.: Imagine what happens when a good is in

shortage?

17
 Principle #7: Markets are usually a good way to organize
economic activity.

➢ A market usually allocates resources through the decisions of

many firms and households. We say MKT decision is always very
precise and efficient.
Households decide what to buy and who to work for, to whom to rent his
land and lend his financial capital
Firms decide who to hire and what to produce.
Firms and HHs look at prices when deciding what to produce and buy, so
they unknowingly take into account the social effect of own actions.
As a result, prices guide decision makers to reach outcomes that tend to
maximize the welfare of society as a whole.

18
 The argument for the Market efficiency
Market and
invisible hand
There are six main properties of market
are two sides of
economy which ensure efficiency.
the same coin

PRIVATE PROPERTY FREEDOM OF CHOICE

SELF- INTEREST COMPETITION

PRICES GOVERNMENT POLICY Efficiency

Incentive
Freedom

19
Principle #8: When markets don’t achieve efficiency,
government can improve society’s welfare.

As the market fails, government can

intervene to promote efficiency and equity.
Market failure occurs when the market
fails to allocate resources efficiently
Equity
Efficiency

Market failure may be caused by…

an externality: the impact of one’s actions on the well-being of a
bystander.
market power: the ability of a single actor to unduly influence
market prices.
Market always fails to produce public goods

20
 Efficiency vs. Equity

➢Consider this situation: A reasonable manager designates a

parking space for handicapped people in a busy parking lot.
➢There is a conflict between equity and efficiency:
 equity means making life “fairer” for handicapped people
 efficiency means making sure that all opportunities to gain
benefit from available resources have been fully exploited by never
letting a parking space go unused.

 How far should policy-makers go in promoting equity over

efficiency?

21
 Economy-Wide Interactions
Principles under economy-wide interactions:

9. In the economy as a whole overall spending is equal overall income

10. Government policies can help the economy to recover from

recession and inflation faster than self-adjustment of the MKT.

• Monetary policy

• Fiscal policy

22
 IV. Three Basic Economic problems

➢ Because of scarcity, an allocation decision must be made. The

allocation decision of a society is comprised of three separate choices:
➔ What and how many goods and services should be produced?

*What : we have to decide WHAT we want most, sacrificing less other

desired goods.

➔ How should these goods/services be produced?

*How : the decisions to use resources efficiently (in different way) and
safely to satisfy people needs.

➔ For whom should these goods and services be produced?

*For whom: It is the market segmentation decision – targeting the

customers most likely to purchase.

23
 V. Models in Economics
 Economists use it to explain the economic situation.
➢ A model is the simplified representation of the interrelationship
between economic variables that is used to better understand
economic situations.

➢Two simple but important models will be considered:

1. circular-flow diagram 2. production possibility frontier

➢ A process or Phenomenon can be composed as a model in several

ways: diagram, table, function/equation, and picture.

➢ Assumption like “ceteris paribus” is helpful when drawing a model

➢ Remember that the “real world” is too complicated to describe in

detail so we use the model.
24
 Model 1: The Circular-Flow Diagram
Revenue Spending
Market for
Goods
Goods &
Services and Services Goods &
Services

Firms Households

Inputs for Labor, land, and

production Market for capital
Factors
Wages, rent, and of Production Income
profit
25
➢ The circular-flow diagram is a model that represents the
transactions in an economy by flows around a circle.

Economic individuals
Firms
Produce and sell goods
and services Markets for Goods & Services
Hire and use factors of Firms sell
production
Households buy
Households
Markets for Factors of Production
Buy and consume goods and
services Households sell
Own and sell factors of Firms buy
production

26
 Model II . Production Possibility Frontier (PPF)
= The Production Possibility curve

➢ PPF illustrates the trade-offs facing an economy that produces

only 2 goods.

→ It shows the maximum quantity of one good that can be produced

for any given production of the another good.

➢ The PPF improves our understanding of trade-offs by considering

a simplified economy that produces only 2 goods by showing each
trade-off graphically.

27
 Model 2: The Production Possibilities Frontier

➢The PPF is a graph showing the various

Q-Computers
combinations of output that can be produce given
the available factors of production and technology.
3,000
Without more resources, a point

C outside the frontier such as D is

2,200
A D unattainable.
2,000
PPF
A & C are attainable

B and efficient
1,000
B is attainable but
inefficient

0 300 600 700 1,000 Q-Cars

28
 Concepts Illustrated by the PPF

Efficiency

Tradeoffs

Opportunity Cost

Economic Growth

The law of increasing opportunity cost

29
  The law of Increasing Opportunity Cost suggests that as the

production of a particular good increases, the opportunity

Q-Computers
cost of producing an additional unit of this good also
increases.
3,000

∆com = 800  Producing the first 600 cars the

2,200
C economy needs to give up 800
A D
2,000 computers…(1 car = 4/3 com.)
PPF
∆car = 600
 Producing more 400 cars
B requires giving up 2200 more
1,000
computers ( 1 car = 11/2 com.)

0 300 600 700 1,000 Q-Cars

30
VII. Economic Growth in the context of PPF

Economic growth is an increase of production of goods and

services. It results in an outward shift of the PPF
because production possibilities are expanded.

The economy can now produce

more of everything, because
resources have increased.

Production is initially at
point A (20 fish and 25
coconuts), → it can
move to point E (25 fish
and 30 coconuts).

31
 Now you try answering some questions !

Q-Computers
An outward shift in the PPF implies the economic growth.

4,000
A trade-off in this model is …

F
3,000
Opportunity Cost of a computer =…
2,200 B
2,100 E
2,000
A
An Efficiency is…
G

0 600 700 750 1,000 Q-Cars

32
 Two Examples of Economic Growth: judge on your own
Furniture : Present goods Highway - Future goods

Country A favors consuming furniture Country B favors consuming highway

CURRENT CONSUMPTION
CURVE
Goods for the Future

Goods for the Future

FUTURE FUTURE
CURVE CURVE

CURRENT
CONSUMPTION CURVE

Goods for the Present Goods for the Present

Country A Country B
33
 Viii. Sources of Economic Growth

➢ Increase in number of population needs inevitable growth in labor

force as well as consumption
Consumption allows us to enhance our lifestyles.

➢ Technological advancements permit us to make better use of the

resources we have.

➢ Improvements in communications and transportation pave the way

for greater efficiencies.

➢ Trade creates opportunities for further specialization.

Trade takes the form of barter when people directly exchange goods or
services for goods or services.

34
IX. Positive versus Normative Economics

Economists have two roles:

 When economists are trying to explain about the world, they are
scientists. They produce positive statement about the world.
 When economists are trying to change the world, they are policy
advisor. They produce normative statement about the world.

 Positive economics (about what is) is the branch of

economics that concerns the description and explanation of
economic phenomena.
 Positive economics is common theory for all. It is a theory
economics.

35
 Normative economics (About what should be) is an economics
that makes prescriptions about the way the economy should work.

 It is what particular policy ought to be recommended to achieve a

desirable goal. It is a policy economics. It is needed for making
recommendation.

 Alternative names:
 Positive economics  Descriptive economics  Theory economics

 Normative Analysis  Prescriptive Analysis  Eco-policy Analysis

36
37
 Now you try

Positive or Normative Statements ?

An increase in the minimum wage will cause a rise in
unemployment among the least-skilled.

Higher national budget deficits will cause interest

rates to increase.

Big and rich wedding parties in Cambodia should be

taxed to raise spending on helping poor people.
 ?
The income gains from a higher minimum wage are
worth more than any slight reductions in employment.

The government should collect more taxes from

tobacco companies; the money for treating smoking-
related illnesses among the poor.

39