1.1 Welcome to Econ 50
This planet [Earth] has — or rather had — a problem, which was this: most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movement of small green pieces of paper, which was odd because on the whole it wasn't the small green pieces of paper that were unhappy.
When most people think about economics, they’re thinking about money, or what they have come to know as “the law of supply and demand.” However, economic activity — producing, trading, and consuming goods — existed before there was ever either money or markets, and many important economic decisions have nothing to do with prices. Economic activity fundamentally consists of producing goods and services using scarce resources, with the end goal of providing utility or happiness for people. To the extent that we’re interested in markets, it’s because markets are an institution that coordinates these activities.
This course takes the approach of first analyzing the “real economy,” absent the existence of markets or other institutions. We’ll model this as what economists have long called a Robinson Crusoe economy; though to bring us into the 21st century, and to deal with a less problematic narrative, we’ll refer to the plot of the movie “Cast Away” rather than the original novel by Daniel Defoe. In that movie, a FedEx manager named Chuck, played by Tom Hanks, is stranded on a desert island, and in order to survive must produce anything he wants to consume. As both the only producer and the only consumer on the island, there are no markets or money involved — Chuck doesn’t pay himself for the coconuts he produces! — but Chuck’s core challenge is the same as any economy: given the available resources, and the technology available to transform those resources into goods, what allocation of resources would result in the most happiness?
For the first four weeks of class, we will introduce the core building blocks of microeconomic analysis, production functions and utility functions. We derive Chuck’s production possibilities frontier from his resources and available technology, and solve Chuck’s problem of what to produce using the fundamental economic modeling tool of constrained optimization. The purpose of Midterm 1, on the Monday of Week 5, is to solidify these techniques.
With this optimization problem as backdrop, we will then rigorously examine the role of the “little green pieces of paper” Douglas Adams refers to in quotation above. We’ll show how the specific institution of a competitive market economy — one potentially involving billions of people and millions of goods — goes about solving these same fundamental problems of what to produce and consume, given the available resources and technology. In weeks 5-7 we will analyze the optimization problems of utility-maximizing consumers and firms, and examine how their optimal choices are affected by market prices. The purpose of Midterm 2, on the Monday of Week 8 will be to solidify our analysis of this behavior.
For the final three weeks of class, we will look at the particular case of competitive markets. We will analyze the special case of profit maximization for a price-taking firm, and then derive the economic “laws” of demand and supply from first principles. We will then shift our attention to the notion of competitive equilibrium, analyzing how the market “chooses” prices. What we’ll see by the end of the course is that prices play the role of a coordinating mechanism that sends signals from consumers to producers about what they value (what gives them utility), and also sends signals from producers to consumers about the opportunity cost of producing different goods.
In general, there will be a textbook reading for each class, accompanied by a Canvas quiz. For the very first class, though, the reading is just the syllabus; please read it carefully, and answer the quiz on Canvas.