Lecture 1

2023-03-23

MIT OCW 14.01SC L1 - Introduction to Microeconomics

MIT OCW 14.01SC - Lec 1 (Youtube)

  • Economics is about scarcity, tradeoffs, resouce optimsation.

    • It is called the 'Dismal science'.
    • Fun because engineering is about resource optimsation.
    • Modern microeconomics founded by Paul Samuelson (at MIT) by introducing math to economics.

  • Two types of actors: Consumers and Producers

    • Build models of their behaviour.
    • Model: relations between two variables.
      • Not precise, but general tendencies in the data.
      • Simplifying assumptions.

  • Consumer:

    • Utility maximisation subject to Budget constraint.

  • Firms:

    • Maximise profit.
    • Subject to demands of consumers and input costs.

  • Three fundamental questions of microeconomics.

    • What goods and services should be produced?
    • How to produce those goods and services?
    • Who gets those goods and services?
    • All three questions solved by one key state variable: Prices.

  • Example: development of the iPod.

    • Would consumers would be willing to spend money to buy iPod and give up other things?
    • Firm gets a signal that consumers are willing to pay an amount of money to buy an iPod.
    • Firm needs to look at the price to produce the iPod.
    • How to make the iPod will depend on the prices the firms have to pay for the chips, metal, etc.
    • Who gets the iPod? The ones willing to pay will get the iPod. The ones who're not willing to pay the amount will not get the iPod.
    • Prices determine what to produce, how to produce, and who gets what is produced.

  • There are some places where this does not apply.

    • E.g. Lines for tickets to a concert.
    • If prices determine everything then there should be no lines.
    • Those willing to pay should get the ticket, those not willing to pay should not get the ticket, why should there be a line?
    • (*we'll come to the taste issue later.)
    • Perfect world: auction of tickets.
    • Evolution towards the economic model (from 30 years ago).
      • Price mechanism has replaced the Line mechanism.

  • Theoretical vs. Emprical economics.

    • Theretical economics: Building models to describe the world.
    • Empirical economics: Testing models to see if it describes the world.

  • Positive vs. Normative economics.

    • Positive: the way things are.
    • Normative: the way things should be.

  • Example: Auctions on eBay.

    • Textbook example of perfectly competitive market.
    • A number of Producers offer to wide range of consumers.
    • Consumers bid up the price until the person who has the highest value for the good gets it.
    • Recent controversial example: Someone auctioned their kidney on eBay.
    • Starting price $25k USD, got to $5M before eBay shut it down.
    • Positive question: why did the price go so high?
      • Next lecture: Twin forces of Supply and Demand.
      • More demand, low supply -> High price.
      • Adam Smith introduced this framework (supply and demand)
        • Water Diamond paradox.
        • Diamond is irrelevant to life and water is most important for life, yet diamond are astronomically expensive and yet water is free.
        • Demand for water is higher but supply is much higher.
      • Demand for kidney: you die without it, so you can spend all your wealth.
      • Supplly: very low.
    • Normative question: Should this sale have been allowed?
      • Many people die waiting for a transplant.
      • If someone is very rich, why shouldn't they be allowed to buy it from me? If the transaction makes both parties better off?
      • Arguments against this sale?
        • Substitution: Who really needs it more? Poor person who might be in a severe condition, Rich person might just be a kidney collector. (lol)
          • Eg. Mickey Mantle: baseball player, raging alcoholic, jumped the queue, got liver transplant, kept drinking and died anyways.
        • Bad decision? May encourage illegal ways of getting kidneys?
          • We don't trust people to make good decisions when money's involved.
            • Someone may sell it anyway without thinking through the risks.
        • Unfairness, Equity: As a society we may feel it is unfair that rich people get things poor people can't. We value equality. Consider at the end of the semester.
      • Tax cuts for rich people? (Normative question.)

  • Microeconomics presents a framework for making decisions.

    • Even non economic decisions.
    • Example: Whether or not to buy the new version of the textbook?
      • First thing to consider: Preferences.
        • Risk-averse or risk-loving? (buy old edition and take a risk?)
      • Second factor: Constraint.
        • How much money you have?
      • Third factor: information from the Market.
        • How much is the price difference?
      • Solve the constraint optimisation.
    • Example: Should I bring an umbrella?
    • As if principle. People may not solve the constraint optimisation problem directly but they behave as if they do.