MICRO ECONOMICS

SCMS_BBA_Sem-I_2019
 ECONOMICS
• Greek word – oikonomia
Oiko – house
Nomos – custom or law
 ECONOMICS

Micro Macro
Economics Economics

Individual Aggregate business

households & firms environment

Economic
Finance, Marketing,
Environment in which
Banking, Governance
a business operates
 MICRO-ECONOMICS

CONSUMERS / FIRMS /
HOUSEHOLDS BUSINESSES

CONSUMER THEORY of the

THEORY FIRM

# Demand # Supply
# Utility Maximising # Profit Maximising
Individuals Firms
APPLICATIONS of ECONOMICS
• Demand Analysis and Pricing
• Production – Planning for output
• HR - Employee planning
• Finance – BEP Analysis, Accounting Profits
v/s Economic Profits, Opportunity Cost
• Strategy: Environment Analysis - PESTLE
You want a cell-phone, a laptop, a bike and
some clothes but you have Rs. 1, 00, 000/- only.
What will you prefer?

Two important terms – Choice and Scarcity

One important concept – Opportunity Cost
Economics is a study of choice under conditions
of scarcity.

Scarcity is a situation in which the amount of something

available is insufficient to satisfy the desire for it.
 Aren’t these true???
• Generally, normal human beings look after
their own well being...
– Students make friends with those students who
make them feel comfortable and secure
– Speak to those teachers who make them feel
comfortable and secure.
– Buy that vehicle which meets their value
proposition
– Take admission in that college which gives them
the best value for money
 Basic Assumptions in Economics
• Other things remaining same.
• The consumers act in a rational manner and seek
maximum satisfaction.
• The consumers’ tastes remain unchanged for a fairly
long period of time.
• The working of the competitive economy stands on
the assumption of perfect competition.
– There are large number of buyers and sellers in the market.
– The commodity is homogeneous in nature.
– There is perfect knowledge and perfect mobility of resources.
– None of the individual buyers and sellers are in a position to
influence price.
 ANYTHING THAT HAS A
NON-ZERO PRICE IS SCARCE
SCARCITY

Land Labour Capital Enterprise

Physical
Human
Space, Time, Effort, Ability &
Capital and
Natural Work Willingness
Capital Stock
Resources
As resources are scarce and choices innumerable
the questions faced by an economy are

What to
Produce

For whom How to

to Produce Produce
Other problems / questions faced by an economy

Problem of Full Employment

Efficient use of scarce resources

Problem of Growth
Growth of resources is related to increase in the
level of production
 OPPORTUNITY COST
• Opportunity cost is an economic term that
refers to the value of what you have to
give up in order to choose something else.
• In other words, it is the value of the best
alternative forgone in making any choice.
 LET’s REVISE
• Economics is a social science that examines how people
choose among the alternatives available to them.
• Scarcity implies that we must give up one alternative in
selecting another. A good that is not scarce is a free good.
• The three fundamental economic questions are: What
should be produced? How should goods and services be
produced? For whom should goods and services be
produced?
• Every choice has an opportunity cost and opportunity costs
affect the choices people make. The opportunity cost of any
choice is the value of the best alternative that had to be
forgone in making that choice.
 Identify the elements of scarcity, choice, and
opportunity cost in each of the following
• The Environmental Protection Agency is considering an
order that a 500-acre area on the outskirts of a large city be
preserved in its natural state, because the area is home to a
rodent that is considered an endangered species. Developers
had planned to build a residential apartment on the land.
• The manager of an automobile assembly plant is considering
whether to produce cars or sport utility vehicles (SUVs) next
month. Assume that the quantities of labour and other
materials required would be the same for either type of
production.
• A young man who went to work as a nurses’ aide after
graduating from high school leaves his job to go to college,
where he will obtain training as a registered nurse.
 Assessment Question
• Make a single sentence using the words
‘choice’, ‘scarcity’ and ‘opportunity cost’.
• What is the opportunity cost of doing BBA
at SCMS?
Scarcity is the condition
of having to make a
choice among
alternatives, which gives
rise to the concept of
opportunity cost.
Hema is a full-time home maker and also takes tuitions
and knits sweaters in spare time. While in Cochin in the
summer holidays, she bought some dress-material for
which she paid Rs. 500 per metre. This material could be
sold back to the local fabric shop in Mumbai @ Rs. 1500
per metre. Hema is considering using that material to
make dresses, which she would sell to her friends and
neighbours. She estimates that each dress would require
four meters of material and four hours of her time, which
she values at Rs. 1000 per hour. If the dress could be sold
for Rs. 9000 each, could Hema earn a positive economic
profit by making and selling the dresses?
SYLLABUS – UNIT-I [10 Hrs]
• Microeconomics: understanding basic concepts
• Nature and Scope of Economics
• Definition of Economics
• Utility meaning and types, Law of diminishing
marginal utility, Indifference Curve Analysis
and Budget line; Consumer’s equilibrium.
Firm and its goals.
Why street performance is not
a thriving profession?

Non–Rivalry in Consumption
Non–Excludability
 RIVALRY IN CONSUMPTION
• Your phone is for your personal use; no one
else can claim ownership of the same
• You reserve a train ticket for yourself; no one
else can travel on your ticket

EXCLUDABILITY IN CONSUMPTION
• STAR SPORTS buying the rights of telecasting
the FIFA World Cup
• PVR buying the display rights for a movie
 ANSWER THESE QUESTIONS
• Which is more useful?
– Water or Diamond

• Which is more costly?

– Water or Diamond

• WHY???
 IN ECONOMIC SENSE
• Water is in abundance and diamonds are rare.
• Water will have a greater TOTAL UTILITY
but diamonds have a higher MARGINAL
UTILITY than water. Thus, diamonds are
more costly.
• In other words, things which have a
GREATER MARGINAL UTILITY will
command a HIGHER price.
 Let’s understand the basics
• NEED
– A need is something you cannot live without, such
as air, water and food.
• WANT
– A want is something that you don't absolutely need
but will make your life a little better.
• DESIRE
– A desire is something you wish to have, regardless
of your needs and wants.
 Let’s understand the basics
• DEMAND
– A desire for a commodity backed by the ability to pay
and willingness to pay for it.
– If a customer is willing and able to buy a need or a
want, it means that they have a demand for that need
or a want. So, the key difference between wants and
demand is desire. Consequently, for people, who can
afford a desirable product are transforming their wants
into demands
• UTILITY
– Is it measurable – Cardinal & Ordinal
– TOTAL UTILITY & MARGINAL UTILITY
NEED–WANT–DEMAND–DESIRE
In terms of “essential for existence”
the most basic would be needs
followed by wants, which when
coupled with the ability and
willingness to pay becomes demand
and then desire which if not fulfilled
doesn’t challenge the existence.
CONSUMPTION THEORY
All the consumers – individuals and
households – aim at utility
maximization and all their
decisions and actions as consumers
are directed towards utility
maximization.
Consumption Theory seeks to answer
• How does a consumer decide the optimum
quantity of a commodity that he/she chooses
to consume, i.e., how does a consumer attain
his/her equilibrium in respect to each
commodity?
• How do consumers allocate their disposable
income between various commodities of
consumption so that his/her total utility is
maximized?
 Assumptions to the Theory of
Consumer Behaviour
• Consumers maximize their satisfaction
• Consumers are rational
• Consumers have limited money income
• Utility is cardinally measurable
– 1 util = 1 unit of money
• Diminishing Marginal Utility
• Constant Marginal Utility of Money
• Utility is additive because its cardinally measurable
 Decision Making by the
Consumer
• Demand is determined by the behavior of
consumers. It is of utmost importance for managers
to understand the dynamics of demand in the
market for a particular product / service offered.

• Consumers have unlimited wants which are

constrained by limited resources / limited income.

• Due to scarcity of resources and unlimited wants,

consumer has to allocate scarce resources to attain
maximum possible satisfaction.
 Decision Making by the
Consumer

Preference Constraints
Set (Wants) (Income)

Optimal
Decision
 Diminishing Marginal Utility
• “The additional benefit which a person derives from a given
increase of his stock of a thing diminishes with every increase
in the stock that he already has.” – Sir Alfred Marshall
• As the quantity consumed of a commodity goes on
increasing, the utility derived from each successive unit
goes on decreasing, consumption of all other
commodities remaining constant.
• When a person continues to consume more and more
units of a commodity at a point in time, e.gs., sweets,
pani-puri, chocolates, ice-creams, etc. The utility that the
person derives from each successive unit goes on
diminishing.
 Assumptions to the Law of
Diminishing Marginal Utility
1. The unit of consumer good must be a standard one
– a cup of tea, a bottle of cold drink, a pair of shoes, etc.
2. Consumer’s taste or preference must remain the
same during the period of consumption
3. There must be continuity in consumption.
– Time interval between the consumption of two units must be
appropriately short
4. The mental condition of the consumer must remain
normal during the period of consumption.
Law of Diminishing Marginal Utility
• The law states that with every successive increase
in the consumption of a commodity, the
marginal utility of the commodity will fall.
• In order to maximize the total utility, consumer will
spend his income on a combination of goods.

• The total utility is maximum when the

marginal utility is zero.
• Since the individual is a rational customer, he wishes
to maximize total utility.
 Diminishing Marginal Utility
Apples consumed Total Utility Marginal Utility
per day (Q) (Utils) (TU) (Utils) (ΔTU/ΔQ)
 Diminishing Marginal Utility
Apples consumed Total Utility Marginal Utility
per day (Q) (Utils) (TU) (Utils) (ΔTU/ΔQ)
1
2
3
4
5
6
7
8
 Diminishing Marginal Utility
Apples consumed Total Utility Marginal Utility
per day (Q) (Utils) (TU) (Utils) (ΔTU/ΔQ)
1 12
2 22
3 30
4 36
5 40
6 41
7 39
8 34
 Total Utility Curve
45

40

35

30
Total Utility

25

20

15

10

0
1 2 3 4 5 6 7 8
Quantity
 Diminishing Marginal Utility
Apples consumed Total Utility Marginal Utility
per day (Q) (Utils) (TU) (Utils) (ΔTU/ΔQ)
1 12 12
2 22 10
3 30 8
4 36 6
5 40 4
6 41 1
7 39 –2
8 34 –5
 Marginal Utility Curve
14

12

10

8
Maginal Utility

0
1 2 3 4 5 6 7 8
-2

-4

-6
Quantity
 Total & Marginal Utility Curve
44

39

34

29
Maginal Utility

24

19

14

-1
1 2 3 4 5 6 7 8
-6
Quantity
Limitations to the Cardinal Approach
• Utility cannot be measured cardinally
• Utility is not additive
• Utility is interdependent and decisions are
rarely taken in isolation.
• Unrealistic assumption
 EQUI–MARGINAL UTILITY
•A consumer has a given income which he has
to spend on various goods he wants.
Q How s/he would allocate her/his given money
income among various goods?
Q What would be her/his equilibrium position in
respect of the purchases of the various goods?
 Assumptions to the Law of
EQUI–MARGINAL UTILITY
• Marginal utilities of different commodities are
independent of each other and (individually)
diminish with more and more purchases.
• The consumer has a limited amount of income.
• Utility is cardinally measurable.
• Marginal utility of money remains constant.
• Utilities of different goods are independent, that is
the goods are neither complements nor substitutes
for one another.
LAW of EQUI–MARGINAL UTILITY
• The law states that the consumer will distribute
his money income between the goods in such a
way that the utility derived from the last
rupee spent on each good is equal.
• In other words, the consumer will spend her/his
money on different goods in such a way that
marginal utility of money expenditure on each good
is the same.
• Marginal utility of money expenditure on a good is
equal to the marginal utility of the good divided by
the price of the good.
– MUm = MUx / Px = MUy / Py
 Marginal Utility of ‘x’ & ‘y’
X consumed per MUx MUy
day (Q) (Utils) (Utils)
1 20 24
2 18 21
3 16 18
4 14 15
5 12 12
6 10 9

Let the prices of goods ‘x’ and ‘y’ be Rs. 2 & Rs. 3 respectively.
Also, the money income available for the two goods is Rs. 24/-.
Marginal Utility of Money Expenditure
Units MUx MUx/Px MUy MUy/Py
(Q) (Utils) (Utils) (Utils) (Utils)
1 20 10 24 8
2 18 9 21 7
3 16 8 18 6
4 14 7 15 5
5 12 6 12 4
6 10 5 9 3

The consumer will be in equilibrium when s/he is

buying 6 units of ‘x’ and 4 units of ‘y’. 10/2 = 15/3 = 5
Marginal Utility of Money Expenditure
[x]
12
Marginal Utility of Money Expenditure

10

0
1 2 3 4 5 6
Quantity
Marginal Utility of Money Expenditure
[y]
9
Marginal Utility of Money Expenditure

0
1 2 3 4 5 6
Quantity
 Limitations to the Law of
EQUI–MARGINAL UTILITY
• Marginal Utilities from expenditure may not be
equalized due to ignorance.
• Inefficient organization or incapable individuals
may not be able divert expenditure to more
profitable channels from the less profitable one.
• A consumer may be in the strong clutches of
customs, or is inclined to be a slave of fashion.
• Frequent changes in prices of different goods render
the observance of the law very difficult.
 Moving towards the Law of Demand
12
Marginal Utility of Money Expenditure

10

0
1 2 3 4 5 6
Quantity