Chapter 1
Introduction
◼ Chapter Outline
1.1 Microeconomics: The Allocation of Scarce Resources
Trade-Offs
Which goods and services to produce.
How to produce.
Who gets the goods and services?
Who Makes the Decisions?
How Prices Determine Allocations
Application: Twinkie Tax
1.2 Models
Application: Income Threshold Model and China
Simplifications by Assumption
Testing Theories
Maximizing Subject to Constraints
Positive Versus Normative
1.3 Uses of Microeconomic Models
◼ Teaching Tips
You might begin the first class by discussing with the students the role of the intermediate
microeconomics class in the larger curriculum. Encourage the students to be interactive by asking
questions, bringing in examples from the newspaper, and questioning concepts that seem untrue or
unrealistic. For many professors, a primary goal of the course is to get students to think like
economists. The material in Chapter 1 should help the students to understand what is required to do.
You might want to ask your students the policy questions listed below as a kind of pretest. Simply
ask them to write down the best answer they can for now, and then put their answers away. You
can then return to these answers later in the semester.
Some suggested policy questions (be sure to ask only questions that you will address later in the
course):
,1. How do minimum wages affect wages, employment, and unemployment?
2. Is the consumer price index (CPI) a good measure of inflation?
3. Why do stores offer coupons instead of simply reducing the price by the value of the
coupon?
4. How do taxes affect consumers and businesses?
5. Why do some workers prefer set wages rather than commissions, even if they might
make more working on commission?
6. Agree or disagree: We should strive to be a zero pollution society.
On a more pragmatic level, I stress to the students that success in the class is heavily dependent
on their approach to the material. Specifically, I emphasize that memorization is an extremely
ineffective tool for studying economics and that students who memorize material are very prone
to confusion and “drawing
a blank” on exams. I try to persuade them that a much better approach is to press for
understanding. I also stress that understanding usually comes only through active engagement
with the material, both in class and out. The problems in the text, as well as the additional
problems available in this manual and the Study Guide, will benefit the students in this regard.
The conceptual and technical questions throughout these problem sets are designed to facilitate
student understanding.
I also emphasize the importance of coming to class regularly. Paul Romer’s article, “Do Students
Go to Class? Should They?” in the Journal of Economic Perspectives (vol. 7, no. 3, Summer
1993:167–74) shows that perfect class attendance is worth between one and two grade points, and
attendance at all rather than half of classes is worth between 0.67 and 1.24 grade points. Referring
to this evidence might add some weight to your argument.
Finally, I recommend that all students bring a protractor and a few colored pencils to class to aid
their note taking. One of the most frequent problems for students who are struggling is sloppy
lecture notes. A protractor is great for drawing lines and curves and has the added benefit of being
transparent. Colored pencils are a big help when students are taking notes on graphs with many
different lines, such as income and substitution effects and long- and short-run cost.
Chapter 1 serves as an introduction to the text as well as a refresher of some basic economic
concepts and definitions. This is a good chapter to get started, during the first day, as most
students wouldn’t have read it before class. It will give you the opportunity to get an idea of the
students’ memory on these basic concepts.
I usually start by asking the class for a definition of economics. If you get several suggestions that
do not include the concept of scarcity, consider writing them on the board. Ask the class if they
can think of what central idea is missing from the definitions given. The discussion of scarcity
and the questions of what, how, and for whom to produce should lead you directly into a
discussion of the role of prices as an allocation mechanism.
,In the discussion of prices and markets, I try to get the students to offer examples from recent
events where prices have risen or fallen sharply (a good current example is oil prices). Another
possibility is to ask the students why some prices are so high (e.g., diamonds) and others are so
low (water, to start on that classic paradox). Ideally, you will end up in a discussion of the ways
in which supply and demand interact to allocate resources. I also like to talk briefly about market
failure and why the United States is a mixed economy rather than a pure market economy. The
Twinkie tax application is a good example for discussion purposes.
When discussing allocation of goods and services, an effective counterpoint to the market system
is consideration of the centrally planned economy. Examples can include China’s version of
central planning, as well as Cuba and North Korea. Many students have very little knowledge of
how centrally planned economies operate, the difficulties they face in meeting the demands of
their citizens, and how these difficulties relate to the current political changes.
The discussion of economic models is very important. Most students do not have a sound
understanding of the construction and purpose of an economic model. Stress the point that
economic models are allegories used to describe behaviors and outcomes that would otherwise be
unnecessarily complicated. Rather than try to duplicate the actual phenomenon, economists use
models to make predictions about the behavior of firms and individuals. Perhaps the most
important point to make regarding models is that they are simplified through the use of
assumptions. You might choose a typical market and describe the wide variety of complex
interactions that would have to be quantified in order to produce a complete model. Then describe
the circumstances under which a very simple economic model can make satisfactory predictions
(where “satisfactory” can be defined a number of ways, such as the coefficient of determination
in a regression model). You may also want to discuss interactions that are too difficult to model
and why. For example, modeling behavior in unstable political climates is difficult because of the
large influence of events that cannot be forecast. Finally, you might discuss the use of models to
test theories and make predictions. Often students have a somewhat jaded view of economists and
their predictions. I like to point out that although predictions often turn out to be incorrect, the
error can frequently be traced to incorrect assumptions made at the time of the prediction. For
example, suppose a forecasting model is constructed to predict baseball game attendance.
Assuming a bright sunny day, attendance at a baseball game is predicted to be 40,000. If only
10,000 fans show up on game day, it could be that the model is bad, but it could also be that the
weather is cool with a steady rain. In this case, the assumption, not the model, was flawed.
Chapter 1 also introduces the difference between positive and normative economics. It does not
take long to cover, and a brief discussion of this point is worth the time. You might begin by
asking students the distinction between positive and normative problems. I often find that
students either do not know at all or are very unsure about their responses. To get the class thinking,
use current societal problems as discussion points. Ask the class what would be a fair price for an
Ebola vaccine. The variety of responses shows the normative nature of the question, but there is
no disagreement that the vaccine should be produced in the least costly way possible, regardless
of how the gains are shared. Note that most problems have both positive and normative aspects
and that by separating objective issues from subjective ones, we can more easily understand and
, approach the problems and find effective solutions. The text example of the wisdom of food price
controls in Africa during droughts makes this point well.
When covering Section 1.3 (Uses of Microeconomic Models), you might discuss the effect of
subprime mortgages on the housing market, or draw on examples from current events that require
the use of models. I like to draw the distinction between structural models that may be used, for
example, to determine an elasticity, and forecasting models that emphasize predictive power over
theoretical correctness. If the students’ backgrounds in statistics are weak, you may have to keep
this discussion at a broad conceptual level. This section provides a great opportunity to make the
subject matter come alive for the students.
This text is designed to be used in courses where calculus is a prerequisite. I find that, even
though students have all taken calculus, they don’t remember much of it. I find it useful to spend
some time reviewing the rules of algebra and the basics of calculus. Also, it is necessary to be
able to take partial derivatives, and these are rarely covered in the introductory calculus course.
Introduction
◼ Chapter Outline
1.1 Microeconomics: The Allocation of Scarce Resources
Trade-Offs
Which goods and services to produce.
How to produce.
Who gets the goods and services?
Who Makes the Decisions?
How Prices Determine Allocations
Application: Twinkie Tax
1.2 Models
Application: Income Threshold Model and China
Simplifications by Assumption
Testing Theories
Maximizing Subject to Constraints
Positive Versus Normative
1.3 Uses of Microeconomic Models
◼ Teaching Tips
You might begin the first class by discussing with the students the role of the intermediate
microeconomics class in the larger curriculum. Encourage the students to be interactive by asking
questions, bringing in examples from the newspaper, and questioning concepts that seem untrue or
unrealistic. For many professors, a primary goal of the course is to get students to think like
economists. The material in Chapter 1 should help the students to understand what is required to do.
You might want to ask your students the policy questions listed below as a kind of pretest. Simply
ask them to write down the best answer they can for now, and then put their answers away. You
can then return to these answers later in the semester.
Some suggested policy questions (be sure to ask only questions that you will address later in the
course):
,1. How do minimum wages affect wages, employment, and unemployment?
2. Is the consumer price index (CPI) a good measure of inflation?
3. Why do stores offer coupons instead of simply reducing the price by the value of the
coupon?
4. How do taxes affect consumers and businesses?
5. Why do some workers prefer set wages rather than commissions, even if they might
make more working on commission?
6. Agree or disagree: We should strive to be a zero pollution society.
On a more pragmatic level, I stress to the students that success in the class is heavily dependent
on their approach to the material. Specifically, I emphasize that memorization is an extremely
ineffective tool for studying economics and that students who memorize material are very prone
to confusion and “drawing
a blank” on exams. I try to persuade them that a much better approach is to press for
understanding. I also stress that understanding usually comes only through active engagement
with the material, both in class and out. The problems in the text, as well as the additional
problems available in this manual and the Study Guide, will benefit the students in this regard.
The conceptual and technical questions throughout these problem sets are designed to facilitate
student understanding.
I also emphasize the importance of coming to class regularly. Paul Romer’s article, “Do Students
Go to Class? Should They?” in the Journal of Economic Perspectives (vol. 7, no. 3, Summer
1993:167–74) shows that perfect class attendance is worth between one and two grade points, and
attendance at all rather than half of classes is worth between 0.67 and 1.24 grade points. Referring
to this evidence might add some weight to your argument.
Finally, I recommend that all students bring a protractor and a few colored pencils to class to aid
their note taking. One of the most frequent problems for students who are struggling is sloppy
lecture notes. A protractor is great for drawing lines and curves and has the added benefit of being
transparent. Colored pencils are a big help when students are taking notes on graphs with many
different lines, such as income and substitution effects and long- and short-run cost.
Chapter 1 serves as an introduction to the text as well as a refresher of some basic economic
concepts and definitions. This is a good chapter to get started, during the first day, as most
students wouldn’t have read it before class. It will give you the opportunity to get an idea of the
students’ memory on these basic concepts.
I usually start by asking the class for a definition of economics. If you get several suggestions that
do not include the concept of scarcity, consider writing them on the board. Ask the class if they
can think of what central idea is missing from the definitions given. The discussion of scarcity
and the questions of what, how, and for whom to produce should lead you directly into a
discussion of the role of prices as an allocation mechanism.
,In the discussion of prices and markets, I try to get the students to offer examples from recent
events where prices have risen or fallen sharply (a good current example is oil prices). Another
possibility is to ask the students why some prices are so high (e.g., diamonds) and others are so
low (water, to start on that classic paradox). Ideally, you will end up in a discussion of the ways
in which supply and demand interact to allocate resources. I also like to talk briefly about market
failure and why the United States is a mixed economy rather than a pure market economy. The
Twinkie tax application is a good example for discussion purposes.
When discussing allocation of goods and services, an effective counterpoint to the market system
is consideration of the centrally planned economy. Examples can include China’s version of
central planning, as well as Cuba and North Korea. Many students have very little knowledge of
how centrally planned economies operate, the difficulties they face in meeting the demands of
their citizens, and how these difficulties relate to the current political changes.
The discussion of economic models is very important. Most students do not have a sound
understanding of the construction and purpose of an economic model. Stress the point that
economic models are allegories used to describe behaviors and outcomes that would otherwise be
unnecessarily complicated. Rather than try to duplicate the actual phenomenon, economists use
models to make predictions about the behavior of firms and individuals. Perhaps the most
important point to make regarding models is that they are simplified through the use of
assumptions. You might choose a typical market and describe the wide variety of complex
interactions that would have to be quantified in order to produce a complete model. Then describe
the circumstances under which a very simple economic model can make satisfactory predictions
(where “satisfactory” can be defined a number of ways, such as the coefficient of determination
in a regression model). You may also want to discuss interactions that are too difficult to model
and why. For example, modeling behavior in unstable political climates is difficult because of the
large influence of events that cannot be forecast. Finally, you might discuss the use of models to
test theories and make predictions. Often students have a somewhat jaded view of economists and
their predictions. I like to point out that although predictions often turn out to be incorrect, the
error can frequently be traced to incorrect assumptions made at the time of the prediction. For
example, suppose a forecasting model is constructed to predict baseball game attendance.
Assuming a bright sunny day, attendance at a baseball game is predicted to be 40,000. If only
10,000 fans show up on game day, it could be that the model is bad, but it could also be that the
weather is cool with a steady rain. In this case, the assumption, not the model, was flawed.
Chapter 1 also introduces the difference between positive and normative economics. It does not
take long to cover, and a brief discussion of this point is worth the time. You might begin by
asking students the distinction between positive and normative problems. I often find that
students either do not know at all or are very unsure about their responses. To get the class thinking,
use current societal problems as discussion points. Ask the class what would be a fair price for an
Ebola vaccine. The variety of responses shows the normative nature of the question, but there is
no disagreement that the vaccine should be produced in the least costly way possible, regardless
of how the gains are shared. Note that most problems have both positive and normative aspects
and that by separating objective issues from subjective ones, we can more easily understand and
, approach the problems and find effective solutions. The text example of the wisdom of food price
controls in Africa during droughts makes this point well.
When covering Section 1.3 (Uses of Microeconomic Models), you might discuss the effect of
subprime mortgages on the housing market, or draw on examples from current events that require
the use of models. I like to draw the distinction between structural models that may be used, for
example, to determine an elasticity, and forecasting models that emphasize predictive power over
theoretical correctness. If the students’ backgrounds in statistics are weak, you may have to keep
this discussion at a broad conceptual level. This section provides a great opportunity to make the
subject matter come alive for the students.
This text is designed to be used in courses where calculus is a prerequisite. I find that, even
though students have all taken calculus, they don’t remember much of it. I find it useful to spend
some time reviewing the rules of algebra and the basics of calculus. Also, it is necessary to be
able to take partial derivatives, and these are rarely covered in the introductory calculus course.
