Micro Economics Chapter 1

 

Micro Economics

Chapter 1 Introduction

'Economics' is derived from the Greek word 'Oikonomia', which means household management. 'Oikos' means "house” 'nomos' means “management” or "law.

Adam Smith wrote the famous book  “An Enquiry in to the nature and causes of wealth of nations” which was published in the year 1776.

Adam Smith is called as the father of Economics.

Adam Smith -Wealth Definition (1776) “Economics is the study of nature of wealth, its generation and spending.’’ He emphasized production and growth as the subject matter of economics.

Alfred Marshall (Neo Classical Economist)- Welfare Definition (1890)

 Famous Book: Principles of Economics. “Economics is the 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 the material requisites of wellbeing.  Thus, on the one side a study of wealth; and on the other and more important side, a part of the study of man”

Prof. Lionel Robbins - Scarcity Definition (1932) Book: Nature and Significance of Economics. ‘‘Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses’’.

Prof. Paul Samuelson-  Growth Definition (1948) “Economics is the study of how men and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future amongst various people and groups of society”.

BRANCHES OF ECONOMICS- Prof. Ragner Frisch coined the terms Micro Economics and Macro Economics.

Micro Economics: Micro Economics is derived from the Greek Word Mikros meaning small. The branch of economics that studies the behavior of an individual consumer, firm, family etc  is known as Micro Economics. Eg. Price of a good, Salary of a teacher. Micro economics became popular with the publication of ‘Principles of Economics’ by Alfred Marshall. Hence he is known as the father of micro economics. Micro economics is also known as price theory.

Macro Economics: Macro economics is derived from the Greek word Makros meaning Large. The branch of economics that studies the behavior of the whole economy, (both national and international) is known as Macro Economics. Macro economics is also known as aggregate economics .Eg. National Income of a country, Total savings, Budget etc. Macro economics gained significance with the publication of ‘General Theory of Employment, Interest and Money’ by John Maynard Keynes in 1936. J.M Keynes is known as the father of Macro Economics. Macro economics is also called as Income theory or employment theory.

Points of difference	Micro Economics	Macro Economics
Unit of study	Individual	Aggregate
Method	Partial Equilibrium	General Equilibrium
View point	Worm,s eye view	Bird’s eye view
Example	Demand for a pen, salary of a person etc.	National Income, Aggregate Demand, inflation etc.

 

CENTRAL PROBLEMS OF AN ECONOMY.

The Central problems of an economy is common in every country whether rich or poor, socialist or capitalist etc.

Reasons for economic Problems

1) Human wants are unlimited

2) Resources are scarce

3) Resources have alternative uses

4) All wants are not equally important

Basic Economic Problems are:

·     Problem of allocation of resources

● Problem of fuller utilisation of resources

● Problem of efficiency of resources

● Problem of growth of resources

Central problems of an Economy:

·       What to produce and in what quantities?

·       How to produce?

·       For whom to produce?

1.What to produce and in what quantities?

This problem is related to allocation of resources.

What to produce implies what good and services are to be produced and in what quantities. It arises due to the fact that resources are scare and wants are unlimited. If we use more resources for the production of one commodity, we will have to reduce the production of other commodity. If a country faces food shortage, more resources are utilised for the production of food materials. On the other hand, if a country faces external threat or war, more resources are utilised for the production of defence materials.

2. How to produce?

How to produce implies which technology is used for the production of goods and services.

There are two types of production technology namely labour-intensive technology and capital-intensive technology.

Capital intensive technology: The production technology which uses more amount of capital and less amount of labour. A capital rich country will choose capital intensive technique. Eg.  USA

 Labour intensive technology: The production technology which uses more amount of labour and less amount of capital. A labour abundant country will choose labour intensive technique. Eg. India.

3. For whom to produce?

It implies how to distribute the produced googs and services among the factors of production in the form of rent, wage, interest and profit (Functional distribution of income).

The central economic problems are solved in different ways by different economic systems like capitalism, socialism and mixed economy.

·       Main Features of Capitalism: Capitalist economy is also called Market economy. It is an economic system in which all means of production are under the ownership and control of private individuals.Other features include existence of private property, profit motive, price mechanism , freedom of enterprise and consumer sovereignty .

The central problems of an economy are solved by the price mechanism through the interaction of demand and supply.

·       Main features of Socialism: Socialist economy is also called Centrally Planned economy. It is an economic system in which all means of production are under the ownership and control of the government. Other features of socialism are public ownership, welfare motive, Central Planning and Equality of income distribution.

The central economic problems of an economy are solved by the government through centralised planning.

·       Main features of Mixed Economy: It is an economic system where all means of production are under the ownership and control of both government and private individuals. It is a mixture of salient features of socialism and capitalism. There exists both public sector and private sector.

The central problems of an economy are solved by both the price mechanism and the government (planning authority).

 

Ø  Production Possibility Curve (PPC) or  Production Possibility Frontier (PPF)

Production Possibility Curve shows locus of combination of two goods that can be produced with available resources and existing technology.

Assumptions:

1.There are two goods produced in the economy.

2.Resource and technology remains constant.

This can be explained with the help of a table and a diagram.

Production Possibilities	Good 1	Good 2	Marginal Opportunity Cost (MOC)
A	0	16	0
B	1	15	1
C	2	13	2
D	3	10	3
E	4	6	4
F	5	0	5

 

 

 

When an economy produces two goods, if it increases the production of one good, it will have to reduce the production of other good. The sacrifice of one good in terms of other good is called Marginal Opportunity Cost (MOC). Any point on the production possibility curve shows combination of two goods that an economy can produce with the available resources and existing technology (A,B,C,D,E,F) . Any point inside the ppc shows Under utilisation of existing resources and technology (point G). Any point outside the ppc shows, it is beyond the capacity of the economy (point H). It requires growth of resources and technology.

If there is under utlisation of resources and technology, the ppc will shift to the leftward or downward .Similary if the resources and technology grows, the ppc will shift to its rightward or upward.

PPC is concave to the origin.

Ø  What is production possibility set?

All possible combinations (sets) of two goods that can be produced from a given level of resources and given level of technology is known as production possibility set.

What is opportunity Cost?

Opportunity cost is the next best alternative cost forgone.

Ø  What is Positive economics and Normative economics?

Economic analysis is of two types namely positive economics and normative economics.

Positive economics deals with what is? In positive analysis results are analyzed without passing moral judgements. There is no value judgement.

Eg. Unemployment level is high in India.

Normative economics deals with what ought to be? The result of an action are analyzed by examining whether they are desirable or not. There is value judgement.

Eg. Population growth in India affects economic growth.

Ref. SCERT Textbook