1. Introduction and Supply & Demand

John Gruber introduces himself as the speaker for this session, marking it with the identifier '1401.' The introduction sets a casual tone, establishing his role in leading or presenting content.

The course will focus on microeconomics with a policy-oriented perspective, using government policies as an organizing theme to make the subject more engaging. While not dominating the class entirely, this approach aims to clarify why certain topics are studied. The instructor emphasizes active participation by encouraging students to ask questions for better understanding and slowing down his naturally fast-paced teaching style. He also clarifies that when he uses "guys," it is meant in a gender-neutral way referring broadly to people or economic agents.

Understanding Microeconomics and Scarcity Microeconomics examines how individuals and firms make decisions in a world of scarcity, focusing on constrained optimization to maximize well-being within limitations. It emphasizes trade-offs, where every choice involves an opportunity cost—the next best alternative forgone. This foundational concept underpins the idea that nothing is free; all actions have inherent costs.

Economics as Constrained Optimization Engineering Modern economics applies engineering principles to human lives and businesses by analyzing decision-making processes driving economies. Rooted at MIT through Paul Samuelson's work in the mid-20th century, it parallels engineering challenges like building robots with limited resources but focuses instead on optimizing economic outcomes for people.

Simplified Models in Microeconomics Microeconomics relies on simplified models to explain complex economic phenomena. These models, unlike scientific laws, are not absolute but provide useful approximations of reality by balancing accuracy and simplicity. By making simplifying assumptions, these frameworks allow for broad insights into economics while remaining accessible for teaching and understanding. The goal is to grasp concepts intuitively first before exploring them graphically or mathematically.

The Water-Diamond Paradox: Supply Meets Demand Adam Smith's water-diamond paradox illustrates the interplay between supply and demand in determining value. While water is essential for life yet often free due to its abundant supply, diamonds are expensive despite their frivolity because they are scarce. This example highlights that neither demand nor supply alone can explain pricing; both must be considered together as part of the 'supply-demand scissors' framework.

The market for roses illustrates the interaction of supply and demand. The downward-sloping demand curve shows that as prices rise, consumers buy fewer roses, while the upward-sloping supply curve indicates producers are willing to sell more at higher prices. These curves intersect at market equilibrium—where both buyers and sellers agree on price and quantity—in this case, $3 per rose with 600 roses sold. This balance ensures mutual satisfaction in transactions but raises questions about how these curves originate or how equilibrium is achieved.

Understanding Positive vs Normative Analysis Positive analysis examines the reality of how things function, while normative analysis explores how things should ideally operate. Using eBay auctions as an example, positive analysis explains market dynamics like supply and demand determining equilibrium prices. A controversial case involved someone auctioning their kidney on eBay; high demand and low supply drove the price to $5 million before it was shut down. This illustrates Adam Smith's principles in action but also raises ethical questions about whether such transactions should be allowed.

Ethical Debate: Should Kidneys Be Sold? Economists argue that allowing kidney sales could save lives by addressing organ shortages while providing financial benefits for sellers willing to take minimal health risks. Buyers gain life-saving transplants they value highly, creating a mutually beneficial transaction under standard economic reasoning. However, this sparks debate over moral implications—whether society should permit commodification of human body parts despite potential advantages.

Market failures occur when the market does not function as expected, leading to inefficiencies. Examples include fraud, where buyers cannot verify the authenticity of goods like kidneys being sold on platforms such as eBay. Another issue is imperfect information; for instance, sellers and buyers may lack critical knowledge about long-term health risks or outcomes related to their transactions.

The current kidney allocation system aims to support individuals, including the poor and those with critical needs. It relies on voluntary donors or organs from accidents, distributing them based on a prioritized waiting list. However, there are concerns about fairness since this method may not always prioritize the most urgent cases effectively. Economic models suggest optimizing organ distribution by considering individual urgency rather than solely following a linear queue.

Behavioral Economics and Decision-Making Flaws People often make irrational decisions due to cognitive biases, challenging traditional economic models that assume rationality. Behavioral economics integrates psychological insights to rigorously model these mistakes, such as selling a kidney without fully understanding long-term consequences. Even with perfect information and no fraud, individuals may misjudge trade-offs or fail to process data correctly.

Capitalism's Growth and Inequality Trade-Offs The capitalist economy has driven tremendous growth in wealth but also created significant inequality within society. While the market allows firms and consumers freedom under minimal government rules, this system results in unequal income distribution where the top 1% holds disproportionate wealth compared to other developed nations. Despite its success in fostering prosperity, capitalism introduces challenges like fraud or misinformation when left unchecked by appropriate regulations.

Command Economy vs Capitalist Efficiency In command economies like the former Soviet Union’s model, governments control production and allocation of goods aiming for equity but often failing due to corruption and inefficiency. Unlike capitalism’s invisible hand theory—where self-interest aligns societal benefits—the centralized approach struggles against human nature's complexity leading ultimately toward collapse. Adam Smith emphasized how markets naturally balance supply-demand through individual choices better than rigid governmental controls could achieve.

Defining 'Best for Society' Through Maximum Surplus The course begins by defining the "best for society" as achieving maximum surplus, where the most goods are produced and consumed. This definition focuses on economic productivity while acknowledging potential issues like pollution or health impacts to be addressed later. The framework relies on Adam Smith's concept of individuals acting in self-interest leading to a productive economy, though it may result in unfair outcomes.

Exploring Demand, Supply, and Market Dynamics Students will learn how consumers make decisions based on utility maximization within budget constraints to derive demand curves. Firms’ production choices involve complex considerations of inputs and outputs across different market structures such as competitive markets or monopolies. The course progresses from understanding these dynamics towards analyzing market equilibrium principles before addressing real-world deviations like market failures and equity concerns.