MICRO ECONOMICS

Deals with
Scarcity

Satisfaction What is
among all Constrained
economic Micro Optimization
agents Economics?

Decision
Making
What are Models?

• A description of relation between different economic variables

• Unlike Laws, not 100% sure but quite probable
• With the help of few assumptions, we try to get simplified conclusions
• Steps to capture relatively broad phenomena

❑Three levels of understanding the models:

• Conceptual understanding
• Graphical understanding
• Mathematical understanding
 Introduction to Demand and supply model

➢ Adam Smith- Wealth of Nations (1776)

Example: Water and Diamond Paradox

➢ Demand and Supply Scissors

➢ Positive & Normative Economics

Example: eBay Auctions ( Kidney )

➢ According to standard Economics , “THE MARKET KNOWS THE BEST”

Adam Smith- Invisible Hand

 Theory Of Consumer Choice

1) Preferences

2) Utility

3) Budget Constraints
Preference Assumptions

1) Completeness: Consumer knows what you want from a set of goods available.
He may be indifferent between 2 goods like, He likes “ A” good as much as “B” good.
But he has a choice.

2) Transitivity: If you prefer A to B and B to C, then you prefer A to C

3) Non–Satiation: More is always better than less

An indifference curve shows the various bundles of consumption that make the consumer equally happy

3 choices of the
Consumer:

A) 2 slice of Pizza and

1 cookie
B) 1 slice of Pizza and
2 cookie
C) 2 slice of Pizza and
2 cookie
Four Properties of Indifference Curves :

1) Higher indifference curves are preferred to lower ones – more is better

2) Indifference curves are downward sloping

3) Indifference curves do not cross – transitivity

Assignment: Draw an indifference curve considering a real life situation while ranking your preferences.
▪ Utility is an abstract measure of the satisfaction or happiness that a consumer receives from a bundle of goods. economists say
that a consumer prefers one bundle of goods to another if one provides more utility than the other.
▪ Indifference curves and utility are closely related .
▪ An indifference curve as an “equal-utility” curve
▪ The marginal utility of any good is the increase in utility that the consumer gets from an additional unit of that good. Most
goods are assumed to exhibit diminishing marginal utility

❑ The rate at which the consumer is willing to substitute one good for the other. This rate is called the marginal rate of
substitution (MRS).
❑ The marginal rate of substitution between two goods depends on their marginal utilities
❑ For example, if the marginal utility of good X is twice the marginal utility of good Y, then a person would need 2 units of good Y
to compensate for losing 1 unit of good X, and the marginal rate of substitution equals 2

The Marginal rate of substitution equals the ratio of the prices. MRS = PX / PY ……………..(1)
The Marginal rate of substitution equals the ratio of marginal utilities. MRS = MUX / MUY …………….(2)
Thus, from 1 and 2, we can say MUX / MUY = PX / PY.
= MUX / PX = MUY / PY.
This equation has a simple interpretation of Equi-Marginal Utility, at the optimum, the marginal utility per rupee spent on good X
equals the marginal utility per rupee spent on good Y.
The consumer is in equilibrium position when marginal utility of money expenditure on each good is equal
4) Indifference curves are bowed inward /convex to origin

The slope at any point on an indifference curve equals the rate at which the consumer is willing to substitute one
good for the other. This rate is called the marginal rate of substitution (MRS).
➢ When the goods are easy to substitute for each other, the indifference curves are less bowed; when the goods are hard
to substitute, the indifference curves are very bowed.
a. In which case are the two goods complements? In which case are they substitutes?

b. In which case do you expect the indifference curves to be fairly straight? In which case do you expect
the indifference curves to be right angle?
The budget constraint shows the various bundles of goods that the consumer can buy for a
given income. Here the consumer buys bundles of pizza and Pepsi. the table and graph
show what the consumer can afford if her income is $1,000, the price of pizza is $10, and
the price of Pepsi is $2
Optimization: What the Consumer Chooses
Demand & Supply model
The Price Elasticity of Demand and Its Determinants

The law of demand states that a fall in the price of a good raises the quantity demanded. The price elasticity of
demand measures how much the quantity demanded responds to a change in price.

Determinants:
Availability of Close Substitutes
Necessities versus Luxuries
Definition of the Market