Principles of Microeconomics
Chapter 1 Thinking Like an Economist
Scarcity is a basic fact of economic life. Having more of one good thing almost always means having
less of another (Scarcity Principle). The Cost-Benefit Principle holds that an individual (or a firm,
or a society) should take an action if, and only if, the extra benefit from taking the action is at least as
great as the extra cost. The benefit of taking any action minus the cost of taking the action is called the
economic surplus from that action. Hence the Cost-Benefit Principle suggests that we take only those
actions that create additional economic surplus.
Four important decision pitfalls
1. The pitfall of measuring costs or benefits proportionally Absolute money amounts, not
proportions, should be employed to measure costs and benefits
2. The pitfall of ignoring opportunity costs It is important to account for all relevant opportunity
costs, defined as the values of the most highly valued alternatives that must be forgone in order to
carry out the action
3. The pitfall of not ignoring sunk costs When deciding whether to perform an action, it is
important to ignore sunk costs – those costs that cannot be avoided even if the action is not taken.
4. The pitfall of using average instead of marginal costs and benefits The Cost-Benefit Principle
tells us that the level of an activity should be increased if, and only if, its marginal benefit exceeds its
marginal costs.
The Not-All-Costs-And-Benefits-Matter-Equally Principle is that some costs and benefits matter in
making decisions, whereas others don’t
Microeconomics is the study of individual choice under scarcity, and its implications for the behavior
of prices and quantities in individual markets. Macroeconomics is the study of the performance of
national economies and the policies that governments use to try to improve that performance.
Statements may be positive or normative. Positive economics consists in the conclusions of
economics that are independent of the ethical value system of the economist. Normative economics
consists in statements in economics that reflect or are based on the ethical value system of the
economist, implicitly, explicitly, or by omission.
, Chapter 2 Markets, Specialisation and Economic Efficiency
Gains from exchange are possible if trading partners have comparative advantages in producing
different goods and services. Maximum production is achieved if each person specialises in producing
the goods or service in which he or she has the lowest opportunity cost (Principle of Comparative
Advantage). Comparative advantage makes specialisation worthwhile even if one trading partner is
more productive than others (absolute advantage) in every activity.
At the individual level, comparative advantage may spring from differences in talent or ability, or
from differences in education, training and experience. At the national level, sources of comparative
advantage include these innate and learned differences, as well as differences in language, culture,
institutions, climate, natural resources and a host of other factors.
For an economy that produces two goods, the PPF describes the maximum amount of one good that
can be produced for every possible level of production of the other good. Attainable points are those
that lie on or within the curve, and efficient points are those that lie along the curve. The slope of the
PPF tells us the opportunity cost of producing an additional unit of the good measured along the
horizontal axis. The Principle of Increasing Opportunity Cost, or the Low-Hanging-Fruit
Principle, tells us that the slope of the PPF becomes steeper as we move downwards to the right. The
greater the differences among individual opportunity costs, the more bow-shaped the PPF will be, and
the more bow-shaped the PPF, the greater will be the potential gains from specialisation.
Factors that shift the economy’s PPF
* Increases in the amount of productive resources available
Investments in new factories and equipment
* Improvements in knowledge or technology that render existing resources more productive
Higher output through increased specialisation
* Population growth
Self-reinforcing: not only do higher rates of saving and investment cause incomes to grow, but the
resulting higher income levels also make it easier to devote additional resources to savings and
investment
Factors that influence specialisation
* Population density
* Laws and customs that limit people’s freedom to transact freely with one another
* Size of the market
Nations, like individuals, can benefit from exchange, even though one trading partner may be more
productive than the other in absolute terms. The greater the difference between domestic opportunity
costs and world opportunity costs, the more a nation benefits from exchange with other nations. But
expansion in exchange does not guarantee that each individual citizen will do better. In particular,
unskilled workers in high-wage countries may be hurt in the short run by the reduction of barriers to
trade with low-wage nations
Chapter 1 Thinking Like an Economist
Scarcity is a basic fact of economic life. Having more of one good thing almost always means having
less of another (Scarcity Principle). The Cost-Benefit Principle holds that an individual (or a firm,
or a society) should take an action if, and only if, the extra benefit from taking the action is at least as
great as the extra cost. The benefit of taking any action minus the cost of taking the action is called the
economic surplus from that action. Hence the Cost-Benefit Principle suggests that we take only those
actions that create additional economic surplus.
Four important decision pitfalls
1. The pitfall of measuring costs or benefits proportionally Absolute money amounts, not
proportions, should be employed to measure costs and benefits
2. The pitfall of ignoring opportunity costs It is important to account for all relevant opportunity
costs, defined as the values of the most highly valued alternatives that must be forgone in order to
carry out the action
3. The pitfall of not ignoring sunk costs When deciding whether to perform an action, it is
important to ignore sunk costs – those costs that cannot be avoided even if the action is not taken.
4. The pitfall of using average instead of marginal costs and benefits The Cost-Benefit Principle
tells us that the level of an activity should be increased if, and only if, its marginal benefit exceeds its
marginal costs.
The Not-All-Costs-And-Benefits-Matter-Equally Principle is that some costs and benefits matter in
making decisions, whereas others don’t
Microeconomics is the study of individual choice under scarcity, and its implications for the behavior
of prices and quantities in individual markets. Macroeconomics is the study of the performance of
national economies and the policies that governments use to try to improve that performance.
Statements may be positive or normative. Positive economics consists in the conclusions of
economics that are independent of the ethical value system of the economist. Normative economics
consists in statements in economics that reflect or are based on the ethical value system of the
economist, implicitly, explicitly, or by omission.
, Chapter 2 Markets, Specialisation and Economic Efficiency
Gains from exchange are possible if trading partners have comparative advantages in producing
different goods and services. Maximum production is achieved if each person specialises in producing
the goods or service in which he or she has the lowest opportunity cost (Principle of Comparative
Advantage). Comparative advantage makes specialisation worthwhile even if one trading partner is
more productive than others (absolute advantage) in every activity.
At the individual level, comparative advantage may spring from differences in talent or ability, or
from differences in education, training and experience. At the national level, sources of comparative
advantage include these innate and learned differences, as well as differences in language, culture,
institutions, climate, natural resources and a host of other factors.
For an economy that produces two goods, the PPF describes the maximum amount of one good that
can be produced for every possible level of production of the other good. Attainable points are those
that lie on or within the curve, and efficient points are those that lie along the curve. The slope of the
PPF tells us the opportunity cost of producing an additional unit of the good measured along the
horizontal axis. The Principle of Increasing Opportunity Cost, or the Low-Hanging-Fruit
Principle, tells us that the slope of the PPF becomes steeper as we move downwards to the right. The
greater the differences among individual opportunity costs, the more bow-shaped the PPF will be, and
the more bow-shaped the PPF, the greater will be the potential gains from specialisation.
Factors that shift the economy’s PPF
* Increases in the amount of productive resources available
Investments in new factories and equipment
* Improvements in knowledge or technology that render existing resources more productive
Higher output through increased specialisation
* Population growth
Self-reinforcing: not only do higher rates of saving and investment cause incomes to grow, but the
resulting higher income levels also make it easier to devote additional resources to savings and
investment
Factors that influence specialisation
* Population density
* Laws and customs that limit people’s freedom to transact freely with one another
* Size of the market
Nations, like individuals, can benefit from exchange, even though one trading partner may be more
productive than the other in absolute terms. The greater the difference between domestic opportunity
costs and world opportunity costs, the more a nation benefits from exchange with other nations. But
expansion in exchange does not guarantee that each individual citizen will do better. In particular,
unskilled workers in high-wage countries may be hurt in the short run by the reduction of barriers to
trade with low-wage nations
