Fundamental of Economics,

Lecture#2
The field of economics is traditionally divided into two broad subfields.
•Micro Economics
•Macro Economics
Introduction to microeconomics:

• Adam Smith is considered the father of microeconomics, who is also the

father of economics.
• According to Smith’s philosophy of free markets, there should be
minimum government intervention and taxation in free markets.
• His idea of an invisible hand- which is the tendency of free markets to
regulate themselves by means of competition, supply and demand, and
self-interest was popular at that time.
• Smith’s opinions on the economy predominated for the next two
centuries; however, in the late 19th and early 20th centuries, the views
of Alfred Marshall (1842–1924), a London-born economist, had a
significant influence on the economic theory.
Microeconomics versus Macroeconomics:

• Microeconomics is the study of how households and firms make

decisions and how they interact in specific markets.
• Macroeconomics is the study of economy-wide phenomena, including
inflation, unemployment, and economic growth.
• Microeconomics and macroeconomics are closely intertwined.
• Because changes in the overall economy arise from the decisions of
millions of individuals, it is impossible to understand macroeconomics
developments without considering the associated microeconomic
decisions.
• For example, a macroeconomist might study the effect of a cut in the
federal income tax on the overall production of goods and services
• To analyze this issue, he or she must consider how the tax cut affects
the decisions of households about how much to spend on goods and
services.
• Despite the inherent link between microeconomics and
macroeconomics, the two fields are distinct.
• Because they address different questions, each field has its own set of
models.
Defining Micro economics
• Microeconomics may look at the incentives that influence individuals
to make certain purchases, how they seek to maximize utility, and how
they react to restraints.
• Microeconomics for firms may look at how producers decide what to
produce, in what quantities, and what inputs to use based on
minimizing costs and maximizing profits.
• Microeconomists formulate various types of models based on logic
and observed human behavior.
• They test the models against real-world observations.
Key questions in Microeconomics

1. What goods and services should be produced?

2. How should they be produced?
3. For whom should they be produced?
4. How much should be produced?
5. At what price should they be sold?
 The representative examples of microeconomics are:

1. Demand: This is how the demand for commodities is determined by income,

choices, cost prices, and other circumstances, such as expectations.
2. Supply: This is to ascertain how manufacturers determine to enter markets,
scale production, and exit markets.
3. Opportunity cost: It is the compromises or the trade-offs that the individuals
and enterprises make to accomplish restrained resources such as money, time,
land, and capital. For instance, an individual who decides to go to an
academy and begin a company may not have enough time or money for both.
4. Consumer choice: The notion that customers maximize their anticipated
utility of purchases implies that they purchase the things they assume to be
most useful to them.
5. Welfare economics: It refers to creating the influence of social programs on
economic choices such as labor participation or risk-taking.
Basic Concepts of Microeconomics

The study of microeconomics involves several key concepts, including but not limited
to:
1. Incentives and behaviors: This address how people as individuals or in firms react to
the situations with which they're confronted.
2. Utility theory: Consumers will choose to purchase and consume a combination of
goods that will maximize their happiness or “utility” subject to the constraint of how
much income they have available to spend.
3. Production theory: This is the study of production or the process of converting
inputs into outputs. Producers seek to choose a combination of inputs and methods of
combining them that will minimize costs to maximize their profits.
4. Price theory: Utility and production theory interact to produce the theory of supply
and demand which determines prices in a competitive market. Price theory concludes
that the price demanded by consumers is the same as that supplied by producers in a
perfectly competitive market. This results in economic equilibrium.
•Where Is Microeconomics Used?
•Microeconomics has a wide variety of uses.
1. Policymakers may use microeconomics to understand the effect of
setting a minimum wage or subsidizing the production of certain
commodities.
2. Businesses may use microeconomics to analyze pricing or production
choices.
3. Individuals may use it to assess purchasing and spending decisions.
What Is Utility in Microeconomics?

• Utility refers to the degree of satisfaction that an individual receives

when making an economic decision.
• The concept is important because decision-makers are often assumed
to seek maximum utility when making choices within a market.
How Important Is Microeconomics in Our Daily Life?

• Microeconomics is critical to daily life even in ways that may not be

evident to those engaging in it.
• Take the case of someone who's looking to buy a car. Microeconomic
principles play a central role in individual decision-making.
• They'll likely consider various incentives such as rebates or low
interest rates when assessing whether to purchase a vehicle.
• They'll probably select a make and model based on maximizing utility
while also staying within their income constraints.
• A car company will have made similar microeconomic considerations
in the production and supply of cars into the market.
Agent of the economy and their objectives
• An economic agent is an entity that engages in economic activities.
• This activity can be buying, selling, or producing goods and services
and influencing capital market.
• There are four types of economic agents:
1. Households or individuals,
2. Businesses
3. Governments, and
4. Central banks.
•Each type of economic agent has different objectives.
Households and Individuals as economic Agents:

• Households and individuals are the most basic economic agents.

• They are defined as a group of people living under the same roof who
shares common resources.
• The household or individual agent is responsible for consumption,
meaning they purchase goods and services to satisfy their needs and
wants.
• Households and individuals impact the economy by influencing both
demand and supply.
• Their demand for goods and services affects prices, and their labor
supply affects production.
Firms as Economic Agents:

• Firms, or “businesses”, are another type of economic agent.

• They are defined as an organization that produces goods and services
to sell them to make a profit.
• The business agent is responsible for production.
• This responsibility for the profit means they combine labor, capital,
land, and entrepreneurism to create goods and services.
• Businesses impact the economy by influencing both demand and
supply.
• Their demand for inputs affects prices, and their supply of goods and
services affects production.
Government as Economic Agents:

• Governments are yet another type of economic agent.

• They are responsible for providing public goods and services and
regulating businesses.
• They are also responsible for stabilization, which means they use
fiscal and monetary policy to maintain economic stability.
• Governments impact the economy by influencing both demand and
supply.
• Their demand for taxes and regulations affects prices, and their supply
of public goods and services affects production.
Central Banks as Economic Agents:

• Central banks are the final type of economic agent.

• They are financial institutions that manage a country’s money supply
and interest rates.
• They also serve as lenders of last resort.
• Central banks impact the economy by influencing both demand and
supply.
• Their money supply management and interest rates affect prices, and
their lending practices affect production.
Production possibility frontier

• A graph that shows the combinations of output that economy can

possibly produce given the available factors of production and the
available production technology.
• Let’s assume an economy that produces only two goods_cars and
computers.
• Together, the car industry and the computer industry use all of the
economy’s factors of production.
• In this case, cars and computers that the economy can possibly produce
given the available factors of production and the available production
technology that firms can use to turn these factors into output.
• Figure shows this economy’s production possibilities frontier.
• If the economy uses all its resources in the cars industry, it can
produce 1,000 cars and no computers.
• If it uses all its resources in the computer industry, it can produce
3,000 computers and no cars.
• The two endpoints of the production possibilities frontier represent
these extreme possibilities.
• More likely, the economy divides its resources between the two
industries, and this yield other points on the production possibilities
frontier.
• For example, it can produce 700 cars and 2000 computers, shown in
the figure by point A.
• Or by moving some of the factors of production to the computer
industry from the car industry, the economy can produce 600 cars and
2,200 computers, represented by point C.
• Because resources are scarce, not every conceivable outcome is
feasible.
• For example, no matter how resources are allocated between the two
industries, the economy cannot produce the cars and computers
represented by point D.
• Given the technology available for manufacturing cars and computers,
the economy simply does not have enough of the factors of production
to support that level of output.
• With the resources it has, the economy can produce at any point on or
inside the production possibilities frontier, but it cannot produce at the
points outside the frontier.
• An outcome is said to be efficient if the economy is getting all it can
from the scarce resources it has available.
• Points on (rather than inside) the production possibilities frontier
represent efficient levels of production.
• When the economy is producing such a point, say point C, there is no
way to produce more of one good without producing less of other.
• Point B represents an inefficient outcome.
• For some reason, perhaps widespread unemployment, the economy is
producing less than it could from the resources it has available: it is
producing only 300 cars and 1,000 computers.
• If the source of the inefficiency is eliminated, the economy can
increase its production of both goods.
• For example, if the economy moves from point B to point C, its
production of cars increases from 300 to 600 and its production of
computers increases from 1,000 to 2,200.
• The PPF shows one trade-off that society faces.
• Once we reach the efficient point of the frontier, the only way of
getting more of one good is to get less of the other.
• When the economy moves from point C to point A, for instance,
society produces 100 more cars but at the expense of producing 200
fewer computers.
• This trade-off helps us understand the cost of something is what you
give up to get it. This is called the opportunity cost.
• The PPF shows the opportunity cost of one good as measured in term
of the other good.
• When society moves from point C to point A, it gives up 200
computers to get 100 additional cars.
• That is, at point C, the opportunity cost of 100 cars is 200 computers.
• Put another way, the opportunity cost of each car is two computers.
Shifting a PPF:

• The PPF shows the trade off between the outputs of different goods at a given
time, for example, suppose a technological advance in the computer industry
raises the number of computers that a worker can produce per work.
• Trade allows countries, individuals, or firms to reach points outside their PPF.
• In addition to trade, there are some other factors that shift a countries PPF,
allowing and change in attainable output .
• These factors include:
• A Shift in Technology
• More Education or Training
• Natural Disaster
Positive versus Normative Economics:

• Positive economics is the study of the facts in economics and

normative economics is the study of the values in economics.
• In the philosophy of economics, economics is often divided into
positive and normative economics.
• Positive economics focuses on the description, quantification and
explanation of economic phenomena;
• Normative economics often takes the form of discussions about
fairness and what the outcome of the economy or goals of public
policy ought to be, as well as prescriptions regarding rational choice.
• Positive and normative statements are fundamentally different, but
they are often closely intertwined in a person’s set of beliefs.
• In particular, positive views about how the world works affect
normative views about what policies are desirable.
• Polly’s claim that the minimum wage causes unemployment, if true,
might lead her to reject Norma’s conclusion that the government
should raise the minimum wage.
• Yet normative conclusions cannot come from positive analysis alone;
they involve value judgment as well.