Micro Economics

M12104
Dr. A. K. Upadhyay
According to the father of Economics,
Prof. Adam Smith, economics is the study
of the nature and the causes of wealth of
nations. According to him economics is the
science of wealth.
Adam Smith is usually considered the founder of
the field of microeconomics, the branch of
economics which today is concerned with the
behavior of individual entities such as markets,
firms, and households. In his famous book, The
Wealth of Nations (1776), smith considered how
individual prices are set, studied the
determination of prices of land, labour, and
capital, and inquired into the strengths and
weaknesses of the market mechanism.
Economics deals with the problem of choice,
According to Prof, Robbins Economics is a
science which studies the human behavior as a
relationship between ends and scares resources
which have alternative uses. There are two
basic facts because of them an economy exists.
The first fact is that the resources are limited,
and the second fact is that the human wants are
unlimited. Everyone is trying to satisfy all his or
her wants with limited resources.
Economics can be divided into two parts,
Microeconomics and Macroeconomics.
Microeconomics has been derived from a
Greek wordmikros and Macroeconomics
has been derived from the Greek word
makros. The meanings of mikros and
makros are small and large respectively.
Microeconomics deals with the individuals,
and Macroeconomics deals with
aggregates.
The Scope of Economics
There is a conflict among the economist
about the scope of economics from the
time period of Prof; Adam Smith (Father of
Economics) to till date, this conflict can be
seen in the various definitions given by
various economists.
According to Prof, Adam Smith in his book, An Enquiry
into the nature and the causes of wealth of nations the
subject matter of economics is to enquire the nature and
the causes of wealth of nations. According to Prof,
Ricardo the subject matter of economics is related with
the distribution of income and wealth.


According to Prof, Marshall the subject matter of the
economics is to study the mankind, or in other words to
increase the social welfare. In against according to Prof,
Pigou the subject matter of the economics is to maximize
the social welfare but that social welfare which is
measurable with the measuring rod of money.
With the help of above definitions we can
say that each and every definition gives us
incomplete information about of the
subject matter of economics, some
definitions are very narrow, and on the
other hand some are very wide.
The questions which have been asked by the economists are
followings:
1. What to produce?
In other words which commodity should be produced/
2. How to Produce?
Or which technology should be adopt, labour intensive or capital
intensive
3. Problem of distribution.
In other words, how the total production of the goods and the
services should be distributed among the people.
4. Are the resources are using economically?
5. Are the resources are fully utilized or unutilized or they are
unutilized?
Above five questions are frequently asked by the economists. The
economic theory deals with the above five questions, and also try to
solve them. Lets discuss all the above questions in detail.
What to Produce
The first problem of economist is related with the
allocation of resources. This problem arises because of
the scarcity of resources, we can not produce all the
commodities in a larger quantity, for that we dont have
the enough resources. Now what we can do, we can
withdraw some resources from the production process of
one commodity and devote them into the production
process of another commodity.
It depends on the desirability of the commodity, the
greater the desire of a commodity, the greater the
amount of resources devoted in the production process
of that commodity. This problem can also understand
from the view point of producer, higher the price of the
commodity, higher the production of that commodity. The
price theory explains how the price of the commodity is
determined.
How to Produce
The problem of how to produce is related with the choice
of technology. It depends on the availability of resources,
in other words we can say that it depends on the
abundant factor of production. In economics normally we
consider two factors of production labour and capital. A
country can be labour abundant or capital abundant, the
problem how to produce is related with the choice of
technology, like we can produce the cloth by hand-loom
or by automatic-machines,
the first one needs a larger amount of labour and a smaller
amount of capital, whether the second method of
production needs a larger amount of capital and a
smaller amount of labour. Now we can say that in this
condition a country has to choose whether it wants to
produce the cloth with capital intensive technique or
labour intensive technique. We can study the physical
relationship of input and output in the theory of
production.
Problem of Distribution

This problem is related with the distribution of goods and
services produced among the people of the country.
There is also a conflict among the economists that which
one should take more from the national product. From
the time period of Adam Smith and David Ricardo we
have this question. The production depends on the
several factors of production like land, labour, capital etc.
Now the question arises that which one should takes the
higher share from the reward of production or from price
of the production, this is the subject matter of the theory
of distribution.
The Problem of Economic
Efficiency

As we all know that the resources are scare, so
that they should be used efficiently. The simplest
method to measure the efficiency is, if we can
not increase the production of a commodity
without decreasing the production of the other
commodity with the help of re-allocation of the
resources, it means we are using our resources
efficiently.
Full Employment of Resources

It is the problem related with the utilization of the
available resources. At the level of individual
person or at the country level, this problem is
very important that whether we are fully utilizing
our resources or not. At the country level to
achieve a higher rate of economic growth fully
utilization of the resources is mandatory, even a
single country can not achieve the growth target
with miss utilization of the resources or
underutilization of the resources.
What is a market

We have heard a lot that most of the
economic problems are resolved through
the market. Another question can be who
solves the fundamental questions of
economics like, what, how and for whom.
You feel surprised to know that there is no
one individual or organization or even the
government of the nation is responsible for
solving these economic problems in a
market economy.
A market is a mechanism through which
buyers and sellers interact to determine
prices and exchange goods and services.
In a market system, everything has a
price, which is the value of the good in
terms of money
Prices represent the terms on which people and
firms voluntarily exchange different commodities.
What is true for the market for consumer goods
is also true of market for factors of production,
such as land and labour.
Prices coordinate the decisions of producers and
consumers in a market. Higher price tend to
reduce consumer purchases and encourage
production. Lower prices encourage
consumption and discourage production. Prices
are the balance wheel of the market mechanism.
Meaning of equilibrium
The term equilibrium has been often used in the
economics. In fact modern economics is
sometime called equilibrium analysis.
Equilibrium means a state of balance. When
forces acting in the opposite direction, are just
equal, the object on which they are acting is said
to be in state of equilibrium. Tie a cord to a piece
of stone and dangle it in the air, after oscillating
from side to side, the stone will come to rest, if
no further disturbance is caused. The stone is
then in equilibrium.
Partial and General Equilibrium
Meaning of partial equilibrium
Partial equilibrium analysis is the analysis of an
equilibrium position for a sector of the economy
or for one or several partial groups of the
economic units corresponding to a particular set
of whereby, it excludes certain variable and
relationship from the totality and studies only a
few selected variables at a time. In other words,
this method considers the changes in one or two
variables keeping all other constant.
General Equilibrium

Meaning of General Equilibrium
As we know that the partial equilibrium analysis
enables us to study the relationship between
only a few variables, keeping others unchanged.
But in real world nothing is constant; we cannot
assume other factors constant for the partial
equilibrium analysis.
It should be noted that the study of
interrelationship between various economic
agents and markets is the subject matter of
general equilibrium analysis.
Demand, Supply and
Competitive Equilibrium
The price of a commodity depends upon
the demand and the supply of that
particular commodity. This part of the book
explains the demand of a good, supply of
a good and the determination of price with
the help of equilibrium through demand
and supply. Before explaining demand,
supply and equilibrium we have to
understand the factors which determine
the demand.
It is necessary to distinguish between
demand and desire. A peon wants to have
a BMW, or a LCD TV. But such needs and
desire do not constitute demand. When
there is a willingness and ability to pay for
that desire, the desire is changed into
demand.
In the words of Prof. Bober, By demand we
mean the various quantities of a given
commodity or service which consumers would
buy in one market in a given period of time at
various prices, or at various incomes, or at
various prices of related goods.
The demand of a commodity or a good depends
on several factors like price of the commodity,
prices of the related goods, income of the
consumers, tastes and the preferences of the
consumers and future price of the commodity
and so on.
We can put all the factors in a functional form:
QD = f (Px, Py, Ic, T&P, Fp, V)
Where QD = Quantity demanded
Px = Price of the commodity
Ic = Income of the consumer
T&P= taste and the preferences of the consumer
Fp = Future price of the commodity
V= Other factors.
The entire factor plays a crucial role in determining the
price of the commodity, but economists are mainly
concerned with the price of the commodity in price
determination. From the time period of Prof, Marshall, (in
cardinal utility theory) many economists have
propounded several theories to explain the relationship
between price and the quantity demand of a commodity.
Cardinal utility theory explains the negative relationship
between price and the quantity demanded. After the
existence of cardinal utility, several other demand
theories came into existence like, Indifference Curve
Analysis, Revealed Preference Theory, Hicks logical
Weak Ordering theory, etc. In this part of the book we
will explain the concept of demand.
Types of Demand:
Demand can be divided into three types,
1. Price Demand
2. Income Demand, and,
3. Cross demand
Price Demand,
Price demand refers to the various quantity
demanded of a commodity or service that a
consumer will buy in a given time period at
various price levels in a market. It is assumed
that other things, such as consumers income,
his tastes and prices of inter-related goods,
remain unchanged.
The demand of the individual consumer is
known as individual demand and the total
demand of the entire consumers for that
commodity is known as market demand
Income demand,
Income demand refers to the various quantity
demanded of a commodity or service that a
consumer will buy in a given time period at
various levels of income. Here we assume that
the price of the commodity or the service as well
as the prices of the related goods and the tastes
and the desires of the consumer does not
change.
Cross Demand
The cross demand of a commodity or service
refers to the quantity demanded of a commodity
or service a consumer will buy with reference to
change in price of inter-related goods or
services, and not of this good or service.
These goods are either substitutes or
complementary goods. A change in the price of
tea, will affect the demand for coffee.
Of these types of demand, price demand is the
most commonly spoken one. Now we study
demand schedule, demand curve, etc., relating
to price demand.
The Meaning of Demand
The demand for a commodity is the amount of that
particular commodity that a consumer will purchase from
the market at various given prices and in a given period
of time. According to the economics view point demand
includes desire to purchase, ability to pay and
willingness to pay. We can not consider desire to
purchase as demand that is not backed by the
willingness to pay and ability to pay. For instance, to
purchase an Audi or a Mercedes can be a desire to
purchase for a person of ten thousand rupees salary, we
can not consider it demand, but to purchase a
Motorcycle can be consider as a demand for the same
person.
Law of Demand
Law of demand states the relationship between price
and the quantity demanded of a commodity. It should be
noted that law of demand is one of the most important
laws of economics, according to the law of demand, if
the other things remain the same, there is an inverse
relationship between price and the quantity demanded.
Other things stand for all the factors that we have in
demand function, except price of the commodity, like
price of related goods, income of the consumer, tastes
and the preferences of the consumer, future price and
some other factors. If all these factors are constant than
there should be a negative or inverse relationship
between price and the quantity demanded. We can
better understand the law of demand with the help of a
table and graph.
Demand Schedule of an
Individual Consumer
Price (Rs.) Quantity demanded
14 15
12 25
10 35
8 45
6 55
4 65
The Demand Curve
D
D
X
Y
0 15 25 35 45 55 65
4




6






8




1
0


1
2


1
4
A
B
C
D
E
F
Quantity
P
r
i
c
e

Now we can better understand the Law of demand with the help of
above table and graph, it is clear from the figure that when the price
is high the quantity demanded is low. According to the law of
demand, there is a inverse relationship between price and the
quantity demanded, now we can plot the price on Y Axis and
quantity demanded on X Axis, what we see in the graph that when
the price of the commodity was 14 Rs, per unit the quantity
demanded was 15 units, when the price of the commodity decrease
to Rs, 14 per unit, quantity demanded increase to 25 from 15, and at
last when price decrease to Rs, 4 per unit, quantity demanded
increase to 65. It is clear from the figure that the slope of demand
curve is negative, because of inverse relationship between price and
the quantity demanded.