Description
An Economist’s Theory of Reincarnation: If you’re good, you come back on a higher level. Cats come back as dogs, dogs come back as horses, and people—if they’ve been really good like George Washington—come back as money.
If each of us could get all the food, clothing, and toys we wanted without working, no one would study economics. Unfortunately, most of the good things in life are scarce—we can’t all have as much as we want. Thus, scarcity is the mother of economics.
Microeconomics is the study of how individuals and firms make themselves as well off as possible in a world of scarcity and the consequences of those individual deci-sions for markets and the entire economy. In studying microeconomics, we examine how individual consumers and firms make decisions and how the interaction of many individual decisions affects markets and the entire economy.
Microeconomics is often called price theory to emphasize the important role that prices play. Microeconomics explains how the actions of all buyers and sellers deter-mine prices and how prices influence the decisions and actions of individual buyers and sellers.
1. Microeconomics: The Allocation of Scarce Resources. Microeconomics is the study of the allocation of scarce resources.
2. Models. Economists use models to make testable predictions.
3. Uses of Microeconomic Models. Individuals, governments, and firms use microeconomic models and predictions in decision making.
Microeconomics: The Allocation of Scarce Resources
Individuals and firms allocate their limited resources to make themselves as well off as possible. Consumers pick the mix of goods and services that makes them as happy as possible given their limited wealth. Firms decide which goods to produce, where to produce them, how much to produce to maximize their profits, and how to produce those levels of output at the lowest cost by using more or less of vari-ous inputs such as labor, capital, materials, and energy. The owners of a depletable natural resource such as oil decide when to use it. Government decision makers—to benefit consumers, firms, or government bureaucrats—decide which goods and ser-vices the government produces and whether to subsidize, tax, or regulate industries and consumers.
Trade-Offs
People make trade-offs because they can’t have everything. A society faces three key trade-offs:
■ Which goods and services to produce: If a society produces more cars, it must produce fewer of other goods and services, because there are only so many resources—workers, raw materials, capital, and energy—available to produce goods.
■ How to produce: To produce a given level of output, a firm must use more of one input if it uses less of another input. For example, cracker and cookie manufacturers switch between palm oil and coconut oil, depending on which is less expensive.
■ Who gets the goods and services: The more of society’s goods and services you get, the less someone else gets.
Who Makes the Decisions
These three allocation decisions may be made explicitly by the government or may reflect the interaction of independent decisions by many individual consumers and firms. In the former Soviet Union, the government told manufacturers how many cars of each type to make and which inputs to use to make them. The government also decided which consumers would get a car.
In most other countries, how many cars of each type are produced and who gets them are determined by how much it costs to make cars of a particular quality in the least expensive way and how much consumers are willing to pay for them. More consumers would own a handmade Rolls-Royce and fewer would buy a mass-produced Ford Taurus if a Rolls were not 13 times more expensive than a Taurus.
Prices Determine Allocations
Prices link the decisions about which goods and services to produce, how to produce them, and who gets them. Prices influence the decisions of individual consumers and firms, and the interactions of these decisions by consumers, firms, and the govern-ment determine price.
Interactions between consumers and firms take place in a market, which is an exchange mechanism that allows buyers to trade with sellers. A market may be a town square where people go to trade food and clothing, or it may be an interna-tional telecommunications network over which people buy and sell financial securi-ties. Typically, when we talk about a single market, we refer to trade in a single good or group of goods that are closely related, such as soft drinks, movies, novels, or automobiles.
Most of this book concerns how prices are determined within a market. We show that the number of buyers and sellers in a market and the amount of information they have help determine whether the price equals the cost of production. We also show that if there is no market—and hence no market price—serious problems, such as high levels of pollution, result.