Lecture Notes Architect

Notes are complete for the portion of the transcript you sent, covering the lecture from the course introduction through the equity discussion. The transcript carries no explicit segments, so the notes follow the professor's seven natural topic shifts, one section per topic. Two caption errors were corrected and one ambiguous term is flagged below. The notes are pure ASCII, so they paste cleanly into any editor or study tool.

Lecture 1: Introduction to Microeconomics

(MIT 14.01SC Principles of Microeconomics, Fall 2011, Prof. Jonathan Gruber; notes cover the first part of the lecture)

What Microeconomics Is

• Microeconomics: the study of how individuals and firms make decisions in a world of scarcity
  • Scarcity is the defining condition: wants for goods, services, and resources exceed what is available
  • The semester is a study of constrained optimization in many shapes and forms
• The course is about trade-offs: given scarce resources, how individuals and firms trade off alternatives to make themselves as well off as possible
• Economics is called the dismal science because economists are always pointing out trade-offs
  • You cannot have everything; you have to give up x to get y
  • "That's why people don't like us"
• The professor's framing: MIT is the perfect place to teach microeconomics
  • The institute is about engineering solutions, which are ultimately constrained optimization
  • 2.70 contest example: given a pile of junk, build something that does something
    • All engineering is constrained optimization: take the resources given and do the best job building something
  • The course is like 2.70, except it runs people's lives instead of building robots
    • Instead of moving a ping pong ball across a table, the subject is how people decide what to consume and how firms decide what to produce
• Modern microeconomics was founded at MIT in the 1950s by Paul Samuelson
  • Samuelson introduced mathematics to economics and developed the field through teaching 14.01, 50 to 60 years ago

The Two Actors and Their Models

• The class focuses on two types of actors in the economy: consumers and producers
  • We build models of how consumers and producers behave
• Model: a description of any relationship between two or more economic variables
  • Economic models are never precise; they are never accurate to the 10th decimal
    • They capture the main tendencies in the data and the main insights into consumption and production decisions
  • Simplifying assumptions are the price of tractability
    • A model that cannot explain reality is useless
    • A model must also be tractable: something teachable in a lecture or less
  • Despite the assumptions, the models yield powerful predictions of consumer and producer behavior

Consumer and Firm Objectives

• Consumers: utility maximization subject to a budget constraint
  • Consumers are constrained by limited wealth (the budget constraint)
  • Subject to that constraint, they choose the set of goods that makes them as well off as possible
  • Utility function: a model of preferences; everything you love in life written down as a u function
  • The consumer decision: write preferences as a utility function, write resources as a budget constraint, solve the constrained maximization
• Firms: profit maximization (pi = profits)
  • Firms maximize profit subject to both consumer demand and input costs
  • Harder than the consumer problem; firms must consider
    • The output side: what consumers want them to make
    • The cost side: what it costs to produce it
  • Combine both to make the most profit

The Three Fundamental Questions of Microeconomics

1. What goods and services should be produced?
2. How are those goods and services produced?
3. Who gets the goods and services?

• All three questions are solved through one key state variable: prices
  • Consumers and firms interact in a marketplace; a set of prices emerges from that interaction
  • Prices allow firms and consumers to make the relevant decisions
• iPod example (casual illustration of the price mechanism)
  • Whether to produce: consumers signal willingness to pay (the iPod launched at

$300, "when $300 meant something")

• How to produce: depends on the prices of inputs
  • Chips, metal, casing, monitors; firms shop across countries and component options
• Who gets them: the people willing to pay the price Apple charges
  • Some are willing and get one; some are unwilling and go without

Where Prices Do Not Rule: the Line Example

• Counterpoint: people wait in line for hours for Lady Gaga concert tickets
  • If prices determined everything, there should be no lines
    • An auction would allocate tickets to whoever is willing to pay the most
    • Waiting in line would play no role
• The economy has been evolving toward the price mechanism
  • Professor's youth: camping out at 3:00 in the morning for concert tickets (the era of line allocation)
  • Today: StubHub, Ticketmaster, and secondary sellers; prices allocate the tickets
  • Classroom poll: most hands went up for having waited in line for a ticket
    • The same question 30 years ago would have raised 90% of hands
    • The price mechanism has started replacing the line mechanism

Core Distinctions: Theory, Evidence, and Values

• Theoretical vs. empirical economics
  • Theoretical economics: the process of building models to explain the world
  • Empirical economics: the process of testing those models to see how well they explain it
  • Goal of theory: a model with testable predictions
  • Empirical work gathers data and tests predictions with statistics, typically regression analysis
  • This course: about 95% theoretical, with empirical evidence brought in along the way
• Positive vs. normative economics
  • Positive economics: the way things are
  • Normative economics: the way things should be
• Perfectly competitive market: eBay auctions as the textbook example
  • Many producers offer goods to a wide range of consumers
  • Consumers bid the price up until the person with the highest value gets the good
  • Price serves exactly the signal it should in allocating goods (the "who gets it" question)

The Kidney Auction: Supply, Demand, and the Normative Debate

• A real case: someone auctioned a kidney on eBay
  • Starting price $25,000; bidding reached $5 million before eBay shut it down and banned body-part auctions
• The positive question: why did the price go so high? The twin forces of supply and demand
  • More demand for a good -> higher upward pressure on price
  • Less supply -> also a higher price
  • Kidney demand is extreme: you die without one, so people will spend all their wealth
  • Kidney supply is very low: few people are willing or well situated to be organ donors
  • High demand plus low supply -> the price went through the roof
• Adam Smith and the water-diamond paradox (The Wealth of Nations, 1776)
  • Water is essential to life and diamonds are irrelevant to survival, yet water is nearly free and diamonds are astronomical
  • Smith's answer: the demand side alone does not settle prices
    • Demand for water is much higher than demand for diamonds
    • Supply of water is even larger than its demand
    • Net result: the price of water ends up much lower than the price of diamonds
• The normative question: should eBay have allowed the sale?
  • For allowing it: the transaction makes both parties better off
    • The seller is paid a large sum; the buyer lives
    • Thousands to hundreds of thousands die every year waiting for a transplant
  • Against, developed through class discussion:
    1. Substitution: a kidney sold is a kidney that never reaches the transplant queue
       • The rich buyer gets it; a poorer patient implicitly does not
       • The counter: valid only if the seller would otherwise have donated it; if the choice is sell it or keep it, there is no trade-off
    2. Need-based allocation: organs should go to those who need them most
       • Example: Mickey Mantle's liver transplant; famous ballplayer, alcoholic, jumped the queue, kept drinking, wasted the liver
    3. Paternalism: people may make bad decisions when money is involved