1. Most of Chapter 1 will have been covered to some degee in your introductory principles class. You might find it helpful to review your notes, check out your old quizzes, skim your book, or ask your friends from the class if they can remember anything you can't.
2. It helps to remember that the "big picture" concept in economics is the Invisible Hand (OK, so it's invisible, so does "big idea" work better for you?). Once you firmly grasp the invisible hand, the partnership between you and economics will begin. Enough of the corny metaphors; what does all that mean? Basically, start looking for the invisible hand principle at work, and just keep looking for it. You'll learn to see it, in some form, in most of the examples throughout the book. Then, you'll see it all around you.
3. Be sure you understand what the assumption of rationality means in economics, and its importance in predicting behavior. Avoid thinking that rationality requires a logical decision-making processes. Examples 1.3, 1.4, and 1.5 might help you see what rationality looks like in practice.
4. It's easy to confuse normative and positive, especially if your principles courses did not stress the distinction. To elaborate, positive deals with what is, what will happen, or why something happened in the past. It is a cause-and-effect, inner-workings, hypothesis-testing way of thinking. If you are seeking "the truth," even if it is unpleasant, then you are probably thinking positively. In short, positive is scientific. Normative, on the other hand, deals with what you want to happen, or what you think is right, fair, important, nice, or good. In a sense, normative is personal.
5. It is also helpful throughout the chapter and course to remember that economics is scientifically useful. In fact, in some ways it is as accurate in its predicitions as pragmatic sciences such as engineering and medicine. The "Ecologist, the Economist, and the Statistician" example illustrates this, but so do most of the examples in the book. Economists are constantly starting from their understanding of how the world is put together, and venturing out to predict how things will change or to explain why things happened as they did.
6. Two recurring and important concepts in economics are optimization and equilibrium. While they may sound similar, you will find it helpful to distinguish between them. One way to do this is to think of decisions of individuals or firms (economic agents) as "optimizing" choices, and think of the workings of markets (or the interactions of economic agents) as "equilibrium".
1. You probably studied quite a bit of this chapter's material in your principles course. If the chapter itself is not enough of a refresher, you might want to go back over your materials from that class.
2. It is very important that you understand the difference between a change in demand (shift of the demand curve) and a change in amount demanded (movement along the demand curve) before you proceed to more advanced material. Just remember, demand for a good doesn't change just because the price of that good changes-- the amount demanded will change when price changes, but demand will not.
3. The technique known as "simultaneous equations" is used frequently from this chapter on. If you have not had much practice substituting one equation into another, you may get a little overwhelmed. However, with a little practice doing the algebra, you will probably find that it is not only easy, but very powerful.
4. Spend a good deal of time making sure you understand the relations between total, average, and marginal magnitudes. While they are mathematical concepts, it is important to understand the graphical connections between them.
5. Mind your Ps and Qs. It is very easy to mix up variables, differentiate with respect to P instead of Q, or sum prices when you mean to sum quantities. Practice will help correct this tendency, but try to be alert and not get frustrated.
1. When studying cardinal and ordinal magnitudes, it's easy for some folks to get them mixed up. A little trick for remembering is that "ordinal" deals with "order" (how a person would rank goods) while "cardinal" and "calculate" both begin with "c" and both deal with numbers.
2. The shapes of indifference curves for various combinations of goods, bads, and neuters is an important topic. It helps to understand that indifference curves show the trade-offs a person is willing to make.
3. Remember that each indifference curve characteristic can be derived logically or is based upon empirical observations.
4. When you view a set of indifference curves, ask yourself that the direction of preference (greater utility) is. Starting out in this way will probably keep your confusion to a minimum.
1. In this chapter, the mathematical calculations might start to overwhelm you. If this happens, the best thing you can do is carefully read through the excercises and solutions in the book. This may seem obvious, but when rushed or panicked, the exercises are easy to overlook.
2. At first, you may find all of the curves in this chapter confusing. One way to keep from being confused is to remember that all of the curves involve seeing how the consumer's optimum choice changes when one parameter is changed. Sometimes, the optimum we are looking at involves only one aspect of the consumer's choice, and sometimes it involves more than one.
3. The Price Expansion Path and the Income Expansion Path are similar in showing what happens to the optimal quantities consumed of both goods x and y when price or income, respectively, are changed. The demand curve and Engel curve show what happens to the optimal quantity consumed of only one good when price or income, respectively, are changed. If it helps, remember that the longer-named curves show both x and y consumption, but the shorter-named curves show only one good's consumption.
4. The Price Expansion Path is related to the demand curve, but they are not the same. Similarly, the IEP is related to the Engel curve, but they also differ from each other. If you can understand the relationships and differences, it may help you keep them straight. Try to construct a demand curve from a PEP or an Engel curve from an IEP, for example.
5. Understanding the distinction between income and substitution effects can be difficult. As it will be coming up often in the book, put in the effort to grasp it now.
6. You may find you understand more if you think about the shapes that indifference curves must have when dealing with normal vs. inferior goods. For example, if the goods are normal, the indifference curves become steeper as we move upward.
7. The analysis of the consumer's optimum in Chapter 4 is difficult for many people, but very important, especially since it will be the foundation for other optimization problems you will encounter later on. You may find that the graphs make more sense to you than the mathematics, or vice versa. If so, try to extend your understanding of one form of the analysis to to the other. If you understand the graph, try to figure out how the math is just showing the same thing in a different way.
1. Elasticity, which is fundamental to this chapter, may be confusing to you. Various definitions of elasticity are useful for different problems, but the most easily understood form seems to be the percentage change in one (dependent) variable over the percentage change in another (independent) variable:
2. The concept of a Giffen good is discussed in the book and its examples, but it is more of a curiousity than an important and commonly-seen phenomenon. If your instructor doesn't stress it, don't stress over it.
1. In previous chapters, the emphasis was on consumers and demand. In this chapter, the emphasis shifts to production and supply. Also, the economic units of major interest now become the firm and the industry.
2. It is easy to fall into the trap of interpreting the short-run and long-run as time periods only, rather than decision horizons in which different levels of choice are possible. If you can, try to think of long-run decisions simply as those in which virtually anything can be done or at least started. A short-run then becomes one made with a great many more limitations concerning what can be decided or changed.
3. The graphical relations discussed in this chapter may take some effort to understand, although you may have had a basic introduction to them in your principles course.
1. Most students readily understand why the supply curve of a competitive firm is the MC curve. However, if you have trouble with it, just remember that the firm is weighing the benefit of producing an additional unit of output (the price) against the cost of producing an additional unit of output (the marginal cost). The amount of output the firm will make and sell (the quantity supplied) is thus found where the price and MC are equal. That means that for any price, the MC shows the quantity that the firm will produce. Maybe that helps and maybe it doesn't.
2. The zero-profit theorem may seem strange. How can zero economic profit be the outcome when so many firms are acting in the way that maximizes their profit? Of course, this is a good example of the Invisible Hand in operation. It is precisely because a large number of firms are producing output in an attempt to get profit that the price of the output falls to equal long run average costs, thus benefitting consumers!
3. If you did not cover the concepts in your principles course, or have forgotten them, be sure to review Consumer Surplus and Producer Surplus. They will be important in understanding future discussions of price controls, agricultural price supports, taxes, tariffs, subsidies, rationing, and minimum wages.
1. By now, you should be able to explain in your sleep why MC = MR.
2. The efficiency loss due to monopoly and regulation are important concepts.
3. Market Segmentation is easily understood at the basic level, but the relationship between the price in a segment and elasticities of demand can be summarized by remembering the formula:
1. You might want to take note that product differentiation is essential to monopolistic competition, but product differentiation arises in other market structures as well -- for example in pure monopoly. To think of product differentiation only in the context of monopolistic competition is a serious error. If the text or your class tend to muddle this in your mind, try to remember that product differentiation occurs in may kinds of market situations.
2. Notice that the text develops the monopolistic competition solution from the monopoly solution for product differentiation by imagining that the separate productive plants of a monopolist become independent firms.
3. The locational analog is a very useful way to understand product differentiation, but keep in mind that it is an analogy. Also, while the linear location metaphor for product differentiation is probably easier to understand, the circular or ring metaphor introduced in the text is actually much more useful.
4. The idea of quality equilibrium is probably entirely new to you, but it simply reflects the real world situation that not all competition is based upon price. Also, you may find the special application to suppression of inventions to be of particular interest.
1. The idea of a Reaction Curve will probably take some time to get used to. Take your time and you will probably get the idea after working through the exercises in the text.
2. The kinked demand curve is a good way to reinforce your understanding of the Marginal Cost/Marginal Revenue curves. The practical value of this theory is in question, however, although it does explain some things and is sort of simple to grasp.
3. The theory of games may be confusing to you, until you sort of remember that it is a "game" itself, with its own little rules. Learn the rules, and you can play (although it may not be exactly "fun").
1. This chapter has lots of implications for everyday decison-making, as well as for some more unusual sorts of decisions. Hopefully, you will find some decisions in it that you either have made or will make in the near future.
2. The foundations for much of the analysis have been laid in previous chapters. It will probably be helpful to review utility theory and consumer choice (chapters 3 and 4), as well as game theory and public goods (chapter 10).
3. Probabilities play a greater role in this chapter than perhaps any other, although the level of complexity is kept low. Time to review your statistics class.
4. The analysis of the “lemons problem” may seem confusing, since ther is a "demand curve" that slopes up (in Figure 11). However, remember that a good’s attributes are held constant when a demand curve is drawn, but a different curve is needed to analyze the effect when attributes can change.
1. You probably will understand the Factor Employment Condition, mrpa = mfca, by focusing on the graphs in the chapter.
1. The leisure/income graph is an important application of preference theory generally and indifference curves in particular. It may be necessary to briefly review Chapters 3 and 4.
2. It may seem strange that we regard leisure as a "good," but you might want to review the chapters on utility to see why that is.
3. Notice that Producer Surplus and economic rent are closely related, but not identical. You might want to make sure you understand when they are (essentially) equal and when they will not be.
1. This chapter is one of the most crucial of the book. In it, the topic of market equilibrium is systematically treated for the first time, apart from the preliminary discussion in Chapter 2.
2. The Edgeworth box may be hard to get used to. Honestly, if you have to turn the diagrams upside-down a few times, we won't tell on you.
3. It is easy to confuse exchange with production. One of the more common errors is to inadvertently say something that applies only where production can take place, when you are actually talking about pure exchange. Much confusion can be avoided if you remember that exchange is simply a reshuffling of a fixed quantity of goods, while production always involves a change in the physical quantities (social totals) of goods.
4. This section on transaction costs of the lump-sum variety is a difficult portion of the chapter. If your professor is going through it, give yourself extra time to understand it.
5. The topic of money, and its role in reducing transactions costs, is particularly interesting because it constitutes a bridge to macroeconomics.
1. The topic of intertemporal choice is often puzzling to students because of the special language used: interest, investment, time-preference, saving, etc. It is reassuring for students to know that, apart from the special terminology, they do not have to learn a new subject matter to deal with intertemporal problems. The standard price-theory techniques of individual optimization and market equilibrium are completely valid and applicable in the realm of intertemporal choice. Indeed, this is one area where practical businessmen and government decisionmakers are aware of the relevance of economic analysis.
2. The concept of Present Value comes easily to most students. A real test of their understanding is to see if they can handle changing interest rates.
3. The graphical interpretation of saving, borrowing, investment, and lending will not be understood after just one pass. Making the connection with the discussion in Chapter 14 (full versus transaction demand and supply, etc.) will do much to help understanding.
1. In the discussion of general equilibrium, and especially when explaining the various conditions for efficiency, a diagram showing the social PPC and an inscribed Edgeworth box is often helpful.
2. The section entitled "What Can Go Wrong? Almost Everything." is very useful for deepening the student's understanding of the operation of the Invisible Hand. References to the Coase theorem, with due regard for real-world applicability, are also helpful.
3. When discussing public goods, the concept of vertical summation of demand curves needs careful attention. Students will be familiar with the technique from Chapter 4, but the logic behind it is somewhat less than obvious.
4. Students are often inclined to consider the Problem of Equality as a violation of the laws of economics. Much confusion can be avoided if you stress the fact that equality can be thought of as a special kind of public good, which arises because of man's tendency to be benevolent to those less fortunate than himself, and jealous of those who are more fortunate.
This chapter makes for both easy reading and interesting classroom discussion. Coverage of this exciting new extension of economic analysis will go far towards deepening the students' interests in economics.
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