Polytechnic University of the Philippines

College of Social Sciences and Development

Department of Economics

INSTRUCTIONAL MATERIALS FOR

MICROECONOMICS

Compiled by

Melcah Pascua Monsura

Maria Vicenta Magpantay
 Table of Contents

Overview about Microeconomics

Chapter 1 Introduction

1.1 Definition
1.2 Methodologies
1.3 Economic Goals
1.4 Production Possibilities Model
1.5 Optimal Allocation
Exercise 1

REFERENCES

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OVERVIEW

Microeconomics studies the behavior of the individuals and the firms. This topic will be
divided into two parts, (a) utility maximization of the individuals and (b) profit maximization and
loss minimization of the firms. The cardinal approach and ordinal approach are the two
approaches used to describe the utility maximization of the individuals. Profit maximization and
loss minimization will be discussed using the market structures in perfect market and imperfect
markets. Pure competition is considered as the perfect market while imperfect markets are
composed of monopoly, monopolistic competition, and oligopoly.

There are some discussions included as introduction in this course. These topics are
needed to explain the two main subjects of microeconomics. This course will start by discussing
the introduction of economics including its definition, fundamentals, methodologies, and economic
goals. These topics are crucial to discuss the ideas of scarcity and opportunity cost under
production possibility curve and identifying the allocative efficiency using marginal benefit (MB)
and marginal cost (MC) analysis. The ideas from these topics will be used in analyzing the
behavior of the firms regarding profit maximization and loss minimization.

Market will also be discussed including demand, supply, market equilibrium and
elasticities. Subjects under elasticity are price elasticity of demand and supply, cross elasticity of
demand, and income elasticity of demand. The demand side of the market has the big contribution
in terms of explaining the consumer’s theory of preference on utility maximization of the
individuals. While all the areas under this topic were needed to further describe the decisions of
the firms. Lastly, when market failure happens in terms of public goods, externalities, and
asymmetric information the government will intervene to efficiency to the public.

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CHAPTER 1: Introduction of Economics1

Learning Objectives: This chapter reviews and discusses the introduction of basic economics
concepts to connect its ideas to microeconomics. After this chapter, the readers will be
able to recognize scarcity as an economic phenomenon that causes economic problems,
exemplify the different approaches in the study of microeconomics, and conceptualize the
welfare concept.

1.1 Definition

Economics is a social science that deals with the efficient allocation of scarce resources
to satisfy unlimited human wants and needs. Efficient allocation of scarce resources means
proper allocation of the limited resources. Wants and needs are two different ideas. Generally, an
individual can live without wants but he or she cannot live without needs.

Resources are classified as capital, land, labor, and entrepreneurship. Land resources
include natural resources such as land itself, mineral deposits, water, air, climate, and wildlife.
Labor resources refer to the physical and mental capacity of man to work in order to produce
goods and services. Capital resources, on the other hand, include man-made goods that produce
other goods like buildings, tools, equipment, and machineries as well as improvements on land
that increase the productive capacity to produce other goods and services. Lastly,
entrepreneurship involves human resources that perform the functions of organizing, managing,
and assembling the other factors of production and making business policy decisions. The
entrepreneur is a risk-taker and an innovator.

There are two major areas in the study of economics. Macroeconomics considers the
aggregate performance of all markets in the market system and is concerned with the choices
made by the large subsectors of the economy—the household sector, which includes all
consumers; the business sector, which includes all firms; and the government sector, which
includes all government agencies, and the foreign sector which include activities related to export
and import of goods, and the flow of capital between the domestic economy and rest of the world

Microeconomics examines the factors that influence individual economic choices and how
the choices of various decision makers (individual consumers, firm or industry, and government
agency) are coordinated by markets.

1.2 Methodologies

There are six (6) well-known methodologies in understanding economics. First, it uses
scientific method to build economic theories since economics is a social science and considered
as a science of scarcity. This includes steps such as identify the problem, gather information and
data, formulate hypothesis, testing the hypothesis through experimentation and observation, and
arriving at conclusion. Primary data from surveys and interviews and secondary data from books,
articles and other sources are the two types of data gathered to support the analysis.
This method is also known as theoretical economics. It is a process of making economic
theories using the facts and the data available. Second methodology is known as the policy
economics. It is a process of making economic policies or laws using the economic theories.

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The diagrams and tables used in this Chapter 1 were collected from McConnel, C. & Brue, S. (2008). Economics:
Principles, Problems, and Policies. 17th edition, McGraw Hill-Irwin.

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 The third methodology is normative economics which is used when someone
considers his/her value judgment to answer “question what should be done” or “what ought to
be”. This methodology belongs to policy economics because it uses the policies or laws which is
considered as a value judgment to the answer the question “what should be done”. On the other
hand, taking out the value judgment to answer the question “what is” pertains to the fourth
methodology which is positive economics. This belongs to theoretical economics because it
uses the facts and data to answer the answer the question “what is the problem looks like”.

Understanding economics also considers the fifth and sixth methodologies, which are
inductive reasoning and deductive reasoning. When someone is analyzing the problem from
a particular to general, he or she is using the inductive reasoning while when an individual
analyzes things from general to specific, he or she considered deductive reasoning.

1.3 Economic Goals

There are eight (8) economic goals which every country wants to achieve. These can be
summarized into an acronym PFB & 5 E’s.

P F B & 5 E’s

Price Full Balance 1. Economic Growth

Level Employment of 2. Economic Freedom
Stability Payments 3. Economic Security
4. Economic Efficiency
5. Equitable Distribution of
Income

1. Price Level Stability. The economy is avoiding having an upswing of the general price
which is called inflation and downswing of the general price which is called deflation.
2. Full Employment. There should be suitable jobs for those people who are willing and
able to work.
3. Balance of Trade. Equal amount of exports and imports.
4. Economic Growth. The increase capacity of the economy to produce goods and
services. It promotes higher standard of living. This can be measured when there is an
increase in real Gross Domestic Product (GDP).
5. Economic Freedom. The economic actors in the economy can do their work freely.
6. Economic Security. This ensures that the people who cannot earn even a minimal
income can survive in everyday needs.
7. Economic Efficiency. All the available owned resources were used at the maximum level
to satisfy the needs and wants of the economy.
8. Equitable Distribution of Income. It avoids that there is a group of people who are
experiencing abundance and a group of people who are experiencing poverty. There is
no rich and no poor.

1.4 Production Possibilities Model

There are two fundamentals of economics namely, economic resources and economic
wants. Based on the definition of economics, economic resources are limited while economic
wants are unlimited. Economic resources include labor, entrepreneurial ability, land and capital.

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 Labor includes all physical and mental abilities. Although entrepreneurial abilities are part
of labor, these are considered special skills which means that not all individuals have this kind of
abilities. Entrepreneurs have the capability to combine all the resources to be productive. Land
includes natural resources like mineral deposits, forests, raw materials, and others. Capital goods
are used to produce another good. These are consumer goods that are ready for consumption.
Money is not considered as capital on the production side because it cannot produce consumer
good.

Consider a Production Possibilities Table below which represents the possible production
using the available resources given the following assumptions: (1) Full Employment, (2)
Productive Efficiency, (3) Fixed Resources, (4) Fixed Technology and (5) Two Goods (consumer
good and capital good in thousands).

Alternatives
Goods
A B C D E
Machines 10 9 7 4 0
Burgers 0 1 2 3 4

Machines are considered as the produced capital goods while the burgers are the
consumer goods. The alternatives are the possible combinations of the two goods that can be
produced. Alternatives A and E show that one good is 0 or no production. All the available
resources were allotted to produce 10 machines while there is no production for consumer good.
On the other hand, alternative E shows that all the available resources were allotted to produce
consumer goods only leaving capital good with no production. The two alternatives are possible
but were not chosen in a real production. Alternative A reveals producing more in the future in
expense of less now while alternative E produces more now in expense of less in the future.

Alternatives A and E were not chosen in a real-world production because A shows no

consumption at present but having more consumption in the future. In a practical sense, an
individual has no satisfaction today but have to wait for the future production to be satisfied.
Alternative E reveals that an individual is satisfied today because of the present consumption but
has no satisfaction in the future. These alternatives are not practical to be chosen since the aim
of economics is to make individuals satisfied today and tomorrow.

The law of increasing opportunity cost is present in the table. The forgone opportunities
or the amount to be sacrificed in order to have another is called opportunity cost. As production
of one good increases, the amount you are giving up is also increasing.

You can produce from alternative A to E or from alternative E to A. Considering the first
process, alternative A shows that there are 10 machines and 0 burger. Moving to alternative B, 1
unit of machine was sacrificed just to have another unit of burger. From B to C, 2 units of machines
were sacrificed to have additional unit of burger. From C to D, 3 units of machines were sacrificed
to have additional unit of burger. Lastly, 4 units of machines were sacrificed to have additional
unit burger from D to E. The production of burger is increasing by one unit from 1 alternative to
another alternative while the number of machines given up is increasing (1, 2, 3, and 4).
Therefore, the law of increasing opportunity cost is present in machines.

Burger can also be the opportunity cost when second process is to be considered. From
E to A, as the number of machines produced increases the amount of burger giving up is only 1.

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Although burger is the opportunity cost, the law of increasing opportunity cost is not present in
burger. Thus, burger is considered as the scarce good while machine is the abundant good. You
are willing to give up more amount of the abundant good just to have at least one unit of the
scarce good.

Graphically, to show the economy’s capacity to produce, a production possibilities curve

known as the PPC will be derived using the production possibility table. Trade-off between two
goods is also visible in this diagram. Using the same assumptions, PPC is shown in the next
graph.

Two important points are needed to be noted: first, all points along the curve are attainable
and efficient. Attainable because resources are available to produce the goods and efficient
because all the available resources were used at the maximum level to produce the two goods.
Thus, PPC represents the maximum combination of two goods that can be produced if resources
are fully utilized.

Since the fixed resources were

fully employed at the PPC, point W is
unattainable and the same time inefficient.
Increase in resources and advance
technology could increase PPC that would
lead to an upward shift of the PPC to attain
Machines

point W. On the other hand, points inside

the PPC (orange shade) are attainable but
inefficient because the resources were not
used at the maximum level. There are
excess resources that could lead to lower
production of the two goods.

Burgers

1.5 Optimal Allocation

On the previous discussion, we consider productive efficiency in producing the two goods.
Given the produced number of consumer goods, we need to determine the number of goods to
be produced to satisfy the society by considering allocative efficiency. Allocative efficiency is the
production of goods and services in at least costly way most wanted by the society. The MB-MC
analysis below will help to answer this question.

Let us analyze the curves first, MC curve is an upward sloping curve which means that
there is a positive relationship between the production of burger and the additional cost of
producing it. On the other hand, MB curve is a downward sloping curve which means that as the
number of burgers increases the additional benefit from it decreases. This happens because of
the Law of Diminishing Marginal Utility; marginal utility means additional happiness or satisfaction.
The additional happiness of an individual from consuming additional same kind of good

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decreases. Thus, MC curve represents the production side while the MB curve represents the
consumption side.

Marginal Benefit & Marginal Cost

Burgers
The optimal allocation can be found when there is no deficiency and there is no excess, it
means that the consumption of the society is equal to the production. Based on the diagram, 2
thousand units of burgers should be produced since MB and MC are equal to $10. Producing 1
thousand units of burger could not satisfy the society because MB = 15 is greater than MC = 5.
Higher MB means consumers want to consume more because they are realizing higher
satisfaction while lower MC means lower cost of production because the number of produced
burgers is low. This production decision is called underallocation. On the other hand, producing
3 thousand units of burgers will lead to an overallocation of production because MB = 5 is less
than MC = 15. Lower MB means the society is experiencing lower satisfaction from consuming
more goods of the same good while higher MC means more production.

Since 2 thousand units of burgers should be produced to satisfy the society, 7 thousand
units of machines should be produced for future production. Thus, from the Production
Possibilities Table, alternative C reveals allocative efficiency.

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Exercise 1

I. Consider the production possibility table below.

Alternatives
Goods
M E L C A H
Machines 15 14 12 9 5 0
Burgers 0 1 2 3 4 5
Note: Machines and Burgers are in Thousands

1. Draw a Production Possibility Curve (PPC) using the table.

2. List the assumptions in analyzing PPC.
3. Explain the trade-off of the two commodities and the Law of Increasing Opportunity Cost.
4. Where are the attainable area and unattainable area? How to attain the unattainable area?
What will the economy achieve if this happens?

II. Underline the correct answer. (20 pts.)

There are three forms of economic resources or factors of production. 1. (Land, Capital)
includes natural resources that can be extracted from water, air, and land itself specifically,
mineral deposits. 2. (Labor, Entrepreneurial ability) pertains to the physical or mental talents
that are utilized to produce goods and services. Lastly, 3. (investment, capital) refers to the
goods that are used for production of other goods and services. However, these resources are 4.
(unlimited, limited) in relation to our needs and wants.

Furthermore, 5. (luxury goods, basic goods) are not necessary for our basic existence
while 6. (luxury goods, basic goods) are goods which stay with us through a lifetime. In reality,
when one of your needs is satisfied, you still look for more. It is because needs and wants are 7.
(unlimited, limited). Thus, 8. (Economics, Macroeconomics) deals with the efficient allocation
of scarce resources in producing goods and services to satisfy human wants and needs.

Economists view things through a unique perspective. 9. (Marginal Analysis, Rational

Behavior) means that the same person may make different choices under different
circumstances but looking for opportunity to increase his utility. In addition, 10. (Marginal
analysis, Rational Behavior) involves in the comparison of additional benefits and additional
costs. Lastly, 11. (Scarcity, Rational Behavior) limits options and necessities that we make
choices

Moreover, there are methodologies used in understanding economy. 12. (Applied

Economics, Descriptive Economics) is simply the compilation of data that describe phenomena
or facts. Those data from surveys and interviews are 13. (secondary data, primary data). While
data taken form released book, journal, or previously conducted researches are 14. (secondary
data, primary data). When the facts are brought into order and tied up to provide meaning, placed
in correct relation, and generalized from them, 15. (economic theory, economic policy) arises.
These are used to formulate policies in solving economic problems, thus becoming 16.
(theoretical economics, policy economics). Moreover, when we consider someone’s value
judgment about what economy should to be, we are using 17. (normative economics, positive
economics). But when we deal with facts and principles to remove our value judgment, we are
using 18. (normative economics, positive economics). On the other hand, economy can also
be explained through reasoning. The process of reasoning from the particular to the general is

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called 19. (deductive reasoning, inductive reasoning. On the other hand, reasoning from
general to particular is called 20. (deductive reasoning, inductive reasoning).

III. Identify each of the following as either a positive or a normative statement. Write PS if the
statement is a Positive Statement and NS if the statement is a Normative Statement before the
number.

_________1. The government should provide basic healthcare to all citizens.

_________2. Government-provided universal healthcare increases public expenditures.

_________3. Other things held constant, an increase in price reduces the quantity demanded.

_________4. The government should give ABS-CBN a franchise to continue its operation.

_________5. GDP posts 6.4% growth in the 4th quarter of 2019.

REFERENCES

McConnel, C. & Brue, S. (2008). Economics: Principles, Problems, and Policies. 17th Edition,
McGraw Hill-Irwin.

McConnel, C. Brue, S. & Flynn, S. (2012). Microeconomics: Principles, Problems, and Policies.
19th Edition, McGraw Hill-Irwin.

McConnel, C. Flynn, S., Brue, S. & Grant (2012). Microeconomics. 2nd Brief Edition, McGraw Hill-
Irwin.

Nicholson, W. (2002). Microeconomic Theory: Basic Principles and Extensions. 8th Edition.
Southwestern Publishing.

Pindyck, R. & Rubinfeld, D. (2005). Microeconomics. 6th Edition, Prentice Hall.

Schiller, B. (2003). The Microeconomy Today. 9th Edition. New York: McGraw-Hill/Irwin.

Slavin, S. (2006). Microeconomics. 7th Edition. Burr Ridge: Illinois: McGraw-Hill/Irwin.

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