Microeconomics

What is an Economy
An Economy is a platform which provides people,
the means to work and earn a living.

Vital Economic Processes

• Production
• Consumption
• Capital Formation
Scarcity
Scarcity is the limited availability of a commodity, which
may be in demand in the market or by the commons.

Wants exceed the available resources

Goods are not readily available

Society does not have enough to satisfy its people

Calls for economising of resources

* Economising of resources – Optimum utilisation of
available resources
Economic Problem

Economic Problem is the problem of choice involving satisfaction of

unlimited wants out of limited resources having alternative uses.

Causes of economic problem

 Scarcity of resources
 Unlimited wants
 Wants with different priorities
 Alternate uses
Central problems of an economy
Central Problems

How to produce? For whom to

What to produce?
produce?

Personal
Commodity Labour Intensive Distribution

Quantity Capital Intensive Functional

Distribution
Central problems of an economy
What to Produce?
Selection of goods and services and quantity of each selected commodity
Consumer goods or capital goods/ Civil goods or war goods

How to produce?
Selection of technique to be used for production of goods and services
Labour intensive techniques
Capital intensive techniques.

For whom to produce?

Distribution of produced goods and services among the individuals within the economy
Positive Economics and Normative Economics

Economics is a science as well as art. But which type of science is a big question here, i.e.
positive or normative?
Positive economics is related to the analysis which is limited to cause and effect
relationship. It is based on facts about the economy.
Normative economics aims at examining real economic events from the moral and ethical
point of view. It is used to judge whether the economic events are desirable or not. It is
value judgment based.
Comparison
BASIS FOR
POSITIVE ECONOMICS NORMATIVE ECONOMICS
COMPARISON
Meaning A branch of economics based on data and A branch of economics based on values,
facts is positive economics. opinions and judgement is normative
economics.
Nature Descriptive Prescriptive
What it does? Analyses cause and effect relationship. Passes value judgement.

Perspective Objective Subjective

Study of What actually is What ought to be
Testing/Verification Statements can be tested using scientific Statements cannot be tested.
methods.
Economic issues It clearly describes economic issue. It provides solution for the economic
issue, based on value.
Example Prices in the economy are constantly rising India should take steps to control prices
Macroeconomics vs. Microeconomics
Basis of difference Macroeconomics Microeconomics
• Basis of study • Problems of scarcity and choice at the • Problems of scarcity and choice at
level of an economy as a whole the individual, household or industry
level
• Central Problem • Fuller utilisation and growth of • Central problem of allocation of
resources - Welfare resources
• Economic variables • Aggregate demand and aggregate • Consumer’s demand and producer’s
supply supply
• Economic agents • Institutional agents like RBI, SEBI • Individual economic agents like
individual consumer
• Degree of • Maximum degree of aggregation of • Limited degree of aggregation of
aggregation economic variables economic variables
• Set of assumptions • No assumptions – General equilibrium • Variables like employment assumed
constant – partial equilibrium
• Other name • Income and employment theory • Price theory

Note: Both Micro and Macro economics are interdependent

Micro – Macro Paradox
What is true and logical at the micro level may not be
applicable at the macro level.

 For Example – Savings is virtue at the micro economic

level, however it is a leakage at macro level that leads to
decline in consumption, investment and production
Opportunity cost
 The most basic definition of opportunity cost is the price of the next best thing you
could have done had you not made your first choice.
 Cost of next best alternative forgone
 In an economy, to produce a certain amount of one commodity, certain amount of
other commodity has to be sacrificed.
 Example - idle cash balances represent an opportunity cost in terms of lost interest
 As our resources are limited we are always forced to make choices between
alternated commodities.
Opportunity cost
Production Possibility Frontier

Production Possibility Frontier refers to graphical

representation of all possible combinations of two
goods that can be produced using the given
resources and technology.

PPF is also known by the following names:

• Production Possibility Curve
• Production Possibility Boundary
• Transformation Curve
Assumptions of PPF
 Only two goods can be produced with the given resources
 The amount of resources in an economy is fixed. However they can
be transferred from one use to another
 The resources are fully and efficiently utilised
 Resources are not equally efficient in production of all goods.
When they are transferred from one good to another, the
productivity decreases
 The level of technology is assumed constant.
 Production Possibility Schedule
Possibilities Good A Good B MOC MRT =
A 21 0 - -
B 20 1 1 1A: 1B
C 18 2 2 2A: 1B
D 15 3 3 3A: 1B
E 11 4 4 4A: 1B
F 6 5 5 5A: 1B
G 0 6 6 6A: 1B
Properties of PPF
 PPF slopes downwards – more and more
units of one good can be produced only be
taking resources away from the production of
another good.
 PPF is concave shaped – more and more units
of one commodity have to be sacrificed to
gain an additional unit of another commodity
Operation of an Economy and PPF
 The point of operation depends on the
efficient utilisation of resources.
 Economy will operate on PPF only when
resources are fully and efficiently utilised.
 Economy will operate at any point inside
PPF if resources are not fully and
efficiently utilised.
 Economy cannot operate at any point
outside PPF
Change in PPF
Shift in PPF – Change in productive
capacity with respect to both the
goods
Rightward shift – Advancement of
technology and/or growth of resources

Leftward shift – Technological degradation

and/or decrease in resources
Change in PPF
 Rotation of PPF - Change in productive
capacity with respect to only one good
Rotation on commodity on X-axis - Advancement
of technology and/or growth of resources for
commodity on X – axis, the PPF rotates to right.
However, it rotates to left in case of technological
degradation or decrease in resources

Rotation of commodity on Y-axis

Advancement of technology and/or growth of
resources for commodity on Y– axis, the PPF
rotates to right.
However, it rotates to left in case of technological
degradation or decrease in resources
Marginal Opportunity Cost
 MOC refers to the number of units of a commodity
sacrificed to gain one additional unit of another
commodity.
 More and more units of one commodity have to be
sacrificed to gain an additional unit of another
commodity

Marginal Rate of Transformation

 MRT is the ratio of the number of units of a
commodity sacrificed to gain an additional unit of
another commodity

 MRT =
Home Work
 Read the lesson
 Answer the lesson-end questions