3360 Unit 2.1 20146-I-18

ENGR 3360U Winter 2012
Unit 2.1
Introduction to Microeconomics
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version F
Unit 2.1 Introduction to Microeconomics
Change Record
Version F Initial Creation
2.1-2
Version F
Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco
Learning Objectives
Understand the basic concepts of Economics
Understand markets and what drives them
Understand what drives economists!
2.1-3
Version F
Course Outline for Unit 2

2.1 Microeconomics
2.2 Macroeconomics
2.3 Money and the Bank of Canada
2.1-4
Version F
Basic Coverage of Microeconomics

2.1.1 Cost-Benefit Principle
2.1.2 Three Common Pitfalls
2.1.3 Production Possibilities
2.1.4 Law of Diminishing Returns
2.1.5 Supply and Demand
2.1-5
Version F
2.1.1 Cost-Benefit Principle

The Scarcity Problem
People have boundless needs and wants but the
available resources are limited (even for Bill Gates)
So much wine, so little time

There are at least 10,000 commercial wines out
there. How to find the one you love best?
Artsys solution; try them all. (At 1 bottle per day,
would take 30 years!)
Engineers solution; drink beer!
2.1-6
Version F
Cost-Benefit Principle
An entity (individual, firm, society) will
take an action if and only if the extra
benefits derived from that action exceed the
extra costs
Homo economicus
Assumptions
People are rational
Not a given that the action will succeed
2.1-7
Version F
Economic Surplus
Economic Surplus is the MONEY benefit of the
action minus its cost
what is not measurable, make measurable
Galileo
Not everything that counts can be measured;
not everything that is measured, counts
Einstein
May be other reasons for doing a thing (Ethics)
2.1-8
Version F
Opportunity Cost
The value of the next-best alternative that
cannot be done because you are doing this
Example
Suppose you can buy an Xbox on campus for
$100. But WalMart sells it for $80 in Ajax, a
$30 return cab ride away. Should you get the
cheaper box? No. The Opportunity Cost is
$100; the cost of going to WalMart is $110 so
your economic surplus is -$10.
2.1-9
Version F
Time is Money
In calculating Economic Surpluses, be sure
to consider YOUR time.
What are you worth per hour?
In the previous case, you could walk to
WalMart. But think of your time cost!
What does it cost you to fail a year at
UOIT?
2.1-10
Version F
Cost of Failing a year in Engineering!

$ of tuition, books, residence = $20K
OC of MacDs = 35(10)(6)(10) = $21K
Lost of last years salary
= $135K
Total Cost = $176K (OUCH!)
2.1-11
Version F
2.1.2 3 Blunders in Economic Estimation

1. Ignoring Opportunity Costs
2. Failure to Ignore Sunk Costs
3. Failure to understand the difference
between average and marginal costs
2.1-12
Version F
1. Ignoring Opportunity Costs

You are scheduled to work at MacDonalds for
Saturday. Your best buddy wants you to go deerhunting up at Bobcageon instead. He argues that
you will get 100 pounds of venison, saving you a
lot in beef costs ($3/pd). Alas the probability of
getting a deer is 1 in 5.
The OC are $10x12 hours = $120.
ES =(3)(100)/5 - 120 = -$60! Dont do it!
2.1-13
Version F
2. Failure to Ignore Sunk Costs

Sunk costs are irretrievable costs.
You buy a ticket to hear Broccoli Spears in
TO through Ticketron for $200. That is a sunk
cost (assuming that you do not scalp it)
You are offered the chance to flip burgers at
MikeyDs at the same time for $60.
Your OC is $60 (not $200+60) because the
$200 is sunk
2.1-14
Version F
3. Failure to understand the average

and marginal cost distinction
Marginal cost is the increase in cost
resulting in doing one additional unit of
activity
Marginal benefit ditto
Example NASA now launches 4 flights per
year. The estimated benefits are $6G per
launch
Should they launch a 5th?
2.1-15
Version F
NASA Data
Launches
1
2
3
4
5
Total Cost
6Gig
8Gig
12Gig
20Gig
30Gig
Ave Marg ES
6
6
0
4
2
4
4
4
6
5
8
4
6 10
0
ES = Economic Surplus
2.1-16
Version F
Fixed and Variable Costs

Be sure not to confuse them
Joining GoodLife costs $100 annual fee
plus $25/month
If the fee is non-refundable, it is a fixed and
sunk cost
If it is refundable, it is only fixed.
All sunk costs are fixed; not necessarily the
reverse
2.1-17
Version F
2.1.3 Production Possibilities

2.1.3.1 Exchange and Opportunity Cost
2.1.3.2 Production Possibilities
2.1.3.3 Comparative Advantage and
International Trade
2.1-18
Version F
2.1.3.1 Exchange and Opportunity Cost

When two or more entities have different
opportunity costs for performing different
tasks, they can increase the total value of
goods and services by trading with each
other
Principle of Comparative Advantage
[total output is largest when each entity
concentrates on the activities for which their
OC is lowest]
2.1-19
Version F
Frick and Frack

Activity A Activity B
Frick
20min
10min
Frack 30min
30min
As OC
Frick
2.0Bs
Frack
1.0Bs
2.1-20
Version F
Bs OC
0.5As
1.0As
Specialization Advantage
The boss mandates exactly 16 units of A must be done in 8 hrs.
Without Specialization
A Time A Units B Time
B Units
Frick
4h
12
4h
24
Frack 2h
4
6h
12
Total Output
16
36
Specialization
Frick
0h
0
8h
48
Frack 8h
16
0h
0
Total Output
16
48
NetGain
0
12
2.1-21
Version F
2.1.43.2 Production Possibilities

Salim lives on Hans Island and is the only
worker there
He can harvest 1.5kg mollusks/hour or he
can pick 3kg blueberries/hour
Assume an 8-hour day
2.1-22
Version F
Salims Production Possibility Curve

12
Mollusks (kg/day)
Attainable efficient
points
Unattainable
point
3
Attainable
0 inefficient point
6
Blueberries (kg/day)
2.1-23
Version F
18
24
Malims Production Possibility Curve

Mollusks (kg/day)
12
3
0
2.1-24
6
Version F
18
24
18
Combo Production Possibility Curve
Mollusks (kg/day)
12
3
0
2.1-25
Version F
6Blueberries (kg/day)
18
24
They Produce Many Babies too

E
A
Mollusks (kg/day)
0
2.1-26
Version F
Mollusks (kg/day)
Outward shift of PPC (tek increase for both)
0
2.1-27
Version F
Mollusks (kg/day)
Outward shift of PPC (tek increase in BBs)
0
2.1-28
Version F
Flow of Income and Expenditure
wages received
labour supplied
wages paid
Labour Market
- households supply
labour
labour hired
- firms hire labourers
Households
Firms
- produce and
sell G&S
- hire labour
- sell labour
- buy goods and
services
Output Markets
G&S acquired
- firms supply G&S
G&S supplied
- households buy G&S

household $ on G&S
2.1-29
Version F
firm $ from G&S
2.1.3.3 Comparative Advantage and

International Trade
Should help out both countries by specializing
But not at all clear to average citizen!
Ask the CAW!
2.1-30
Version F
2.1.4 Law of Diminishing Returns

for any productive enterprise, when at least
1 input is held constant while other inputs
are increased, there will be an eventual
decline in the rate of extra output
2.1-31
Version F
Farmer Example
Farmer Fred has 10 acres. He can harvest 1000 bushels of wheat
himself. By adding more workers, he can increase production.
The following table illustrates the LODR.
2.1-32
YEAR
# of WORKERS
PRODUCTION
1000
2000
1000
2800
800
3400
600
3800
400
3900
100
3900
Version F
DELTA
Inverted U-Curve (M Gladwell)

# of glasses of wine/week vs. life expectancy
2.1-33
Version F
Farmer Example
Farmer Fred has 10 acres. He can harvest 1000 bushels of wheat
himself. By adding more workers and ADD more land,, he can
increase production. The following table illustrates the LOIR2S.
2.1-34
YEAR
LAND
# of WORKERS
PRODUCTION
10
1000
20
2000
1000
30
3200
1200
40
4600
1400
50
6200
1600
60
8000
1800
70
10000
2000
Version F
DELTA
Law of Increasing Returns to Scale

If ALL inputs are increased, economies of
scale will increase total productivity.
2.1-35
Version F

Up until 1990, the ROR of an IBM
mainframe was 80%. If it cost them 1
million dollars to build, they charged $1.8M
What would you pay for a 32G memory
stick? A new printer? A new laptop?
How does a company price its product?
Apple and their new i-phone for example?
2.1-36
Version F
Musings
Supply forces that urge people to construct
something
Demand money willing to be spent by buyers
for that thing
Sellers-Buyers
Monopoly only one seller
Air infinite supply, cost zero
Consider a bumper wheat crop; price plummets
2.1-37
Version F
Selling Burgers in TO
If Torontonians would pay $100/burger
Wed all be hawking burgers on Yonge St
Then the supply would exceed the demand (how many
burgers can a person eat? Cant store them)
Prices would fall
Wed come back to class
If gas prices dropped to 50 cents a litre; $5.00 a litre?
How to quantify this effect?
2.1-38
Version F
The Supply Curve (Highly Idealized)

4
Price ($/Burg)
Supply
3
2
1
0
2.1-39
4
8
12
16
20
Supplied Quantity (1000s of hamburgers/day)
Version F
The Demand Curve

Price ($/Burg)
4
3
Demand
2
1
D
0
2.1-40
4
8
12
16
20
Demanded Quantity (1000s of hamburgers/day)
Version F
The Equilibrium Point

Price ($/Burg)
4
3
2
Supply
Demand
1
0
2.1-41
4
8
12
16
20
Quantity (1000s of hamburgers/day)
Version F
The Equilibrium Point

Price ($/Burg)
Excess Supply of
8K burgs
3
Excess Demand of
8K burgs
Demand
1
0
2.1-42
4
8
12
16
20
Version F
Supply & Demand

Are the two blades of a pair of scissors
(Alfred Marshall)
Explain the action of all sorts of markets
Foreign Exchange for example
1$CND = $0.96US
1$US = $1.04CDN
2.1-43
Version F
More Likely Shape

A
PRICE
4.00
2.00
1.00
5
2.1-44
Version F
11
QUANTITY
More Demand Shapes

DC
PRICE
B'
2.1-45
A'
5 6
Version F
DC'
QUANTITY
15
PERFECTLY
INELASTIC
PRICE
PRICE
Extreme Demand Elasticity
QUANTITY
2.1-46
Version F
PERFECTLY
ELASTIC
QUANTITY
PERFECTLY
INELASTIC
PRICE
PRICE
Extreme Demand Elasticity
QUANTITY
Life-saving drug
2.1-47
Version F
PERFECTLY
ELASTIC
QUANTITY
Mustard A
Mustard B
PERFECTLY
INELASTIC
PRICE
PRICE
Extreme Supply Elasticity
QUANTITY
2.1-48
Version F
PERFECTLY
ELASTIC
QUANTITY
PERFECTLY
INELASTIC
PRICE
PRICE
Extreme Supply Elasticity
QUANTITY
Hope Diamond, land, EMS
2.1-49
Version F
PERFECTLY
ELASTIC
QUANTITY
CDs, pencils
Elasticity of Demand
When the price of a good increases, demand
falls. But not all fall the same rate.
For example, if the price of peas went up
20%, the demand would plummet. If the
price of cigarettes went up 20%, demand
would hardly change.
The demand for peas is elastic; cigarettes,
inelastic.
2.1-50
Version F
Definitions of Price Elasticity

Price elasticity of demand = percentage change
in quantity resulting from a 1% change in price
Example if the price of gas falls 1% and the demand
rises 2%, = 2 (we ignore the minus sign)
Elastic if >1
Inelastic if <1
Unit elastic if =1
2.1-51
Version F
Observations on Elasticity
If >1, an increase in price will reduce total
revenue(& vv)
If <1, an increase in price will increase
total revenue(& vv)
If =1, an increase in price will leave total
revenue unaffected (& vv)
2.1-52
Version F
Typical Examples
Green peas 2.80
Restaurant meals 1.63
Automobiles
1.35
Electricity 1.20
Beer (non-engineers)
Movies
0.87
Air travel (off-shore)
Shoes
0.70
Coffee
0.25
Theatre/opera
0.18
Beer (engineers) 0.01
2.1-53
Version F
1.19
0.77
Summary
The market for a good is the totality of all actual and
potential buyers and sellers.
For a given price, the supply curve shows the quantity
of that good that the sellers are willing to create and
sell
The demand curve is the quantity that the buyers will
buy at that price
Market equilibrium is where the two curves cross;
buyers quantity-price-pt. = sellers quantity-price-pt.
2.1-54
Version F
Reaching Equilibrium
May take time; curves may shift
For example
Freeze in California
Supply tanks, demand is constant, price soars
But hard to increase supply (need to plant more
trees etc.)
2.1-55
Version F
Changes in the Equilibriums

That is; shifts in the curves NOT caused by price
Caused by improved production techniques
Caused by changes in tastes, worries over transfat, bad weather, etc.
Note the terminology
Increase in quantity demanded (slide down the curve)
static prices/demand
Increase in Demand line shifts to the right
prices/demands shift
2.1-56
Version F
Increase in Demand
Price ($/Burg)
Increase in
Demand
At every price,
the quantity
demanded
increases
2
1
0
2.1-57
D'
4
8
12
16
20
Version F
Shifts in the Supply Curve

Price ($/Burg)
S'
3
2
Demand
1
0
2.1-58
4
8
12
16
20
Version F
Suppose that Norman Nerdo develops a

new process to take a live cow in at one end
and spit out beef patties at the other
Becomes 50% cheaper to make hamburgers
than before
The whole supply curve shifts to the right
2.1-59
Version F
Canonical Rules on Supply & Demand

P'
P
D
S
P
P'
D
2.1-60
Q Q'
Quantity
Version F
P
P'
D'
Q' Q
Quantity
S'
Price
Q Q'
Quantity
Price
S
Price
Price
D'
S'
P'
P
D
Q' Q
Quantity
Canonical Rules on Supply & Demand
Price
Q Q'
Quantity
D
Q Q'
Quantity
Version F
Burgers
cause cancer
P
P'
D'
Q' Q
Quantity
S'
Cost of cows
halves
P
P'
Price
Burgers act
like Viagra
P'
P
2.1-61
Price
Price
P'
P
D'
S'
Mad cow
doubles the
price
D
Q' Q
Quantity
Price /$kg

RCMP decides to get tough on drugs. Spends a
bunch of $ and drives the hoods off. Supply
curve shifts backwards.
S'
S But look! Total $ spent
on drugs increases!
Chances
of
your
laptop
being
800
stolen increases!
500
D
4 5
Q (1000 kgs/day)
2.1-62
Version F
PRICE
Price Ceilings
D
P*
PC
QS
2.1-63
Version F
Q*
QD
QUANTITY
Price Ceilings
Shortages, queues
Housing for example
Common in demand economies
2.1-64
Version F
Price Floors
D
PC
PRICE
P*
QD
2.1-65
Version F
Q*
QS
QUANTITY
Mohair Madness
In the 2nd WW, Americans needed mohair
wool to protect pilots at high altitude. So the
US gov put a huge subsidy in place to
encourage the production of goat wool
Now we have no need of it
Subsidy is still there
Go figure!
2.1-66
Version F
Perversity of Price Supports

American example
Pay framers NOT to grow crops!
Imagine if I am paid NOT to teach!
Give it away? Ruin the Nigerian wheat
farmer
2.1-67
Version F
Morale
Let the Invisible Hand of the Market do its
work (Adam Smith)
Produce what you do best
Note the connection with international trade
FREE TRADE SI!
UNFREE TRADE NON!
2.1-68
Version F
Marx was WRONG

Karl not Groucho
A child of five could understand Economics.
Send someone to fetch a child of five! pace
Groucho Marx
Je suis Marxiste tendance Groucho!
2.1-69
Version F

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ENGR 3360U Winter 2012

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Course Outline for Unit 2

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Basic Coverage of Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

2.1.1 Cost-Benefit Principle

So much wine, so little time

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Cost of Failing a year in Engineering!

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

2.1.2 3 Blunders in Economic Estimation

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

1. Ignoring Opportunity Costs

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

2. Failure to Ignore Sunk Costs

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

3. Failure to understand the average

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Fixed and Variable Costs

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

2.1.3 Production Possibilities

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

2.1.3.1 Exchange and Opportunity Cost

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Frick and Frack

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

2.1.43.2 Production Possibilities

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Salims Production Possibility Curve

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics

Malims Production Possibility Curve

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 2.1 Introduction to Microeconomics