Microeconomics 1

Lecture 1-2
12 April 2025

The Fundamental Questions of Society

1. What to Produce?
Definition: Deciding which goods and services to prioritize given limited resources.
Key Concepts:
• Trade-offs: Choosing one good means sacrificing another.
• Opportunity Cost: The value of the next-best alternative forgone (e.g., building a
hospital instead of a shopping mall).
Examples & Applications:
1. National Level:
o Healthcare vs. Defense: A government allocating funds to vaccines (healthcare) instead
of fighter jets (defense).
o Education vs. Infrastructure: Building schools versus highways.
2. Individual Level:
o A farmer choosing to grow wheat (profitable) instead of vegetables (less profitable but
nutritious).
o A student buying textbooks (education) over concert tickets (entertainment).
Economic Systems & Approaches:
• Capitalism: Market-driven (consumer demand dictates production).
o Example: Tech companies prioritizing smartphones over landline phones.
• Socialism/Planned Economies: Government decides based on societal needs.
o Example: USSR’s focus on heavy industry over consumer goods.
• Mixed Economies: Blend of market and government priorities (e.g., U.S. subsidies for
renewable energy).
2. How to Produce?
Definition: Determining the methods and technologies used to create goods/services.
Key Concepts:
• Efficiency: Maximizing output with minimal waste.
• Factor Intensity: Labor-intensive vs. capital-intensive production.
Examples & Applications:
1. Labor-Intensive:
o Handmade textiles (e.g., Indian sarees) vs. automated textile factories.
o Small-scale farming in developing nations (reliant on human labor).
2. Capital-Intensive:
o Car manufacturing using robots (e.g., Tesla factories).
o Automated warehouses (e.g., Amazon’s use of AI and robotics).
3. Sustainability:
o Renewable energy (solar/wind) vs. fossil fuels (coal/oil).
Factors Influencing "How":
• Technology: Advances reduce costs (e.g., 3D printing in manufacturing).
• Resource Availability: Oil-rich nations may use energy-intensive methods.
• Cultural Values: Ethical production (fair-trade coffee) vs. cost-cutting.

3. For Whom to Produce?

Definition: Deciding how goods/services are distributed among society’s members.
Key Concepts:
• Income Distribution: Wages, profits, and wealth inequality.
• Equity vs. Efficiency: Fairness vs. economic productivity.
Examples & Systems:
1. Market-Based Distribution:
o Income determines access (e.g., luxury cars for the wealthy).
o Critique: Can lead to inequality (e.g., 1% owning 40% of wealth in some nations).
2. Government Redistribution:
o Progressive taxation (higher earners pay more) and welfare programs.
o Example: Universal healthcare (Canada) vs. privatized systems (U.S.).
3. Rationing Systems:
o During crises (e.g., WWII rationing, COVID-19 vaccine prioritization).
Modern Debates:
• Universal Basic Income (UBI): Should everyone receive a fixed income?
• Merit vs. Need: Should rewards go to the skilled or the disadvantaged?

Connecting the Questions: Real-World Scenarios

1. Climate Change:
o What? Renewable energy vs. fossil fuels.
o How? Green tech (solar panels) vs. coal plants.
o For Whom? Balancing developed nations (high emissions) vs. vulnerable regions (low
emissions but high climate risk).
2. COVID-19 Pandemic:
o What? Vaccines vs. non-essential goods.
o How? Fast-tracked R&D vs. traditional drug trials.
o For Whom? Vaccine hoarding by rich nations vs. COVAX for poorer countries.

Key Frameworks & Diagrams

1. Production Possibility Frontier (PPF):
o Illustrates trade-offs between two goods (e.g., guns vs. butter).
o Points inside the curve = inefficiency; outside = unattainable without growth.
o Example: A country choosing between military spending (guns) and consumer goods
(butter).
2. Circular Flow Model:
o Shows how resources, goods, and money move between households, firms,
government, and international markets.
o Answers "for whom" by tracking income flows (wages, profits, taxes).

Case Study: Post-War Germany

• What? Focus on rebuilding infrastructure (roads, factories) over luxury goods.
• How? Marshall Plan funding + capital-intensive industrial methods.
• For Whom? Prioritized equitable growth to prevent extremism (leading
to Wirtschaftswunder/"economic miracle").

Discussion Questions
1. Ethics vs. Efficiency: Should a poor country prioritize feeding its people (equity) or
investing in industries (efficiency)?
2. Technology’s Role: Does automation answer "how to produce" but worsen "for whom"
(job losses)?
3. Globalization: Who decides "what to produce" when supply chains span continents?
2. Brief History of Economic Thought
1. Ancient and Medieval Economics
• Ancient Greece:
o Aristotle: Distinguished between "oikonomia" (household management)
and "chrematistics" (wealth accumulation). Warned against usury (excessive interest).
o Plato: Advocated for a class-based society in The Republic, with rulers, warriors, and
producers.
• Medieval Scholastics:
o Thomas Aquinas: Just price theory (fair pricing based on labor and need, not greed).
Condemned exploitation but tolerated trade for mutual benefit.

2. Mercantilism (16th–18th Century)

• Core Idea: Wealth = accumulation of gold/silver. Promote exports, restrict imports via
tariffs.
• Key Practices:
o Colonialism (extract resources from colonies).
o State monopolies (e.g., British East India Company).
• Critics: Later economists like Adam Smith called it "zero-sum" and harmful to free trade.

3. Classical Economics (1776–1870s)

Founders:
• Adam Smith (The Wealth of Nations, 1776):
o "Invisible hand": Self-interest in free markets leads to societal good.
o Division of labor (e.g., pin factory example).
• David Ricardo:
o Comparative advantage: Nations should specialize in what they produce most efficiently
(e.g., Portugal/wine, England/cloth).
o Labor theory of value (value derived from labor input).
• Thomas Malthus: Warned of population growth outpacing food supply ("Malthusian
trap").
Key Themes:
• Free markets, minimal government, and laissez-faire policies.
• Focus on long-term growth and capital accumulation.

4. Marxian Economics (Mid-19th Century)

• Karl Marx (Das Kapital, 1867):
o Critique of capitalism: Exploitation of workers (surplus value).
o Predicted class struggle (proletariat vs. bourgeoisie) leading to socialism.
• Key Ideas:
o Dialectical materialism: Economic systems evolve through conflict.
o Labor theory of value (refined from Ricardo).

5. Neoclassical Economics (1870s–1930s)

Founders:
• Alfred Marshall: Synthesized classical ideas with new concepts.
o Supply and demand: Equilibrium pricing.
o Marginal utility (value based on incremental satisfaction).
• Léon Walras: General equilibrium theory (interconnected markets).
• William Stanley Jevons: Marginal revolution (decisions based on marginal
costs/benefits).
Key Themes:
• Mathematical modeling of rational decision-making.
• Focus on efficiency and optimal resource allocation.

6. Keynesian Economics (1930s–1970s)

• John Maynard Keynes (The General Theory of Employment, Interest, and Money, 1936):
o Response to the Great Depression.
o Key Ideas:
▪ Aggregate demand drives economies.
▪ Government intervention (fiscal policy) to combat recessions (e.g., New Deal).
▪ "Animal spirits": Psychology influences investment.
• Post-Keynesians:
o Paul Samuelson: Merged Keynesian and neoclassical ideas (neoclassical synthesis).

7. Monetarism (1970s–1980s)
• Milton Friedman:
o "Inflation is always and everywhere a monetary phenomenon."
o Advocated controlling money supply over fiscal policy.
o Critiqued Keynesianism during stagflation (1970s).
• Policy Impact: Central banks (e.g., Fed under Paul Volcker) prioritized inflation control.

8. Modern Developments (1980s–Present)

1. Behavioral Economics:
o Daniel Kahneman & Amos Tversky: Prospect theory (loss aversion, irrational decision-
making).
o Richard Thaler: Nudge theory (designing choices to improve outcomes, e.g., retirement
savings).
2. New Institutional Economics:
o Douglass North: Institutions (laws, norms) shape economic performance.
3. Environmental Economics:
o Focus on sustainability, externalities (e.g., carbon pricing, Elinor Ostrom’s work on
commons).
4. Development Economics:
o Amartya Sen: Capability approach (economic freedom = ability to live a fulfilling life).
o Esther Duflo: Randomized control trials (RCTs) to test poverty interventions.
5. Austrian School:
o Friedrich Hayek: Critiqued central planning; emphasized decentralized knowledge in
markets.

Key Debates in Economic History

1. State vs. Market:
o Keynesian (pro-government) vs. Monetarist/Neoclassical (pro-market).
2. Equity vs. Efficiency:
o Marx (redistribution) vs. Friedman (market freedom).
3. Rationality vs. Irrationality:
o Neoclassical (rational agents) vs. Behavioral (bounded rationality).

Timeline of Major Works

Year Thinker Work/Contribution

1776 Adam Smith The Wealth of Nations

 Year Thinker Work/Contribution

1867 Karl Marx Das Kapital

1890 Alfred Marshall Principles of Economics

1936 John Maynard Keynes The General Theory

1963 Milton Friedman A Monetary History of the United States

2008 Richard Thaler Nudge (Behavioral Economics)

Microeconomics vs. Macroeconomics

1. MICROECONOMICS
Focus: Individuals, firms, markets, and institutions.
Key Topics
1. Scarcity & Choice
o Opportunity Cost: Value of the next-best alternative (e.g., choosing college over a job).
o Utility Maximization: Consumers seek the most satisfaction (e.g., buying coffee vs. tea).
2. Supply & Demand
o Equilibrium: Where supply = demand (e.g., smartphone market pricing).
o Elasticity:
▪ Price Elasticity: Gas (inelastic) vs. luxury cars (elastic).
▪ Cross-Elasticity: Substitute goods (Coke vs. Pepsi).
3. Market Structures
o Perfect Competition: Many sellers, identical products (agriculture).
o Monopoly: Single seller (e.g., utilities).
o Oligopoly: Few firms (e.g., airlines, OPEC).
4. Market Failures
o Externalities: Pollution (negative) → solved by carbon taxes.
o Public Goods: National defense (non-excludable).
o Information Asymmetry: Moral hazard (insurance fraud).
5. Role of Government
o Regulation: Antitrust laws (breaking up monopolies).
o Behavioral Economics: Nudges (e.g., automatic savings enrollment).
6. Advanced Topics
o Labor Markets: Wage determination (education vs. minimum wage).
o International Trade: Comparative advantage (U.S. tech exports).
 2. MACROECONOMICS
Focus: Economy-wide phenomena and policies.
Key Topics
1. National Income Accounting
o GDP: C+I+G+(X−M)C+I+G+(X−M).
o Real vs. Nominal GDP: Adjusted for inflation.
2. Unemployment & Inflation
o Types of Unemployment: Frictional (job transitions) vs. structural (automation).
o Inflation Causes: Demand-pull (too much spending) vs. cost-push (oil prices).
3. Aggregate Demand & Supply
o AD Components: Consumption (C), Investment (I), Government (G), Net Exports (NX).
o AS Shifts: Technology ↑ → long-run growth.
4. Policy Tools
o Fiscal Policy: Government spending/taxes (e.g., COVID stimulus checks).
o Monetary Policy: Central banks adjusting interest rates (e.g., Fed’s QE).
5. Global Issues
o Economic Growth: Driven by technology (Solow model).
o Exchange Rates: Strong currency → cheaper imports.
o Sustainability: Green GDP (factoring environmental costs).

BRIDGING MICRO & MACRO

1. Micro → Macro
o Example: Household savings (micro) → National investment (macro).
o Case Study: 2008 crisis (micro mortgages → macro recession).
2. Macro → Micro
o Example: Interest rates (macro) → business loans (micro).
o Case Study: Minimum wage hikes (micro labor costs → macro consumption).
Major Divisions of Economics
1. Positive vs. Normative Economics
o Positive: Fact-based analysis ("Unemployment is 5%").
o Normative: Value-based judgments ("Unemployment should be lower").
2. Subfields:
o Labor Economics: Wages, employment, discrimination.
o Environmental Economics: Pollution taxes, climate policies.
o Development Economics: Poverty reduction, growth in low-income nations.
o Behavioral Economics: Psychology-driven decisions (e.g., "nudges").
o International Economics: Trade, exchange rates, globalization.
Example:
• Environmental Economics: Carbon pricing (micro) vs. global warming’s macro impact.