Introduction To Micro Economics
Introduction To Micro Economics
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.
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.
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
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:
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.
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.
Price
intersects with supply curve.
E
P
Thus, OP and OQ are equilibrium
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.
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.