Intermediate Microeconomics

February 20, 2000

Class Notes (Chapter 1-5)

Chapter 1

1. Conditions of the Market Economy
1. Private Property Rights
1. Every separable resource has an individual who is assigned as an owner who has the exclusive right to benefit from its employment in the production of consumers' goods. But the owner cannot cause harm to others by its use.
2. The owner of a right can exchange it.
2. Specialization: distinctly different tasks that ultimately yield satisfaction are performed by different people.
3. Money
1. Barter vs. money exchange
2. Characteristics of money
3. Importance of capital accounting
4. Reckoning and signaling functions of money
5. Knowing how to use money
2. Origin of the Market Economy
1. Private Property Rights
1. Emergence of equality before the law
2. Emergence of a judicial system to settle property disputes.
1. Judgments about the ownership of newly produce property
2. Specialization
1. Specialization due to differences in abilities; the incentive to specialize if specialization is not already present
2. Specialization by tradition vs. specialization by choice
3. Money
1. One theory: the more marketable item becomes money
2. Another theory: people in a specialized community would tend to store marketable items; thus low storage cost is also a characteristic of money
3. Use of a particular item as money is based on expectations
3. Roles in the Market Economy
1. Most fundamental roles are resource-supplying, producing, consuming-saving
4. Pure Market Economy
1. Why private property rights are always incomplete
1. Physically impossible or very costly to enforce some property rights: air, water, media for sound and light waves
2. Common property resources that result from the passage of laws or from following traditions
3. Public goods
1. two characteristics
1. a number of people benefit simultaneously

1. it is impossible to exclude beneficiaries
1. example: dam or flood control project
1. Other goals besides encouraging the production of wealth.
1. National defense, redistribution of wealth, regulation of behavior, making government decisions subject to the will of the people (democracy)
2. Government and cultural intervention that reduce the scope of the market economy
1. Types of government intervention
1. Government enterprises
2. Government regulation and price setting
2. Cultural intervention: blocking the production and sale of particular goods or services

Chapter 2

1. Wants
1. Wants in economics
1. Definition: the assumed ends that get manifested in choices to buy and sell
1. Do we know that individuals make choices?: behaviorism vs. mentalism
2. Wants vs. needs
1. Needs: inherited or learned drives - these compel choice but cannot be controlled by the actor. Individuals must choose according to needs; they have no real choice; they are controlled by their needs.
2. Wants: a person can choose to satisfy them or not. Although he will be better off if he chooses to satisfy his wants, he is not compelled to satisfy his wants.
2. Wants and goods
1. Goods satisfy wants directly
2. Goods can only be experience by satisfying other goods
3. Relative Nature of Wants for Specific Goods
1. Everything has a price: an extreme example
2. No free goods
3. Preference structure: an imaginary photograph of an individual's relative wants.
4. Marginal Units
1. Definition: the last or next unit; when a person make a choice, he chooses the last unit over the next unit or units of something else. He compares marginal units.
2. Inframarginal units: units earlier in the serious than the last one
3. The water-diamond paradox: resolved when the difference between marginal and inframarginal units was recognized.
4. Marginal characteristics: important when a choice is made of whether to buy only one of an item. Example: comparing two houses.
5. Generalized wants and specific goods
1. Wants can often be placed into classes, such as a want for recreation, a want for dinner outside the home, a want for clothing.
6. Wants change over time
1. wants seem to change with aging, with travel, and with other experiences
2. some changes are partly predictable; some are not
7. Competing and Joint Wants
1. some goods or actions can satisfy the wants of more than one person at the same time: entertainment. We can say that individuals have a joint want for the good or action.
2. others can satisfy one person's want only if it is not used to satisfy the want of another person. We can say that individuals have competing wants for this good or action.
2. Goods
1. Goods refer to services also, although we often use the phrase "goods and services"
2. Perishable and Durable Goods
1. We can never be certain that an infinitely durable thing will always be a good: example of gold
2. Otherwise perishable goods can be made durable through techniques of preservation: smoking, drying, refrigeration.
3. Re-usable durable goods
4. Depreciation and Appreciation
1. Deterioration: change in physical properties that render a good less satisfying
2. Obsolescence: the character of a good whereby it loses want-satisfying value even though its physical characteristics do not change; complete obsolescence: a thing is no longer wanted.
3. Depreciation: a fall in price of a durable good
4. Appreciation: a rise in price of a durable good
3. Complementary and Substitute Goods
1. Complementary: a consumer expects two goods to provide greater satisfaction when used together than when used separately; each good complements the other.
2. Substitute: a consumer expects more than one good to satisfy the same want.
4. Which Items are Goods?
1. Difficult to determine because we cannot read peoples' minds
2. Economics not concerned with this
3. Different goods for different people
4. Every example of a good is hypothetical
5. To say that an item is a good may be inserting a personal value judgment - the case of national defense
3. Cost
1. Opportunity cost of an item: the satisfaction from other items that must be given up to obtain it.
2. Opportunities to satisfy one's wants by using time are part of the opportunity cost of a good.

Chapter 3

1. Introduction
1. What causes some nations to be wealthier than others?
2. What causes some people to be wealthier than others?
3. Fundamental characteristic of all resources: individuals expect them to help them satisfy their wants indirectly



2. Types of Resources
1. Labor as physical movements only
2. Land: events of nature - natural resources
3. Capital goods: the collection of material resources that would not exist unless other complementary resources had already been used to produce them. Land is really a type of capital good. Tell why.
4. Human capital: man-made knowledge
5. Specialized and non-specific resources



3. Human Capital to the Isolated Actor
1. Types of Human Capital
1. Knowledge of wants
1. includes knowledge of time preference
2. low and high time preference
2. Technical knowledge
1. knowledge of goods
2. knowledge of how other resources can be used to produce goods
3. Knowledge of knowledge
1. Knowing how to do something is knowledge of knowledge
2. Experimentation is evidence of knowledge of knowledge
4. Knowledge of how to acquire knowledge
1. knowing that experimentation leads to new knowledge
2. Complementary and Transformation Character of Human Capital
1. Complementary
2. Transformation
1. transforms non-resources into resources
2. two examples
1. knowledge that an item is a resource transforms the non-resource into a resource
2. knowledge that helps produces other knowledge: learning
3. Structure of Technical Knowledge
1. Order vs. Structure: explanation of the diagrams
2. The Structure of Production
4. Economic Knowledge and Entrepreneurship
1. How One Person's Knowledge Plays a Role in Other's Planning
1. Two person specialization and trade
2. A market economy

1. Entrepreneurship
1. Definition: the part of distinctly human action in a market economy that causes the production and consumption of all goods.
2. Penniless entrepreneur
3. Pure entrepreneur
1. appraisement, undertaking, uncertainty-bearing
4. How entrepreneurship creates resources: even with knowledge there would be no resources unless there was appraisement, undertaking, and uncertainty-bearing
5. The driving force behind coordination.

Chapter 4

1. Introduction
1. Knowledge to the philosopher, scientist and biologist vs. knowledge to the economist
2. Knowledge to the economist is a resource
3. The huge amount of specialization in the use and production of knowledge in a modern market economy



2. Adam Smith, the Wealth of Nations, and the Diversity of Economic Knowledge
1. Economic knowledge = division of labor
2. Two examples of the division of labor
1. The pin-maker as an example of division of labor caused by an employer
2. Specialization in butchery, brewing, and baking caused the a person seeking gain by specializing and then selling the product produced through his specialized actions.
3. Specialization due to natural differences not as important as specialization due to learning.
4. We can expect that under private property rights, the gradual division of labor will make a nation wealthy.



3. Definition of Lowest Opportunity Cost
1. Lowest opportunity cost exists if the combined costs of producing goods are lower under one particular distribution of rights to property than under a different distribution.
2. In the hypothetical market economy, individuals have an incentive to redistribute rights to control resources so that in the resulting distribution, each resource is used in the production activity in which it is judged to have the lowest opportunity cost.



4. Ownership, Specialization and Competition
1. Specialization under three initial ownership situations
1. A (with the comparative advantage) owns the right
2. B owns the right
3. No one owns the right - each produces half of the pecans
2. The incentive to create rights
1. The gathering game - trying to get more for oneself while causing the other to get less
2. Conflict
3. Apparent Exceptions
1. Begrudging: the cost (foregone income) due to begrudging and discrimination
2. Satisfaction from the work
4. Shared specialization due to increasing marginal cost of gathering



5. Two-Stage Production (see table 4-1 on p. 7)
6. The Incentive to Produce and Use Specialized Economic Knowledge
1. The example where one of two identical farmers decides to specialize in fence-building
2. Comparative and Absolute Advantage
3. How a person who decides to specialize also causes others to become specialists
4. Why everyone does not necessarily gain from specialization: how existing producers of a good or of a substitute can be harmed by copying
5. Invention (discovery) and copying
1. Intellectual property rights
2. Patent system

Chapter 5

1. Introduction
1. Review of the 4 types of knowledge
2. Other types of knowledge in a market economy
1. Knowledge of others' wants
2. Technical knowledge possessed by others
3. Knowledge of others' knowledge
3. Importance of knowledge of others in a market economy
4. Dispersion of economic knowledge in a market economy based on specialization and lowest opportunity cost
5. Implications of dispersed knowledge
1. We shall never be able to comprehend all of it
2. The dispersed knowledge must somehow be coordinated
6. Concern of this chapter: to discuss and give examples of different kinds of specialized knowledge
2. Knowledge of Wants
1. Wants and Demand
1. Specialized knowledge of demands for each separate type of product
2. The need for knowledge of wants by the suppliers of resources.
2. Knowledge of Horizontal Demands
1. To understand horizontal demands, we assume that goods are produced by fully vertically integrated producers
2. Knowledge of horizontal demands: knowledge about consumer demands for each good.
3. Diversity of demands
1. Compare a society in which different communities have similar demands with one that is comprised of communities in which citizens have different demands
2. Specialists in knowledge of demands would emerge in a society in which citizens have different demands. This specialized knowledge would be possessed by producers or their employees.
3. Knowledge of Vertical Demands
1. The structure of sales and marketing: discoverers of mineral deposits, miners, refiners, molders, parts suppliers, assemblers, wholesalers, retailers.
4. Specialization in the structure of sales and marketing
1. Retailer: possesses specialized knowledge of
1. consumer demands and
2. wholesalers' goods and their prices
2. Wholesaler (distributor)
1. Varieties
1. wholesalers of a particular product
2. wholesalers of a particular brand name producer or set of producers
3. wholesalers who supply particular retailers with every good they sell
4. wholesalers who supply retailers with only part of all the goods they sell
5. franchises
3. Producer and Resource-Suppler
1. Enormous complexity of the structure of production
2. In every business and individual decision to produce and sell a resource, people strive to attain knowledge of demands. Because of the level of complexity of the supply system, we can say little else about this.
4. Advertising
5. Knowledge of Wants for Job Satisfaction
1. Substitution of more desirable working conditions for money pay
2. The optimal supply of pay and working conditions
3. How market interventions interfere with the optimal supply
6. Causes of Changing Wants
1. Aging
2. New products and new packaging
3. Mobility
7. Advertising
1. Three types
1. Advertising that enables you to achieve a higher level of satisfaction than otherwise and than you felt before - advertising that informs
2. Advertising that makes you feel worse off than before if you do not change your behavior - advertising that creates wants
3. Advertising that makes you feel worse off than before if you do not change your behavior but which enables you to achieve a higher level of satisfaction than otherwise - information about a health hazard.
2. Economics not concerned with whether advertising is informative or want-creating.
3. Technical Knowledge Produced by Others
1. Tremendous growth over last three centuries
2. Causes of the growth in a Market Economy
1. Efforts to produce at lower costs than competitors
2. Emergence of new products in accordance with the diversity of tastes and the possibility of advertising
3. Deliberate research by
1. large diversified businesses
2. the military
3. universities
3. How technical knowledge is acquired
1. Directly through experience: trial and error in conjunction with the active, receptive and curious mind; experimentation.
2. Indirectly through speech and the written word
1. Ancient rituals to preserve technical knowledge
2. Government financing of foreign scientific study
1. This may fail unless there are opportunities at home to profit from the use of this knowledge
4. Scientific Knowledge
1. Formal Science
1. The long process of learning and understanding others' experiments and their results
2. The modern scientific mind as
1. an encyclopedia of knowledge of others' experiments and results
2. a library index of books and journals
3. The do-it-yourselfer as a practical scientist
5. Why technical knowledge is acquired, produced, and communicated
1. The do-it-yourselfer aims to satisfy his wants
2. The producer aims to earn a profit. To do this, she needs scientific knowledge to successfully operate her business in a changing world and to hire others to help her.
3. Prospective employers provide incentives in the form of relatively high salary offers to scientists; students and parents respond.
4. Knowledge of Others' Knowledge
1. Who possesses this knowledge?
1. Investsors: stock-market speculators, bankers and other lenders, and guarantors of loans
2. Employers, consumers and employees
2. Substitutes for Knowledge of Others' Knowledge
1. Financing of businesses is the most important
2. Substitutes for financiers' knowledge of business planners' knowledge
1. Acquiring general knowledge of a business planner's competence and trustworthiness instead of specific knowledge about the plan
2. Making a contract that holds the borrower liable for losses; effectiveness depends on a nation's contract law system.
3. Three reasons why knowledge of others' knowledge is indefinite
1. Infinite regress: A knows that B knows that A knows.
2. So many individuals in a modern market economy.
3. To know something is an indefinite concept itself; there is no limit to the knowledge a person can have of some thing.
5. Knowledge of How to Acquire Knowledge

Chapter 6

1. Introduction: importance of coordination: possession of resources (or what outsiders call resources) is not enough. A thing won't be a resource unless someone knows how to coordinate it with other resources.



2. Coordination in a One-Person Situation
1. Two types of actions: ordinary and learning
2. Coordination of ordinary actions
1. The fisherman's use of his knowledge of tides
2. The many actions of the fisherman on the day he decides to fish.
1. Other actions involved in fishing
2. Other non-fishing actions
3. Actions, sub-actions, and coordination
1. complementarity and potential conflicts among sub-actions
2. Coordination among animals and plants: absence of a will
3. Coordination of learning programs
1. Four types of coordination
4. Coordination in a utility sense: Coordination in the utility sense means that the individual regards his sub-actions as having a more desirable result than if the sub-actions were combined in some other way.
5. Coordination and the choice of the optimal alternative
6. Errors: full coordination can probably never be achieved
7. Insider and outsider view
3. Types of Planning and Coordination in a Market Economy
1. Centralized planning: actions performed by different individuals that are coordinated by a single individual, we say that they are coordinated by means of centralized planning.
1. Collective planning
2. Business planning

Chapter 7

1. Introduction: chapter concerned with coordination of the many types of resources, including human capital, described earlier in the book
2. Two types of cooperation described by Wakefield
1. Simple: several men lifting the same weight
2. Complex: several men or groups employed at different times and different places, and in different pursuits
3. Reinterpretation in light of the modern market system
1. Simple: coordination by means of an employment agreement
2. Complex: coordination by means of an agreement among independent contractors.
4. Reinterpretation in terms of planning
1. Simple: centralized business planning
2. Complex: decentralized planning of businesses, independent contractors, and agents.
5. The case of vertical integration: transforms complex coordination into simple coordination
3. Interpersonal coordination
1. Intrapersonal and interpersonal coordination. An example of the latter is trade.
1. Subjective vs. output point of view of coordination: use the case of slavery to distinguish the two
2. Elitist point of view: presumes to know (a) utility of each person or (b) what is best.
1. Equality elitist
1. equality overrides all other considerations.
2. presumes to know utilities and assumes that greater equality of utilities is best.
3. Professional economics: interpersonal comparison of utilities is illegitimate
1. Demonstrated preference: unless people make errors, choice demonstrates preference; therefore exchange demonstrates greater coordination.
4. Errors and haggling
1. Errors mean that exchange may not result in greater coordination although it is expected to
2. Haggling means that individuals sometimes have an incentive not to achieve greater coordination.
4. Coordination Among Many People in a Market Economy
1. Definition of market coordination in a utility sense: a situation in which the actions of separate individuals are combined to yield what at least one individual believes is a better result, yet no one believes is a worse result, than if the actions were not combined.
1. Why no situation satisfies this definition.
2. Compensation models are imaginary
2. Practical meaning of market coordination
1. The concept of local interpersonal coordination
2. Tracing the effects of a technological advance
1. invention of a superior consumers' good
2. invention of a superior resource (third-order good)
3. Even technological advance does not necessarily lead to greater market coordination in the utility sense.
3. Concept of full coordination: imaginary economy in which resources are used in a way that they generate the greatest possible consumer satisfaction, as measured in money.
1. It is not possible for two resources to change places without reducing the output of at least one of the goods and also without reducing the utility of one of the consumers.
5. Specialist Coordinating Roles
1. The intermediary role: discovering and taking advantage of gains from exchange
1. The contractor vs. the supplier of fencing materials
2. The role can be played by a trader or by a specialist intermediary
3. How the intermediary role promotes specialization: wheat farmer, miller, baker.
4. Markets, prices and "coordination by markets and prices" means coordination by individuals acting in the intermediary role
2. The undertaking role: coordinates by directive; coordination typically requires monitoring
3. The limited purviews of intermediaries and undertakers
6. Coordination of Learning Programs
1. Undertakers play a relatively minor role
1. Lack of incentive because labor and skills are owned by the person who possesses them
2. Means of overcoming this lack of incentive: fringe benefits, pension
3. Job-specific human capital
2. Anticipated coordination
1. Development of talents in the arts and in athletics; if the talent is in demand, an intermediary will probably emerge to coordinate, since coordination will be profitable

Chapter 8

1. Introduction
1. Two problems in describing economic interaction under the conditions of the market economy
1. Complexity: we have only a limited capacity to comprehend the actions of others
1. specialization
2. inability to see into others' minds
2. Invention: individuals are inventive: they can invent new resources, new goods, and new methods of production and distribution
2. Although we cannot understand inventive activity, we can incorporate it into our descriptions of economic interaction. We do this by including in our descriptions a contrast between a model of a robot economy, or a no entrepreneur economy, and an economy that contains pure entrepreneurs: the pure entrepreneurial economy.
2. The Entrepreneur Role
1. Introduction
1. Characteristics of the Entrepreneur
1. Appraisement
2. Undertaking
3. Uncertainty bearing
2. How some individuals gain control over more resources than others: some deliberately set out to gain control while other deliberately set out to sell or rent their control over resources
2. Non entrepreneur roles in the market economy
1. Concept of a role
1. why we use the concept of a role: to isolate particular aspects of their total action for further study.
2. building a composite of the aspects, or characteristics, in which we are interested
3. the example of the "student role"
4. reservation or qualification: no one is ever only a student
2. Consumer saver role: maximizes utility, has time preference. We often use the term "consumer" to refer to this role, but the saving characteristic is implied.
1. consumers as borrowers and lenders; consumers are always net lenders, since producers must borrow their money in order to maintain their capital.
3. Resource supplier role: maximizes income from use of resource
3. The entrepreneur role
1. Three functions
1. appraisement
1. definition of an appraisal: an estimate of the money value of a resource in the production and exchange of some good
2. definition of an arbitrager, the purest example of appraisement
2. undertaking: making a decision to employ resources to produce and sell a good
3. uncertainty-bearing
1. definition: period of production
2. lack of knowledge during the period of production
1. knowledge of wants, methods of production, others knowledge
2. changes in these
3. uncertainty-bearing in everyday life
1. dividing up the uncertainty bearing
2. laws absolving individuals of uncertainty bearing obligation
2. Producing entrepreneurs as final controllers of resources: those who deliberately desire to control resources in an effort to profit from their decisions
3. Entrepreneurial action as a bet: a bet that her knowledge about the wants, abilities, and knowledge of others is correct.
4. Profit and loss
1. definition
2. anticipated and realized profit and loss
3. profit is uniquely perceived (determined) by each individual; what one person regards as profit (loss) may not be so regarded by another.
5. Uncertainty vs. risk
1. uncertainty refers to knowledge of peoples' actions; it is typically uninsurable at reasonable rates
2. risk refers to technical, or scientific, knowledge; it is often insurable
1. class probability: role of a die
2. case probability: science cannot predict for certain because not enough knowledge yet exists
6. Active vs. passive roles
4. The Pure Entrepreneur
1. Embodies all of the active characteristics of the human being
2. Special assumptions
1. produces a single good from start to finish: he is perfectly vertically integrated
2. completely guarantees all loans. Therefore, he must possess wealth
1. guaranty: wealth that is not used to finance business but which guarantees that the money lent in business will be repaid
2. function of this assumption: to transfer all uncertainty bearing to the pure entrepreneur
3. Note that to guarantee loans, the pure entrepreneur must possess wealth
3. How to elucidate inventiveness
1. contrast human action with the behavior of a machine
2. contrast human action with the behavior of animals
3. The No Entrepreneur Economy
1. Roles
1. Robot producers
1. borrow money from consumer-savers
2. buy resources from resource suppliers
3. produce and sell consumers' goods to consumer-savers
4. repay loans with interest
5. no profit, choice or uncertainty
2. Robot resource suppliers
1. pure income maximizes
2. select highest paying employment for their resources
3. turn income over to consumer savers
3. Robot consumer savers
1. pure utility maximizes
2. use income to either buy consumers' goods or save
3. select highest interest on their saving
4. No time, although we can conceive of a kind of simulated period of production
2. Households, Firms, Industries, and the Structure of Production
1. Households
1. Real households
1. consist of members who act together as a unit
2. own resources and financial assets, including net worth in businesses
3. produce goods and services
4. plan and coordinate
5. participate in undertaking of businesses
6. act as intermediaries
7. speculate
8. bear uncertainty
9. make errors and adopt means of reducing the harmful effects of their errors
2. No entrepreneur economy households
1. a utility maximizing robot consumer saver
2. consumes perishable goods
3. an income maximizing robot resource supplier
4. cannot appraise resources; can only respond to prices bid by firms
2. Firms
1. Real firms
1. are sole proprietorships, partnerships, or corporations
2. produce products of different qualities and types
3. may be conglomerates
4. may be only partly vertically integrated
5. are often continuously engaged in research
2. No entrepreneur economy firms
1. are sole proprietorships
2. produce only one consumers' good
3. are perfectly vertically integrated
4. produce the same product again and again according to the same methods of production
5. borrow money from households, buy resources from households, sell their goods to households, use the proceeds to repay their loans plus interest
6. cannot earn profit
3. Assumptions about Alternatives
1. Homogeneous units of heterogeneous goods
2. Productivity differences among resources of the same type
3. Capital vs. non-capital resources
4. Assumption of markets and prices
5. Absence of time; time represented by the need to produce capital goods before achieving the lowest production cost
6. Competition
1. Absence of inventiveness
2. No distinctly human copying; all copying is immediate
3. Absence of rivalry; price competition means that all firms must charge the same price

Chapter 9

1. The Market Demand Curve
1. A relationship between price and quantity demand for all consumers of a good.
2. Demand curve is an aggregate: the horizontal sum of individual demand curves.
3. Consumers' surplus
1. Determining the consumers' surplus for one unit
2. Determining the consumers' surplus for many units
1. Unit by unit calculation
2. Sum of the area under a demand curve but above the price line (this assumes that the same market price is available to all consumers and that consumers can buy as many units as they want
3. Applications of Consumers' Surplus Analysis
1. Change in consumers' surplus due to a change in market price
2. Each consumer must pay the highest price he is willing to pay for each unit
3. Effects on demand of an excise tax on consumers (assume that the tax is borne completely by consumers)
2. Supply and Cost
1. The assumption of increasing marginal costs
2. Why supply has an upward slope
1. Scarcity of specialized resources
1. definitions of specialized and non-specific resources
2. the concept of a superior resource
3. opportunity cost and the decision to accept employment in a specific job
2. Copyright system