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  1. 1. 2 Introduction to Microeconomics BY: CHETAN ACHARYA
  2. 2. Its natural, the curiosity of a student who begins to study economics is to know what is about it. A student of economics would like to know ‘what is economics’ and ‘what is its subject matter’. Similarly some other curiosities like its nature, scope, implication, need, etc. may arise in the beginning. Amazingly, a definite and precise answer to these curiosities cannot be found. Several attempts have been made by several economists from history to yet to define economics. However, a precise and universally acceptable definition of economics has not yielded yet.
  3. 3. Economists right from Adam Smith who is known as ‘The Father of Economics’ to modern economists have defined it differently according to their own perception and circumstances. Smith gave wealth definition, Marshall focused on material welfare, Robbins forwarded scarcity and choice concept. The idea of Robbins is considered as more systematic and scientific than other. This idea produced a social science status of economics. Some economists remarked, economics is an unfinished science and is still a very young. Nevertheless, it is essential for a beginner to have a basic understanding of the nature and subject matter of economics.
  4. 4. Economics is a social science which studies economic activities of humankind. Here, economic activities refer to those behaviors of people at which people have conscious effort to derive maximum benefits from the use of limited resources and opportunities available to them. People, they have unlimited needs and limited resources to meet such needs. Economics primarily concerns with the behavior of the people that how they allocate their limited resources and opportunities to their alternative uses to produce and consume goods or services to satisfy their unlimited needs. The effort of the people to maximize their gains from their limited resources is primarily concerned with to make choices. The compulsion for making choices arises due to following basic issues of economic life.
  5. 5. The compulsion for making choices arises due to following basic issues of economic life.  Unlimited human wants Limited resources are available to satisfy human wants Effort of people to maximize their gains
  6. 6.  Human wants are endless and go on increasing without meeting their end because  Unquenchable desire to raise living standard, comforts and efficiency;  Tendency to accumulate of things beyond their present needs;  Increasing human needs and knowledge, inventions and innovations;  Satisfying one want creates need for many other things:  Wants-meet cycle i.e. one need satisfied, other comes up and etc.
  7. 7. Thus, throughout human life human wants continue to increase. However, all human wants are not equally urgent and important. Satisfying one want gives more pleasure than the others and therefore for the purpose of gain maximization people have to make a choice from several wants.
  8. 8. • Thus, it can be concluded that “Economics is a social science which studies the economic activities and consequences and brings out cause and effect relationship between such economic events. It provides tools and techniques of analyzing economic phenomena and tools and technique for predicting the consequences of economic decisions and events”.
  9. 9. 10 economic theories Every science flows certain methods for the expiation variables. Since economics is a science, it also adopts certain methods, laws or principles or guidelines for the discovery and identification of the relationship between its variables. An economic law or theory which traces out a casual relationship between economic variables. An economic theory is well argued and confirmed statement which explains the cause and effect relationship between dependent and independent variables.
  10. 10. 11 A theory includes a set of assumptions, hypothesis and results which provide a clear way to express the interrelationship between concerned variables. A well structured or defined theory has the following elements:  Definition  Assumptions  Predictions  Tests  Results
  11. 11. Problems of Scarcity and Choice Scarcity is a situation of insufficiency or unavailability or shortage of something. In economics, it is a situation at which excess of demand over the supply of goods and services. It reflects the imbalance between demand for resources and their supplies. Scarcity lacks the sufficient resources to satisfy human needs. Economic resources are available in limited stock and human needs cannot get fulfilled at once. Scarcity is not just a problem of an individual.
  12. 12. It is a problem of the entire economy of a nation as well. An economy has to perform number of activities but it is not possible to carry out all activities at a time due to scarcity of resources. Therefore it gives rise to national economic problems such as: unemployment, poverty, inequality and low quality of life, low infrastructure development, etc. Therefore every human society and hence every economy face a basic economic problem due the insufficiency of resources to fulfill their desire.
  13. 13. • Choice refers to the act of selecting few from several. In economics choice is the rational act or process of selecting few wants from the bundles of wants. As already discussed, human wants are unlimited and resources to fulfill such wants are limited. All human needs cannot be satisfied at once due to the scarcity of resources. Since an individual or economy has limited stock of resources and unlimited wants and so, must decide which need to be satisfied so that gains would be maximized. Therefore again, every human society and hence every economy face another economic problem ‘choice’ due the insufficiency of resources to fulfill their endless desire at once.
  14. 14. Basic Economic Problem Unlimited Wants Limited Resources Problem of Choice Unlimited Wants Limited Resources Problem of Choice Basic Economic Problem
  15. 15. Allocation of resources is related with the use of scarce resources to maximize gains. It means goods and services are produced in such a manner that the gain derived from them is to be maximum. As already stated that, human wants are endless where as resources to meet are limited. Therefore, it is not possible to satisfy all wants simultaneously with limited productive resources. So, limited resources must be used very carefully and the allocation of resources is a rational decision for the achievement of optimal benefits. Allocation of Resources
  16. 16. • Allocation of resources is a basic and key issue of economics. Scarcity and choice both are the fundamental economic problem of every individual or economy. Choice arises due to insufficiency of productive economic resources in comparison to needs to maximize gains. Due to this fundamental economic problem, a producer/society/economy needs to confront some questions and these questions are:
  17. 17.  What to produce? It is the problem of choice between goods. All goods and services are not equally valued in terms of utility derived by the consumers. Some goods may yield higher level of satisfaction and some less. Since all goods and services cannot be produced at once due the insufficiency of productive resources, this requires valuation or ranking of goods and services from most valued to least one. Thus, the problem what to produce is related to the problem of efficient allocation of scarce resources to produce that goods or service which is high valued to the consumers.
  18. 18.  How to produce? It is also related to choice technique. This problem is related to how to determine an optimum combination of input resources in the production of goods and services. Labor and capital, two inputs are available in limited stock. So, a given quantity of commodity can be produced with a number of alternative combinations and each alternative combinations of production involve different cost structure. An efficient technique of production, whether labor intensive or capital intensive, is concerned with this problem.
  19. 19. Whom to produce? Due to the availability of limited productive resources, the want of all population cannot be satisfied at once. So, decision is to be made regarding the how many people’s need is to be satisfied. It means targeted consumer group should be identified. In this direction, basic needs of the common people cannot be ignored. This is another norm of the allocation of resources.
  20. 20.  At what quantity and price to produce? In free market economy, this problem is solved by the market forces. The interaction between demand and supply determines the price quantity of products and factor inputs. The price normally represents the relatively scarcity. The best and efficient technique to produce is the least cost. The minimization of cost is the efficient technique of production.
  21. 21. How to promote economic efficiency? Economic efficiency refers to a situation at which scarce resources are used in a most efficient way that the maximum output is produced. The minimum waste of resources while producing goods or services promotes economic efficiency. If unlimited productive resources are available, there would not be worry about the waste of resources.
  22. 22. How to maintain welfare? Production of goods and services only is not the final solution. Again, another economic problem is still the efficient distribution system. Efficient distribution system assures the welfare in the economy. Efficient allocation of resources avoids worsen of one and better of another.
  23. 23. How to balance sectoral development? While allocating the resources, the governments most consider the balanced policies. The balance between rural and urban, consumer goods and capital goods, regional balance etc must be addressed. How to address to problem of economic growth? Economic growth is the increase in producing capacity of an economy during a certain period of time. The need for increasing producing capacity of the economy arises due to at least two reasons. One, most of the economies in the world has the imbalance between the growth of population and productive resources. The population growth is much faster than the productive resources. Therefore, most of the nations have been experiencing the problem of unemployment and poverty. Hence, the allocation of resources must consider and address the problem.
  24. 24. How to stabilize economy? Business cycle is an important feature of free economy. Such ups and downs are very common in such capitalist economy. Hence, these economic fluctuations cause the wastages and idleness of resources. Therefore, this problem is another basic economic issue.
  25. 25. The nature, subject matter, scope, need of economics, as it is known today, has expanded vastly in post-world war II. Now, in modern era, the system of economic analysis can be classified into two major categories: 1. Microeconomics: It deals with the microscopic analysis of economic variables and system. It studies areas including issues like production, cost, price, distribution, welfare etc. The word ‘micro’ is derived from the Greek word ‘mikro’ which means small and hence microeconomics studies the individual economic units such as markets, firms, households. Microeconomics deals with the choice and decision making behavior of consumers, producers resource owners etc. Introduction of Microeconomics and Macroeconomics
  26. 26. Microeconomics is a traditional concept. All the economic theories in the classical period were micro analysis. The foundation of the microeconomics was ‘An Inquiry into the Nature and Cause of Wealth of Nations’ by Adam Smith in 1776 AD. Microeconomics fundamentally concerns with the study of how individuals and firms find a best solution to the basic economic problems of maximizing their gains from their limited resources. To maximize their gains, individuals have to make a number of choices between unlimited needs and best alternative use of their resources.
  27. 27. 2. Macroeconomics: The word ‘macro’ is derived from the Greek word ‘makro’ which means large and therefore macroeconomics deals with the economic variables in aggregate/lumping/big/whole form such as national income, economic growth, employment, investment, general price level, aggregate demand, aggregate supply, balance of payment, fiscal and monetary policies etc. It is concerned with the study of various elements of the economic system as a whole. It deals with the nature, relationship, and behavior of macroeconomic variables.
  28. 28. Macroeconomics deals with the economic variables in aggregate/lumping/big/whole form such as national income, economic growth, employment, investment, general price level, aggregate demand, aggregate supply, balance of payment, fiscal and monetary policies etc. macroeconomics is relatively new and younger concept in economic literature. With the publication of ‘The General Theory of Employment, Interest and Money’ in 1936 AD by John Maynard Keynes, macroeconomics got a separate existence. However, the terms ‘microeconomics’ and ‘macroeconomics’ were coined and used first time by a Norwegian economist, Ragnar Frisch, in his paper “Proposition Problems and Impulse Problems in Dynamic Economics” published in Economic Essays in the Honor of Gustav Cassel in 1933 AD.
  29. 29. 1. Simple Micro-statics Simple micro-statics explains the relationship between different microeconomic variables at a given period of time under the situation of equilibrium. It shows the static functional relational relationship between different variables at a given time. Types of Microeconomics
  30. 30. 31 O Q P E S D Quantity Price
  31. 31. 32 2. Comparative Micro-statics This just compares the different equilibrium situations at different period of time. with the change in time, the micro economics variables change which helps to deviate the initial equilibrium position. Comparative micro-statics compares the new equilibrium situation with old one. It does not concern with the process of how one equilibrium situation disturbs and new equilibrium condition attains.
  32. 32. 33 O Q P E S D Quantity Price E’ D’ Q’ P’
  33. 33. 34 3. Micro Dynamics It explains the lagged relationship between the microeconomic variables. This describes how the old equilibrium position deviates and new position attains. It is concerns with the changeable condition between old equilibrium position and new equilibrium position.
  34. 34. 35 Qe Pe Q’e P’e E E' Q P
  35. 35. It explains the real nature of the economy. The positive science answers the question of what, when, how etc. According to J.M. Keynes “a positive science may be defined as a body of systematized knowledge concerning what is”. It deals with only what is or how a society face economic problems and how they are solved. How economic processes work and how the economic mechanisms are functioning but does not tell and suggest how they should function. Positive economics uses economic models to analyze economic activities. It is essential for economic policy makers because it gives the real picture of the economy without binding in any moral rules or ethics. Positive Economics
  36. 36. It deals with the economic processes bases on ethics or moral rules. It means normative economics is that branch of economics which is based on ethics or moral rules. According to J.M. Keynes “a normative science may be defined as a body of systematized knowledge concerning what ought to be”. Normative Economics
  37. 37. 1. In positive economics, statements can be empirically verified. It is universal and value does not differ from person to person where as statements may or may not be verified in normative economics. Normal economic is related to personal belief and value judgment and may be different from person to person. 2. positive economics is free from value judgment and ethical consideration and it remains neutral over ends where as normative economics concerns with the value judgment and ethics. Distinction Between Positive and Normative Economics
  38. 38. 3. Positive economics depends upon scientific logic and answers the questions of what is, where as normative economic depends upon ethical logic and answers the question of what should be. 4. Positive economics is objective and quantitative in nature where as normative economics is subjective and descriptive in nature. 5. The aims of positive economics is to explain how society makes decision about consumption, production, distribution, exchange and public finance where as normative economics makes recommendations to suggest what should be done for economic betterment. 6. Positive economics establishes principles and theories where as normative economics formulate spolicy.
  39. 39.  Allocation of Resources  Theory of Product Pricing  Theory of Factor Pricing  Theory of Economic Welfare  Theory of Demand and Supply Scope of Microeconomics Importance/Use of Microeconomics  Functioning of an economy  For efficient allocation of Resources  Useful in Designing Economic Policies  Basis for Welfare economics  Useful in Business decision making  Resource Allocation  Production decision  Pricing Policy  Cost Analysis  Demand Analysis  External Sector Trade
  40. 40. Limitation of Microeconomics Analysis of individual units  Unrealistic assumptions  May not be applicable in totality  Abstract nature  Wrong conclusion  Welfare theory opinion Beyond of other economic subjects 41
  41. 41. Chapter Assignment 1. What is microeconomics? Explain the positive and normative aspect of economics. 2. Differentiate between positive economics and normative economics. 3. “Scarcity is the root cause of all economic problems” Discuss. 4. Explain the importance of microeconomics in business decision making. 5. “The study of economics centers upon the problem of scarcity. “ explain what is meant by this statement and assess whether the use of economics can solve the problem. 6. What do you mean by economic theories? Explain. 7. Explain the types of microeconomics. 8. Point out the limitation of microeconomics. 9. Distinguish between micro-macro economics. 10. What are the functions of microeconomics? 42
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