1. Introduction To Microeconomics

1. Introduction To Microeconomics - Transcript

Session Objectives
To understand the nature and scope of economics The focus would be on the definitions and classification of economics relevance of microeconomics significance and limitations of microeconomics scarcity and choice and answering the fundamental issues of what how and for whom to produce to make the best use of economics
The focus is on how the basic questions of economy i e what how and for whom are answered in different economic systems The differences between various economic systems shall also be seen How production is optimized with the help of the production possibility curve and analysis of PPC with full utilization of resources and when there is a technological development The concepts of partial equilibrium and general equilibrium analysis are also discussed The session is concluded with how various economic factors influences the business
Definition Classifications of Economics
All the definitions of economics focuses on two aspects scarce resources and unlimited wants For
Example A piece of land which is a limited resource can be utilized for any economic purpose like agriculture industry housing etc There is no dearth of its usage but the area of land is limited So a rational economic choice has to be made Therefore economics explain day to day economic activity of an individual firm or a nation
Economics can be viewed as a science or as an art Further it can also be classified as pure economics and applied economics or positive and normative economics A broad classification of economics can be done by dividing economics into micro and macro economics
Is Economics a Science or an art
Economics can be viewed as a science or as an art A science must be capable of formulating laws explaining the circumstances under which a particular result can be achieved and also the change in the result due to changes in the variables If economics is a science why does it fail to
predict the future course of events like unemployment and price fluctuations
predict how an individual reacts in a particular situation
quantify the economic variables in all the situations As many a times economic decisions are based on human attitudes and emotions
As economics deals with the wants needs and demand of human beings it is sometimes defined as an art
Art is a system of rule for the attainment of given end J M Keynes
An art like a science is a systematized body of knowledge however unlike a science it provides specific solutions to specific problems
is a systematized body of knowledge
provides specific solutions to specific problems
is more practical than science
Applied and Pure Economics
Some economists categorize economics into pure economics and applied economics
Well known economist Professor Bye defines a pure science as one that furnishes the tools with which applied science works The two go hand in hand but the former must precede for without it the latter is without the proper means for accomplishment of its tasks
According to Professor Stigler more than 90 percent of economists spend over half their time on applied or empirical subjects only a small minority is interested in advanced theoretical discussions
Positive Economics
A positive science may be defined as a body of systematized knowledge concerning what is It is not about ends it is concerned with moral judgments Positive economics
explains the economics according to their causes and effects
help establish uniformities
describes the facts of an economy
deals with how an economic problem is solved
deals with questions like Does free trade raise or lower wages for the citizens The economic impact of raising the taxes
Example Positive statement Unemployment is 9 percent of the labor force
Positive statement Ceteris Paribus if tuition fee is hiked enrollment of students will fall
Normative Economics
A normative science is a body of systematized knowledge relating to the criteria of what ought to be and concerned with the ideal as distinguished from the actual
Normative science
objective is determination of ideals
involves value judgments
deals with how the problem should be solved
involves no rights or wrongs
involves political debates and decisions
issues cannot be solved by economic analysis alone
raises questions like should poor people be required to work if they are to get government assistance
Example Normative statement Unemployment ought to be reduced
Normative statement Tuition fee should be reduced to ensure more students obtain education
Microeconomics and Macroeconomics
Microeconomics is concerned with specific economic units and a detailed consideration of the behavior of these individual units
Microeconomics focuses on
economic system from the perspective of households and business firms
the nature of individual consumption and production units within a particular market or economic system
the decisions that people and organizations make with regard to the allocation of resources and prices of goods and services
the various policies like tax policies and government regulation at the individual level and at the firm level
the reasons for variations in price due to change in demand and supply
Macroeconomics can be defined as the branch of economic analysis which studies the behavior of not one particular unit but all the units combined together Therefore macroeconomics is a study in aggregate
Macroeconomics is concerned with
obtaining the overview or general outline of the structure of the economy
relationship between the major aggregates which constitute the economy
Importance of Microeconomic Analysis
Maximizes resource utilization
Microeconomics studies the problems of satisfying multiple wants with a limited amount of money at both individual and firm level
Advocates market economy
In order to ensure efficient allocation of resources and capital and to attain self sufficiency microeconomics advocates a free market economy where demand and supply determine the allocation of resources
Basis of welfare economics
Microeconomics dictates the conditions of economic efficiency and also suggests the means to attain the efficiency A major part of welfare economics is based on microeconomics
Provides tools for evaluating economic policies
As microeconomics deals with consumption and production it helps in understanding and removing the hindrances in achieving the production efficiency
Construction and use of models
Economic models can be abstractions or simplification of the real world They help not only to describe the actual situation but to suggest policies that would most successfully and most efficiently bring about desired results and to predict the outcomes of such policies and other events Economic models can be in the form of
Words
Numerical tables
Graphs
Algebra
Limitations of Microeconomics
Microeconomics deals with the individual perspective not the aggregate economy
What is applicable to an individual may not be true for an economy
Example Retrenchment may help a particular firm but if all firms in an industry retrench their employees it will have a negative effect on the economy
Assumptions like full employment in the economy and those other things will remain unchanged when one particular variable is changed are not valid in many situations
Example An assumption of full employment will not hold true for an economy where underemployment is the norm
Microeconomics deals with specific parts of the economy and tries to provide solutions to specific problems only overlooking the broader problems in the economy
Scarcity and Choice
If there is no scarcity in the economy
people would not work hard to earn extra money
firms will have no problem pertaining to wages of the labor
governments need not worry about spending and taxes
There would not be any economic good All goods would be free like sand in the desert or seawater on the beach
But it is not possible in the real world Resources are scarce and wants are unlimited So consumers firms and governments want to maximize their satisfaction with the available resources It is possible only through efficient utilization of available resources by making choices
Example Suppose an individual has fixed sum of money he can use either to pursue further education or start a business The opportunity cost of the choice becomes the decisive factor
Therefore the factors that influence the decisions of the individuals in making the choice are budget constraint and personal preferences
Fundamental Questions for an Economy
To utilize the scarce resources in the most efficient manner a firm or an economy has to address the following questions
What to produce
How to produce
For whom to produce
These questions become relevant not only because the resources are scarce but also because of their alternate uses
What to produce
Any government faces scarcity of land labor and capital thus it cannot satisfy all the needs of the economy In order to optimize the satisfaction it needs to choose which goods and services to produce with the limited resources available Similarly an individual has to decide how much to consume and how to save Even while spending he needs to utilize the resources in such a way that he can derive maximum satisfaction from it
How to produce
Depending upon the availability of the resources a firm or an economy can decide how to produce If the economy has abundant labor it can go for labor intensive industries or projects Similarly if a firm has huge capitals it can invest in sophisticated technologies and minimize the labor costs Depending on the resources available techniques of production can be labor intensive or capital intensive
For whom to produce
One has to analyze the beneficiaries of the scarce resources If the utilization of the resources is not directed properly the basic purpose of the production would die
Economic Systems
There are different ways through which a society can answer the basic economic questions of what how and for whom to produce To allocate the scarce resources the societies are organized through alternative economic systems The answers to these fundamental questions largely depend upon the extent of control the government exercises over the economy
In general economic systems are fundamentally classified into two forms One where government exercises complete control over the economy all the decisions are taken by it and individuals and firms have no say in the functioning of the economy known as command economy Two market forces drive the economy Decisions are made in the markets and individuals and firms come to agreement to exchange goods and services through payment of money This economic system is known as market economy These are the two extreme forms of economic systems An economic system that is the combination of both the systems has become more common in contemporary economies known as mixed economy
Market Economy
A market economy is one in which individual and private firms make the major decisions about production and consumption This economic system emphasizes the freedom of individuals as consumers and suppliers of resources and allows market forces to determine the allocation of scarce resources through the price mechanism However no economy is completely a market economy or a command economy instead they lie some where in between This form of economy is also called as pure capitalism or laissez faire
Example United States of America Japan etc are some of the economies tilted towards capitalism
Characteristics of Market Economy
In a market economy firms produce that generates maximum profits what using the most efficient methods of production how Firms produce the goods keeping in mind the target customers for whom
In this economic system individuals enjoy freedom as consumers and suppliers of resources This enables the market forces to determine the allocation of scarce resources in the most efficient manner
Price is the primary influencing factor for both producers and consumers If a producer is earning more profits on a particular product he concentrates all the resources towards that product
In this economic system the role of the government is negligible Consumers choose the goods they want and producers allocate their resources to produce the goods that consumer prefer
In this system efficiency is attained only through profit motive Producers try to minimize the costs through efficient ways of production and consumers get maximum value for the goods and services
The extreme form of market economy where the government has no role at all to play in the economy is known as laissez faire economy
Command Economy
In command economy all the decisions pertaining to production and distribution of goods are taken by government In this type of systems efficiency can be achieved only when demands are accurately estimated and resources are allocated accordingly This economic system is also called communism
Example USSR was an example of command economy China is the other example
Features of command economy
All decisions right from allocation of resources to the distribution of resources is taken by the government
Market attains efficiency only when there is accuracy in the demand estimation and resources are allocated accordingly
As the government has full control over the economy consumers are just price takers They have to accept the prices fixed by the government
Individuals choice and preferences have least importance All the decisions are taken by the government keeping in mind the national goals
As the prices are controlled by the government there exists equality in the economy Moreover compared to other types of economies there is more even distribution of income
As all the enterprises are owned by the government government is the biggest employer in the economy
USSR was the best example for the command economy Where the government had absolute control over the economy
Mixed Economy
Mixed economy is a combination of both market and command economy Real world economies are arrayed between the extremes of pure capitalism and the command economy
Features of mixed economy
In contemporary era it is hard to find any economy that is either absolute market or command economy All the modern day economies are a mix of both the economic systems
In order to have a high level of employment and controlled inflation government controls the price fluctuations sometimes
To answer the basic economic questions of what how and for whom cost benefit analysis is used
All the decisions are based on economic viabilities and rationalities
Decisions on any project are taken only when social benefits exceed social costs
Government takes care of basic services like healthcare and education
Example Authoritarian capitalism was existent during Hitler s Nazi Germany where the economy was subject to high degree of governmental control and direction but property was privately owned Market socialism prevailed in Yugoslavian economy which is characterized by public ownership of resources coupled with increasing reliance on free markets to organize and coordinate economic activity
Production Possibility Curve
Production possibility curve helps in analyzing how individuals producers and other economic agents use the scarce resources to meet the unlimited needs
Production can be defined as the process of using the services of labor and other resources to make goods and services available
Resources include
Land
Land includes natural resources like forests rivers and minerals
Labor
Labor includes services of physical and intellectual capabilities of human beings
Capital
Equipments tools structures materials and skills created to produce goods and services
Entrepreneurship
Entrepreneurship is the talent to develop products and processes and to organize production to make goods and services available
Assumptions made while constructing PPC
While constructing the production possibility curve certain assumptions have to be made
Those are
The economic resources available during a period of time are in fixed quantity
The economic resources can be used to produce only two categories of goods
Some inputs are better used in producing one of these classes of goods rather than the other
Technology remains unchanged for the given period
The economy is operating at full employment and achieving full production
Production Possibility Schedule

Production possibility Schedule
Production possibilities
Wheat in tons
Sugar in tons
A
0
15
B
1
14
C
2
12
D
3
9
E
4
5
F
5
0
The curve indicates the schedule along which the society can choose to forego sugar for wheat
It can be seen from the table that as the production of wheat increases the production of sugar decreases more than proportionately
At production possibility A with the given resources an economy can produce either one ton of wheat or 14 tons of sugar
With the limited resources if the economy wants to produce an additional ton of wheat it has to forego two tons of sugar
Similarly if the economy wants to produce 5 tons of wheat it has to completely forego the production of sugar
Therefore an increase in the production or consumption of one good can be achieved only through the opportunity cost of the other good
Depending upon the requirement of either of the products an economy has to concentrate its resources to have the maximum satisfaction
As we concentrate on producing more and more of a particular good the opportunity cost keeps on increasing As a result the PPC is concave to the origin
PPC with Full Utilization of Resources
PPC shows the maximum combined output of two goods
In the graph points L and M are on the curve representing the full utilization of resources
In reality production at its actual capacity may not happen
Point inside the curve N shows underutilization of the resources and also shows there is an unemployment in the economy
As the resources are scarce an increase in the production of one good comes at the cost of cutting the production of another good
In the long run production can increase due to various reasons resulting in upward rise in the production curve
Main Sources of Economic Growth
If the production possibility curve of an economy moves upwards it indicates a growth in the economy The reasons for the economic growth are
Increase in the quantities of available economic resources available
Example Generally with an increase in population there is going to be an increase in factors of production thereby increasing the total production of the economy
Improved quality resources
If the industry happens to be labor intensive the continuous learning helps in improvement of the labor skills This increases the productivity of labor and the economy grows
Advanced technologies
Improved technology results in increase in production
Example In agriculture the improvements in biotechnology resulted in rise in production Thus PPC rises upwards from AF to A1F1
Uses of the PPC
Knowledge of economic efficiency
Production possibility curve illustrates whether economy is utilizing the resources efficiently or not
Distribution of national income
PPC helps in analyzing the distribution of national income Suppose a country has steel reserves it can be seen whether it is being used for infrastructure development or defense technologies
Choice of the production techniques
Based on the nature of the product being manufactured the type of manufacturing process can be determined If the product is more labor intensive more labor can be deployed if it involves high end technologies more capital can be employed to procure the technologies Thus allocation of resources can be more accurate and proper
Economics and business
In the changing business environment business managers need to keep a constant watch on both micro and macro economic aspects
Based on the demand for the product the products need to be manufactured
Example Kellogg misread the demand for the Cornflakes in India and suffered heavy losses
Demand study helps in determining the quantity to be produced
If the firm produces products more than the demand it incurs losses due to heavy inventory costs
Depending upon the production processes resources need to be allocated
Based on the demand and the capability of the customers products need to be priced
Various external factors like governments economic policies interest rates threats from foreign manufacturers etc also influence the business
Partial Equilibrium and General Equilibrium Analysis
Partial equilibrium analysis PEA and general equilibrium analysis GEA are two different approaches for analyzing the functioning of an economy with inter related markets
Partial equilibrium analysis PEA
The concept of PEA was popularized by Alfred Marshall an English economist in the 19th century Under PEA a market is studied in isolation from the rest of the economy PEA studies the impact of market forces such as the forces of demand and supply in relation to changes in price of commodities and or factors
The limitation of PEA is that it is not applicable when there is interrelationship between commodities or between factors of production Further it is very complex to apply PEA to understand how an economy functions as a whole
General equilibrium analysis GEA
GEA is useful to study the economy as a whole and takes into consideration simultaneous equilibrium of all markets In an economic system there is a high degree of interrelationship and interdependence among various markets for commodities and factors of production In addition to this there are many decision making agents like consumers producers resource owners and workers who make decisions to maximize their individual profits GEA studies how these various factors function simultaneously in an economy
Both PEA and GEA are useful in their own way
PEA provides an explanation for determining price and quantity for a given product or factor market when each market is independent and viewed in isolation
GEA on the other hand explains simultaneous equilibrium of markets when prices and quantities of products and factors are considered as variables
In this way both PEA and GEA are useful and have to be applied appropriately according to the requirements of the study
Summary
Definition and classifications of economics
Microeconomic analysis Importance and limitations
Scarcity and choice
Different Types of Economic Systems
Construction of Production Possibility Curve
Understanding Partial Equilibrium Analysis and General Equilibrium Analysis
Relationship between Economics and Business