MICROECONOMICS

(ECO 162)
INTRODUCTION TO
MICROECONOMICS

LEARNING OUTCOMES
At the end of this lesson, the students should be
able to:
i. Define economics and distinguish between
microeconomics and macroeconomics.
ii. Describe basic economic concepts: Scarcity, choices
and opportunity cost.
iii. Explain the basic economic problems.
iv. Explain graphically basic economics concept using
PPC.
v. Distinguish the three types of economic systems.

HISTORY ON DEFINITION OF
ECONOMICS
Economics is a science that studies human behavior as a relationship
between ends and scarce means which have alternative uses
L.Robbins (1894-1984) .
ii. Economics is a study of how people use their limited resources to try to
fulfill their unlimited wants and involves alternative or choices K.E.
Case and R.C. Fair.
iii. Economics is the science of how a particular society solves its economic
problems Milton Friedman (1912)
iv. Economics is the study of mans actions 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 the material requisites
of well-being. Thus it is on one side a study of wealth and on the other
and more important side, a part of the study of man - Alfred Marshall
(1824-1924)
i.

DEFINITION OF ECONOMICS
Economics is a social science study which concern on how
human being allocates the limited resources in order to
fulfill the unlimited needs and demands.
Economic can be subdivided into two branch;
macroeconomic and microeconomic.
Microeconomic analyzes the specific economic units in
details such as households, firms and government.
Macroeconomics, on the other hand, analyzes the
aggregate behavior of the entire economy.

Build more hospitals

or schools?
GOVERNMENT

HOUSEHOLDS

OPEN ECONOMICS

FIRMS

ECONOMIC CONCEPTS
Three main economic concepts involves;
i. Scarcity (land, labour, capital and enterprise)
Occurs as human wants are always greater than the
available resources.
The most important concept in economics. If there is no
scarcity, then there will be no economics study.
ii. Choice
When scarcity exists, choices are to be made out of the
available alternatives.
iii. Opportunity cost (Second Best-Forgone alternative)
The second-best alternative that has to be forgone for
another choice which gives more satisfaction.

ECONOMIC CONCEPTS
This economics concept is simple :
Because the resources are scarce, therefore choices
have to be made. Once choices are made, there will
be an opportunity cost as the value of the next-best
choice (alternative) available.
What is the opportunity cost by choosing to study at
university???

THREE BASIC ECONOMIC PROBLEMS

What to produce?
What kind of product/services are going to be produces.
Depends on the type and quantity of goods and services needed by
the countries
How to produce?
What resources are going to be used, what techniques are going to
be used to produce.
Depends on the cheapest method of production (Labor VS
Machine).
For whom to produce?
How will nation distribute income to reduce the gap between rich
and poor.
Depends on the distribution of income in the society.

PRODUCTION POSSIBILITIES CURVE (PPC)

Since with scarcity problem, no country in this world can produce unlimited
numbers of goods.
Therefore, an economy will produce goods depending on various
combinations of factors of production.
PPC shows the various possible combination of goods and services
produced within a specified time period with given technology and
resources.
Assumptions to illustrate PPC includes;
i.
Full-employment

The economy is operating in full employment and full efficiency

ii.

Fixed resources

The amount of available economic resources or factor of production are fixed

iii.

Technology constant

State of technology and method of production does not change

iv.

Production of two goods

Assuming that the country is producing only two type of goods

PRODUCTION POSSIBILITIES CURVE

Foods (Million units)
150

A
Y (Unattainable due to scarcity)

120
90

60

X
(Attainable but inefficient: Lead
to wastage/unemployment)

ABCD: Attainable and Efficient

points (Choices)

30

D
10

20

30

40

50

Figure 1.1 : Production Possibilities Curve

Clothes (Million units)

PRODUCTION POSSIBILITIES CURVE

i.

Point inside the PPC (Point X)

These combinations of foods and clothes are attainable and can be

produced.
However, it shows the resources are not fully utilized and the production
has not reached its maximum level.

ii.

Points Outside the PPC (Point Y)

This point which lies outside the PPC is unattainable due to limited
resources
Shows the concept of scarcity.

iii. Points along the PPC (Point A, B, C and D)

Combination are attainable and efficient.

Shows the second basic economic concept of choices.

PRODUCTION POSSIBILITIES CURVE

iv. Movement from one point to another point

Illustrate the third basic economic concept of opportunity cost.

E.g. movement from point A to B
Point A (100 X, 50 Y) to Point B (50 X, 75 Y) : In order for this
country to produce an additional of 25 millions units of good Y, it has
to forgone 50 millions units of good X.
Good Y

75

50

50

100

Good X

PRODUCTION POSSIBILITIES CURVE

v.

Shifts of the PPC

a)

Outward shift (Increase in output): Due to improvement in the new

technology, increase in resources and technology, economy growth and
increase in population.
Inward Shift (Decrease in output) : Due to natural disaster, reduction in
factors of production and

b)

Corn

Corn

Corn

PRODUCTION POSSIBILITIES CURVE

vi. Shape of the PPC

The shape of PPC depends on the types of opportunity cost.

Opportunity cost is calculated based on how much one good
is forgone to obtain other good.
Basically, there are three types of opportunity cost;
i. Increasing opportunity cost
ii. Constant opportunity cost
iii. Decreasing opportunity cost.

Production Possibilities Curve: Increasing

Opportunity Cost

Good Y

5
4

Good X
1

Figure 1.2 : Increasing Opportunity Cost

Increasing opportunity cost means

that when a country produces more
of one good, it has to forgone more
amounts of another goods.
Figure 1.2 shows that 1 unit increase
in Good X from 1 to 2 units had to
forgone 1 unit of Good Y.
Additional unit of Good X from 2 to 3
units involves 2 units of Good Y.
This is called increasing opportunity
cost as more units of Good Y are
forgone for additional unit of Good X.
PPC is concave due to increasing
opportunity cost.

PRODUCTION POSSIBILITIES CURVE: Constant

Opportunity Cost
Good Y
6

Constant opportunity cost means

that when a country produces
more of one good, it has to
forgone the same amounts of
another goods.
Figure 1.3 shows that same
amount of Good Y is forgone for
each additional unit of Good X.
PPC is linear as the opportunity
cost is constant.

D
2

Figure 1.3 : Constant Opportunity Cost

6
Good X

PRODUCTION POSSIBILITIES CURVE: Decreasing

Opportunity Cost

Good Y
4

D
1

Figure 1.4 : Decreasing Opportunity Cost

Good X

Decreasing opportunity cost occurs

when a country produces more of
one good, it has to forgone lesser
amounts of another goods.
Figure 1.4 shows that 1 unit increase
in Good X from point A to B involves
two units of Good Y forgone.
An additional increase of Good X
from point B to C forgone 1 units of
Good Y and number of Good Y
forgone continues to decrease.
This is called decreasing opportunity
cost as lesser units of Goods Y are
forgone for additional unit of Good X.
PPC is convex due to decreasing
opportunity cost

PRODUCTION POSSIBILITIES CURVE

i. Apr 2010 (Part B, Q 2)
ii. Apr 2006 (Part B, Q2)

ECONOMIC SYSTEMS
Economic system is a way of organizing the relationship
among individuals, firms and government to make choices on
the basic economic questions.
The three basic economic problems (what to produce, how
to produce and for whom to produce) are solved depending
on the economic system chosen by the society.
Basically, there are four types of economic system which have
been practiced, namely;
i.
ii.
iii.
iv.

Capitalist economy system

Socialist economy system
Mixed economy system
Islamic economy system

i.

CAPITALIST MARKET SYSTEM

A capitalism is an economic system where individuals without

government intervention take all the main economic decision.
Also known as market economy, free enterprise system and
laissez-faire.
This economy is characterized as economic freedom, where an
individual can act at their own wishes without any control from
the government.
The example of countries practicing the capitalist economic
system are the United States of America (USA), France, Canada,
Japan, and Britain.

CAPITALIST MARKET SYSTEM:

CHARACTERISTICS
i.

Government intervention

There is no intervention by the government in the making of

economic decisions.
Government only exist as the law enforcer and set the rules and
regulation to ensure the stability of economic condition of the
country.

ii. Private ownership of resources

Every individual in the country has a right to acquire resources.

This enable individual to own resources as well as to establish any
enterprise at their choices.
They are free to trade, invest and organize to produce within the
countrys legal framework.

CAPITALIST MARKET SYSTEM:

CHARACTERISTICS
iii. Consumers sovereignty
Consumer is the king concept is practiced in this system.
Consumers taste and preference will affect the production of
goods and services.

iv. Competition
Market economy also characterized as highly competitive
among the producers to obtain the highest profit.
In order to attract more customers, producers will use
various marketing strategies to sell their products better.

CAPITALIST MARKET SYSTEM:

CHARACTERISTICS
v. Price System

Price system is a system used to make economic decisions.

In this system, price mechanism is practiced. It means that
the price is determine according to the force of demand
and supply and without any intervention.
All economic processes of consumption, production,
exchange, savings, investment and distribution will work
according to this price mechanism and is labeled as
invisible hand by Adam Smith.

CAPITALIST MARKET SYSTEM:

ADVANTAGES
i.

Production according to the needs of consumers

Producers are producing goods and services according to the

tastes of consumers, which maximize the consumers needs and
satisfaction.

ii.

Economic freedom

It means the right to earn and retain property as well as freedom

of enterprises and choices of occupation.
Thus, it will lead to the sourcing of the countrys manpower in
different units of production.

iii. Resources are efficiently utilized

Competition creates efficiency in producing quality goods at

lower cost since techniques are more efficient.

CAPITALIST MARKET SYSTEM:

ADVANTAGES
iv. Varieties of consumer goods

Competition takes place in various aspects such as shape,

colour, design and packaging of the products.
Thus, consumer will enjoy a wide variety of the same
product.

v. Enhance trade, business and R&D

Entrepreneurs or producers will always look out for new

innovations to compete with other producers to provide
high quality goods.

CAPITALIST MARKET SYSTEM:

DISADVANTAGES
i.

Inequality of distribution of wealth and income

Since with no government intervention, the system of

private property widens the gap between the rich and the
poor.
Thus, this will lead to unequal distribution of income
among the societies.

ii. Inflation and high unemployment rate

Disparity of demand and supply of labour occurs as it is

governed by the invisible hand
Unstable business fluctuation will cause high
unemployment rate during the depression.

CAPITALIST MARKET SYSTEM:

DISADVANTAGES
iii. Lack of social welfare

In market economy, social welfare is ignored as the

business entrepreneurs do not provide any pension, social
security or accident benefits to their employees.

iv. Unnecessary variety and wasteful competition

Too much of competition will lead to unnecessary high cost

of production.
This happen as some producers will highly advertised their
products in order to attract consumer due to stiff
competition in this market system.

CAPITALIST MARKET SYSTEM:

DISADVANTAGES
v. Misallocation of resources

In this system, producers objective is to maximize profit

and therefore only produce outputs which give higher
profits.
This will lead to production of luxury goods (for rich people)
and resulting surplus as well as lack of production for the
poor people.

vi. Social cost

Workers may face social cost (health problem) arising from

the polluted environment caused by improper disposal of
factory wastes since producers' intention is to increase the
private profit and welfare of the workers is often neglected.

HOW CAPITALIST MARKET SYSTEM

SOLVE BASIC ECONOMIC PROBLEM
i.

ii.

iii.

What to produce?
In this economic system, production depends on the goods
demanded by the consumer.
An entrepreneur will only produce goods and services where there
is demand from consumer in order to gain higher profit.
How to produce?
Depends on the techniques of production whether to use labor
intensive, capital intensive or combination of both techniques.
Cheapest method of production will be adapted not only to
maximize profit but also to achieve efficiency.
For whom to produce?
This problem will be solve through price system.
Goods and services are obtained by anyone who can afford.

ii.

SOCIALIST MARKET SYSTEM

Socialist market system is a centrally planned economy where

government or central authority makes all economic decision.
Any private individual has no right to make their own economic
decisions.
There will be no private property rights since all resources are
owned by government.
Also known as command economy and planned economy.
There are only few countries which practice this economic
system such as Russia, Cuba, Laos, Vietnam and North Korea.

SOCIALIST MARKET SYSTEM:

CHARACTERISTICS
i.

Public ownership of resources

All resources are owned and operated by the state or the

government in the interest of society as a whole.
This is to ensure equal opportunity for all citizens regardless
of their income.
ii. Central planning authority
Central Planning Authority acts as government and
responsible for making economic decision for the society.
Government will plan and allocate the resources between
current consumption and investment for the future.

SOCIALIST MARKET SYSTEM:

CHARACTERISTICS
iii. Less importance of price mechanism
Market forces are less important in this economic system.
Prices are fixed by the government and not determined by
the forces of demand and supply.
Private profits are not allowed and public interest is
emphasized.

iv. Central control and ownership

Government intervenes in all aspect of economic activities
including production, consumption and distribution of goods
and services.

SOCIALIST MARKET SYSTEM:

ADVANTAGES
i.

Production according to the basic of society

Government produced goods and services according to the

societies basic needs such as foods, clothes and building
material.
Production is not by the purchasing power of rich society but
more concern on the society as a whole.

ii. Equal distribution of income

There will be no difference between rich and poor as this

system provides equal opportunity for all citizens in earning
income.
Wealth is also equally distributed since private enterprise
are limited.

SOCIALIST MARKET SYSTEM:

ADVANTAGES
iv. No serious unemployment/recession or inflation

Since the economy is taken fully care by the government,

there will be no serious economic problems as the
governments main objectives is to maintain the stability of
economic.

v. Social welfare

Government will provide all citizens of the country full

social security such as pensions, accident benefits and
others.
With all concerns from government, labor dispute and
wastage of resources do not exist in socialist system.

SOCIALIST MARKET SYSTEM:

DISADVANTAGES
i.

Lack of incentives and initiatives by individuals

There is absence of profit motive in individuals.

Thus, this will lead to economic inefficiency since jobs are
provided by the government and individuals are not
motivated to work harder.

ii. Loss of economic freedom of consumers

There is no choice given to consumer and they accept

whatever the public enterprise produce.
Since with the limited number of private enterprises, there
are limited variety of goods and services as well as
restricted available choices.

SOCIALIST MARKET SYSTEM:

DISADVANTAGES
iii. Absence of competition

Since there are limited private enterprise exist in this

market system, there will be less R&D activities occurs.
Thus, quality of products will be low since there is no
competition.

iv. Waste of economic resources

Government might produce goods and services that are not

required by the people such as military equipments.
This will lead to overproduction of certain goods and
underproduction of certain other goods.

HOW SOCIALIST MARKET SYSTEM

SOLVE BASIC ECONOMIC PROBLEM
i.

What to produce?

In this economic system, planning authorities decides what to produce.

The Central Planning Authority will collect detailed statistics on the
resources availability and fix up with national priorities.

ii.

How to produce?

The Central Planning Authority will also decides on what techniques to be

used in the production of goods and services.
The choice is between traditional or modern techniques.

iii.

For whom to produce?

The distribution of national product is decided by Central Planning

Authority.
The distribution of various commodities is done through a set of
administered fixed prices. (Necessities good are fixed at lower price while
luxurious good are fixed at higher price)
This is to ensure low inequalities in the distribution of income among
societies.

iii. MIXED MARKET SYSTEM

Mixed market system is an economic system which
has a mix of capitalist and socialist systems to solve
basic economic problems.
A mixed economy is where both public and private
sectors play their roles in the economy.
Most of the countries in the world practiced this type
of economic systems. This includes Malaysia,
Singapore, Thailand, Germany, South Africa and many
others.

MIXED MARKET SYSTEM:

CHARACTERISTICS
i.

Public and private ownership of resources

Private enterprise conduct business freely.

The government encourages private sectors by providing
infrastructure and facilities.
ii. Price mechanism and economic plan used to make
economic decisions.
Price mechanism is used on pricing of goods and services.
However, government will intervene in setting up prices on
certain commodities.
This includes sugar, oil, rice where government declared as
controlled items .

MIXED MARKET SYSTEM:

CHARACTERISTICS
iii. Government intervention
Government will not intervene in the economy except for
particular industries.
Government uses the legislation for unsafe goods,
categorized as illegal products such as military items, drugs,
etc.
Government also uses direct provision such as education,
defense and health to increase standard of living.
Besides, government also control the income disparity
through income taxes and welfare payment.
Government will also control the existence of monopolies in
order to avoid customers being exploited by monopolist.

MIXED MARKET SYSTEM:

ADVANTAGES
i.

More stable economics

Since there is a lot of government intervention, the economic will be

more organized. Thus, economic condition will be more stable.

ii.

Lower social cost

Externalities such air, noise and water pollution will be lower due to
government intervention.
Thus, social cost will be lower as government enact laws to ensure
production methods used caused least harm to the environment.

iii. Narrow gap between rich and poor

Government intervention through imposing progressive tax will help to

narrow down the gap between the rich and the poor.
Higher income earners are taxed more than lower income earners.

MIXED MARKET SYSTEM:

ADVANTAGES
iv. Social welfare

The government will provides public goods at an affordable

price in order to enable lower income earners to benefit
the public goods as well.
Government will ensure that public and private enterprise
provide all citizens of the country full social security such as
pensions, accident benefits and others.

HOW MIXED MARKET SYSTEM SOLVE

BASIC ECONOMIC PROBLEM
i.

What to produce?

In this economic system, what to produce decided by the public and private
sectors.
The goods and services produced depends on the consideration of social
welfare as well as economic growth.

ii.

How to produce?

The private sector will choose the most efficient and cost-effective
techniques of production (labor intensive vs. capital intensive) while
government will enact laws to combat inefficiencies arising from
externalities.

iii.

For whom to produce?

The distribution of goods and services is also decided by the public and
private sectors.
Price mechanism is not fully functional in mixed economies.
Government intervene directly through price control and indirectly
imposing indirect taxes and subsidies.

iv. ISLAMIC MARKET SYSTEM

Economic activities in Islam are not seen from the materialistic
aspect only but also the spiritual aspect in this world and the life
hereafter.
The only objective of the Islamic Economic System is to achieve
Al-Falah, which means success in ones life in the world and also
the life hereafter.
The basic philosophical foundation in the Islamic Economic
System includes;
a) Tauhid
b) Rububiyyah
c) Tazkiyyah
d) Khalifah
e) ukhuwwah

ISLAMIC MARKET SYSTEM:

PHILOSOPHICAL
a) The concept of Tauhid
The concept of believing that in Islam there is only one God to
be worshipped which is Allah SWT.
The belief of Tauhid is divided into two, namely;
i. The relationship between man and Allah SWT (Habluminallah)
ii. The relationship among mankind (Habluminannas)
b) The concept of Rububiyyah
The concept of believing that Allah SWT alone is the creator
and the most powerful.
He also gives bounties and organizes mans economies
activities for genuine interest to achieve Al-Falah in this world
and the life hereafter.

ISLAMIC MARKET SYSTEM:

PHILOSOPHICAL
c) The concept of Tazkiyyah

The concept of purification of man.

Islam believes that before one indulges in any economic activities,
he must mould pure and good soul.
For example, one can purify his wealth by giving out tithe (Zakat)
and donating (Sedekah) to the poor.
When the wealth of the rich reaches a certain stated amount, it
must be levied with zakat, which aims to help the poor.

d. The concept of khalifah

The concept of vicegerent that man is the servant of Allah SWT.

In Islam, men are created as trustees and they are responsible to
prosper the land and always to be in servitude to Allah SWT set by
the Islamic Law (syariah)

ISLAMIC MARKET SYSTEM:

PHILOSOPHICAL
e) The concept of Ukhuwwah
The concept of brotherhood in Islam.
Islam believes that all men are brothers and they must love
and respect each other and be responsible.
Those who are willing to sacrifice for their brothers show the
sign of faith.
Oppression, extortion and miserliness do not exist in the
Islamic Economic System.

HOW ISLAMIC MARKET SYSTEM

SOLVE BASIC ECONOMIC PROBLEM
i.

What to produce?

In this economic system, what to produce are decided through the

principles of Syariah as been stated in Al-Quran and As- sunnah.
The goods and services produced must be permissible (halal) and in
accordance with the classification of goods in Islam.

ii.

How to produce?

The producer will choose the most efficient and cost effective methods
of production. (labor vs. capital intensive)

iii.

For whom to produce?

In distributing the goods and services, the need of the poor should
come first instead of the rich.
This, however, does not mean that the needs of rich are being ignored.
It just that the production of luxury goods for the rich should come
later than the need of the poor.

END OF CHAPTER 1
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