Chapter 1 - Introduction

Microeconomics
Notes

Important Terms
• Economy
Economy refers to the whole collection of production units by which people earn their living.

• Economics
Economics refers to the study of how a society chooses to use its limited resources, which have
alternate uses, to produce goods and services and to distribute them among different groups of
people in order to satisfy unlimited human wants.

• Economic Problem
‘Economic problem’ is the problem of choice involving satisfaction of unlimited wants out of
limited resources having alternative uses.
The root cause of all economic problems is ‘Scarcity’.
Scarcity in economics refers to the limitation of supply of a good in relation to its demand.

Reasons for Economic Problem

Economic problem arises due to: (a) Scarcity of resources (b) Unlimited human wants and (c)
Alternate uses of resources.

1. Scarcity of resources: The supply of resources (i.e. land, labour, capital, etc) is limited in
relation to their demand and the economy cannot produce all what people want. It is the basic
reason for the existence of economic problems in all economies. These resources are available in
limited quantities in every economy, big or small, developed or underdeveloped. No economy in
the world is rich in all the resources. There would have been no problem if resources were not
scarce.

2. Unlimited human wants: Human wants are never ending, i.e. they can never be fully
satisfied. As soon as one want is satisfied, another new want emerges. Wants of the people are
unlimited and keep on multiplying and cannot be satisfied due to limited resources.

Human wants also differ in priorities, i.e. all wants are not of equal intensity. For every
individual, some wants are more important and urgent as compared to others. Hence, people
allocate their resources in order of preference to satisfy some of their wants.

3. Alternative uses of resources: Resources are not only scarce, but they can also be put to
various uses. It makes choice among resources more important. For example, land can be used
for farming , setting up a factory or a school etc. As a result, the economy has to make a choice
between the alternative uses of the given scarce resources. If one resource can be put to only
one use, there would be no problem of choice.

Two features of resources:

a) Resources are scarce and limited. b) Resources have alternative uses.

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 Two features of human wants:
a) They are unlimited, i.e. they can never be fully satisfied.
b) Human wants differ in priorities. Some wants are more basic and urgent and may require
immediate attention than the others.

Central Problems of an Economy

Problem of allocation of resources: Every economy faces the problem of allocating the scarce
resources having alternative uses to the production of different possible goods and services in such
a manner that it ideally meets the needs of the society. It also involves the distribution of the goods
and services produced among the individuals within the economy in an optimal manner.
‘Problem of resource allocation would not arise, if resources do not have alternative uses.’
If a resource can be put only to a specific use, then the problem of resource allocation would not
arise.

Central problems are the economic problems faced by every economy. An economy has to allocate
its scarce resources after choosing from different potential bundles of goods to be produced, select
the technique of production and also decide as to how the output, thus produced, should be
distributed in the economy.

The central problems faced by an economy can be categorised under three heads:

I. What to produce and in what quantities

• This problem involves selection of goods and services to be produced and the quantity to be
produced of each selected commodity. It arises since resources are limited in an economy and
can be put to alternative uses.
• Producing more of one good usually means less resources will be available for the production of
other goods. For example, production of more cars is possible only by reducing the production
of other goods using similar resources.
• Production of more war goods is possible only by reducing the production of civil goods. So, on
the basis of the importance of various goods, an economy has to decide which goods should be
produced and in what quantities.
• The problem of 'What to produce' has two aspects:
(i) What possible commodities to produce: An economy has to decide, which consumer goods
(rice, wheat, clothes, etc.) and which of the capital goods (machinery, equipment, etc.) are to
be produced. In the same way, economy has to make a choice between civil goods (bread,
butter, etc.) and war goods (guns, tanks, etc.).
(ii) How much to produce: After deciding the goods to be produced, the economy has to decide
the quantity of each commodity that is selected. It means, it involves a decision regarding the
quantity to be produced, of consumer and capital goods, civil and war goods and so on.

Guiding Principle: The guiding principle is to allocate resources in such a way that gives
maximum aggregate satisfaction.

II. How to produce (choice of technique of production)

• The central problem of ‘how to produce’ is the problem relating to the choice of technique of
production to be used for producing different goods and services. By ‘technique’, we mean what
particular combination of inputs to be used for production.
• A good can be produced using different techniques of production depending on the availability
of resources. Broadly, the choice is between the two types of techniques– labour-intensive
technique and capital-intensive technique.
• The technique which uses more labour and less capital (machines) is labour intensive technique.
The technique which uses more capital and less labour is capital intensive technique.

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 For example: In the U.S, being capital-rich, wheat is produced using capital-intensive
techniques while in India, being labour-rich, wheat is produced using labour-intensive
techniques.

Guiding principle :The guiding principle for the choice of technique is to adopt that technique
through which maximum output can be produced at minimum cost using the least possible scarce
resources.
III. For whom to produce (or the problem of distribution of output and incomes between the
members of the society)
• This problem relates to the distribution of produced goods and services among the individuals
within the economy, i.e. selection of the category of people who will ultimately consume the
goods, i.e. whether to produce more goods for the poor and less for the rich or more for the rich
and less for the poor.
• Since resources are scarce in every economy, no society can satisfy all the wants of its people.
Thus, a problem of choice arises.
• Goods are produced for those people who have the paying capacity. The capacity of people to
pay for goods depends upon their level of income. It means, this problem is concerned with
distribution of income among the factors of production (land, labour, capital and enterprise),
who contribute to the production process.
Guiding principle: The guiding principle is to ensure that the most urgent wants of the society
are fulfilled to the maximum possible extent.

Difference between Microeconomics and Macroeconomics

Microeconomics Macroeconomics
Microeconomics is that branch of economics Macroeconomics is that branch of economics
which studies the behaviour of individual which studies the behaviour of aggregates of the
economic units of an economy. economy as a whole.
Its main tools are Demand and Supply. Its main tools are Aggregate Demand and
Aggregate Supply.
The basic objective of this theory is ‘Price The basic objective of this theory is
Determination’. ‘Determination of National Income and
Employment’.
It is also called ‘Price Theory’. It is also called ‘Theory of Income and
Employment’.
Examples of microeconomics studies: Examples of microeconomics studies:
(i) Study of individual or market demand (or (i) Study of income and employment in the
supply) for a commodity. economy.
(ii) Price determination of a commodity. (ii) Study of rate of inflation or general price
levels in the economy.

• Interdependence of Microeconomics and Macroeconomics

➢ Microeconomics depends on Macroeconomics. For example, demand for a commodity is
influenced by the taxation policies prevailing in the economy.
➢ Similarly, Macroeconomics depends on Microeconomics. For example, national income is
the sum total of factor incomes earned by all residents of an economy in a fiscal year.

Opportunity Cost
Opportunity cost is defined as the value of the next best alternative foregone.

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For example: Suppose an individual is given three job offers namely A - which pays `20,000 per
month, B - which pays `18,000 per month and C - which pays `6,000 per month, all other
conditions remaining same.

If he avails the best job offer which pays him `20,000 a month, he foregoes the next best job offer
of `18,000. Hence `18,000 is the opportunity cost of choosing the best alternative.

Difference between Positive and Normative Economics

Positive Economics Normative Economics

Positive economics deals with ‘what is’ and is a Normative economics deals with ‘what ought
statement of economic facts. to be’ or ‘what should be’.

It is based on facts and can be verified using It is not based on facts and cannot be verified
actual data. using actual data.
It does not involve value judgements so is not It involves value judgements, so is suggestive
suggestive in nature. in nature.
Examples: Examples:
(i) Price levels in India are rising. (i) The unemployment rate should be reduced.
(ii) There is high rate of unemployment in India. (ii) The government should decrease its
expenditure to reduce the rate of inflation.

• RECAP

➢ Positive economics deals with ‘what is’ and is a statement of economic facts. It is based on
facts and can be verified using actual data but does not involve any value judgments.
➢ Normative economics deals with ‘what ought to be’ or ‘what should be’. It cannot be verified
using actual data but involves value judgements.
➢ Microeconomics is that branch of economics which studies the behaviour of individual
economic units of an economy. e.g. Demand and Supply of a commodity.
➢ Macroeconomics is that branch of economics which studies the behaviour of aggregates of the
economy as a whole. e.g. Aggregate Demand and Aggregate Supply.
➢ Economic problem is the problem of choice involving satisfaction of unlimited wants out of
limited resources having alternative uses.
➢ Central problems are the economic problems faced by every economy. There are three central
problems of an economy: (i) What to produce and in what quantities (ii) How to produce (iii)
For whom to produce.
➢ Opportunity cost is defined as the value of the next best alternative foregone.

Click on the following link for further explanation of the topics discussed above:

https://www.youtube.com/watch?v=nxwlhb1Arfg (Economics, Economy & its Central Problems)

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 SUMMARY

Economy refers to the

whole collection of
production units by which
people earn their living Microeconomics is that
branch of economics
Positive economics deals which studies the
with ‘what is’ and is a behaviour of individual
statement of economic economic units e.g.
facts. It can be verified Demand and Supply of
using actual data but does a commodity
not involve any value
judgements.
Macroeconomics is
that branch of
economics which
studies the
behaviour of
aggregates of the
Normative economics deals economy as a whole.
with ‘what ought to be’ or e.g. Aggregate
‘what should be’. It cannot
Introduction to
Demand and
be verified using actual data Microeconomics Aggregate Supply.
but involves value
judgements.

Economic problem
is the problem of
choice involving
satisfaction of
Opportunity cost is unlimited wants out
defined as the value of of limited
the next best alternative resources having
foregone. Central problems of an alternative uses.
economy

What to produce and For whom to produce

in what quantities (or the problem of
distribution of output
and incomes)

How to produce (choice of

technique of production)