0% found this document useful (0 votes)
143 views60 pages

Introduction To Micro Economics

1. The document introduces economic theory and its key elements: definitions, assumptions, predictions, and tests. 2. It discusses the central economic problems of allocation of resources, production possibility curve (PPC), and scarcity and choice. The problems of allocation of resources include what and how much to produce, how to produce, for whom to produce, achieving full employment, and achieving growth of resources. 3. It explains the PPC concept using a table and graph to illustrate the trade-offs between producing two goods with limited resources. The PPC can shift due to changes in available resources. 4. It defines scarcity as limited resources relative to unlimited wants, requiring choice between alternative uses of resources.

Uploaded by

infinity warz
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
0% found this document useful (0 votes)
143 views60 pages

Introduction To Micro Economics

1. The document introduces economic theory and its key elements: definitions, assumptions, predictions, and tests. 2. It discusses the central economic problems of allocation of resources, production possibility curve (PPC), and scarcity and choice. The problems of allocation of resources include what and how much to produce, how to produce, for whom to produce, achieving full employment, and achieving growth of resources. 3. It explains the PPC concept using a table and graph to illustrate the trade-offs between producing two goods with limited resources. The PPC can shift due to changes in available resources. 4. It defines scarcity as limited resources relative to unlimited wants, requiring choice between alternative uses of resources.

Uploaded by

infinity warz
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 60

Introduction to

Micro- Economics
Chapter 1
Presented By :
Tirtha Raj Khadka
An Introduction to Economic Theory
An economic theory is defined as a model along with the specified and
empirical economic variables and facts used to explain and predict the
changes. In other words, an economic theory is a formal explanation of the
relationship between independent and dependent variables.

A Well defined economic theory has following four elements.

1. Definition:
An economic theory is composed by the set of definition that clearly
explain the nature of economic variables to be used in developing the
model.
2. Assumptions:
Assumptions are used to summarize the conditions under which a
theory is meant to work.

3. Predictions:
The facts that can be concluded from theory are defined as
predictions.

4. Tests:
An economic theory is carried with a set of empirical tests against
actual data, from which predictions can be verified and compared.
Central Economic Problem or Basic Economic Issues :
Allocation of Resources, Production Possibility Curve (PPC)
and Scarcity and Choice

a. Allocation of Resources
The scientific management of all available resources in the
production distribution and exchange of goods and services
in the economy. In a free market economy allocation of
resources deals with the following basic problems of an
economy.
1. What of produce and how much to produce?

The first problem is what and how much to produce goods and services? Due to scarce
resources, each economy has to decide what and how much goods and services are to
be produced in the economy. For example, consumer goods, capital goods and war
time goods etc. is to decide what and how much goods and service are to be produce.

2. How to Produce ?

The second problem is how to produce goods and services? This problem is concerned
with the choice of technique of production which implies, A technique of production
which would maximize output or minimize cost of production should be used.
For example:
(i) Labour Intensive Technique:
Under this technique, labour play a major role in the production. Here,
labour is used more than capital . This technique creates more jobs and
solve problem of unemployment.

(ii) Capital Intensive Technique:


Under this technique, capital play a major role. Here capital is used
more than labour. This technique goes for large volume of production.

An economy must decide as to which technique is to be used in a given


industry so that efficient production is obtained.
3. For Whom to Produce ?
Due to scarce resources, an economy has also to decide for whom
to produce and how to distribute the production? Human wants are
unlimited and resources are always limited so that sufficient
quantities of goods and services cannot be produce to meet all the
demands of people. So, the economy has to decide for whom to
produce goods and services and distributed among the different
income groups in the society.
4. Problems of Full Employment
This is the another problem of an economy how to achieve
full employment of resources. The problem with economy is
how to use its available resources, make maximum output
with minimum effort and wastages be made possible.
Efficient allocation of resources refers to the optimum
combination of factor of production.
5. How to achieve growth of resources?
Another central problem of an economy is to increase the
level of production is known as the problem of growth of
resources. Any economy can achieve the objective of growth
of resources through the efficient utilization of available
resources and technological advancement.
Concept of Production Possibility Curve (PPC) or (frontier)
Meaning:
PPC is the locus of various combination of two goods which is produced
by use of limited resources in the economy.
Assumptions:
The concept of PPC can be explained with the help following
assumptions:
I. Economy is producing only two goods X and Y
II. No change in technology in production.
III. Available resources are fully and efficiently utilization in the
economy.
IV. Time period is given in production.
For the simplicity, we assume that only food and cloth can be
produced with the given resources.
It can be explained with help following table and figure.

Combination Food Cloth


A 0 20
B 1 18
C 2 14
D 3 8
E 4 0
In the table, In the economy, combination A shows
production of cloth only and combination E shows
production of food only i.e. 20 and 4 units by using
available resources respectively. similarly, the
producer can produce from the combination B,C,D
of 1,2,3 and 18,14,8 food and cloth respectively.
. Y

A
2O
B
Cloth

16
C F
12 G
D
8

4 E X
O 1 2 3 4
Food
In figure, quantity of food and clothes are measured in x-axis and y-axis
respectively. Point A shows production possibility of 20 unit cloth only and
no production of food. Similarly, B, C, D shows different production
combination of food and cloth i.e. (1,18), (2,14) and (4,8) respectively. Point
E shows 4 unit of food production only and no production of cloth. If we
join all these points we get PPC which is concave to the origin.

In the figure, point F lies outside of PPC which is desirable but not
attainable due to limited resources. Similarly point G lies inside of PPC
which is attainable but not desirable due to less utilization of available
resources. It is also known as transformation curve.
Shift in PPC
The PPC will shift rightward or upward and leftward or downward
under the following conditions
1. Rightward shift in PPC
 Increase in capital or available resources
 Increase in labour
 Use of new technology
 Increase in time period
2. Leftward shift in PPC
 Decrease in capital or available resources
 Decrease in labour
 Use of old technology
 Decrease in time period
Y
E

Cloth
A Outward Shit PPC
C Initial PPC

Inward Shit PPC

O B F X
D
Food
In figure, AB initial PPC curve. PPC rightward shift from AB to EF due
the increase in available resources. Similarly, PPC leftward shift from
AB to CD due the decrease in available resources.
Concept of Scarcity
Scarcity refers to the limited supply of productive resources in relation to
their demand. Human wants are unlimited but resources means limited.

Concept of Choice
Choice refers to a process of selecting highly urgent wants from
unlimited wants in order to achieve optimum allocation of limited
resources. It means human wants are not equally urgent therefore most
urgent wants are fulfilled first and postponed the less urgent want due
to limited resources.
The Economic Problems: Scarcity and Choice
In ordinary sense, scarcity refers to the unavailability of goods and
service, in an economy. But, in economic sense, a commodity is scarce
not because it is rare in the market but the resources to have it are
limited. The resources are scare, it does not mean that they are not
available but they are limited in comparison to human wants. Scarcity
is taken in relative sense rather than absolute term, which explains the
relationship between limited resources and unlimited wants. There is
poverty and human unhappiness because of scarcity of resources.
The scarcity and choice theory was developed by modern economist
Lionel Robbins in his book “An Essay on the Nature and Significance
of Economic Science” in 1932 A.D According to him “economics is the
science which studies human behavior as a relationship between
ends and scarce means which have alternative uses”. His argument is
that economics is concerned with the problems arising from scarcity.
People solve the problem of scarcity by allocating scarce resource to
best possible uses. Most of man’s economic activities are moving
around the problem of scarcity and choice.
This is the central idea in Robbins Definition. The main point in the study of
scarcity and choice are as follows:
1. Unlimited human wants or ends
2. Scarce resources/limited means
3. Alternative uses of scarce resources
4. All wants are not equally urgent
5. Problem of choice
5. Human science
Economic theory explains the laws and principles, which governs the
functioning of an economy and its various parts. An economy exists
because of tow basic facts. Firstly, human wants for goods and services are
unlimited and secondly, productive resources to produce goods and
services are scarce. We cannot satisfy all our needs because of scarce
resources. It is the scarcity problem which gives rise to many other
economic problems.
Economics is the subject that aims to utilize scarce resources in a
scientific way so that human beings can achieve maximum satisfaction
from the use of limited economic resources. The problem of scarcity is
present not only in developing nations but also in highly developed
countries. However, the nature of scarcity changes along with the
change in living standard and life system of human beings.
Problem of scarcity gives rise to some problems generally known as
basic economic problems. The society has to solve these problems to
promote material well being of its people. These basic economic
problems related to what commodities are to be produced, how they
are to produced, how the national product is to be distributed among
the people and how much to provide for future growth. Problem of
resource allocation, choice of production methods and economic
growth has their roots in scarcity of resources.
Choice is the process of selecting some goods or wants from a bundle of
goods or wants. Human wants are unlimited. So, people are unable to fulfill
all their want at once since resources are limited. They can satisfy only
some of their wants. Some wants should be sacrificed to satisfy some other
wants. Hence, people postpone less urgent wants to satisfy more urgent
wants.
Resource allocation occupies central position in economics. In free market
economy, allocation of resource is determined by the price mechanism.
Force of demand and supply govern the market through price mechanism.
Producers are guided by relative price and various commodities. They
market decisions regarding the nature and mount of good to be produced
on the basis of profit expectation. In planned economy, the central planning
authority on the basis of state priorities makes decision regarding allocation
of resources. In mixed economy, both price mechanism and public have
their role in resource allocation.
Human wants were limited or resources unlimited, there would be no
scarcity and there would be no problem of choice. Because of scarcity
we are forced to choose. Thus, the problem of choice deals with
utilization of scarce resources in such a way that it satisfies human
wants in the best possible way. Unlimited wants and limited resources
lead to economic problem and problem of choice in an economy of the
country.
Scope of economics:
The total area of study or coverage of economics is called scope of economics.
Subject Matter of Economics:
It refers to what we study in economics. It can be explained on the following
three bases:

1.On the Basis of Popular Definitions:


Different economists have widely discussed about the subject matter
of economics in different time period. According to Adam Smith,
subject matter of economics is the study of nature and causes of
wealth. According to Alfred Marshall subject matter of economics
is the study of all those activities of human beings which promote
material welfare. Similar, According to Robbins subject matter of
economics is the study of scarcity and choice.
2. On the Basis of Economic Activities (Traditional Approach):

Human wants are unlimited but resources to fulfill them are always limited.
Therefore, the subject matter of economics can be viewed as a continuous
circle of unlimited wants, efforts and satisfaction is shown below.

Wants

Satisfaction Efforts
In the study of economics wants , efforts, satisfaction are related to the
consumption, production, exchange, distribution and public finance which
are the subject matter of economics and explained as follows:

a. Consumption:
The process of satisfying human wants is called consumption. In the
other words , the act of consuming different types of goods and services
in the economy by consumer is called consumption. Under this, we study
various theories like, law of demand, law of diminishing marginal
utility, law of substitution etc.
b. Production:
It is a process of creating final goods services by using available resources in
the economy. Under this, we study various theories like : law of variable
proportion, law of returns to scale etc.

c. Exchange:
Exchange studies how goods are exchanged between different parties. For
this, the process of determining price of goods and services is called
exchange. Under this, we study determination of price of the products in the
various types of market structure like: Perfect competition, Monopoly ,
Monopolistic competition etc.
d. Distribution:
The distributions of national product among various factors of
production like land, labour, capital and organization etc in the form of
rent, wages, interest and profit is also the subject matter of economics.

e. Public Finance:
It is the branch of economics which deals with revenue and expenditure
of the government. Under this, we study various theories like
government revenue, government expenditure, fiscal policies, public
debt etc.
3. Modern Approach:
Modern economists have divided the subject matter of economics into
two parts:
a. Microeconomics:
It studies the economic activities of individual units like individual
household, firm, consumer, market etc.
b. Macroeconomics:
It deals with aggregate economic activities like aggregate demand
and supply of all goods and services, national income, economic
growth, unemployment etc.
Difference between Micro and Macro
Economics
Microeconomics and Macroeconomics both are branches of
economics. Both economics are complimentary in the sense
that they support each other for effective economic analysis.
Both play an important role in formulation of economic
principles. However, the main differences between them are as
follows:
Microeconomics Macroeconomics
1. The term Micro is derived from Greek word The term Macro is derived from Greek word
‘Mikros’ which means small ‘Makros’ which means large.
2. Microeconomics is a study of individual Macroeconomics is a study of aggregate
economic variables like: Demand, supply, economic variables like: aggregate demand
price etc. and supply, price level etc.

3. It has very narrow scope i.e. an individual, It has very wide scope i.e. a country
a market etc.
4. Classical and neo-classical economists like: The renowned economist J.M. Keynes
Adam Smith, J.B. Say, David Ricardo, specially developed macroeconomics
Alfred Marshall, A.C. Pigou, J. B. Clark
developed microeconomics.

5. It is based on partial equilibrium analysis, It is based on general equilibrium analysis.


other things remaining the same.
6. Laws and principles are based on Laws and principles are far from
assumptions. assumptions.
7. Equilibrium is determined by market demand Equilibrium is determined by aggregate demand
and supply. and supply.
8. The subject matters of microeconomics are The subject matters of Macroeconomics are to
consumption, production, distribution and deal with theories of employment, national
determination of product and factor pricing income, saving, investment garner price level,
etc. trade cycle etc.
9. Microeconomics establishes theories and Macroeconomics formulates policies according to
principle which are universally accepted. It is the need of an economy. It is more normative
more positive economics. economics.
10. It is known as price theory. It is known as income and employment theory.

11. Principle variable of microeconomics are Principle variable of macroeconomics are


demand , supply, prices etc. national income, inflation, money supply,
money demand etc.
12. The main objective if microeconomics is how The main objective of macroeconomics is how to
to allocate scarce resources. achieve full employment.
Interdependence between Micro and Macro –
Economics ( Interrelationship between Micro
and Macro Economics )
Microeconomics is the study of individual parts of the economy
whereas macroeconomics is the study of the economy as a whole.
The two approaches are not competitive but complementary to
each other.
According to Edward Shapiro: Macroeconomic theory has a
foundation in microeconomic theory and microeconomic theory
has a foundation in macroeconomic theory. This concept can be
explained by the help of following headings:
Dependence of Micro- Economics on
Macro - Economics
This concept consists of the following topics which are
explained as follows:
1. Study of Product Price:
The determination of price of a commodity depends upon
general price level in the economy. The determination of
general price level is the subject matter of macroeconomics
whereas determination of individual price is the subject
matter of microeconomics. Hence, the study of
microeconomics depends upon macroeconomics.
2. Study of Wage Rate:
Determination of wage rate of a single labor is affected by
wage rate of all labor of the economy. Hence, the study
of microeconomics depends upon macroeconomics.
3. Study of Profit:
Profit is the subject matter of microeconomics but it
depends on macroeconomic variable such as
employment level, aggregate demand, national income,
general price level etc. Hence, the study of
microeconomics depends upon macroeconomics.
4. Study of Interest Rate:
Interest rate is the subject matter of microeconomics but it
determined by the interaction between macroeconomic
variables like demand for money and supply of money.
Hence, the study of microeconomics depends upon
macroeconomics.
5. Study of Consumption:
Consumption is the subject matter of microeconomics
analysis because it is the individual economic activity.
Consumption of an individual depends upon the
consumption of goods and services by the society in the
particular place. Hence, the study of microeconomics
depends upon macroeconomics.
Dependence of Macro - Economics
on Micro - Economics
This concept consists of the following topics which are
explained as follows:
1. Study of National Income:
National income is the subject matter of macroeconomics
but national income is the sum of individual income. The
study of individual income is the subject matters of
microeconomics. Hence, the study of macroeconomics
depends upon the study of microeconomics.
2. Study of General Price Level:
General price level is the subject matter of macroeconomics but
general price level is the average of all prices of individual goods
and services. The study of individual price of goods and services
is the subject matters of microeconomics. Hence, the study of
macroeconomics depends upon the study of microeconomics.
3. Study of Total Saving:
The total saving of an economy depends upon the saving of
different sectors. Total saving is the sum of personal saving,
business saving and government saving. The saving of different
sector depends on the microeconomics. Hence, the study of
macroeconomics depends upon the study of microeconomics.
4. Study of Investment:

Investment is the subject matter of macroeconomics but


investment is determined by rate of interest. The study of
rate of interest is the subject matters of microeconomics.
Hence, the study of macroeconomics depends upon the
study of microeconomics.
Difference between positive and
normative economics
Economics is a science in case of positive and
normative economics analysis are two different
aspects of economics.
Positive economics study the real nature of the subject. So it
explains what is, what was and what will be. It means, positive
economics is not related to rightness and wrongness of things. It
does not give massage about morality but explain the reality.

Normative economics explains the situation of what ought to be, what


should be. So, normative science studies the things not as they are but as
they ought to be. The result obtained from normative study may not be
applicable in all situations. It gives about rightness or wrongness.
Positive Economics Normative Economics
1. Classical and modern economists Neo-classical economists like: Alfred
like: Adam Smith, J.B. Say David Marshall, A.C. Pigou ,J.B. Clark describe
Ricardo and Prof. Lionel Robbins economics as a normative science.
describe economics as positive
science.

2. Statements can be empirically Statements may or may not be


verified. empirically verified.

3. Positive economics study ‘ What Normative economics study ‘what ought


is.’ to be.’

4. It depends upon scientific logics It depends upon ethical logics or values.


or fact.
5. It is universal and value does not It is related to personal belief and value
differ from person to person. judgment may differ from person to
person.
6. It establishes principles and It formulates policies.
theories.
7. For example: For example:
 Government has adopted  Unemployment is worse than
policies to reduce inflation.
unemployment.  Students should not leave their
 If the students became regular class.
frequently absent in class,
they may fail in the exam
Importance/use of Microeconomics
Microeconomics is very important place in the study of economic theory. It
is applied to solve the various economic problems. Mainly, it plays an
important role in formulation of those economic policies which promote
the welfare of the people. Microeconomics has both theoretical and
practical importance which can be explained with the help of following
points:
1. To understand the function of an economy:
Microeconomics gives the knowledge of the working of a free enterprise
economy. In such economy there is no agency to plan and coordinate the
working of the economic system. It tells us how producers and
consumers take decision about how to produce, what to produce, how
to distribute, what to consume etc. without any unrelated force.
2. To produce tools for economic policies:
Microeconomics helps in the formulation of economic policies such as
fiscal policy, monetary police, trade policy, industrial policy and it also
examine implication and effectiveness of these policies. It also explains
the condition of efficiency in production and consumption.

3. Useful in business decision making :


Microeconomics helps to decision making for business firm in demand
analysis, cost analysis, and the method of calculating prices and
prediction of economic events or variables.
4. Useful in international trade:
Microeconomics is also used to explain the gain from international
trade, balance of payment, disequilibrium and the determination of
foreign exchange rate in the field of international trade.
5.Efficient allocation of resources:
Microeconomics helps in the efficient allocation of resources.
Microeconomics theory explains the condition of efficiency in both
production and exchange. It suggests suitable policies achieve a high
economic growth, economic prosperity and stability in an economy.
6. Study of human behavior:
Microeconomics studies many forms of human behavior with the help of
the law of diminishing marginal utility, law of Equi-marginal utility,
indifference curve analysis and so on.
Microeconomics in Business Decision Making

Microeconomics can be used to solve certain operational


problems faced by business enterprises. It helps business firms to
achieve maximum production with the given amount of
resources. With the help of microeconomics, business enterprises
can make decision on demand analysis, cost analysis, pricing
techniques and so on. It is very useful in business decision making
in the following areas:
1.Resource allocation:
Business firms have limited/ scarce resources by which they are facing the
problem of optimization i.e. profit maximization or cost minimization.
Microeconomics helps to make optimum allocation of resources to achieve
desired goals. It also helps business firm to find out the answers of what to
produce, how much to produce, and for whom to produce.
2. Production decision:
The business firms have to produce various goods and services with the help
of limited resources. They can use different techniques but they have to
choose best one. Microeconomics helps to find out optimal production
decision.
3. Cost analysis:
Cost analysis is an important area of microeconomics. There are many
theories to explain different types of cost such as fixed cost, variable
cost, average cost, marginal cost, long-run cost, short-run cost etc.
4. Pricing Techniques:
Microeconomics provides knowledge as how price of goods and services
are determined. It provides the basis for analyzing the pricing problems.
The pricing decisions are taken on the basis of law of demand, Law of
supply, elasticity of demand, consumer behavior and so on.
5.Demand forecasting:
Microeconomics provides the basis for demand forecasting to the
decision maker. Demand analysis is very important in business decision
making.
Limitations of Microeconomics
Even though, microeconomics is very useful in economic analysis, it is not
far from criticism. The important limitations of microeconomics can be
explained with the help of given points:

1. Limited Scope:
Microeconomics studies only a part of the economy and does not give
the knowledge about the working of whole economy. It is not always
good to have knowledge of small unit which microeconomics gives.
2. Unrealistic Assumptions:
Microeconomics is based on unrealistic assumptions like, other things
remaining the same ( ceteris paribus), full employment, existence of market
economy etc. these assumptions do not have hold true in real life. In practice,
economic environment is changing regular and economy always operates at
less than full employment.

3. Ignore the Role of Government:


Microeconomics assumes the absence of government intervention in the
economic activities of the society. In practice, however government controls
and regulations of economic activities through the various policies.
4. May not be Applicable in Total Economy:
What is true in case of individual units may not be true in case of
aggregates. For example, individual saving is good because it
promotes individual’s economic prosperity. But, if all individual
of the economy save then it is very harmful for the economy.
This is because, effective demand is reduced which in turn
reduces the employment and income in the economy.
Types of Micro- Economics
1. Analysis Micro – Static:
It deals with the final market equilibrium situation whereas the equality
between demand and supply at given point of time. It means, it analyses
the condition of equilibrium price and quantity of a commodity at a
particular period of time. It does not deal with the process by which the
forces of demand and supply have reached the equilibrium position. It
can be explained with the help of following figure:
In figure, E is the equilibrium Y
D S
point where demand curve

Price
intersects with supply curve.
E
P
Thus, OP and OQ are equilibrium

price and quantity of a commodity D


S
respectively where quantity
O Q X
demand is equal to quantity
Quantity
supply.
2. Comparative Micro – Static
Comparative micro static is concerned with a comparative
study of different equilibrium position at different points of
time. However, it deals with the comparison of one
equilibrium position to another equilibrium position when
there is change in microeconomic variables.
. D1
Y
D S
E1
Price P1
E
P
D1
D
S

O Q Q1 X

Quantity
In figure, E is the equilibrium point where DD i.e. demand curve
intersects with SS i.e. supply curve. Thus, OP and OQ are equilibrium
price and quantity of a commodity respectively.

Let us suppose, demand curve shifts from DD to D1D1, the new


equilibrium Point is E1. At this situation OP1 and OQ1 are equilibrium
price and quantity is obtained respectively. The comparative micro
static compares the equilibrium points E and E1 but does not explain
how equilibrium is reached from E to E1.
3. Micro Dynamics
Micro dynamics refers to a position by which the system
passes from one position of equilibrium to another
equilibrium position. It can find the path followed by the
system over a period of time moving from the old
equilibrium to new equilibrium. It can be explained with the
help of following figure:
. D1
Y S
P1 D a b
E1
Price P0
d c
E
P
D1
D
S

O Q Q0 Q1 X

Quantity
In figure, E is the initial equilibrium point. When demand increase, the
demand curve shifts from DD to D1D1. This means, price of the
commodity increases from OP to OP1 whereas supply remains
constant. At this price OP1 demand is less than supply which shows
the pressure to decrease on price to OP0. This process continues up to
E1 point where final equilibrium is attained. The path of equilibrium
from old to new equilibrium points can be show as 𝐄 → 𝐚 → 𝐛 → 𝐜 →
𝐝 → ⋯ ⋯ → 𝐄𝟏 . Thus, micro dynamics shows the process of
adjustment from one equilibrium point to another.

You might also like