Chapter 1

INTRODUCTION TO MICROECONOMICS

Learning Objectives
At the end of the chapter, the student should be able to discuss the following:
1. Nature and Scope of Economics
2. Importance of Microeconomics
3. Difference between Micro and Macro Economics.
4. Scarcity, Choice and the Production Possibility Curve
5. Economics and Business

OVERVIEW
Economics is defined as the social science that deals with the production,
distribution, and consumption of goods and services. It studies how individuals,
businesses, governments, and nations make choices on allocating resources to satisfy
their wants and needs, trying to determine how these groups should organize and
coordinate efforts to achieve maximum output. Evolved in the 19th century, the
economic studies have become one of the most significant studies of modern days.
From a small shop to a country, Economics plays a crucial role in the efficient running of
both. No business can flourish without applying the principles of economics. The study
of economics is extensive and varied. The nature and scope of economics depend upon
the interaction of economic agents and how economies work.
Economics is probably not what you think. It is not primarily about money or
finance. It is not primarily about business. It is not mathematics. What is it then? It is
both a subject area and a way of viewing the world.

Lecture Files
The writer deemed to compile various lectures from wide array of sources and is
summarized for the benefit of discussions pertaining to economics.

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NATURE AND SCOPE OF ECONOMICS

Nature of Economics

The nature of economics deals with the question that whether economics falls
into the category of science or arts. Various economists have given their arguments in
favour of science while others have their reservations for arts.

Economics as a Science

To consider anything as a science, first, we should know what science is all

about? Science deals with systematic studies that signify the cause and effect
relationship. In science, facts and figures are collected and are analyzed systematically
to arrive at any certain conclusion. For these attributes, economics can be considered
as a science. However, economics is treated as a social science because of the
following features:

• It involves a systematic collection of facts and figures.

• Like in science, it is based on the formulation of theories and laws.
• It deals with the cause and effect relationship.

These points validate that the nature of economics is correlated with science. Just
as in science, various economic theories are also based on logical reasoning.

Economics as an Art

It is said that “knowledge is science, action is art.” Economic theories are used to
solve various economic problems in society. Thus, it can be inferred that besides being
a social science, economics is also an art.

Scope of Economics

Economists use different economic theories to solve various economic problems

in society. Its applicability is very vast. From a small organization to a multinational firm,
economic laws come into play. The scope of economics can be understood under two
subheads: Microeconomics and Macroeconomics.

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Microeconomics

Microeconomics examines individual economic activity, industries, and their

interaction. It has the following characteristics:

• Elasticity: It determines the ratio of change in the proportion of one variable to

another variable. For example- the income elasticity of demand, the price
elasticity of demand, the price elasticity of supply, etc.
• Theory of Production: It involves an efficient conversion of input into output. For
example- packaging, shipping, storing, and manufacturing.
• Cost of Production: With the help of this theory, the object price is evaluated by
the price of resources.
• Monopoly: Under this theory, the dominance of a single entity is studied in a
particular field.
• Oligopoly: It corresponds to the dominance of small entities in a market.

Macroeconomics

It is the study of an economy as a whole. It explains broad aggregates and their

interactions “top down.” Macroeconomics has the following characteristics:

• Growth: It studies the factors which explain economic growth such as the
increase in output per capita of a country over a long period of time.
• Business Cycle: This theory emerged after the Great Depression of the 1930s.
It advocates the involvement of the central bank and the government to formulate
monetary and fiscal policies to monitor the output over the business cycle.
• Unemployment: It is measured by the unemployment rate. It is caused by
various factors like rising in wages, a shortfall in vacancies, and more.
• Inflation and Deflation: Inflation corresponds to an increase in the price of a
commodity, while deflation corresponds to a decrease in the price of a
commodity. These indicators are valuable to evaluate the status of the economy
of a country.

IMPORTANCE OF MICRO ECONOMICS

Today microeconomics occupies a very important place in the study of economic

theory. It is an important method of economic analysis. Professor Keynes regards as “a
necessary part of one’s apparatus of thought. It is microeconomics that tells us how a
free market economy with its millions of consumers and producers work to decide about
the allocation of productive resources among the thousands of goods and services.”

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 As Professor D.S. Watson observed,” microeconomic theory explains the
composition or allocation of total production. Why more of some things are produced
than others”.

Microeconomics has both theoretical and practical importance which may be

summarized as follows:

a. Helpful in the Efficient Employment of Resources:

Microeconomics is helpful in the efficient employment of the limited,
scarce resources of a country. The principal problem faced by the modern
government is the allocation of its scarce resources among the competing
ends. It is the burning problem of the day. Microeconomic theory explains the
condition of efficiency in both production and consumption, which are vital to
economics and highlights the factors which are responsible the departure
from efficiency. On this basis microeconomic theory suggests suitable policies
which should be adopted by modern governments to promote economic
efficiency and thereby achieving all-round growth, prosperity and stability in
the economy.

b. Understanding Free Enterprise Economy:

Microeconomics is of great importance in understanding the working of
free enterprise economy without any central control. In such an economy
there is agency to plan and coordinate the working of the economic system.
Such decisions as to how to produce, what to produce, when to produce, and
for whom to produce are taken independently by the producers. Similarly,
decisions as to what to consume, whom to consume and how much to
consume are decisions taken by consumers themselves.

c. Helpful in the Development of International Trade:

Microeconomics is also helpful in the development of international trade. It
is used to explain the gains from international trade, balance of payment
disequilibrium and the determination of foreign exchange rate.

d. Helpful in Understanding the Implications of Taxation:

Microeconomics is also helpful in understanding the implication of
taxation. It helps in explaining as to whether an income tax leads to decrease
in the social welfare or an excise duty or sales duty. It is the imposition of an
excise duty or sales tax that leads to the decrease in social welfare rather
than income tax.

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 e. Basis for Welfare Economics:
The greatest justification for the study of micro economics is that it
provides the basis for welfare economics. The entire structure of welfare
economics has been built on price theory which is the constituent part of
microeconomics. It shows how the relative prices of various products and
factors are formed. A.P. Lerner observed, “Microeconomic theory spells out
the condition of efficiency and suggests how it can be achieved. These
conditions can be of great help in raising the standard of living of the
population.

f. Provides Tools for Evaluating Economic Policies:

Microeconomics provides tools for evaluating economic policies of the
state. Microeconomic theory explains the condition of efficiency in
consumption and production and highlights the factors which are responsible
for the departure from efficiency. On this basis microeconomics suggests
suitable economic policies to promote economic efficiency and welfare of the
people. A Price policy is also an important tool for economic policies.
Microeconomics helps the state in formulating correct price policies and
evaluating them in proper perspective.

g. Construction and Use of Models:

Microeconomics constructs and uses simple models for understanding of
actual economic phenomena. In this field, the usefulness and the importance
of microeconomics is aptly stated by Professor A.P. Lerner, he writes,
“microeconomic theory facilitates the understanding of what would be a
hopelessly complicated confusion of billions of facts by constructing simplified
models of behaviour which are efficiently similar to the actual phenomena
depart from certain ideal constructions that would mostly achieve individual
and social objectives”. He further writes,” thus they help not only to describe
the actual economic situation but to suggest policies that would most
successfully and most efficiently bring about desired results and to predict the
outcomes of such policies and other events”.

DIFFERENCE BETWEEN MICRO AND MACRO ECONOMICS

Micro and Macro Economics are neither different subjects, nor they are
contradictory, rather, they are complementary. As every coin has two aspects – micro
and macroeconomics are also the two aspects of the same coin, wherein one’s demerit
is others merit and in this way, they cover the whole economy. The only important point
which makes them different is the area of application.

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 Microeconomics talks about the actions of an individual unit, i.e. an individual,
firm, household, market, industry, etc. On the other hand, the Macroeconomics studies
the economy as a whole, i.e. it assesses not a single unit but the combination of all i.e.
firms, households, nation, industries, market, etc.

This section argues the concept and all the key differences between
microeconomics and macroeconomics in tabular form.

BASIS FOR
MICROECONOMICS MACROECONOMICS
COMPARISON
Meaning The branch of economics The branch of economics
that studies the behavior of that studies the behavior of
an individual consumer, the whole economy, (both
firm, family is known as national and international)
Microeconomics. is known as
Macroeconomics.
Deals with Individual economic Aggregate economic
variables variables
Business Application Applied to operational or Environment and external
internal issues issues
Tools Demand and Supply Aggregate Demand and
Aggregate Supply
Assumption It assumes that all macro- It assumes that all micro-
economic variables are economic variables are
constant. constant.
Concerned with Theory of Product Pricing, Theory of National Income,
Theory of Factor Pricing, Aggregate Consumption,
Theory of Economic Theory of General Price
Welfare. Level, Economic Growth.
Scope Covers various issues like Covers various issues like,
demand, supply, product national income, general
pricing, factor pricing, price level, distribution,
production, consumption, employment, money etc.
economic welfare, etc.
Importance Helpful in determining the Maintains stability in the
prices of a product along general price level and
with the prices of factors of resolves the major
production (land, labour, problems of the economy
capital, entrepreneur etc.) like inflation, deflation,
within the economy. reflation, unemployment
and poverty as a whole.
Limitations It is based on unrealistic It has been analyzed that
assumptions, i.e. In 'Fallacy of Composition'
microeconomics it is involves, which sometimes
assumed that there is a full doesn't proves true
employment in the society because it is possible that

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 which is not at all possible. what is true for aggregate
may not be true for
individuals too.

Interdependency

As microeconomics focuses on the allocation of limited resources among the

individuals, the macroeconomics examines that how the distribution of limited resources
is to be done among many people, so that it will make the best possible use of the
scarce resources. As microeconomics studies about the individual units, at the same
time, macroeconomics studies about the aggregate variables.

Both are of the view that the nation’s economic welfare is possible only when
there is the best possible utilization of productive resources. In this way, we can say that
they are interdependent. Further, to have a full understanding of economics, the study
of both the two branches is pertinent.

SCARCITY, CHOICE AND THE PRODUCTION POSSIBILITY CURVE

This section explains about scarcity and choice as economic problems. There
are a number of problems that can arise from choices that are made by people, whether
they are individuals, firms or government. Choices or alternatives (or opportunity cost)
are illustrated in terms of a production possibility curve.

The Problem of Scarcity

Scarcity means that people want more than is available. Scarcity limits us both
as individuals and as a society. We live in a world of scarcity. People want and need
variety of goods and services. This applies equally to the poor and the rich people. It
implies that human wants are unlimited but the means to fulfil them are limited. At any
one time, only a limited amount of goods and services can be produced. This is
because the existing supplies of resources are extremely inadequate. These resources
are land, labour, capital and entrepreneurship.

These factors of production or inputs are used in producing goods and services
that are called economic goods which have a piece. These facts explain scarcity as the
principal problem of every society and suggest the Law of Scarcity, The law states that
human wants are virtually unlimited and the resources available to satisfy these wants
are limited.

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The Problem of Choice

Scarcity requires choice. People must choose which of their desires they will
satisfy and which they will leave unsatisfied. When we, either as individuals or as a
society, choose more of something, scarcity forces us to take less of something else. a
society can produce only a small portion of goods and services that its people want.
Therefore, scarcity of resources gives rise to the fundamental economic problem of
choice. As a society cannot produce enough goods and services to satisfy all the wants
of its people, it has to make choices.

A decision to produce one good requires a decision to produce less of some

other good. So choice involves sacrifice. Thus every society is faced with the basic
problem of deciding what it is willing to sacrifice to produce the goods it wants the most.

When there is scarcity and choice, there are costs. The cost of any choice is the
option or options that a person gives up. For instance, the more roads a country
decided to construct the fever resources will there be for building schools. So the
problem of choice arises when there are alternative ways of producing other goods. The
sacrifice of the alternative (school buildings) in the production of a good (roads) is called
the opportunity cost.

Most of economics is based on the simple idea that people make choices by
comparing the benefits of option A with the benefits of option B (and all other options
that are available) and choosing the one with the highest benefit. Alternatively, one can
view the cost of choosing option A as the sacrifice involved in rejecting option B, and
then say that one chooses option A when the benefits of A outweigh the costs of
choosing A (which are the benefits one loses when one rejects option B).

There are a number of problems that can arise from choices that are made by
people, whether they are individuals, firms or government. Choices or alternatives (or
opportunity cost) are illustrated in terms of a production possibility curve.

Production Possibilities Curve and What It Shows

A production possibility curve measures the maximum output of two goods using
a fixed amount of input. The input is any combination of the four factors of production.
They are land and other natural resources, labour, capital goods, and entrepreneurship.
The manufacture of most goods requires a mix of all four.

For example, say an economy can produce 20,000 oranges and 120,000 apples.
On the chart, that's point B. If it wants to produce more oranges, it must produce fewer

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apples. On the chart, Point C shows that if it produces 45,000 oranges, it can only
produce 85,000 apples.

By describing this tradeoff, the curve demonstrates the concept of opportunity

cost. Making more of one good will cost society the opportunity of making more of the
other good. The production possibility curve delineates the cost of society's choice
between two different goods.

Each point on the curve shows how much of each good will be produced when
resources shift from
making more of one
good and less of the
other.

For example, say an

economy can
produce 20,000
oranges and
120,000 apples. On
the chart, that's point
B. If it wants to
produce more
oranges, it must
produce fewer
apples. On the chart,
Point C shows that if
it produces 45,000
oranges, it can only produce 85,000 apples.

By describing this tradeoff, the curve demonstrates the concept of opport

unity cost. Making more of one good will cost society the opportunity of making
more of the other good. The production possibility curve delineates the cost of
society's choice between two different goods.

Production Possibility Frontier

The curve delineates the production possibility frontier. It's the maximum amount
that can possibly be produced of both goods given the level of resources. An economy
that operates at the frontier has the highest standard of living it can achieve. It is
producing as much as it can using the same resources.

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 If the amount produced is inside the curve, then all of the resources are not being
used. On the chart, that is point E.

One reason is that there is a recession or depression. There is not enough

demand for either good. Layoffs occur, resulting in lower levels of labour being used.

Another reason is a bit more complicated. An economy falls within the curve
when it is ignoring its comparative advantage. For example, Florida has the ideal
environment to grow oranges. Oregon's climate is best for apples. Florida has a
comparative advantage in orange productions, and Oregon has one in apple production.
If Florida ignored its advantage in oranges and tried to grow apples, it would force the
United States to operate within its curve. The U.S. standard of living would fall.

Conversely, any point outside the PPF curve is impossible. More of both goods
cannot be produced with the available limited resources. On the chart, that is point F.

What the Shape of the Curve Tells You

The production possibility curve bows outward. The highest point on the curve is
when you only produce one good, on the y-axis, and zero of the other, on the x-axis. On
the chart, that is Point A. The economy produces 140,000 apples and zero oranges.

The widest point is when you produce none of the good on the y-axis, producing
as much as possible of the good on the x-axis. On the chart, that is point D. The society
produces zero apples and 40,000 oranges.

All the points in between are a trade-off of some combination of the two goods.
An economy operates more efficiently by producing that mix. The reason is that every
resource is better suited to producing one good than another. Some land is better suited
for apples, while other land is best for oranges. Society does best when it directs the
production of each resource toward its specialty. The more specialized the resources,
the more bowed out the production possibility curve.

How It Affects the Economy

The curve does not tell decision-makers how much of each good the economy
should produce. It only tells them how much of each good they must give up if they are
to produce more of the other good. It is up to them to decide where the sweet spot is.

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 In a market economy, the law of demand determines how much of each good to
produce. In a command economy, planners decide the most efficient point on the curve.
They are more likely to consider how best to use labour so there is full employment.

They must create more demand for either or both products. Only after that occurs
can more resources can be used to produce greater output.

Supply-side economists believe the curve can be shifted to the right simply by
adding more resources. But without demand, they will only succeed in creating
underutilized resources. There can be a benefit in increasing the labour force. Once the
unemployed are working, they will increase demand and shift the curve to the right. For
it to work, they must be paid enough to create the demand that shifts the curve outward.
There must also be enough unemployed to make a difference. An economy in full
employment won't add more workers no matter how much corporate taxes are cut.

A decrease in resources can limit growth. If there is a shortage of one input, then
more goods will not be produced no matter how high the demand. In those situations,
prices rise until demand falls to meet supply. It creates cost-push inflation.

TIME FREEZE!!!

Review questions:

1. Economists say that a thing is scarce when:

a. only a finite amount exists.
b. there is at least one use for the thing.
c. the amount available is less than what people would like to have.
d. the amount of the item is both finite and decreasing

2. In 1997 Brenda Barnes resigned as CEO of Pepsi-Cola North America to spend

more time with her three young children. How would an economist tend to view
this choice?
a. It was an expensive choice because she gave up a great deal of income
to stay at home.
b. It was an inexpensive choice because she already had a great deal of
wealth.

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 c. It was an unnecessary choice because women really can "have it all."
d. It was an irrational choice because she was not concerned with her own
self-interest.

ECONOMICS AND BUSINESS

How Economics relates to Business?

Business and economics go side by side. Economics determine the supply and
demand of a certain products in a particular economy. On the other hand, businesses
rely on the economic principle of scarcity to make money. It offers products and
services that generate economic output and selling goods and services to consumers. If
goods and services are readily available, it will be impossible to sell it and realize
profits. Due to scarcity, people are willing to pay money to obtain certain goods and
services in order to satisfy their needs and wants. Despite the above mentioned
relationship between these two branches of social sciences, they are different from
each other.

What are Economics and Business?

Economics

Economics is about carefully and analytically studying the human behavior with
regards to limited incentives or resources. It is a branch of social science that studies
the decisions and actions of employees, firms, customers, individuals, and
governments, in order to identify their impact on the economy of a country. It is related
to a large number of subject matters, including but not limited to politics, mathematics,
international relationships, etc.

Business

Business, on the other hand, is an economic system whereby goods and

services are exchanged between two or more parties for money. Every business needs
different forms of funds, and customer base to whom it can sell its product on a regular
basis in order to make profits.

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 It is about maximizing the value of wealth with respect to the behavior of people.
It consists of a collection of different activities and organizational behavior, including
finance, accounting, management, business strategy, human resource, sales and
marketing, product development and analysis.

It also takes into account the external factors of an economy, political situation of
a nation, and government laws and regulations to assess how it will impact an
organization and an industry as a whole. Furthermore, it also analyzes the rapidly
changing environmental conditions so as to see their impact on the overall value.

1. Key Concepts
Economics
The key concepts of economics are supply and demand, the rate of
interest, the rate of exchange, production, inflation, international trade, balance of
payment, and more. Economics enables individuals to think with logical
reasoning and to read theories, so that they can be applied in understanding the
mechanism of economies around the world.
It allows people to be able to comprehend the complex issues of an
economy in such a way that they are able to gain benefit out of it.

Business

The key concept of a business is to earn profit and to maximize

shareholder’s wealth. An increase in the wealth of business eventually increases
the stock prices of a company, which consequently increases shareholders’ net
worth.

2. Types
Economics – Types
There are different strands of economics, including micro-economics and
macro-economics, pure and applied economics, and industrial and financial
economics.
Micro and Macro Economics – Microeconomics deals with economic
decisions at a micro level. It is about people and firms in any given economy and
evaluating the element of human behavior. For example, micro economics tells
you the impact of price on purchasing decision of a consumer. On the other
hand, macroeconomics deals with decisions at a large level. It deals with
aggregate decisions taken by people of a particular country, for example, it
caters the questions like the influence of the change in interest rates on national
savings. Both micro and macro-economics are connected with each other, and

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 can be helpful for individuals and the overall economy to make informed
decisions.
Pure and Applied Economics – Pure economics deals with pure logic and
deals with principle lines of arguments, whereas, applied economics is an
application of economic theories in a real world with a motive to anticipate the
probable results, as it deals with providing details.
Industrial and Financial Economics – Industrial economics is a study of
corporate sectors, industries and markets, which includes the firm of all sizes and
levels, from a small grocery store to a superstore or shopping malls. It includes
different industries, such as, car production, electricity generation, or food
industry. Financial economics is a branch of economics that focuses on monetary
activities. It is concerned with the relationship of various financial variables,
including rates of interests, asset prices, and shares.

Business Types
There are different types of businesses, including sole proprietorship,
partnership and corporation. Sole proprietorship is a business owned and run by
a single person and is considered as a simple form of entity. It is not a legal entity
and therefore, does not have separate ownership from its owner. In a partnership
business, a relationship exists between two or more persons who carry on
business activities. Every partner participates by contributing labor, property,
skill, and money. Profits and losses of the business are shared by all the partners
as per their agreement with one another.
A corporation is a legal entity and is basically owned by shareholders who
invest in the capital of a business to run its operations, and then there is a limited
liability, wherein, the liability of a partner doesn’t exceed the amount invested in a
partnership or limited liability company.

3. Measures
Economics
Economists explain the variations in economic variables and measure
these variations as time progresses. For instance, they measure how market
interactions defines the value of products, such as, computer software, motor
vehicles, properties, or even haircuts. The measurement basis varies in
economics; it can either be in absolute term or it can be a relative measure of
quantity and price. For measurement of relative value, index numbers are
commonly used.

Business

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 Every business has a vision statement and a mission statement, on the
basis of which, long term goals and short term objectives are identified. To make
sure these goals and objectives are successfully met, key performance indicators
(KPIs) are defined by the companies. These KPIs are defined to measure
performance of a business. In the absence of these indicators, it becomes
difficult and challenging to materialize the objectives and goals of a company.
There are many businesses that rely mainly on financial statements and
sales outcome as a primary indicator of financial performance. But, an entity can
create a lot of other KPIs in order to make sure the overall goals are met. This is
a very effective tool to measure the success of a company as it gives a clear
picture of where the business is standing at a certain point in time by tracking
performance, which eventually leads to improving performance wherever
needed.

4. Others
Economics
It comprises the key issues faced by individuals and countries around the
world, including poverty, recession, tax decisions, economic downturn,
globalization, pollution, and trading. It is basically about why individuals or the
government makes certain choices. It also includes the likely impact of
government decisions on the economy of that country as well as on the global
economy.

Business
It takes into account the key decisions in modern, competitive, and often
global environments, including how they advertise their goods, why a company
approached the labor market in another country, how the final accounts will be
compiled, why would companies go for mergers or take a restructuring decision,
what marketing strategies should be used to boost sales and attract customers. It
also accounts for the effect of change in government regulations, competition,
and ethical issues of a given economy, such as going green or reducing carbon
emission.

References:

D. Sujatha (2013). Importance of Micro Economics. Retrieved from

http://economics4bastudents.blogspot.com/2013/06/importance-of-micro-economics.html

H. Waqar (2019). Difference Between Economics and Business. Retrieved from

http://www.differencebetween.net/business/difference-between-economics-and-business/

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K. Amadeo (2019). Production Possibilities Curve and What It Shows. Retrieved from
https://www.thebalance.com/production-possibilities-curve-definition-explanation-examples-4169680

N.D. (2018). Nature And Scope of Economics. Retrieved from https://studiousguy.com/nature-and-scope-of-

economics/

N. Kwat. Scarcity and Choice as Economic Problems (With Diagram). Retrieved from
http://www.economicsdiscussion.net/economic-problems/scarcity-and-choice-as-economic-problems-with-
diagram/18143

R. Schenk (2019). Scarcity and Choice. Retrieved from

http://ingrimayne.com/econ/Introduction/ScarcityNChoice.html

S. Surbhi (2019). Difference Between Micro and Macro Economics. Retrieved from
https://keydifferences.com/difference-between-microeconomics-and-macroeconomics.html

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