Last Updated on: 20th August 2024, 12:30 pm

Micro Economics Introduction

Micro Economics

In this part, we discuss about the meaning & basic concept of Micro Economics, to make familiarity of the following concept & terms

• Macro & Micro Economics
• Positive & Normative science
• Economic Laws
• Economic Model
• Economic System
• Capitalist Economy
• Socialist Economy
• Mixed Economy
• Productivity Possibility Curve
• PPC Shift in Economic Growth

Economics

In general, every human being wants material wealth. Human wants are unlimited, while the resources at his possession are limited. Economics is all about getting maximum out of limited resources.

A nation is composed of people. The behavior individual people impacts the economics of type people, i.e the state.

The Term ‘Economics’ is obtained from Greek words OIKOS and NEMEIN,meaning the rule or law of the household. Primarily it dealt with the way in which a housewife made the most efficient utilisation of the scarce resources at her disposal. Later, this concept was used to analyse how best the resources, i.e. manpower, raw material and capital must be managed to get the maximum benefit from them.

Economics, therefore,  is concerned with not just how a nation distributes its resources to various uses, but it also deals with the process, by which the productive capacity of these resources can be further enhanced.  

So, Economics is a science (systematic, rational and logical study) of wealth, material well being, alternative choices and their evaluation, dynamic growth & development.

Economics in the eyes of Economists

• Adam Smith : According to Adam SmithEconomics means “the study of the nature and causes of generation of wealth of a nation”. He denied the role of state in economic affairs.
• J.B. Say : According to J.B. Say, “Economics is the science, which deals with wealth”.
• Marshall : Marshall has defined economics, as the study of mankind in the ordinary business of life. It examines that part of individual and social action, which is most closely connected with the attainment and with the use of material requisites of well being.
• Robbins : As per Robbins definition “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. 
• Samuelson : According to Prof. Samuelson ‘Economics is the study of how men and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future, amongst various people and groups of society. Paul A Samuelson defines Economics in terms of Dynamic growth and development.
• Keynes : As per Keynesian theory, the economy consists of labour market, money market and goods market.

The definition of Economics,  recognizes the dynamic change taking place, both in the means, as well as in the ends. It has, therefore, called as growth-oriented definition of economics.

 Importance of Economics

• Price fixation: It assists the firm in price fixation, which is influenced by a number of other factors.
• Maximize profits: Economics gives the methods to producers maximize their profits by utilising various factors of production.
• Demand and supply: The reward or return given to a factor of production is ascertained by the forces of demand and supply in the market, explaining that a factor of production must be paid according to its marginal productivity.
• Utilisation  of resources to optimum capacity: Economics gives the requisite information to the planners to utilise the resources to their optimum capacity.
• Working of economy: Economics assists the academician to study the working of the economy.

Characteristics of Economics

• Object of study: Economics focuses on the study of activities, which assist in the acquisition of wealth.
• Economic liberty and free trade: Economics advocates liberty and free trade (called the policy of laissez-faire). Laissez-Faire is the doctrine that Government should not interfere in Commercial Affairs.
• Systematized body of knowledge: Economics is the science of exchange value of wealth. It is a systematized body of knowledge, rather than a technique of managing the household, or of raising the revenues for the state.

Economics as Science & Arts

Economics is considered to be both Science & Art.

Economics considered as Science

The term ‘Science’ means the systematized body of knowledge, which traces the relationship between cause and effect. As per this definition, Economics is that branch of knowledge where various relevant facts have been systematically compiled, classified and analyzed. Judged from this stand point, Economics is a full-fledged science because it makes use of the scientific techniques in its researches and investigations.

Economics is considered as science, because, its knowledge is systematized, it establishes the cause and effect relationship between two economic phenomena, its study depends on estimations & its laws have the ability to predict events with reasonable degree of exactness.

However, Economics cannot predict as accurately as the physical science economics deals with human behaviour, which is highly uncertain. Further, controlled experiment is not possible on human behaviour.

Economics considered as Art

An art is a systematized body of knowledge, which lays down precepts or specific solutions for specific problems. The aim of art is to formulate the precepts immediately applicable to policy.Economics is also an art, because, economics develops the skills of solving economic problem (for example, preparation of budget and formulation of budgetary policies), economist also applies knowledge and skill to solve basic economic problems.

An economist has to make various graphs and diagrams, such as demand curve, supply curve etc, which are in fact, a part of art.

Economics Science or Arts- Conclusion

So, economics can be treated both as a science as well as an art. To analyse the causes and effects of poverty and wealth, economics falls within the purview of Science. To lay down policies for the removal of poverty, through personal skills and practical know how, it falls within the purview of Arts. This provides a balanced attitude.

Economics as Positive & Normative Science

Economics is considered to be both Positive Science and Normative Science.

What is Positive Science : A positive science deals with things as they actually happen. It describes their causes and effects, but remains neutral as regards ends; without passing moral judgments, or how the economics theories may be applied in practice (beneficial or harmful to the society).

The theory ‘A seller would sell goods at a price to derive maximum profit’ is out come of study of  positive science, as it is based on natural cause & effect, not on moral value or judgments.

What is Normative Science : A normative science, deals with things, as they ought to be, explaining the moral rightness or wrongness of things.

The theory,’ No tax should be imposed on poor’, is a thought of Normative Science, which is based on moral righteousness, rather than practical behavior.

Economics as Positive Science

The classical Economists considered Economics as a positive science and that the economists should not look into rightness or wrongness of economic events. For example, a person can spend his money any way he likes (liquor, drugs, or milk). An economist should not direct him.

Economics as a Normative Science

Economics as a normative science, not only interprets facts as they are, but also justifies them.  Economics would work for searching out and prescribing certain course of action to attain certain desired goals. In view of present day problems due to large scale production, ecological degradation, price control, unemployment, etc. the significance of normative economics has considerably increased.

Economics Positive Science or Normative Science – Conclusion

Economics thus has both positive and normative aspects. While laying down theories, Economics may be treated as pure and Positive Economics, but as a method of practical application, it includes Normative Economics, i.e. welfare propositions also.

Distinction  between Economics as Positive & Normative Science

Positive Science	Normative Science
Economics as Positive Science expresses what it is	Economics as Normative Science expresses what should be
Economics as Positive Science is based on logical cause & effect of facts	Economics as Normative Science  is based on ethics
Economics as Positive Science deals with realistic situation	Economics as Normative Science deals with idealistic situation
Economics as Positive Science can be ascertained from facts and data	Economics as Normative Science cannot be verified with data
Economics as Positive Science deals with how an economic problem is solved	Economics as Normative Science deals with how an economic problem should ideally be solved

Economic Laws Deduction Methods

The economic laws may be deduced by two methods.

• Deductive Method : Under this method, law are deduced logically. It is also known as Abstract & priori Method. The conclusions are drawn on long accepted general fundamental assumptions, axioms. So, the logic is deduced form General to Particular. So, under this method, perceiving that Man behaves in rational manner, people would buy at cheapest cost and sell at a price to derive maximum profit. However, due to various limitations of knowledge of market & market conditions, this may not happen in practice.
  Deductive methods involve stepwise deductive logical method of perceiving the problem, deducing appropriate hypothesis, testing of hypothesis and deriving conclusions. For example, we deduce that price & demand are inversely related (demand increases when price falls, and vice versa). However, often such theories cannot be universally applied and suffer from limitations.
• Inductive Method : Under this method, conclusions are based on  enquiry and analysis of facts. So, the logic is deduced form Particular to General, based on observation of individual cases.
  Inductive methods involve perception of problem, collection, analysis of data using proper statistical techniques, analysing the reasons and relationship of variants and set rules for verification of principles. In modern days, Inductive logic are gradually being applied. However, human behaviour are not guided by scientific or mathematical formula. So, the conclusions derived under Inductive Method, also suffer from various limitations.

However, the two methods are not mutually exclusive, and are simultaneously used. For example, Deductive method is used to create a theory, which is then verified and refined by observations by Inductive Method.

Micro & Macro Economics

Micro & Macro Economics

Micro Economics

Micro Economics deals with a small part of the national economy of a country. Micro Economics is the branch of economic analysis, which studies the economic behaviour of the individual unit (a specific person, a household, or a firm) in the national economy.

Micro Economics is the study about how various units of the economy work and how they attain their equilibrium. Micro Economics looks into the composition or allocation of total production, why some things are produced more than that of others, how a firm maximizes its profits.

Micro Economics deals withProduct Pricing, Consumer Behaviour, Factor Pricing, Economic conditions of a section of society, Study of firms, Location of Industry, etc, like Price Fixation by a Producer Firm, Location of an industry at a particular place, etc.

Macro Economics

Macro Economics is the study of the economic system as a whole, the overall conditions of an economy (like total production, total consumption, total saving and total investment, averages and aggregates) of the whole system rather than with the particular units. Macro Economics gives a bird’s eye-view of the entire economic system. It helps in devising economic policiesfor the nation as a whole.

Macro economics studies the whole forest, rather than each tree. So, macro economics establishes the functional relationship between large aggregates

Macro Economics deals withNational Income and Output, General Price Level, Balance of Trade and Payments, External Value of Money, Saving and Investment, Employment and Economic Growth etc, like Value of Rupee vis-à-vis Dollar, Balance of Payments Deficits, Reasons for saving rates being high or low, etc.

Distinction between Micro and Macro Economics

	Micro Economics	Macro Economics
Scope	Micro Economics is study of individual economic units. It is narrow in scope.	Macro Economics is study of the economic system as a whole. It is wider in scope.
Range	Micro Economics deals with individual income,   individual prices, individual output etc.	Macro Economics deals with national income, price level, national output etc.
Focus	Main focus of study of Micro Economics is on demand and supply of a particular commodity.	Main focus of study Macro Economics is on  aggregate demand and supply of the economy as a whole.
Price	Micro Economics Determines ‘relative prices’	Macro Economics determines ‘absolute prices’.
Analysis	Micro Economics makes partial Equilibrium Analysis.	Macro Economics makes general equilibrium analysis.

Economic Laws

Economic laws are those social laws, which relate to branches of study to measure the strength of the motives, by money and price.

Economic laws are statements about the cause and effect relationship between two economic phenomenon. Economic laws are only prediction of an economic phenomenon to behave in a particular manner in response to a particular positive factor (e.g. ‘the law of Demand’). Economic laws are about influences of human behaviour on the application of scarce resources for the fulfillment of unlimited human wants. 

Features of Economic Laws

• Temporary and general: Economic laws are temporary in nature, framed in a particular social and institutional setup. As the setup changes, the established law may change.
• Predicted and hypothetical: Economic laws are hypothetical because they are based on human behaviour, which is highly changeable and uncertain. They are just prediction as human behaviour cannot be experimented in a laboratory, or expressed in mathematical formula.
• Conditional: The economic laws pre-suppose some conditions (sometimes idealistic), which may not happen in real situations.
• Relative: Economic laws cannot be universally applied as they are relative to time and place. However, general economic Laws, based on human behaviour, may be universal.

Economic Model

An Economic Model is an organized set of relationship that explains the function of an economic entity (e.g a household, a single industry or a national economy), under a set of simplified assumption.

Types of Economic Models

• Physical model: Physical models show representation or economic aspect in form of photographs, paintings, sketches, etc. However, such models are not much effective.
• Analog models: In Analog models, one set of properties are shown with the other set of whole system process in form of graphs, charts, etc. showing relationship of the variables.
• Symbolic models: In Symbolic models, the inter-relationships are expressed through mathematical symbols. There are different types of such symbolic economic models, like :
• Quantative models : Based on statistical data.
• Allocation models : Used for optimised solution (e.g. profit maximization)
• Scheduling model : Determining best sequence of performing operations.
• Queuing models: Minimising the time & cost of servicing & waiting.
• Simulation model: Use of random number as basis for observing  behaviour of economic entity.
• Inventory models: To estimate cost of holding and ordering and determining optimum inventory level.

Advantage of Economic Model

• Discreet scientific expression: It helps communication by transforming theories into discreet scientific expression (e.g. graph, equation, diagram etc.).
• Complex economic environment: It helps to study the complex economic environment.
• Analysis and interpretation: It facilitates proper analysis and interpretation.
• Economic solution: It is applied for economic solution for problems like unemployment, poverty, slow development etc.
• Prediction: It can be applied for predictions. 

Economic system

Every economic system has scarce resources and unlimited human wants, with problem of distribution of resources, in regard to Item of production, Method of production, Allocation of production, etc.

• Item of production: Every economy has only limited resources. Therefore, it has to make a conscious choice and set up priorities of items of production to satisfy the maximum wants of the major section of people.
• Production method: The economy has to decide how the goods and services will be produced, with best possible quality and price.
• Consumers: Goods produced in the economy are to be allocated amongst different individuals & different factors of production.

Economic System refers to mode of production exchange, distribution, consumption and the role of Government  in economic activity.

Types of Economic System

• Capitalist Economy : Economic System based on private ownership of capital and production inputs, production of goods and services for profit.
• Socialist Economy : Economic system based on public or collective ownership of the means of production.
• Mixed Economy : Mixed Economy system features characteristics of both capitalism and socialism. A mixed economic system allows a level of private economic freedom in the use of capital, as well as  allows for governments to interfere in economic activities to achieve social aims.

Central Problems of Economy

The different economics adopt different techniques for solving their central problems.

• Capitalistic Economy: Capitalistic economy being a free economy, solves the problem through price mechanism, through relative price structure for different kinds and qualities of goods and services.
  To maximise their revenue, producers will produce relatively high price goods, and will tend to produce goods and services for those buyers, who will pay them maximum price.
• Socialistic economy: In a socialistic economy, the government tries to maximize social welfare, Government will encourage to produce those goods which are most useful for the society. Socially beneficial (e.g. labour intensive technique in case of mass unemployment) technique of production will be applied. Goods will be produced for poor & weak classes even when it implies loss on production.
• Mixed Economy: Mixed economy takes up the merits and avoids the demerits of capitalistic economics, decisions regarding what, how and for whom to produce are considered on the basis of price mechanism as well as social consideration.

Capitalist Economy

Under capitalist economy system, factors of production (land, labour, capital and organisations) are owned by private individuals. Profit is the sole motive.

Features of Capitalistic economy

• Minimum Government restriction: Government does not intervene in day-to-day economic activities of an individual. Producers as well as consumers take their independent decisions.
• Private ownership: Factors of production e.g. machines, mines, factories, farmhouses etc. are owned by private entrepreneurs. They are free to use these to produce commodities, the way they like to. 
• Consumer sovereignty: Consumers have total freedom to consume any product, according to their choice. The producers, therefore, produce as per consumer demand.
• Free market: The entrepreneurs have freedom to take decision regarding production and profitability on their own. The price is determined  by demand and supply in the market.
  Under free market economy, when consumers increase purchase of goods and the level of demand exceeds supply, then price will start to increase. Capitalist economy uses price as the principal means of allocating resources.
• Profit motive: The prime motive is to maximize profit. So, people tend to take up assignments that would generate profit, and avoid non profitable ventures.

Merits & Demerits of Capitalist Economy

• Merits : Capitalist Economy isself adjusting, allows competition, provides efficient utilisation of resources, allows consumer freedom and enhances availability of products, at lower price.
• Demerits : Capitalist Economy tends to cause inequality of income, class Struggle, neglect of social welfare, economic insecurity & monopoly

Socialist Economy

In socialist economy, the means of productions are owned, managed and centralized by whole community represented by the state. Government is the main decision maker regarding allocation, exchange, price fixation, production of goods.

Features of Socialist Economy

• Economic Equality: The motive of socialist economy is to bring economic equality of people by reducing the gap between different sections of the society.
• Social Welfare: In socialist economy, the economic and other activities are directed towards social welfare and not profit making, like, equitable allocation of national income, enhancement of Economic Development, more employment, reduction of poverty, etc.
• State Ownership: In socialist economy,  the means of production are owned by the government. Key economic institutions like bank, transport and communication etc. are normally owned and managed by the government.
• Government Control:  In socialist economy, decisions regarding allocation & distribution of resources, price determination, production, consumption and saving levels are taken by the central body, who chalks out a long-term economic development plan, and  delegates to smaller bodies for implementation.  

Merits & Demerits of Socialist Economy

• Merits : Socialist Economy iscompletely regulated, equitable and provides satisfaction of consumers needs.
• Demerits : Socialist Economy tends towardsBureaucracy, lower quality, concentration of economic & political powers.

Mixed Economy

Mixed Economic System allows for the simultaneous operation of publicly and privately owned enterprises.

It imposes private and public control, reflecting characteristics of both capitalism and socialism.

Features of Mixed Economy

• Individual freedom:The consumer enjoys total sovereignty, have freedom to choose the goods to consume & produce accordingly. Government may control the prices in public interest, through public distribution system.
• Economic development:The main motive is economic development, reduce inequalities and provide adequate employment opportunities. The price policy is governed by public welfare motive, rather than making profit.
• Co-existence of public and private sectors:Public sector mostly controls industries of national importance, while in private sector, industries producing consumption goods are established. The objective is to strengthen both sectors and help each other. Government helps to boost both the sectors simultaneously.
• Planned Economy System: The mixed economic system is a planned economic system, laying down certain goals for the development of whole economy. The public sector runs to reach their goals. The Govt. creates a conducive atmosphere that the private sector also has to reach the preplanned goals.

Merits & Demerits of Mixed Economy

• Merits : Mixed Economy enablesproper allocation of resources, economic stability & rapid economic development.
• Demerits : Mixed Economy tends to infect inefficiency & corruption, Concentration of economic power and is unable to remove inequality of income.

Production Possibility Curve

The Central Economic problems may be analysed & understood by graphical representation of alternative possibilities.

The Production Possibility Curve is a hypothetical representation of the amount of two different goods that can be obtained by shifting resources from the production of one, to the production of the other.

 “Production Possibility Curve (PPC) showsalternative production possibilities of two sets of goods, with the given resources and techniques of production.

PPC gives the maximum quantity of each goods that can be produced, as well as combination of each type of goods that can be produced

Production Possibility Curve is also known as Production Possibility Frontier,

PPC is also called Production Possibility Frontier. The term Frontier generally means Boundary or Limit, as the PPC sets the limit, i.e  maximum production quantity of each product. 

PPC is also called Transformation Curve. Transformation in general means conversion from one to another. PPC show how change in production of one product may cause change in the production of other product, showing combination of the products.

Production Possibility Curve  Assumptions

PPC curve is constructed on certain assumptions. There are only two types of goods to be produced (e.g. TV and wheat). There are limited amount of productive resources, which remain fixed. Resources are neither unemployed nor underemployed. Technology does not change.

The table depicts that at extreme levels, (A & F) applying all resources for Wheat, 16 thousand quintals of Wheat can be produced, on the other hand employing all resources, six thousand TV sets can be produced.

Example data of production possibilities

Production Possibilities	TV (in 000 pcs)	Wheat (in 000 Qtls)	Opportunity Cost for Wheat  forgone
A	0	16
B	1	15	(16-15) = 1
C	2	13	(15-13) = 2
D	3	10	(13-10) = 3
E	4	6	(10 – 6) =4
F	6	0	(6-0)=6

The PPC diagram

Production Possibility Curve

-The PPC Curve AF, shows the various combinations of two goods which the economy can produce with a given amount of resources.

-Since the given resources are fully employed and utilized, the combination of two goods produced can lie anywhere on the PPC but not outside or inside it.

-Point U (inside the curve) means that the economy would not be utilizing its resources fully. Point I (outside the curve) means that economy would not have the capability to produce with the given technology and resources.

-When the economy grows, there will be an outward shift in the PPC

Opportunity Costs

• Since resources are limited and they are fully employed, the economy has to give up something of one to obtain some more of the other. This sacrifice(i.e., giving up) is called as the Opportunity Cost.
• The opportunity cost is measured by the number units of goods foregone to produce additional  quantity of goods.
• The table shows the opportunity Cost, in terms of Wheat not produced, for every thousand units of TV sets produced.
• Opportunity Costs generally show an increasing trend.This is because a given resource is suitable more for the production of one goods than another. For example, resources like land is more useful for Wheat than TV sets production. So, greater sacrifice of Wheat would be made for each additional production of TV sets.

Nature of PPC Diagram

• The curvature of PPC indicates the Opportunity Costs trend. Increasing Trend means Concave to the Origin. Constant Trend is indicated by Straight Line. In Decreasing Trend, it is Convex to the Origin
• The slope of PPC is dependent on the trend of Opportunity cost.
•  In increasing opportunity cost, the curve is concave (which is the normal case, as any given resources is more suitable to one product than the other.
• In decreasing opportunity cost, the slope is convex.
• PPC is straight line (neither Convex nor Concave), if the opportunity cost remains same (where same input is required for both the products).
• PPC is negatively sloped, i.e. downwards from left to right (called Concave Slope to the origin), due to scarcity of resources.
• All points on the PPC, (i.e. Points A to F) represent full utilization of the resource. These points show that goods and services are produced at least cost and no resource is wasted, i.e. the economy is productivity efficient.

Opportunity Cost Diagram

Increasing opportunity cost

The example of increasing opportunity cost, depicting a curve concave to the origin, is the most common example of Production Possibility Curve or Production Possibility Frontier. Economy specializes more and more into one product (such as moving from point B to point D), the opportunity cost of producing that product increases, because we are using more and more resources that are less efficient in producing it.

With increasing production of wheat, workers from the TV industry will move to it. At first, the least qualified (or most general) wheat workers will be transferred into making more TV, and moving these workers has little impact on the opportunity cost of increasing TV production: the loss in wheat production will be small. However, the cost of producing successive units of TV will increase as resources that are more and more specialized in Wheat production are moved into the TV industry

Constant opportunity cost

With constant opportunity cost, a straight-line (linear) PPF is produced. This case reflects a situation where resources are not specialised and can be substituted for each other with no added cost. Products requiring similar resources (e.g bread and cake) will have an almost straight PPF and so almost constant opportunity costs. With constant returns to scale, there are two opportunities for a linear PPF: i) only one factor of production to consider, ii) the factor ratios in the two sectors are constant at all points on the PPC curve. 

Constant Opportunity Cost diagram

Decreasing Opprtunity Cost

Decreasing Opportunity Cost diagram

Decreasing Opprtunity Cost

The law of decreasing opportunity cost states that a firm’s opportunity cost reduces when production declines. When the cost of producing one product reduces, making the next unit also reduces. In this scenario, increased production decreases the opportunity cost.

The PPC is convex to the origin when the opportunity cost between two goods is decreasing or when the number of units sacrificed for one good goes on falling as the number of additional units gained increases.

Economic Growth and shift in PPC

When an economy is at PPC curve, it is ‘productively efficient’. But there is also scope of progress and one PPC can shift to another PPC on the right, indicating Economic Growth.

All the points in PPC indicate that the economy is productively efficient, meaning that no resource is wasted.

Improvement in technology, greater capital formation, increase in population brings rightward shift of the PPC curve.

In such case, the PPC move rightwards from the curve P to P1, in which both the  goods are produced more in quantity.

If a point falls inside the production possibility curve it means both resources are under utilised or there is unemployment in the economy.

Shift in PPC Diagram

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MCQ related to Micro Economics

MCQ related to Micro Economics Introduction