Economics, Definitions, Economic problem, Opportunities, Production possibility model

Microeconomics
MGT-223

Instructor: Iqra Mushtaq

 Contents
• Definitions of Economics
―Wealth concept
―Welfare Concept
―Scarcity Concept
• Nature and scope of Economics
• Economic Problem
• Branches of Economics
• Economic analysis
• Economic choice and Opportunity cost
• Factor of production
• Production possibility frontier
Remember we are here
 Stages & Definitions of Economics

Wealth Welfare Scarcity

Definition Definition Definition
(Adam Smith) (Alfred (L. Robbins)
Marshall)
• Wealth Concept : Adam Smith, who is
generally regarded as father of economics,
defined economics as “ a science which
enquires into the nature and cause of wealth
of nation”. He emphasized the production and
growth of wealth as the subject matter of
economics.
• Welfare Concept : According to A. Marshall “Economics
is a 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. Thus, it is
on one side a study of wealth; and on other; and more
important side, a part of the study of man.
• “Principles of Economics” in 1890.
• Scarcity Concept : According to Lionel
Robbins: “Economics is the science which
studies human behavior as a relationship
between ends and scarce means which have
alternate uses”.
• Economics is a social science concerned with the
efficient use of scarce resources to achieve the
maximum satisfaction of economic wants.

• Scarce resources: There are only limited number of

resources such as workers, machines, factories, raw
materials etc. Yet there are a number of different
ways in which they could be used.
• Similarly people only have limited amount
of money. Yet they have lots of needs and
wants to satisfy.
• Also Government has limited amount of
money!!! However, it is unable to satisfy all
its wants.
 Nature and scope of economics
• Economics is the science that deals with production, exchange and
consumption of various commodities in economic systems.
• It shows how scarce resources can be used to increase wealth and human
welfare.
• The central focus of economics is on scarcity of resources and choices
among their alternative uses.
For example, a farmer can grow paddy, sugarcane, banana, cotton etc. in
his garden land. But he must choose a crop depending upon the
availability of irrigation water.
• So, there are two major factors, responsible for the emergence of
economic problems. Unlimited human wants and scarcity of available
resources.
• Economics deals with how the unlimited human wants are to be
satisfied with limited resources so that we can get satisfaction.
ECONOMIC PROBLEM arises because of….
• Scarce Resources
• Unlimited wants
 Scope of economics
• Similar to physical and life sciences, as well as other social
sciences, economics depends on the scientific method.
• Observe real world behavior. [People change their
demand when price changes, We wear warm clothes in
winter, I like to watch movie in free times, We love to visit
Naran]
• Formulate explanation (Why)
• Testing
• Accepting or rejecting the hypothesis.
• If same results obtain in continuous testing, it helps to
formulate theory or economic principles.
• Other-Things-Equal Assumption
• In constructing their theories, economists use the ceteris
paribus or other-things-equal assumption—the assumption
that factors other than those being considered do not change.
• For example, consider the relationship between the price of
Pepsi and the amount of it purchased. This is helpful because
the economist can then focus on the relationship between the
price of Pepsi and purchases of Pepsi in isolation without being
confused by changes in other variables
• Graphical Expression
• Many economic models are expressed graphically.
 Economic principle
• Economic principle is a statement about economic
behavior or the economy that enables prediction of the
probable effects of certain actions.
• There are some other things you should know about
economic principles.
• Generalizations Economic principles are generalizations
relating to economic behavior or to the economy itself.
• Economic principles are expressed as the tendencies of
typical or average consumers, workers, or business firms.
• For example, economists say that consumers buy more of
a product when its price falls.
 Branches of Economics
• Microeconomics: study the behavior of individual
entities such as market, firms and households
e.g. How individual prices are set, how prices of
land, labor, capital are set, inquires into the
strength and weakness of the market mechanism.

• Macroeconomics: concerns with the overall

performance of the economy e.g. Total income,
total output, aggregate expenditure, employment,
inflation, etc.
 Economic Analysis
• Economic analysis is the process of driving economic principles
from relevant economic facts.

Types of economic analysis

Positive Economic Analysis Normative Economic Analysis

The analysis of facts and data to
establish the scientific generalizations
about economic behavior. “Statements
about how the world actually operates
—what is”. E.g. what is the
unemployment rate in an economy,
what is country’s GDP.
The part of economics involving value
judgments about what the economy
should be like, focused on which
economic goals and policies should be
implemented. “Statements about how
the world should be”. E.g. How
unemployment rate could be reduced or
How can a country raise its GDP.
 Economic choice and Opportunity cost

• Due to scarce resources people make

economic choices which create sacrifice
because alternatives must be given up.

• Economic choice is deciding between different

uses of scarce resources.
Opportunity Cost
• The amount of other product that must be
forgone or sacrificed to produce a unit of a
product.
• It is the value of the second best alternative
forgone.
• It is the benefit that is lost in making a
choice between two competing uses of
scarce resources.
• Everything has an opportunity cost.
 Society’s Economizing Problem
• Now what is economic problem? Choice because of scarcity. So society
has the economizing problem.
• Should it devote more of its limited resources to the criminal justice
system (police, courts, and prisons) or to education (teachers, books, and
schools)? If it decides to devote more resources to both, what other
goods and services does it forgo? Health care? Energy development?
• Scarce Resources
Society has limited or scarce economic resources, meaning all natural,
human, and manufactured resources that go into the production of
goods and services.
• This includes the entire set of factory and farmand all the equipment,
tools, and machinery used to produce manufactured goods and
agricultural products; all transportation and communication facilities; all
types of labor; and land and mineral resources.
 Resource Categories/ factor of
production/inputs
• Economists classify economic resources into four general categories.
• Land: includes all-natural resources used in the production process,
such as arable land, forests, mineral and oil deposits, and water
resources.
• Labor: consists of the physical and mental talents of individuals used
in producing goods and services. The services of a logger, retail clerk,
machinist, teacher, professional football player, and nuclear physicist
all fall under the general heading “labor.”
• Capital: includes all manufacturing goods used in producing consumer
goods and services. Included are all factory, storage, transportation,
and distribution facilities, as well as tools and machinery. Economists
refer to the purchase of capital goods as investment.
• Entrepreneurial Ability is the special human
resource, distinct from labor.
• The entrepreneur takes the initiative in combining
the resources of land, labor, and capital to produce a
good or a service. The entrepreneur makes the
strategic business decisions that set the course of an
enterprise.
• He is an innovator, who commercializes new
products, new production techniques, or even new
forms of business organization.
 Production Possibilities Model
• Society uses its scarce resources to produce goods and services.
• Production possibility model helps to understand the alternatives and
choices.
• Assumptions:
• Full employment The economy is employing all its available
resources.
• Fixed resources The quantity and quality of the factors of production
are fixed.
• Fixed technology The state of technology (the methods used to
produce output) is constant.
• Two goods The economy is producing only two goods: pizzas and
industrial robots. Pizzas is the consumer goods while industrial robots
are the capital goods, products that satisfy our wants indirectly by
making production of consumer goods more efficient.
 production possibilities table
• A production possibilities table lists the
different combinations of two products that
can be produced with a specific set of
resources, assuming full employment
• In producing more pizzas, society increases the
current satisfaction of its wants. But there is a
cost: More pizzas mean fewer industrial robots.
Society chooses “more now” at the expense of
“much more later.”
• By moving toward A, society chooses to forgo
current consumption, thereby freeing up
resources that can be used to increase the
production of capital goods. Society is choosing
“more later” at the cost of “less now.
 Production possibility curve
• shows different
combinations of goods
and services that
society can produce in a
fully employed
economy, assuming a
fixed availability of
supplies of resources
and constant
technology.