Lecture 1 · Week 2 · Besanko & Braeutigam ch. 1 · about 35 min

Analyzing Economic Problems

The toolkit microeconomics brings to every decision: scarcity and opportunity cost, marginal analysis, the difference between positive and normative claims, and what makes a market a market.

By the end you can

Compute opportunity cost and explain why it, not accounting cost, drives rational decisions
Apply marginal analysis: keep doing something while marginal benefit exceeds marginal cost
Distinguish positive economics from normative economics
Define a market and distinguish perfectly competitive markets from other market structures

What microeconomics studies

Microeconomics studies how individual households, firms and markets make decisions when resources are scarce, and how those decisions interact to determine prices and quantities. Where macroeconomics asks “why is the whole economy growing or shrinking,” microeconomics asks “why does this firm charge this price, and why does this household buy this much.”

Opportunity cost

Every choice has a cost measured not in money alone, but in the best alternative given up.

Opportunity costDefinitionFormula sheet →

\text{Opportunity cost of an action} = \text{value of the best forgone alternative}

Use it when a decision involves giving up one option to take another, even when no money changes hands directly, such as choosing how to spend an afternoon.

Marginal analysis

Rational decision-makers do not usually ask “should I do this activity at all?” — they ask “should I do a little more of it?” This is marginal analysis, and it is the single most-used tool in microeconomics.

The marginal decision ruleKey ruleFormula sheet →

\text{Keep expanding an activity while } MB \gt MC; \text{ stop when } MB = MC

$MB$: marginal benefit of one more unit
$MC$: marginal cost of one more unit

Use it when you are deciding how much of something to do — how many units to produce, how many hours to study, how many workers to hire — rather than a simple yes/no decision.

Positive versus normative economics

Positive vs normativeDistinctionFormula sheet →

\text{Positive: what IS, testable with data} \qquad \text{Normative: what SHOULD BE, a value judgement}

Use it when a statement needs to be classified as a factual claim (positive) or an opinion about policy (normative), a very common first-exam question.

Economic models and ceteris paribus

Economics builds deliberately simplified models of reality — not because reality is simple, but because a model with every detail included would be too complicated to learn anything from. Models isolate the relationship of interest by holding everything else fixed.

Ceteris paribusLatin: 'other things equal'Formula sheet →

\frac{\partial Q^d}{\partial P}\Big|_{\text{income, tastes, other prices fixed}} \lt 0

$Q^d$: quantity demanded, held to a strictly negative response to P only once every other influence is held constant

Use it when a model isolates the effect of one variable — such as price — by assuming every other relevant variable stays fixed.

What makes a market

MarketDefinitionFormula sheet →

\text{Market} = \text{buyers and sellers whose interactions determine the price of a good or service}

Use it when you need to identify the relevant market for a good before analysing supply, demand, or market power.

A key question in defining a market is substitutability: goods are in the same market if buyers readily switch between them in response to price changes. Markets differ enormously in structure, and this course builds toward comparing two extremes: perfectly competitive markets, where many small buyers and sellers trade an identical (homogeneous) product and no single participant can affect the price, and monopoly, the opposite extreme with a single seller. Most real markets sit somewhere between.

Conditions for a perfectly competitive marketChecklistFormula sheet →

1.\ \text{Many small buyers and sellers} \quad 2.\ \text{Homogeneous (identical) product} \quad 3.\ \text{Free entry and exit} \quad 4.\ \text{Full information}

Use it when you need to check whether a described market can be treated as perfectly competitive, the benchmark model built up over Weeks 9 to 10 of this course.

Exam practice

Summary and review

Scarcity forces choice; the true cost of any choice is its opportunity cost, the best forgone alternative.
Sunk costs are already spent and irrelevant to forward-looking decisions.
Marginal analysis: expand an activity while MB > MC; stop at MB = MC.
Positive economics describes what is (testable); normative economics prescribes what should be (a value judgement).
Ceteris paribus isolates one relationship by holding everything else fixed — the core simplifying device of economic models.
A perfectly competitive market has many small buyers and sellers, a homogeneous product, free entry/exit, and full information.