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Raising a new Generation of Leaders

ECN 211
MICROECONOMICS
INTRODUCTION
FOUNDATION AND MEANING OF MICROECONOMICS

• The terms- Microeconomics and

Macroeconomics were first used by Ragna
Frisch
• But now adopted by economists globally.
• Microeconomics is derived from Greek word,
mikros(small), and
Macroeconomics,makros(large)
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MEANING OF MICROECONOMICS CONT’D

• Studies economic actions and behaviour of

various economic units or agents of the
economy.
• These units include consumers(households),
producers(firms) workers and resource
suppliers.

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DECISION MAKING- ALLOCATION OF RESOURCES

• Microeconomics explains how resources are allocated to

the production of various goods in the economy.

• Allocation depends on prices of various goods and prices

of factors of production in a free market economy.

• Microeconomics analyses how relative prices of

goods(product pricing-Theory of demand and theory of
production and cost), and factors(factor pricing-theory of
distribution) are determined.
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 ECONOMIC EFFICIENCY

• Microeconomics also explains whether the

allocation of resources is efficient, i.e whether the
allocation maximizes the satisfaction of the people.
• Three Economic Efficiencies-
-efficiency in production
- Efficiency in distribution and consumption
- Allocative economic efficiency-efficiency in the
direction of production.
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 ECONOMIC EFFICIENCY

• Microeconomics explains how the efficiencies

are achieved and what could lead to decline in
satisfaction.
• Hence, welfare economics is an important
branch of microeconomic theory.
• Microeconomics explains the conditions of
efficiency(Pareto-optimal conditions)
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 PARETO CONDITIONS

• 80% of the effects usually come from 20% of

the causes.
• 80% of resources are owned by 20% of the
population.
• 20% of clients usually bring about 80% of sales

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 MEANING OFMICROECONOMICS CONT’D

• Studies equilibrium of various economic units one

by one and the interrelationship to one another.
• It determines the mechanism by which different
units attain position of equilibrium.
• For example, the demand of an individual
consumer for a good, and derivation of market
demand for the good (i.e demand of a group of
individuals)

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 ECONOMIC EFFICIENCY CONT’D

• Microeconomics deals with the following

issues-
-what goods to produce and the quantity
-how to produce the goods
-distribution of the goods among people
-the efficiency of production and distribution.

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 MICROECONOMICS VS MACROECONOMICS
• Both analyze the economy but with different approaches.
• Microeconomics analyses the economy by examining the
behaviour of individual economic units, their
interrelationships and equilibrium adjustments to one
another, hence the allocation of resources in the economy.
• The issue of general equilibrium comes in also as a result
of the interrelationships and through many adjustments
and re-adjustments to changes.

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MICROECONOMICS VS MACROECONOMICS cont’d

• Microeconomics examines the whole

economy microscopically- Prof. A.P. Lerner
• It also examines how all economic units get
adjusted at the same time.( General
Equilibrium Analysis-interrelationships of
parts within the economy as a whole)

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 MICROECONOMICS VS MACROECONOMICS cont’d
• Macroeconomics analyses the behaviour of the
large aggregates e.g total employment, national
product or income and general price level in the
economy.
• Care must be taken in the use of the word
aggregate to distinguish the two because-
-

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 MICROECONOMICS VS MACROECONOMICS cont’d

Microeconomics examines behaviour of industry(an

aggregate of firms producing the same or similar
product).
- It also deals with determination of price of a product
through the interaction market demand and market
supply for a product

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 MICROECONOMICS VS MACROECONOMICS cont’d

• Macroeconomics is concerned with

aggregates- cutting across various products or
industries.
• Macroeconomics explains what determines
the level of national income, output and
employment, and causes of their fluctuations.

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 MICROECONOMICS VS MACROECONOMICS cont’d

• Macroeconomics also explains the growth of

national income over a long period of time.
• J.M. Keynes gave more attention on
macroeconomic analysis in his book-A General
Theory of Employment, Interest and Money”,
published in 1936 ( Keynesian Revolution) –quite
against Classical Say’s Law of Markets with full
employment assumption.
• Inflation is a subject of macroeconomics
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INTERDEPENDENCE BETWEEN MICROECONOMICS AND
MACROECONOMICS
• Theories relating to the behaviour of some
macroeconomics aggregates are derived from
theories of individual behaviour e.g
-theory of investment( from profit rate and interest rate)
-Aggregate consumption function.
- Determination of general price level explained by
theory of relative prices of products and factors.

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INTERDEPENDENCE BETWEEN MICROECONOMICS AND
MACROECONOMICS
• Microeconomics also depends on macroeconomics
to some extent,e.g
-Determination of profit rate and interest
rate(microeconomics) depends on level of
aggregate demand, national income and the
general price level in the economy.

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USES AND LIMITATION OF MICROECONOMICS
• It provides suitable policies for promoting
economic efficiency and welfare of the people.
• It makes us to know that a modern economy is so
complex that no central planning body can obtain
all the information necessary for its efficient
operation.
• It shows how monopoly leads to misallocation of
resources and loss of economic efficiency or
welfare.
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 USES AND LIMITATION OF MICROECONOMICS
• It shows that when externalities (harm or benefits
made to those external to the producers and
consumers) exit, free working of the price
mechanism fails to achieve economic efficiency.
• It also explains the factors which determine the
distribution of the incidence or burden of a
commodity tax between sellers and consumers

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 USES AND LIMITATION OF MICROECONOMICS

• It helps to know the damage done to social welfare

by the imposition of tax, especially the imposition
of indirect tax.
• It can also show the gain from international trade
and can be used to explain the factors which
influence the distribution of this gain among the
trading partners.

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 ECONOMIC SYSTEM

• Ownership structure and how production,

distribution and consumption are organized.

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 TYPES OF ECONOMIC SYSTEMS
• CAPITALISM (FREE-MARKET OR FREE-ENTERPRISE
ECONOMY OR LAISSEZ-FAIRE)

• SOCIALISM

• MIXED-ECONOMY

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 CAPITALISM

• PRIVATE OWNERSHIP OF PRODUCTIVE ASSETS

• FREEDOM OF CHOICE
• INVISIBLE FORCES OF DEMAND AND SUPPLY
DETERMINE MARKET PRICE ( PRICE-MECHANISM)
• GOVERNMENT FUNCTIONS- RESTRICTED TO
SECURITY AND ENFORCEMENT OF RULES FOR
PROTECTING ECONOMIC FREEDOM

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 SOCIALISM(COMMAND ECONOMY)

• PRODUCTIVE RESOURCES ARE PUBLICLY OWNED.

• CENTRAL GOVERNMENT DECIDES ALLOCATION OF
PRODUCTIVE RESOURCES.
• NO FREEDOM OF CHOICE

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 MIXED-ECONOMY

• PRIVATE AND PUBLIC OWNERSHIP OF PRODUCTIVE

RESOURCES.
• GOVERNMENT CAN INFLUENCE THE WORKINGS OF
ECONOMY THROUGH-
-TAXATION
-PRICE CONTROL LEGISLATION
-SUBSIDY
-WELFARE PAYMENT 25
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 FUNCTIONS OF AN ECONOMIC SYSTEM

• ALLOCATES RESOURCES
• DETERMINES TECHNIQUES OF
PRODUCTION(CAPITAL OR LABOUR INTENSIVE)
• DETERMINES PATTERN OF DISTRIBUTION OF
GOODS AND SERVICES
• STRIVES TO MAINTAIN ECONOMIC STABILITY

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