_Microeconomics _
By: DanniLion
Outline Thesis Statement: Microeconomic mechanisms can predict future
technology impacted economic outcomes. I. What is Economics? A. What do
economics tell us? B. The science of economics 1. defining microeconomics 2.
some terms and definitions II. Using Microeconomic models A. Theory 1.
practical application 2. household choices III. Economic Growth A. The cost of
economic growth B. Capital accumulation C. Technological change IV. Individual
and Market Demand A. Household Consumption Choices 1. Constraints 2.
Preferences 3. Marginal utility a. an analogy 4. Utility maximization
V. Predictions Based on Marginal Utility Theory A. Price increases
B. Increases of income VI. In Conclusion This paper will attempt to examine
microeconomic structures in relation to technological advances. The impact of
increasingly available technology is a major economic force. Prior to 1975,
for example, viewing a first run movie at home was technically possible but
economically infeasible. Only the wealthy chose to view moves at home. VCR’s
became available in 1976, with a typical price tag of $2000.00 Even at such a
high price, that invention slashed the price of home viewing. Today a VCR can
be purchased for $200.00, a fraction of its’ initial cost. Videos can be
rented for approximately a dollar or purchased for around $20.00. Home viewing
has become common in a few short years, where formerly it had been available
only to the very rich. In what other ways has technology changed the way of
life and can microeconomic mechanisms accurately predict future economic
outcomes? What is Economics? The simple answer to the question, “What is
the economy?” is to state that the economy is the means by which resources are
allocated. A more accurate portrayal of economic process is to view it as a
machine that produces three distinctly different results: · First, the economy
determines what goods and services will be produced and in what quantities. ·
Secondly, it indicates how various goods and services will be produced. ·
Thirdly, it resolves the question of distribution. Markets for goods and
services, and markets for production of those goods and services – command
mechanisms –directly correlate with the choices made by households, firms and
governments. The US economy relies mainly on markets but to a degree on
command mechanisms. The US economy is an open economy and has become highly
integrated with the global economy. This is a fairly recent development, with
foreign investment into US business outstripping US investments in foreign
enterprises shifting the balance in the mid-1980s. Economists study these
financial movements in order to determine the underlying principles driving
the economy. This approach utilizes the same rigor and objectivity of natural
scientists. Economic science, like natural science, is an attempt to discover
a body of laws. All sciences use the same criteria in the investigative
process: careful and systematic observation and measurement, and the
development of a body of theory to direct and interpret observations. That
theory is a general rule or principle that allows economists to understand and
predict the economic choices that people make. Theories are derived from
building and testing economic models. Economic models are built on four key
premises. These basic assumptions are: · People have preferences · People have
a fixed amount of resources and a technology that can transform resources into
goods and services. · People choose how to use resources and technology to
increase economic well-being. · People’s choices are coordinated – buyers
choose what sellers offer and vice versa. The implications of such models are
that the values of various prices and quantities result in “equilibrium”. That
is, situations in which everyone has made the best possible choices, given
their own preferences, information, resources, and technologies, and that
those choices are coordinated and compatible with the choices of everyone
else. Equilibrium is the solution or outcome of an economic modelEconomic
models fall into two categories: Microeconomics and macroeconomics.
Microeconomics is the branch of economics that studies the choices of
individual households and firms. Because it analyzes the behavior of economic
units, microeconomics is a most important social science. Microeconomics
theory is used to analyze various circumstances and outcomes from decision
making. In addition, microeconomics provides foundations for scientists of
other social disciplines. Microeconomics is a highly useful tool in business
management, aiding in planning, finance, and marketing. However,
microeconomics is not limited to business applications. Government
administration, political science, history, social- behavior, and much more
can be viewed through the lens of microeconomics What do microeconomics
tell us? Careful analysis using microeconomic models answer those questions
dealing with technological change, production and consumption, wages and
earnings. Economic concerns involving unemployment, inflation, and the
differences in wealth among nations are macroeconomic A major cog in the
microeconomic machinery is the concept of “scarcity”. This is easily summed up
as the universal state in which wants exceed resources. Scarcity fuels
“production”, the conversion of land, labor, and capital into goods and
services. Services are made up of intangible commodities such as haircuts,
phone calls and cab rides. Goods are tangible – cars, socks, VCRs, and bread.
Goods are classified as either capital goods, i.e., those goods with long term
use such as buildings cars, computers, etc., or consumption goods. Consumption
goods are items that can be used one time only, such as pickles and
toothpaste. Finite resources and the available technologies limit what can be
produced in terms of goods and services. The boundary between what can and
cannot be produced is referred to as the production possibility frontier
(PPF). Using Microeconomic Models Understanding the PPF as applied to real
life is critically important. To make that concept easier to grasp a model
economy can be devised that, while simpler than real life situations, provides
enough accurate information to draw viable conclusions and make feasible
predictions. To build this model, features essential to understanding the real
economy must be incorporated, but copious details are eliminated. The model
will be simplified by establishing three important criteria: 1. Everything in
this model that is produced is also consumed, stabilizing capital resources so
that they neither grow nor shrink. 2. There are only two goods rice and cloth.
3. There is a single individual involved with this economy, “Joe”. Joe’s
setting is a deserted island, with no outside contact. Joe uses all the
resources available to him to produce rice and cloth. It requires Joe to labor
10 hours a day. The amount of cloth and rice produced relies on how many hours
are devoted to the activity. producing them. If Joe does no work, nothing is
produced. To produce six pounds of rice in a month, Joe must work two hours a
day. Devoting more hours to rice increases monthly output, but the return rate
diminishes as Joe has to use increasingly unsuitable land in that production.
Initially, Joe plants in fertile wet land. As the best quality land is put
into production, remaining available land becomes drier and less productive.
Eventually, all workable land is used and time and effort must now be devoted
to reconditioning other types of land To produce cloth, Joe gathers wool
from sheep on the island. As he devotes more hours to gathering wool and
weaving fiber, cloth output increases. If Joe devotes all his time to raising
rice, he can produce twenty pounds of corn a month. He cannot, however,
produce any cloth. Conversely, if Joe devotes all of his time to making cloth,
he can produce five yards a month but will have no time for the rice crop. He
can vote some of his time to rice and some to cloth but not more than ten
hours total. Thus he can spend two hours a day producing rice and eight hours
producing cloth, or any combination of hours equaling ten hours This clearly
illustrates the production possibility frontier as a boundary identifying what
is obtainable and what is not. Calculate Joe’s PPF by using the information in
Table 1. These calculations are summarized in Figure 1 and graphed as Joe’s
PPF. To understand these calculations, first examine the data found in Figure
1. Possibility A shows an entire working day devoted solely to rice
production. In this case 20 pounds of rice per month is the forecasted yield,
while no cloth is produced. Possibility B demonstrates two hours daily in
cloth production and eight hours producing rice, yielding a total of eighteen
pounds of rice and one yard of cloth monthly. The pattern continues onto F,
showing an entire working day devoted to cloth production The work day is
defined as two hour blocks of time in Table 1, however, any feasible
allocation of a day hour work day will
________________________________________________________________________demonst
rate the potential various combinations of rice and cloth along the line
joining points A, B, C, D, E, and F. in Figure 1. This indicates the
Production Possibility Frontier. Production can be maintained at any point on
or within the attainable frontier - the area discerned as yellow inside Figure
1. Points outside that frontier are unattainable. To produce at points beyond
the frontier, there would have to be more time allotted to the working day. A
ten hour work day allows for various combinations of rice and cloth production
at the PPF. A work day less than ten hours will allow for production only at a
point inside the frontier Table 1 Production Possibilities Hours Worked
Rice Grown Cloth Produced (per day) ( lbs. per month) (yards per
month) 0 either 0 or 0 2 either 6 or 1 4 either 11 or 2
6 either 15 or 3 8 either 18 or 4 10 either 20 or 5
_______________________________________________________________________________
_______________ If Joe performs no labor no rice or cloth are produced. If Joe
labors for 2 hours daily and devotes all that time on corn production he will
produce 6 pounds of rice per month. If that same time is used for cloth
production, 1 yard of cloth is produced but no rice. The last four rows of the
table indicate the amount of rice or cloth that can be produced per month as
more hours are devoted to those activities.
_______________________________________________________________________________
_______________ _____________________________________ Production
Possibility Frontier Figure 1 Rice 20 A in lbs. 18 B per month 16
C Unattainable 14 12 Z D 10 8 6 E Attainable 4
Production possibility 2 frontier F 0 1 2 3 4 5 6 7 8 9
Cloth in yards per month Rice Cloth in in lbs. yards per
per Possibility month month A 20 and 0 B 18 and 1
C 15 and 2 D 11 and 3 E 6 and 4 F 0 and 5 The
graph lists six points on Joe’s production possibility Frontier. Row E tells
us that if Joe produces 6 pounds of rice, the maximum cloth production that’s
possible is 4 yards. These same points are graphed as A, B, C, D, E, and F in
the figure. The line passing through these points is the production
possibility frontier, which separates the attainable from the unattainable.
The attainable area contains all the possible production points. Joe can
produce anywhere inside the area or on the production possibility frontier.
Points outside the frontier are unattainable. Models such as these provide a
structure for understanding how production works and aids in decision making
by demonstrating what opportunities exist and what is required to take
advantage of those opportunities. But having more of one means having less of
another. This is referred to as opportunity cost Opportunity cost is
measured by evaluating the PPF. How much cloth has to be given up to get more
rice and vice versa are the questions requiring answers using the rice and
cloth model. If all allotted monthly working hours are used to grow rice,
there are twenty pounds of rice but no cloth. How much rice is given up to
produce one yard of cloth? Figure 1 shows that a single yard of cloth will
cost two pounds of rice to produce. If an additional yard of cloth is
produced, the progression from point B to point C indicates that it will cost
three pounds of rice to produce the second yard of cloth. The next yard of
cloth costs six pounds of corn. It has been learned from the model that the
opportunity cost of cloth increases as more cloth is produced. This is also
true in reverse. The first six pounds of rice costs one yard of cloth to
produce. The next five pounds of rice costs an additional yard of cloth, and
so on. The opportunity cost of rice also increases. Contributing to this
phenomenon is the factor of inequality; not all scarce resources are equally
useful in all activities. For example, while some of the land on Joe’s
hypothetical island is extremely suitable for high yield rice crops, the
remaining landscape may be rocky and barren. The sheep on the island, however,
prefer rocky and barren land Obviously, the optimum use of this island
resource is to use the most fertile, wet land to grow rice and the most rocky
and barren land to raise sheep. Only if a larger rice yield is desired will it
be necessary to attempt to cultivate the less desirable land. If all allocated
time is devoted to cultivating rice then it becomes necessary to use
unsuitable low yielding land. Devoting some of the time to making cloth and
reducing some of the time spent growing rice produces a small drop in crop
yield but a large increase in the output of cloth. Conversely, if all
allocated time is used to make Seal Straugh cloth, a small reduction in
woolgathering leads to a large increase in rice production What has been
learned from the model provides fundamental lessons in real world economy. The
world has a fixed number of people endowed with a given amount of limited time
and human capital. These limited resources can be utilized, using the
available but limited technology to produce goods and services. But there is a
limit to the goods and services that can be produced, a boundary between
what’s attainable and unattainable For example, the political candidate who
offers better education and human services must simultaneously be prepared to
increase taxes or reduce services in another sector such as road maintenance
or fire protection. On a much smaller but equally important scale, each time
an individual rents a video, that same individual must determine where to
expend remaining cash resource, be it popcorn, soft-drinks or something else
entirely. The cost of one more video is one less of something else. It is
impossible to escape from scarcity and opportunity costs. Given the limited
resources available to any individual, the more of one thing always means less
than another and the more of anyone service or product, the higher its
opportunity cost. Economic Growth The PPF defines a clear boundary between
what is and is not attainable. However, that boundary is not static. It is
constantly changing. At times the PPF moves inward, reducing production
possibility. Other times, it moves outward. Using the “Joe’s Island” analogy
for example, excellent growing and harvesting conditions would have the effect
of pushing the production possibility frontier outward. Expansion of
production possibilities is termed economic growth Over the last 100 years,
the PPF has expanded exponentially. The question at hand for the new
millennium appears to be how far can the economic envelope be pushed? The cost
incurred in economic growth involves two key factors: capital accumulation,
the growth of capital resources; and technological progress, new and better
methods of producing goods and services. As a result of these factors in the
nation’s current economic profile, there are an enormous quantity of trains,
planes, and automobiles, producing far more available transportation than was
experienced when only horses and buggies were available as transport.
Satellites make transcontinental communications possible on a scale much
larger than what could have been predicted using cable technology. However,
accumulating capital and developing new technology are costly Economic
growth wears a cloak of trade-off. If all resources are devoted to the
production of food, clothing, houses, entertainment, and other consumer goods,
and none to research, development, and accumulating capital, there will be no
more capital and no better technologies in the future than exist at present.
Production possibilities in the future will be exactly as they are today.
Future economic expansion requires that fewer goods are produced for future
consumption. Resources that are freed up today allow for the accumulation of
capital. In turn, better technologies for the production of consumption goods
can be developed in the future. The cut in output of consumer goods today is
the opportunity cost of economic growth. Household Consumer Choices
Individuals determine what goods and services they will consume. The total
quantity of those desired goods and services is called market demand. The
relationship between the quantity of a good or service by a single individual
and its price is called individual demand. Market demand is the sum of all
individual demands. These demands are better understood by examining the
mechanism used by households in making consumer choices. Consumption choices
made by households are determined by two factors: constraints and preferences.
Consumer choices made by any household are limited by that household’s income
and the price of the desired goods or services purchased. Marginal utility
theory assumes that a household has a given income to spend and that it has no
influence on the prices of goods or services it purchases. A representation of
this theory follows: House A has a monthly income of $100.00 and is
constrained by that limit. House A spends its dollar resources on only two
items – books and beverages. Books cost $6.00 each. Beverages cost .50 each or
$3.00 a six pack. House A can purchase as many as ten six packs a month or
five books a month. There are many other purchase combinations conceivable.
Consumption possibilities can be visualized similar to the PPF, and the
structure of Figure 1 is an excellent representation of such a consumption
possibilities model. House A must decide how to divide the monthly income
between books and beverages. The likes and dislikes of the members of that
household drive those purchasing decision. This is referred to as preference.
Marginal utility theory uses the highly abstract concept of utility to
describe those preferences The concept of utility can best be explained with
an analogy. Take, for example, the concept of temperature. It’s easy to
understand the difference between feeling hot and cold, but hot and cold are
not something observable. Water turns into steam when hot enough or ice when
cold enough and those are observable phenomena. In order to predict when such
changes will occur an instrument can be constructed. Such an instrument is
called a thermometer. The scale on the thermometer is the essence of
temperature. The units used to measure that temperature are arbitrary. That
is, the weight and value assigned to those units are subject to the judgment
of the designer of the scale. An accurate prediction of water turning to ice
can be made when a thermometer using a Celsius scale reaches 0°. But the units
of measure themselves are meaningless because this same events takes place
when a Fahrenheit thermometer shows a temperature of 32° The concept of
utility allows for predictions about consumption choices in much the same way.
It must be pointed out, however, that marginal utility theory is not as
accurate as the theory that allows us to predict when water will turn to ice.
Total utility refers to the total benefit, or pay out, derived from the
consumption of goods or services. The level of consumption determines the
quantity of total utility. This concept can be illustrated by using the
consumption possibilities of House A. Table 2 shows House A’s total utility
from consuming different quantities of books and beverages. If no books are
purchased in a month, there is no utility from books. If one book is purchased
monthly 50 units of utility are assigned. Total Utility from Books and
Beverages Table 2 Books Beverages___ Monthly Quantity Total
Utility Monthly Quantity Total Utility 0 0 0 0 1 50 1 75
2 88 2 117 3 121 3 153 4 150 4 181 5 175 5 206
6 196 6 225 7 214 7 243 8 229 8 260
9 241 9 276 10 250 10 291 As the number of book purchases
increase, total utility increases. If ten books are purchased 250 units of
utility are awarded. The other part of the table shows the total utility of
beverage consumption. As beverages are consumed total utility rises Marginal
utility is that change in total utility resulting from a one-unit increase in
the quantity of consumed goods or services. When consumption of books moves
from four to five monthly, total utility from books increases from 150 to 175
units. Thus, for House A marginal utility of procuring a fifth book each month
is 25 units. Marginal utility appears midway between the quantities consumed.
The change in consumption from four to five is what produces the marginal
utility of 25 units. The more books House A purchases a month the more total
utility it gets. However the marginal utility decreases, with each purchase.
For example, marginal utility from the first book is 50 units. The second book
has a marginal utility of 38 units and the third, 33 units. This decrease in
marginal utility as the consumption of a good increases is the principle of
diminishing marginal utility. Marginal utility is positive but diminishes as
consumption increases. These two features come about in this way: The members
of House A enjoy reading so benefit from the purchase of books. That casts
marginal utility in a positive light. Marginal utility diminishes as more
books are purchased due in part to opportunity cost and in part to lessening
benefit. Those readers still enjoy a good book but the 30th is not quite as
satisfying as the first. Utility maximization is the attainment of the
greatest possible utility. A household’s income and the prices that it faces
limit the utility that it can obtain. The model in Table 3 is used to examine
the allocation of spending to establish the maximum total utility. Assume that
Household A has $30.00 per month book and beverage budget. When House A
consumes two books and six beverages a month it receives 313 units of total
utility. This is the best that can be done within the Any other combination of
books and beverages generates less than 313 units of total utility. In
maximizing total utility, that is, allocating income to achieve the most total
utility units, consumer equilibrium is created. Books and Beverages
Utility-Maximization Combinations Table 3
________________________________________________________________________
Books Total Utility from Beverages Quantity Total Utility Books
&Beverages Total Utility Beverages 0 0 291 291 10 1 50 310
260 8 2 88 313 225 6 3 121 302 181 4 4 150 267
117 2 5 175 175 0 0
_______________________________________________________________________________
______ Predictions Based on Marginal Utility Theory This information allows
for economic prediction. This is relevant because income and prices are not
stagnant. What happens to House A’s consumption of books and beverages when
their prices and House A’s income changes? Determining the effect of a change
in price on consumption involves three steps: 1 Determine the combinations
that can be purchased at new prices. 2 Calculate the new marginal utilities
per dollar spent. 3 Determine the maximum utility resulting in consumer
equilibrium. This process demonstrates that if, for example, the price of
books falls but beverages remain constant in pricing, House A will most likely
increase consumption of books and indulge in fewer beverages. If house A does
not adjust it’s consumer habits it losses consumer equilibrium. A rise in
income, however, brings about an increase in consumer goods. Should House A
increase it’s books and beverages budget to $42.00 consumer equilibrium is
reached when seven books and seven beverages are purchased monthly. Marginal
utility theory is used by economists to answer a wide range of questions. An
example of this can be found in it’s application in determining the
fluctuations in popularity between wooden and aluminum baseball bats. Another
example is the ability of the theory to answer questions about patterns of
consumer spending. But as well as explaining consumption choices, it can be
used to explain all household choices. The allocation of time as well as
capital can be decided using marginal utility theory. And it’s often been
stated that time equates to money. In Conclusion What does all this mean to
the modern consumer? There becomes a point for consumers when all resources,
intangible capital such as time as well as tangible dollars, goods and
services, has to be factored into the cost/benefit analysis of consumption and
production. Making intelligent consumer choices requires a clear understanding
of the opportunity cost and an applied strategy for maximizing total utility.
When that takes place a window for technological advancement is opened. New
technologies enable producers to eliminate some of those factors that drive up
production costs and therefore prices. For example, the development of new
technology for the manufacture of tape by companies such as 3M has lowered the
cost of producing tapes and increased the available supply. Technology
advances in the area of sticky products is now available and affordable to the
masses. However, that technology has also made obsolete other goods and
services. Tape sales may be up due to market demand created by new tape
technology, but the market for library paste is drying up. Makers of library
paste may or may not be able to hold enough market share to continue
production. But until it is no longer economically feasible to produce library
paste, consumers have choices beyond tape when considering sticky products.
Basically, consumers are faced with more choices than at any time ever before.
In a spiraling effect, these consumer choices have created the opportunity for
increasing technology. And that technology has changed every aspect of day to
day life and all human transactions. We live in a style that previous
generations could not have imagined. Goods such as home videos and microwave
popcorn now appear on the average shopping list. Advances in medicine have
cured previously fatal diseases. Homes are more spacious, people eat better,
grow taller, and are even born larger than in past generations. Economic
growth and technological change have made the current generation richer than
the generations of our parents and grandparents. But we have not created
Utopia. As a society we experience opportunity cost with each new
technological advancement. The extent of that cost can be measured with the
tools of microeconomics that have been examined in this paper. Possible
production frontier graphs can be employed in the planning and decision making
stage prior to production. Determining how an item is priced, and therefore
its’ profitability, is a function of marginal utility theory. All of this
helps industry to decide if and how to go about introducing new products and
technology. That’s critically important simply because just because we can, it
doesn’t always mean we should. Seal Straugh Notes
_Bibliography _
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