Microeconomics: A Computational Approach

A Computational Approach

Gerald E. Thompson

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781315499871
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This concise and comprehensive introduction to economics offers readers at all levels a more realistic approach to understanding the elements of resource and product markets, including the role of business decisions; technological change; product differentiation; uncertainty; and the optimal location of activities. With the book's easy-to-use software package for computations, even non-economists will become strongly motivated and can gain a proficiency in economic analysis as well as in practical and professional decision-making skills. End-of-chapter problems, computer exercises, programming examples, and numerous diagrams further enhance the book's usefulness.

Part I

Basic Economics and Decisions

1

Good Economic Thinking: Its Focus and Its Limitations

The aim of our study is to understand better the economic part of our lives in order to manage such affairs wisely. And we find the economic strand to be closely intertwined with other strands, making the task a challenging one.

Through it all, the economic aspect involves the common phenomenon of scarcity. Loosely speaking, this means that more of things are desired or needed than is available. Many goods and services, such as those involved in providing security, justice, and national defense, are “consumed” in a collective fashion. However, in these cases, as well as in others, scarcity is still involved.

Also, an understanding of the costs of things, which in a sense are indicators of relative scarcity in relation to their demand, requires viewing all buyers of a product or service to be taken together as well as all of the sellers.

Thus, our attention will focus at times on an individual person’s or an individual firm’s decision. At other times we shall look at all such decisions involving a specific product or service in the aggregate because of their effect on prices and the availabilities of goods and services.

The scarcity of goods and services to satisfy the desires of people implies the need for choices to be made. Thus, economic study focuses on decision making by individuals, organizations, and governments in making choices on the use of their limited resources such as time, money, land, equipment, facilities, or other such limited resources.

Much attention must be focused on the sources of goods and services (the entrepreneurs, managers, producers, etc.) who must make choices on what to produce with their limited resources and how it is to be produced (that is, the “techniques” to be used in production).

Furthermore, people in a free society viewed in the aggregate “decide” (without full awareness) through a system of markets or political institutions on what goods and services are produced by the whole system, how and where they are produced, and more or less, how much each person receives of society’s total output.

We surely agree that the complex economic reality that we seek to understand presents a challenge. We want to become familiar with the best thinking available to us from the past as well as new ways of viewing and thinking about economic questions. Thus, our job is that of trying to understand well how our complex economic and business world functions and then, also, trying to learn how to make good assessments of what might happen in real situations and to make good decisions in those situations both in our work and our private lives.

We will try to take a more “hands-on” approach so the discussion does not seem so remote from reality. We will focus on decisions by consumers, firms, and government. Hence, we will use the simple “possibilities” tables and graphs where appropriate and illustrate the principles of rational decision making using “decision trees.”

Good assessments of real situations (that is, assessing well what might happen and what is the best thing to do) require, first of all, an awareness that real situations are usually too rich, too diverse, and too interrelated and ever-changing for us to be able to capture them fully in our thinking. And this is true whether the thinking is formal or whether it is informal and intuitive.

Thus, invariably we have to leave much of reality out of our thinking, which of course makes the thinking somewhat incomplete. This commonly results in errors in the prediction of events and subsequent errors in decision making. We need to remember that real events may be caused, in part, at least, by factors we did not take into account. (Note: If, as the great philosophers have asserted, in a deep sense all reality is interrelated and past reality creates future reality, to attain perfect prediction and perfect decision we would have to incorporate all of reality and its interrelatedness into our thinking, which, of course, is impossible.)

The overriding need, then, is to try to identify, in light of our current knowledge, those elements in reality that are most important on which to focus so as to predict well and to make good decisions.

2

Free Markets: A Subtle and Decentralized System of Decision and Control Over Resource Use

The study of economics exists because of the limitations in the availability of resources needed to produce the goods and services we want. Simply put, the land, labor, equipment, and facilities used to produce one product are not at the same time available to produce other products. Therefore, choices have to be made on the uses of the available resources. These choices involve at least four interrelated decisions. They are:

1. What goods and services are to be produced with the limited resources (and how much of each).

2. For Whom the goods and service are to be produced; that is, “who is to get them.”

3. How the goods and services are to be produced; that is, “by what technology.”

4. Where they are to be produced; that is, the location of the production.

The need for making these decisions appears in some way in all economic systems, both those small and simple, and those large and complex. At one extreme we see the need arising in the isolated self-sufficient frontier farm family; at the other, we see the need in the modern, complex, and interdependent economy involving millions of individuals. In the latter, however, there exists extreme specialization of labor, equipment, and facilities along with the necessary use of money and markets for the pricing and allocation decisions involving the many products, services, and resources. Also, the goods and services consumed are for the most part goods and services created by others.

In the case of the frontier farm, the family can simply make all of the four decisions more or less directly without involving outside entities. Essentially, family members see that “what they produce is what they get.” In the modern economy, however, these decisions, subtle and often spontaneous, involve many people, firms, markets, and governments. But here, too, we find that the amount of goods and services available to the people depends on how much is produced in the entire system.

Because of the dominant role played by free markets in making these four decisions, we need to examine in more detail just how free markets perform these functions of arriving at the decisions and also in controlling the use of resources.

What Goods and Services Are to Be Produced and in What Quantities

In a modern real economy, many different products and services can be produced with the resources available. We say that the resources limit the “possibilities” for the production of goods and services.

To help convey the nature of these limitations and to make them a bit more concrete we can construct a simple numerical production-possibilities graph, as shown in Figure 2.1. Of course, this is only a “concept” graph indicating the general nature of the basic economic problem.

The shaded region in Figure 2.1 represents possibilities for the production of the two products. We can think of Product 1 as being “consumer goods” such as clothing and Product 2 as “capital goods” such as machines. The resource limitation line marks the boundary of all of the possible output combinations of Product 1 and Product 2.

Table 2.1 shows a basic data table that lies behind the graph in Figure 2.1. From this table we constructed the graph in Figure 2.1. Thus, given the resource amount of 12 hours for a period (in reality, more like hundreds of thousands of hours of labor or machines) Product 1 with its rate of use of 2 hours would permit 6 units of Product 1 to be made if all resources were devoted to it. Product 2 would then have an output of 0.

Figure 2.1 A Production-Possibilities Graph

Analogously, the point (0,3) represents the output combination if all resources were devoted to making Product 2. Other points on a straight line drawn between the two points above represent possible combinations of the two products in light of the resource availability of 12 hours. A possible combination that does not lie on the limitation line is the point (2,1). Such points are associated with the failure to use all resources fully. If such a combination were to occur it would likely be temporary.

At times, we may construct a table showing selected combinations of the outputs of the products that are possible, such as is done in Table 2.2. In effect, a choice can be made from these combinations or the numerous other combinations represented by points on the resource limitation line in Figure 2.1.

Table 2.1

Basic Data Table

	Rates of resource use (in hours)
	Product 1	Product 2	Resources available
Resources	2	4	12

Table 2.2

Product Combinations Table: Selected Combinations of Product 1 and Product 2 That Are Possible

Product 1	Product 2
0	3
2	2
4	1
6	0

We have selected a (2,2) point in Figure 2.1 as a possible mix of the two products currently preferred. The point represents 2 units of output of each product. Then, let us suppose a change in relative preference occurs regarding the two pr...

Table of contents

• Cover Page
• Half Title Page
• Title Page
• Copyright Page
• Contents
• List of Diagrams, Figures, Tables, and Policy Boxes
• Preface
• I Basic Economics and Decisions
• II Computational Economics and Decisions
• Answers to Selected Problems
• Selected Bibliography
• Index
• About the Author