The document discusses the distinction between microeconomics and macroeconomics, with micro focused on individual decision-making and macro on the economy as a whole. It also explores key economic concepts such as scarcity, opportunity cost, and allocation mechanisms, detailing different economic systems and their characteristics. Lastly, it emphasizes the importance of relative prices in addressing fundamental economic questions regarding production, technique, and income distribution.

1. Some fundamental principles

2. Microeconomics versus
Macroeconomics
• Microeconomics is concerned with the
economic decisions made by individuals, e.g.
consumers, occupational groups, industries,
markets.
• Micro is focused on the particular.
• Macroeconomics is concerned with the
economy as a whole.
• “The whole” is typically interpreted as the
nation.

3. Micro vs. Macro
Micro categories and examples
• Prices of particular goods.
• Theory of individual
consumer behavior.
• Employment in particular
occupations and industries.
• Choice of technology by
particular firms.
• Policies that affect
particular industries and
markets.
Macro categories and examples
• The general level of prices.
• The general level of
employment and
unemployment.
• The general level of
economic activity, e.g. Gross
Domestic Product.
• Aggregate demand,
aggregate supply.

4. Definition of economics.
• The definition of economics found in most
textbooks is stated as a problem.
• Economics is the study of how people
(individuals, nations) attempt to satisfy
apparently unlimited wants, needs and desires
given that they possess limited (scarce)
resources.

5. Does this definition (problem) apply to
everyone?
• Does it apply to you?
• Does it apply to the richest person in the
world? Bill Gates?
• Can Bill Gates have everything? Do
everything?
• Is Bill Gates constrained in any way in his
allocation of resources?
• Does he face any resource constraints? Time?

6. Key concepts
• Scarcity
• Opportunity cost
• Allocation
– The fact that resources are scarce implies that
every economic choice entails a cost.
– The fact that costs are incurred when a choice is
made implies that rational decision makers
require an allocation rule or mechanism to guide
their decision making.

7. Opportunity Cost
• The opportunity cost of any economic choice
is the highest-valued alternative foregone
when a choice is made.
• Opportunity cost is not the sum total of all
goods and services foregone.
• Out of the menu of all alternatives foregone,
the opportunity cost of a particular choice is
what the choice-maker most otherwise would
have preferred to have had.

8. What is the opportunity cost to you of
taking this course?
• What do you give up when you take this course?
• Do you have alternative uses for the time and
other resources you allocate to this course?
• Out of the menu of alternatives available to you
to which you might dedicate these resources,
which would you most otherwise prefer?
• This most-preferred alternative is your
opportunity cost of this course.
• Study hard!

9. Allocation mechanisms.
• An allocation mechanism is a device that
enables an economic decision maker to
rationally allocate scarce resources to achieve
some desired end or outcome.
• Economic systems are typically characterized
by the nature of their allocation mechanisms.

10. Economic systems and their allocation
mechanisms.
Type of system
1. Traditional system: lack of
change, lack of
technological progress,
hierarchical social
organization.
2. Command system:
government dominance.
3. Market system a.k.a. the
price system.
Type of allocation mechanism
1. Ascription, custom, assigns
resources and economic
roles.
2. Government allocates
resources, determines
prices and incomes.
3. Relative prices determined
by market forces.

11. How would you characterized the
economic system of the U.S.?
• Does the U.S. have any elements of the
traditional system?
• Does government play any role in the
allocation of goods and services in the U.S.?
• While the U.S. is probably a “mixed” system, it
is by far dominated by the market system of
resource allocation.

12. The concept of relative price.
• A relative price is a rate of exchange of
commodities.
• Any relative price can be expressed as a ratio of
nominal (money) prices.
• Example: Suppose the (nominal) price of a taxi
ride in Buenos Aires is P10 (ten pesos) and the
price of a bottle of wine is P50. What is the
relative price of a taxi ride in Bs. As.?
– Relative price of taxi=nominal price of taxi/nominal
price of wine= P10/P50 = 1/5 (bottle of wine.)
– Relative price of wine=P50/P10= 5 (taxi rides.)

13. Why do economists insist on the
concept of relative price?
• Relative price is the notion most akin to
opportunity cost.
• What is the opportunity cost of a taxi ride in the
above example? 1/5 bottle of wine.
• Relative price is the operative notion of price
even in a context where we are accustomed to
the currency.
• When you evaluate the price of a good priced in
U.S. dollars, don’t you consider what those
dollars would otherwise purchase?

14. 3 functions of relative price.
• Incentive function.
• Signaling function.
• Rationing function.

15. Incentive function.
• The incentive function of price relates to the
fundamental incentive associated with the
market system, a.k.a. private property capitalism,
to wit, PROFIT.
• Profit (π) = Total revenue (TR) – Total costs (TC).
• Total revenue = Price of output (P) x Quantity of
output sold (Q).
• Total cost= Prices of productive factors (PF) x
Quantity of production factors (QF).

16. Productive factors (an aside)
• Productive factors, a.k.a., productive resources,
a.k.a., productive inputs, include the following:
– Labor or human resources, i.e. mental and physical
productive abilities of people.
– Capital, i.e. physical plant, equipment, machinery,
tools, etc.
– Land or natural resources, e.g. land, forests, minerals.
– Entrepreneurship, i.e. willingness and ability to
combine productive enterprise in the pursuit of profit.

17. Incentive function (cont.)
• Write profit as π = (PxQ) – (PFxQF).
• As price increases, ceteris paribus*, profit
increases, and there is a greater incentive to
produce this good. Productive resources then
will be allocated towards the production of
this good.
• “Profit makes the world go round in private
property capitalism.”

18. Signaling function of relative price.
• Relative prices provide decision makers with the
information they need to make rational decisions.
• Suppose you were told that the average starting
salary for college grads with majors in economics
was $43,419 while that for finance majors was
$38,024.*
• Would the relative price (wage rate) have an
influence on how you allocate your scarce time
and tuition dollars? Would it provide you with a
“signal” as to how to decide?

19. Rationing function.
• The rationing function of relative price refers to the ability of price
to allocate a scarce food to those most willing and able to pay.
• Suppose there are more people who want to see the Super Bowl
than there is available seating in the stadium at the face value price
for a ticket?
• A rising price for the ticket in the “secondary” (“black”) market for
the tickets will reduce the number of people who want to pay and
increase the number of people who are willing to sell.
• When the price increases to a high enough level, the number of
buyers will equal the number of sellers and the good will be
perfectly rationed (allocated) to those most willing to pay.

20. 3 fundamental questions.
• Every economic system(traditional, command,
market) must address itself to 3 fundamental
questions that allocation issues.
• The market system addresses these questions
via the relative price mechanism.
• The questions are:
– What to produce?
– How to produce?
– How to distribute (allocate) output/income?

21. What to produce?
• What should be the composition of output? How
should it be divided between consumption goods
versus capital goods? How should it be divided
between necessary goods and luxury goods?
• In private property capitalism the answer to these
questions is provided by relative prices, which in
turn determine relative profitability.
• Why does our pharmaceutical industry provide
several treatments for male pattern baldness, but
very no effective treatment for malaria?

22. How to produce?
• This question asks which productive technique,
i.e. combination of productive factors, should be
used to produce a particular output.
• The answer involves relative prices of productive
factors.
• If firms wish to increase profits, they must
minimize costs of production. (Recall the profit
equation!)
• To minimize total costs firms will those
techniques that involve relatively cheap
productive inputs.

23. How to distribute output/income?
• Why does Peyton Manning have so much
more stuff than I do?!
• (Because his income is higher, dummy!)
• Why is his income higher?!
• (Because the relative wage for elite football
talent is much greater that that for mediocre
economics teaching talent, idiot!)
• Oh, right! It comes down to relative price,
again.