Micro Chapter Summaries

Chapter 1: What’s in Economics for You?: Scarcity, Opportunity Cost, Trade

Presents the key concepts for making smart choices — scarcity and opportunity cost.We explain the most basic choice — producing for yourself or specializing, trading in markets and depending on others. There is a simple example — using tables of numbers that are implicit production possibility frontiers — illustrating the gains from trade and comparative advantage. The last two sections use the implicit metaphor of economic theory as a road map, and end with the map of the Three Keys that are the core principles that guide smart choices.

Chapter 2: Making Smart Choices: The Law of Demand

Develops demand as a response to two questions: “How badly do you want it?” and “How much are you willing and able to give up for it?”Demands are smart choices when expected benefits are greater than costs, and we explain the importance of marginal benefit (Key 2).We develop quantity demanded and the law of demand from an example of choice among substitutes, focusing on what happens to buying decisions when prices change.We then provide examples of the five factors that change demand, and discuss substitutes, complements, and normal/inferior goods. The final section on elasticity of demand focuses on the intuition of elasticity as responsiveness, and the relation between elasticity and total revenue. Elasticity is presented as a crucial concept for making smart business pricing decisions.

Chapter 3: Show Me the Money: The Law of Supply

Motivates the supply decision as a choice among alternative opportunities, comparing expected benefits and costs at the margin.We show that all costs are ultimately opportunity costs. Quantity supplied is developed using examples of willingness to work, and a business example of choosing among alternative products to supply. The example of Paola’s Piercing and Fingernail (PPF) Parlour is an implicit production possibilities frontier (without ever using that term) that yields increasing marginal costs (and the law of supply).We emphasize the simple calculation of opportunity cost as give up/get. The five factors changing supply are illustrated with examples. The final section illustrates price elasticity of supply, emphasizing how to avoid (not-smart) business decisions to promise more than you can deliver over time.

Chapter 4: Coordinating Smart Choices: Demand & Supply

Describes markets as a process — the interaction between buyers and sellers. Markets combine competition and cooperation (voluntary exchanges) and require property rights as the rules of the game.We explain the miracle of markets in providing the goods and services we most value.We begin with excess demand (shortages, frustrated buyers) and excess supply (surpluses, frustrated sellers) and focus on the quantity and price adjustments that will be made to smart decisions, driving prices to market-clearing.We explain equilibrium as a balance of forces of competition and cooperation. The final section examines how markets respond to changes in demand or supply. Price signals in markets create incentives so that self-interest, coordinated through Adam Smith’s invisible hand of competition, results in the “miracle of markets”— an intuitive shorthand for efficiency.

Chapter 5: What Gives When Prices Don’t: Demand & Supply When Governments Fix Prices

Examines the unintended consequences of government price-fixing policies —quantities adjust instead.We examine problems caused by rent controls, and discuss more effective policies to help the homeless.We discuss minimum wage laws, and explain unemployment as quantity adjustment.We discuss debates about the effectiveness of minimum wage laws and show how the impact on employment depends on the elasticity of demand for labour. The message is that to have an informed political viewpoint about living wage laws you need to understand elasticity of demand. The final sections examine efficiency/equity trade-offs, to show that policies that hamper price adjustments and cause inefficiencies may still be justified on equity grounds.We compare health care in the U.S. and Canada, and discuss the difference between an efficient market outcome (when many cannot afford healthcare) and an equitable outcome (where there are waiting lists due to lack of price adjustments).We introduce the positive/normative distinction for understanding which policy choices can be decided by empirical evidence, and which require values. The emphasis is on helping students make informed policy choices as citizens.

Chapter 6: Finding the Bottom Line:  Opportunity Costs, Economic Profit/Loss & the Miracle of Markets

Focuses on economic profits as a measure of business success and as the signal directing markets. The distinction between accounting profits and economic profits is illustrated with a small business example. We then show what the accountants miss — the opportunity costs of your time and money — and develop the economist’s conceptions of normal profits and economic profits. This is the importance of Key 3 — count implicit costs. The final section illustrates how economic profits direct the invisible hand, using examples of economic loss, breakeven, and economic profits as signals for smart business decisions to exit, continue in, or enter an industry.

Chapter 7: The Power to Price: Competition & Monopoly

Focuses on how market prices are set somewhere between the maximum consumers are willing to pay and the minimum businesses are willing to accept. Where prices settle depends on competitive conditions and a business’s market power (which in turn depend on the availability of substitutes and the elasticity of demand). Market power is presented as a continuum, ranging between the extremes of pure monopoly (price maker) to our intuitive term for perfect competition, extreme competition (price taker).We describe the characteristics of market structure — substitutes, product differentiation, number of businesses, barriers to entry. In describing economies of scale, we define fixed costs, variable costs and total costs, and average total costs.We describe market power as inversely related to elasticity of demand.We characterize competition as an active attempt to increase profits and gain the market power of monopoly, whether through cutting costs, increasing quality, product differentiation, advertising, buying out competitors, or erecting barriers to entry.We end with Schumpeter’s concept of creative destruction to explain the inherent change and growth of the market economy, and to explain controversial trends like offshoring, the destruction of manufacturing jobs in Canada, and technological obsolescence of products, which nonetheless improve overall living standards over time.

Chapter 8:Pricing for Profits: Marginal Revenue & Marginal Cost

Develops, for any market structure, the common “recipe” for setting the profitmaximizing price and quantity: estimate marginal revenues and marginal costs, and then set prices that allow you to sell all quantities for which marginal revenue is greater then marginal cost. Based on the “one-price rule” (when buyers can resell), we explain when marginal revenue equals price (the price taker of extreme competition) and when marginal revenue is less than price (businesses with some pricing power). For marginal cost, we develop examples where marginal cost increases with increasing output and where marginal cost is constant (for most businesses not operating at capacity). We combine this information for the business’s quantity decision (choose quantity where marginal cost equals marginal revenue) and the decision to set the highest possible price allowing sale of the target quantity. We tie the recipe back to the Three Keys, and emphasize the importance of Key 2 (marginal decisions). Finally, we look at industries where the one-price rule does not apply, and explain how businesses can increase profits through price discrimination.

Chapter 9: Monopoly Rules: Government Regulation, Competition & the Law

Focuses on market failures caused by economies of scale or collusion, and government attempts to correct the failures. The policy challenge is gaining efficiencies of economies of scale, but avoiding inefficiencies of restricted output and increased price. We examine public ownership and regulated private monopoly, focusing on simple rate of return policy. To motivate competition law, we describe cycles of gasoline price wars, and explain them as strategic, competitive decisions.We use a simple prisoners’ dilemma game to explain the tension between the Nash equilibrium outcome and the fact that players would be better off if they could trust each other.With the complication of trust, there are now two smart choices — high prices are a smart choice based on trust, while price wars are a smart choice based on non-trust.We discuss cartels (OPEC), and competition law as government attempts to counter collusion.We contrast public-interest and capture views of government, and focus not on the normative question of “should governments intervene?” but on the positive question, “When will government action improve market failures, and when will it produce a worse outcome?” A citizen must evaluate evidence to decide which is worse — market failure or government failure — and make normative, political decisions about regulation policies that may trade off public safety versus efficiency and lower prices.

Chapter 10: Acid Rain on Others’ Parades: Externalities, Carbon Taxes, Free Riders & Public Goods

Externalities, Carbon Taxes, Free Riders, and Public Goods Focuses on how to make smart personal and social choices about pollution. We revisit Chapter 4’s invisible hand conclusion, and ask why markets also produce “bads” like pollution and traffic jams. In explaining externalities (Key 3 — count external costs) we show that smart personal choices are not the same as smart social choices, for both negative and positive externalities.We explain the policy rule: choose the quantity of output where marginal social cost equals marginal social benefit.We discuss policy options for remedying this market failure (carbon taxes and cap-and-trade systems), and emphasize the phrase behind all policies (internalize the externality). For positive externalities,we explain free riders and why markets won’t produce lighthouses. Using a numerical education example we again show differences between smart private and social choices, pointing out the role for government in providing public goods, and examine subsidies and public provision.

Chapter 11: What Are You Worth?: Demand & Supply in Input Markets and The Distributions of Income & Wealth

Demand and Supply in Input Markets, and Income and Wealth Distributions Explains income as a function of prices and quantities in input markets. Even efficient market outcomes may yield serious inequality and poverty.We present this market “failure” as an efficiency/equity trade-off. Input prices are wages for labour, interest for capital, rent for land, profits for entrepreneurship.We explain wages from derived labour demand, and use the Three Keys, especially Key 2’s marginal focus, to explain smart business hiring decisions. The rule is: Hire additional labour as long as marginal revenue product is greater than the wage.

Returns to capital focuses on present value as essential for smart investment choices, when benefits are spread out over the future and cost is in the present. The rule is: Choose if present value of stream of future returns is greater than the price of the investment. Economic rent is a return to any input in relatively inelastic supply, which we illustrate with superstar salaries. The final section presents income and wealth data, and we discuss education/training and progressive taxes/transfers policies to help those who are poor.We discuss the Robin Hood principle — take from the rich and give to the poor — and that the opportunity costs of tax-changed income distributions are incentive effects. For the normative question of should we help those who are poor, we outline “yes” and “no” answers that students will hear from politicians and must decide for themselves, depending on whether they are being taken from/given to, on equity conceptions (equal opportunity or equal outcomes), and on values about efficiency/equity trade-offs.