Unit- 1: Introduction to Microeconomics

Origin of Economics

The term economics was derived from Greek word ‘Oeconomicus’. In

Greek, ‘oeco’ means household and ‘nomicus’ means management. So,
economics means managing a house with limited resources or funds.

Economics is the social science that studies the production, distribution,

consumption, and exchange of goods and services using available resources. It is
the study of how societies use scarce productive resources to produce goods and
services of various kinds, and to distribute them among different people.

Development of economics

There are three periods in the development of economics. They are,

1. Classical period

The time period from 1776 AD to 1890 AD in the history of development of

economics is called classical period. The famous economists of this period were
Adam Smith, David Ricardo, T.R. Malthus etc. The leader of this period was Adam
Smith. According to classical economists, “Economics is a science of wealth”.

2. Neo-classical period

The time period from 1890AD to 1932AD in the history of the development
of economics is called neo-classical period. The famous economists of this period
were Alfred Marshall, Edwin Cannan, Carl Menger etc. Alfred Marshall was the
leader of this period. According to neo-classical economists, “Economics is the
science of material welfare”.

3. Modern period

The time period from 1932AD onward in the history of the development of
economics is called modern period. The famous economists in this period are
Lionel Robbins, J.M. Keynes, Paul Samuelson etc. According to the modern
economists, “Economics is a science of scarcity and choice”.
Various definitions of economics

1. Classical definition/Wealth definition/Adam Smith’s definition

Classical definition was given by Adam Smith who is popularly known as

father of economics. He has published his book “An enquiry into nature and
causes of wealth of nation” in 1776 A.D. According to Adam Smith, “Economics is
the science of wealth”.

Features

1. Study of wealth

According to classical definition of economics given by Adam Smith,

economics is only related with study of wealth. It studies production,
consumption, distribution and exchange of wealth.

2. First priority to wealth

According to Adam smith, economics should give first priority to wealth and
second priority to mankind. According to him mankind is for wealth but wealth
can’t be for mankind.

3. Role of economic man

According to this definition, economics studies the behaviour and role of

economic man. Economic men are that human beings who have only one
objective of earning more and more wealth at any cost.

4.Source of wealth

According to this definition, wages earned by labour is the only one source
of wealth of nation. According to Adam smith, amount of wages can be increased
through the division of labours.
Criticisms

1.Too much emphasis on wealth

This definition has given too much emphasis on wealth rather than human
beings. But the critics said that wealth is for human being but human beings
aren’t for wealth. Wealth should be used for benefits for mankind.

2. Narrow definitions

The definition given by Adam Smith is narrow in the sense that economics
is concerned only with wealth earning activities. This definition doesn’t include
those human beings who are engaged in social services or who are not involved in
earning wealth.

3. Unrealistic concept of economic man

According to the Adam Smith, every human being is economic man who
tries to earn more and more wealth. But the critics said that all human beings
have their own qualities of life such as feelings of cooperation, love, respect etc.
which may provide more satisfaction than wealth.

4. Single source of wealth

According to this definition, the only one source of wealth of nation is

wages earned by labours. But critics of this definitions said that there are also
other sources of wealth of nation such as natural resources, human resources,
capital resources etc.

2. Neo-classical definition / Welfare definition / Alfred Marshall’s

definition of economics

Neo-classical definition of economics was given by Alfred Marshall. He

published his book ‘Principles of Economics’ in 1890A.D. According to Marshall,
“Economics is the study of mankind in ordinary business of life. It inquires how a
man earns income and how he uses it. Thus, it is on the one side study of wealth
and on the other, the most important part is the study of mankind.”
Features:-

1. First priority to mankind

According to Marshall, economics is the study of mankind in relation to

wealth. He further added that wealth is for the betterment of mankind, but
mankind is not for wealth. So economics should give first priority to mankind.

2. Study of material welfare

Marshall has focused on material welfare rather than human welfare. The
satisfaction obtained by the consumers from the consumption of physical good or
material good like basic, habitual, luxury goods etc. is called material welfare.

3. Study ordinary man

According to Marshall, economics studies ordinary man rather than

economic man. Ordinary man are those who get involved in earning wealth as
well as try to experience cooperation, love , respect, prestige etc. to make life
more meaningful.

4. Social science

According to Marshall, economics studies those human beings who live in

society. It does not include isolated persons not belonging to society such as
monks, beggars etc. Since, economics studies people living in a society, it is called
social science.

Criticisms

1. Classificatory

Marshall classified human activities into material and non-material

welfare. Similarly, men are classified as ordinary and extra ordinary. But he could
not clarity the differences between them. So, in the view of critics, this definition
is classificatory.
2. Narrow scope

Marshall has highly focused only on material welfare. He couldn’t include

non-material activities such as services of doctors, teacher, lawyer, engineers, etc.
So his definition has narrowed the scope of economics.

3. Exclude human science

According to Marshall, economics studies the behaviour of people living in

society. But, according to critics, economics should study all human beings
whether they participate in social activities or not.

4. No clear concept of welfare

Marshall has highly focused on material welfare rather than human

welfare. Critics said that welfare differs according to time, place and
circumstances. There are many activities which mayn’t promote human
welfare but they are regarded as economic activities.

Q. Distinguish between wealth and welfare definition of economics.

3. Modern definition / Scarcity definition / Lionel Robbins’s definition of

economics

Modern definition of economics was given by British economist Lionel

Robbins. He published a book “An essay on the nature and significance of
economic sciences” in 1932 AD. According to the Robbins, “Economics is the
science which studies human behaviour as a relationship between unlimited ends
and scarce means which have alternative uses.”

Features

a. Unlimited ends (wants)

According to Robbins human wants are unlimited and they can never be
fulfilled. If one want is fulfilled new want arises immediately. Cycle of human
wants can never be fulfilled during life time. If human wants were limited, there
would be no any problem.
b. Limited means (resources)
The word ‘means’ refers to resources like human resource, natural
resources, etc. available to mankind. According to Robbins, the available
resources are limited in comparison to human demand. As population increase
demand also increase. So the problem of scarcity is increasing day by day.

c. Alternative Uses

Robbins said that the limited resources have alternative uses. They can be
used here for one purpose and there for another purpose. He suggested that
many alternative goods are available in market. Among them we should choose
on the basis of need and ability.

d. Problem of choice

Though human wants are unlimited, all of them are not equally important.
More important wants have to be fulfilled immediately and less important wants
can be postponed. So, human being should make choice of wants. According to
Robbins, making a choice is really an economic problem.

Criticisms

a) Neglects major problems of modern economy

Robbins’ definition of economics was unavailable to address the major

problems of modern economy such as unemployment, poverty, inequality,
economic growth, etc. According to critics, modern definition of economics
should analyze these economic problems.

b) Limited to allocation of recourses

Robbins’ definition is totally based on allocation of available resource. But

according to critics, economics should study not only allocation of recourses but
also production, exchange, distribution and reutilization of recourses.
c) Unnecessary emphasis on scarcity

Robbins’ definition of economics has given unnecessary emphasis on

scarcity. Critics said that economic problems arise not only from scarcity of
resources but also from plenty of resources and over production.

d) Similar to Marshall’s definition

According to critics, Robbins’ definition is not totally different from

Marshall’s definition because both of them have common conclusion about
resource or wealth utilization for material welfare or satisfaction of mankind.

Comparison between the welfare definition and scarcity definition of economics

Similarities

Welfare definition Scarcity definition

1. Economics is the study of mankind. 1. Economics is the study of human

behaviour.

2. Study of wealth in relation to 2. Study of scarce resources to meet

mankind. human wants.

3. Aims to utilize wealth to achieve 3. Aims to utilize scarce resources to

maximum material welfare. achieve maximum satisfaction.

4. Related with use of limited quantity 4. Related with the alternative use of
of wealth. limited resources.

Differences
 Welfare definition Scarcity definition

1. The science of material welfare. 1. The science of scarcity and choice.

2. Aims to promote material welfare to 2. Aims to satisfy maximum possible

mankind. wants from scarce resources.

3. Economics is both material and social 3. Economics is simply a human science.

science.

4. It is classificatory definition. 4. It is analytical definition.

5. Based on the concepts of normative 5. Based on the concepts of positives

science. science.

Superiority of Robbins’ definition over Marshall’s

1) Scientific definition
Robbins’ definition is considered more scientific than Marshall’s
definition. Robbins’ definition is related with real problems and is applicable
everywhere. But Marshall’s definition is just classificatory.

2) Universal application
Robbins’ definition is universal because it is applicable in all types of
economy. It is applicable in capitalist, socialist, and mixed economy. So it has
wide scope.
3) Science of choice
Robin’s definition provides the best way for an individual to get maximum
satisfaction from limited budget. It guides businessman to earn maximum
profit from limited resources. Similarly, it guides government to use limited
resources to fulfil infinite needs of citizens.
 Concept of positive and normative economics

Positive economics
The concept of positive economics was introduced by classical and
modern economists. A positive science may be defined as a body of systematic
knowledge related to ‘what is’, ‘what was’ or ‘what will be’. The study of reality or
what is happening is called positive economics. Positive economics study the
things as they happen in reality. It simply tries to explain real situation without
any value judgement. It aims to explained cause and effect relation between
economic problems. It is universal and value doesn’t differ from person to person.
It is not related with rightness or wrongness of the things. Examples: - If price of
car decrease, demand for petrol increases.
Normative economics
The concept of normative economics was introduced by neo-
classical economists. Normative science may be defined as a body of systematic
knowledge related to ‘what should be’ or ‘what ought to be’. The study of
outcome and determining whether they are good or bad is called normative
economics. The normative economics studies the things as they should be. It
never tries to make detailed study on cause and effects of any economic
problems. The result obtained from normative studies mayn’t be applicable in all
situations. It gives judgement about rightness or wrongness of the things.
Normative analysis may be influenced by personal bias in some cases.
Examples: Government should not impose tax on basic goods.

Concept of microeconomics and macroeconomics

Microeconomics

The word ‘micro’ was derived from Greek word ‘mikros’ which,
means small. So, microeconomics is the study of small individual units of an
economy. Micro-economics may be defined as study and analysis of individual units
such as a consumer, a producer, an industry, individual price, income, wage and so
on. Microeconomics studies how the various individual units do their economics
activities and how they reach at equilibrium state.

Microeconomics deals with resource allocation, product pricing, and factor

pricing. Microeconomics makes microscopic study of various elements of the
economy.

Macroeconomics

The word ‘macro’ was derived from Greek word ‘makros’ which means
large. It means macroeconomics is the study of economy as whole or in aggregate
form. Macroeconomics may be defined as that branch of economics which studies
the behaviour of aggregate unit such as national income, price level,
unemployment, aggregate consumption, aggregate investment, foreign trade
policy, etc. Macroeconomics is the study of aggregates. So, it is also called
aggregate economics.

Macroeconomic theories deal with the determination of national income

and employment. So, it is called income theory. Macroeconomics includes the
theories that study and explain aggregate of economy, national level economic
problems and policies aimed at solving those problems.

Differences between microeconomics and macroeconomics

Microeconomics Macroeconomics

1. The word ‘micro’ was derived 1. The word ‘macro’ was derived
from Greek word ‘mikros’ which means from Greek word ‘makros’ which means
small. large.
2. It is the study of individual units of 2. It is the study of the economy as a
the economy. whole or in aggregate form.

3. Its area of study includes a 3. Its area of study includes national

consumer, a household, a seller, an income, nation output, price level, etc.
industry, etc.
 4. It is also called price theory. 4. It is also called income theory.

5. Laws and principles in 5. Laws and principles in

microeconomics are based on macroeconomics are far from
assumptions. assumptions.
6. Its objectives are utility 6. Its objectives are economic
maximization for consumer, profit development, price stability, reducing
maximization for producer, etc. unemployment, etc.

Concept of scarcity and choice

Scarcity

In general, scarcity refers to insufficient supply or shortage of something.

The term scarcity in economics means a situation in which wants and needs are in
excess of the available resources. It means lack of enough resources to satisfy all
desired wants of individuals, society and the nation as well. Human wants are
unlimited, but the means or resources to satisfy them are always limited. Scarcity
explains this relationship between limited resources and unlimited wants and the
problems arising from it. Scarcity of resources gives birth to national economic
problems like poverty, inequality, unemployment, etc.

Choice

The act of selecting few goods or quantity among the bundles of goods is
called choice. In other words, it is the process of selecting few wants from the
bundles of wants. Problem of choice comes due to the limited resources we have
in comparison to wants. Choice explains the concept that resources are scarce; so
choices have to be made by consumer, producer, firms, government. If there is
scarcity, how to make priority and selection under the resource constraint is
called choice.
 We have scarce resources to satisfy our unlimited wants. As a result of this
problem, the next problem scarcity creates is to make a choice for all. So, scarcity
and choice are the basic problems in economics.

Opportunity cost

The second best alternative that has been sacrificed while taking an
economic decision is called opportunity cost. In other words, the cost of next best
alternative that has been foregone is called opportunity cost. For example;
suppose a student has 3 hours time with him. Two alternative options available
are; doing homework and watching a movie. If a student decides to do homework
its opportunity cost is the entertainment that could be received by watching
movie. If he decides to watch movie, its opportunity cost is doing his homework.

Allocation of resources

The scientific and appropriate utilization of scare productive resources to

meet the unlimited wants of human beings is known as allocation of resources.
Due to scarcity of resources, the available resources should be used
appropriately.

The main problems relating to the proper allocation of resources are

explained below;

1. What to produce

The first problem related with resource allocation is ‘what goods and
services to produce and in what quantities?’ The production must meet the
maximum social need as it is the first priority. The problem of what to produce
depends on the necessity of the people of the country.

2. How to produce

The second problem related to allocation of resources is concerned with

the method of production. If more labors are used in production it is called labor-
intensive technology. When more capitals like machinery are used, it is capital-
intensive technology. The choice of technology depends on the current state of
the economy.

3. For whom to produce

Due to scarcity of resources, we cannot satisfy all wants of the people. So,
before producing goods, the targeted consumer group should be identified. It
means, whether the production is for teenagers or for middle age group or for old
age group? Meeting the basic requirements of all groups of people is main criteria
of resource allocation.

4. Balanced development

While allocating resources a country should give equal importance to all

sectors for balanced development. There should balance between rural and urban
sector, home consumption and export promotion, consumer and capital goods
production, etc.

Production Possibility Curve (PPC)

A graphical representation of the maximum level of output that an

economy can produce with the full utilization of the existing resources is called
production possibility curve. In other words, a graph indicating alternative
combinations of two commodities that can be produced when all the available
resources are efficiently used is called PPC. It is also called product transformation
curve or production possibility frontier.

Assumptions

1. Economy is producing only two goods say consumer(x) and capital(y) goods.

2. There is full employment of resources.

3. Production technology is given and constant.

4. Factors of production are given and fixed.

5. Time period is given.

The concept of PPC can be explained with the help of following production
possibility schedule.

Table: Production possibility schedule

Combinations Goods ‘X’ Goods ‘Y’

A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0
We assume that only two goods, suppose X and Y can be produced with
the available resources. The first column represents the various production
possibilities or combinations. If all available resources are fully used to produce
goods Y, we can produce 15 units of it and no goods X (combination A). Similarly,
if all resources are use to produce goods X, we can produce 5 units of it and no
goods Y (combination F). In between these two combinations, there are other
combinations like B, C, D, and E which show we can produce a combination of
both goods X and Y. Due to scarcity of resources, production of one goods cannot
be increased without reducing the production of other goods.

Production possibility curve is shown in the figure below,

 In the above figure, quantity of goods X and Y are measured along X-axis
and Y-axis respectively. If we plot various combinations of goods X and Y form the
above table, we get the curve AF. It is production possibility curve.

Any point outside PPC like G may be better but it is not attainable because
of limited resources. Similarly, any point inside PPC like H may be possible but do
not represent efficient utilization of resources.

Notes:-

- PPC is also called product transformation curve because it shows more and
more amount of one goods cannot be produced without transferring the
resources from the production of another goods.
- The PPC expand outwards because more and more amount of one goods
must be sacrificed to increase the production of other goods. (OR- it is due
to increasing opportunity cost.)
- Production possibility curve becomes straight line/linear when opportunity
costs are constant.

Shift in PPC

The movement of PPC from its initial position to inward or outward position
due to various reasons is called shift in PPC. Production possibilities of a nation
change over time. PPC may shift due to change in technology, investment,
productivity of labor, etc. PPC either shift outward or inward. It can be shown
with the help of following fig,
 Fig: shift in PPC

Causes of outward shift

1. Due to improvement in technology;

2. Due to increase in productivity of labor through training and education;

3. Due to increase in investment in capital;

4. Due to availability of raw materials in large quantity;

5. Due to availability of new natural materials like land for production;

Causes of inward shift

1. Due to backwardness in technology;

2. Due to decrease in productivity of labor;

3. Due to shortage of natural resources;

4. Due to decrease in size of population;

5. Due decrease in investment in capital;