Microeconomics:

An Introduction and Overview

Assot. Prof. Muhammad Zubair Noormal

What is Microeconomics?

 Economics defined as:

“The study of the allocation of scarce resources among alternative
uses.”
 Scarce: “No enough basic resources (such as land, labor, and capital
equipment) in the world to produce everything that people want.
 Every society must choose, how its resources will be used.

 Microeconomics defined as:

“The study of the economic choices individuals and firms make

and of how these choices create markets.”
What is Microeconomics?

A society faces 3 key tradeoffs:

1. Which goods and services are to be produced?
2. How to produce them?
“How much labor and inputs should a firm use to produce a car”
3. Who gets the good and services (allocation)
 Workers need to choose how to allocate their time between labor and
leisure.
 Firms need to choose how to allocate their investment between human
capital and machines.
 Households need to choose how to allocate their incomes between
savings and expenditure, and which expenditures.
Why Study Microeconomics?

 To conceptualize the important economic decisions you must make in

your life and that can often lead to best decision making.
e.g. Purchase Decisions…etc.
 For Businesses: Any firm must try to understand the nature of the
demand for its product.
e.g. A firm that continues to produce a good or service that no one
wants will soon find itself in bankruptcy.
 Firms are also concerned with their costs. To minimize the costs and
maximize the profits.
Why Study Microeconomics?

 It is also studied to evaluate broad questions of government policy,

whether certain laws and regulations contribute to or detract from
overall welfare.

 To understand imaginative ways of measuring how various government

actions affect consumers, workers, and firms.
e.g. Health care, Antitrust policy, or Minimum wages

 Because we can’t have everything, we need to make trade-offs and

Microeconomics provides a way to think about tradeoffs.
Micro versus Macroeconomics

What is the difference between micro and macro economics?

 Microeconomics: Behavior of individual economic units like consumers,

producers, landowners, families, etc. How and why do they make the
decisions they make?

 Macroeconomics: Analyzes how the entire national economy performs. It

analyzes unemployment, inflation, price levels, interest rates (many things
we take as given in microeconomics).
Economic Models

How do economists allocate resources?

“They develop theoretical model.”
 By a “Model” we mean a simplified representation of reality.

“Think about how useless a map on a one-to-one scale would

be.”
 A model’s power stems from the elimination of irrelevant detail.

 It allows the economist to focus on the essential features of the

economic reality he or she is attempting to understand.
 For example, What determines the price of apartments?

“Model: A simplified description of the apartment market.”

Economic Models

 The models are abstractions of the real world

 Too complicated to take into consideration all factors.
 Without simplifications we would not be able to make
predictions.
 Like a roadmap, does not give each house, but the basic
essentials i.e. major streets, highways and sometime main
attractions.
Economic Model Example

Determinants of Poster Demand on Campus

You are advertising a big event for the freshman class. How many
posters will you need?
 Factors in your model:

 Price to make poster

 Factors not in your model:
 Content of poster, placement of poster, relative size of poster
 Are there any constraints to this model?
 the amount of budget you have to spend on poster advertising.
Types of Variables in a Model

Exogenous Variable: One whose value is taken as given in a model.

Endogenous Variable: One whose value is determined within the model
being studied

Which factor(s) would have you taken as given in the poster example?
 Price (exogenous)
Which factor(s) are determined by your model?
 The quantity of posters needed (or demanded)
Tools of Microeconomic Analysis

1. Constrained Optimization

2. Equilibrium Analysis

3. Comparative Statics
Constrained Optimization

 Constrained Optimization: An analytical tool used when a decision

maker seeks to make the best (optimal) choice, taking into
consideration possible restrictions on the choice.

This tool has two parts:

1. Objective Function: shows the relationship the decision maker
seeks to optimize (maximize or minimize).
2. Constraint: limits or restrictions that are imposed on the decision
maker.
Constrained Optimization Example

You want to maximize your happiness during your second year at

university.
 Objective Function: Utility (Happiness)
Utility=f(days swam in pool per month (s), energy drinks per week(e)).
U=s*e
 The thing you are maximizing or minimizing.
 Constraints: s.t. (subject to)
Income: 𝐼 = 𝑆 ∗ 𝑃𝑠 + 𝐸 ∗ 𝑃𝐸 , where P is the price.
 Many max or min problems have some kind of a constraint you have to
work with.
Equilibrium Analysis

 General Definition: Equilibrium analysis is an analysis of a system in

a state that will continue indefinitely as long as the exogenous factors
remain unchanged
 Equilibrium is achieved at a price at which the market clears.
 i.e. A price at which the quantity offered for sale just equals the quantity
demanded by consumers.
Equilibrium Analysis

Price (P)
Doctors visit Qd: demand
Qs Supply

P* 50 Equilibrium: Qd=Qs

Q1
. 10 Q2 Quantity (Q)
Number of appointments
per day
What if price is higher than P*?
P
Price ($) Qd: demand
Doctors visit Qs Supply
Excess Supply

70

50

8 13 Quantity (Q)
Number appointments
per day
What if price is lower than P*?

P
Price ($) Qd: demand
Doctors visit Qs Supply

70

50

30

Excess Demand

5 13 Q Quantity
Number of appointments
per day per doctor
Comparative Statics

 Examine how a change in an exogenous variable will affect the level of

an endogenous variable.
 First, look at the value of the endogenous variable at the initial level of the
exogenous variable.
 Second, look at the value of the endogenous variable at the new level of
the exogenous variable.
 A comparative statics analysis compares the equilibrium state of a
system before a change in the exogenous variables to the equilibrium
state after the change.
 Comparative Statics Analysis: Example

 Worldwide market for unprocessed coffee beans

Price per pound

Supply (P, W)
What if a decrease in rainfall
occurs?

Note: Decrease in rainfall

negatively affect the supply of
coffee beans.

Demand (P, I)

Quantity, pounds
Comparative Statics Analysis: Example Cont.

Price per pound New Supply (P, W’)

Supply (P, W)

•
•

Demand (P, I)

Quantity, pounds
Positive and Normative Analysis

 Definition: Positive Analysis can explain what has happened due to

an economic policy or it can predict what might happen due to an
economic policy.

 They do not necessarily have to be correct or true, but you can prove
them one way or another.

e.g. Government borrowing increased by 25% last year.

Positive and Normative Analysis

 Definition: Normative Analysis is an analysis of what should be done

(a value judgment)
 Normative statements are opinions based on a value judgement. They can
not be proven one way or another.
 They often contain words like “should” or “must” or “ought to”.
 They are an individuals ideas about how the economy should run.

e.g. The Government should not have borrowed so much money last year.
The End
of Chapter one.