MICRO ECONOMICS

By: Dr.K.S.Rathore
Department of Management
PIM,Gwalior
Email:kishansingh.rathore@prestigegwl.org
Contact- 9926486860

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 Syllabus-Unit -I
• The economy and Basic Problem: What is an
economy? How an economy works? Basic Problem of
an economy, How Market Mechanism solves the
basic Problems of economy
• Introduction to Microeconomics: An overview on
economics, Concept of Microeconomics,
Methodology of Positive Economics- Model building,
Uses of Microeconomics theories & Limitation,

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 Objective of the session
• To understand what is economics
• To understand what is scarcity
• To understand what is optimum utilization
• To understand what is positive or normative
economics

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 What is economics?

Imagine yourself as the richest

person of the world and answer
this question is:

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Can you buy everything. You
want……The must be ‘No’ but why?
Because
1. Wants are unlimited
2.Means are limited (scares)

No matter how rich you are as an individual, your resources

are never enough to satisfy your all wants likewise no matter
how rich you area nation, you will never find enough
resources to achieve everything you wish……..
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Resources as alternative uses as well

At micro level…
Farmer decide production
: rice, sugarcane, wheat
etc..

At macro level…
Government decide tax revenue …for
purchase defense good or for construction of
shelter

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 The Economic Problem
OWhat goods and services should an economy
produce? – should the emphasis be on
agriculture, manufacturing or services, should
it be on sport and leisure or housing?
OHow should goods and services be produced?
– labour intensive, land intensive, capital
intensive? Efficiency?
OWho should get the goods and services
produced? – even distribution? more for the
rich? for those who work hard?
 SCARCITY
• The excess of wants resulting from having
limited resources (land, labor, capital and
entrepreneurs) in satisfying the endless
wants of people.
• It is a universal problem for societies – it is
not limited to poor countries.
• To the economist, all goods and services
that have a price are relatively scarce. This
means that they are scarce relative to
people’s demand for them.
 Factors of Production
• Land
- natural resources available for production
- renewable resources: those that replenish
- non-renewable resources: cannot be replaced
• Labor
- physical and mental effort of people used in
production
• Capital
- all non-natural (manufactured) resources that are
used in the creation and production of other products
• Enterprise (Entrepreneurship)
- refers to the management, organization and
planning of the other three factors of production
 Factors of Production

Payments
to factors
Land Labor Capital Enterprise
of
Productio
n

Rent Wages Interest Profit

INCOME
 Problem of allocation of scare resources or
optimum utilization of resources

Means: Problem of choice

So economics is a subject matter of rational

management of limited resources in such a manner that
at Micro level , a individual or consumer may able to
maximize his satisfaction and an individual producer
may able to maximize his profit and at Macro level , a
country is able to achieve his GDP growth

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Examples:
You must choose between buying jeans or buying shoes.
Businesses must choose how many people to hire
Governments must choose how much to spend on welfare.

Economics Defined
Economics-Social science concerned with the
efficient use of limited resources to achieve
maximum satisfaction of economic wants.
(Study of how individuals and societies deal
with ________)
scarcity
 What is Economy ?
Now, we are in position to understand what actually
is economy
•People perform different economy activities Like…
1.Professors go to college
2.Doctors go to hospital
3.Farmers go to fields and
4.Industrialists go to their industries

The nature and level of economic activities performed by

people of an area would reveal a system by which people of
that area earn their living. This system is called economy.
 5 Key Economic Assumptions
1. Society’s wants are unlimited, but ALL resources
are limited (scarcity).
2. Due to scarcity, choices must be made. Every choice
has a cost (a trade-off).
3. Everyone’s goal is to make choices that maximize
their satisfaction. Everyone acts in their own “self-
interest.”
4. Everyone acts rationally by comparing the marginal
costs and marginal benefits of every choice
5. Real-life situations can be explained and analyzed
through simplified models and graphs.
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Pre-classical microeconomic theory
Before, Adam Smith, economics was more disparate
(different in every way) with no commanding overall
theory.
Classical microeconomic theory
Classical microeconomic theory was developed by
Adam Smith (Wealth of Nations, 1776) and later
economists, such as David Ricardo The essential aspect
of classical microeconomic theory include
Determination of market price and output

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Neo-classical theory
• Neo-classical theory is a modern re-interpretation of
classical economics of the nineteenth century. Neo-
classical theory places importance on markets, but
developed new ideas, especially regarding utility and
rational choice theory.
• Neoclassical economics is a broad theory that focuses
on supply and demand as the driving forces behind
the production, pricing, and consumption of goods
and services. It emerged in around 1900 to compete
with the earlier theories of classical economics.

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 Early Definitions
• According to Adam Smith
– Economics is concerned with an enquiry into nature and
causes of wealth

• According to a French economist J.B. Say

– Economics is science which treats of wealth

• The American Economist, F.A Walker is of the view that

– Economics is that body of knowledge which relates to wealth

• In all these definitions, key position is assigned to

WEALTH
 Problem with Early Definitions
• Too much emphasis on wealth

• This led to development of view that Economics

teaches selfishness and came to be called a “dismal
(Uncheerful) science”

• Thus, all the vices attributed to wealth became

attached to the science of wealth (i.e Economics)
 Change in Definition
• In the last quarter of the 19th Century
humanistic character of Economics had come
to be well recognized

• Schaffle in Germany and Droz in France placed

the role of man in Economics higher than that
of wealth

• It is now fully recognized that wealth is only a

means to an end, the end being human
welfare
 Marshallian Definition
• Marshal said
– Political Economy or Economics, is a 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 well-being
 Study of Marshall’s Definition
• Marshall’s definition puts emphasizes on four
points:
– Economics does not regard wealth as the be-all and end-
all of economic activities
– Economics is not concerned with ‘economic man’ but is
concerned with an ‘ordinary man’
– Economics is a social science and not one which studies
isolated individuals
– Economics studies only ‘material requisites of well-
being’ or causes of material welfare
 Criticism on Marshallian View
• Lionel Robbins criticized Marshall’s definition on following grounds:
– It is not right that an economists confine their attention to the
study of material welfare
• because in the actual study of economic principles, both the
‘material’ and non-material things
– Marshall’s definition is classificatory
• because it makes a distinction between material welfare and
non-material welfare
– It unduly restricted the scope of Economics
• All those sums which are paid for ‘immaterial’ services e.g.
services of doctors or lawyers etc.
Contd…
 Robbins, Definition
• Robbins defined Economics as

– Economics is the science which studies human

behaviour as a relationship between ends and

scarce means which have alternative uses

 Study of Robbins’ Definition
• Robbins’ definition lays down the following three
fundamental propositions which constitute basis
of the structure of economic science
– “Ends” refer to wants. Human beings have wants
which are unlimited in number
– Wants are unlimited but the means to satisfy them
are strictly limited
– Scarce means are capable of alternative uses

• Thus, in Robbins’ sense, economic activity lies in

man’s utilization of scarce means having
alternative uses, for the satisfaction of multiple
ends
 Criticism on Robbins’ Definition
• Robbins’ definition attracted following criticism
– Robbins reduced economics to only valuation theory.
• Other aspects of the study of economics have been
relegated to the background e.g aggregates
– Individual choices having no social implications cannot
form the basis of subject-matter of Economics
– Economic growth and economic development has not
been covered by Robbins’ definition
– This definition does not explain problem of
unemployment
– Human touch is entirely missing
– Robbins has made Economics more abstract and
complex and hence difficult and fruitful
 Modern Definitions
• The credit of bringing about a revolution in
economic thinking goes to Lord J.M. Keynes.
According to him
– Economics studies how the levels of income and
employment in a community are determined
• Thus, in Keynesian terms, Economics is defined as
– The study of the administration of scarce resources and
of the determinants of income and employment
• In Benham’s words
– Economics is a study of factors affecting the size,
distribution and stability of a country’s national income
 Major Economic Problems

• What is an economic problem?

– The economic problem lies in making the best

possible use of our resources so as to get
maximum satisfaction in case of a consumer and
maximum output or profit for a producer
 Fundamental Problems
• What to produce?
– Quantity and range of goods to produce
– Resources are limited, we must choose between different
alternative collection of goods and services that may be produced
• How to produce?
– Techniques of production e.g labor intensive, capital intensive
• For whom to produce?
– It means that how the national product is distributed i.e. who
should get how much
• Are the resources economically used?
– No wastage or misutilization of resources since they are limited
• Problem to full employment?
– Economy must endeavor to achieve full employment not only of
labor but of all its resources
• Problem of growth?
– Economy must expand or develop to maintain conditions of
stability
 Micro & Macro Economics
Economics Micro Macro
Issues
Means Small economics Large, at the level of economy as
unit whole
Study of Price: theory of Aggregate output or general price
determination price level in the economy as whole i.e
study of theory of income &
employment

Assumption Macro variable Micro variable remain constant

about variable remain constant

Principal Theory of Equilibrium level of output &

components consumer employment, monetary policy, fiscal
behavior, theory policy, GDP, Government
of producer budget,Exchange rate, Bop (Balance of
behavior, theory Payment), Inflation and deflation,
of price business cycle etc.
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 Positive or Normative Economics
Positive
It deals with economic issues (economic behavior) related to
past, present and future.
Facts and data based: It tasted and proved
Eg. Read following observation carefully
1.On the eve of independence, poverty in India affected larger
percentage of population than now ( Observation is related to
past)
2.22% of population of India is absolutely poor (below poverty
line) (It is observation related to present)
3.If population of India continue to grow at the existing rate, then
%age of population below poverty line will exceed 22% ((It is
observation related to future)
Thus ‘positive economics’ is the ‘what was’, ‘what is’ and ‘what
would be’. 32
Normative Economics
It deals with opinion related to economic issues and problems.
It is subjective based . Opinion can not be proved
Different economist may offer different opinion on the
solution of economic problem.
Eg. Opinion involved value judgment
1.MGNREGA ( Mahatma Gandhi National Rural Employment
Generation Act) will one day bring an end to the problem of
unemployment in the country
2. MGNREGA is just a programme of financial aid to the
unemployment peoplein rural India. It will make the people
‘parasites and life long unproductive’
3. MGNREGA uses taxpayers money’ and should therefore, be
stopped

Thus ‘Normative economics’ is merely opinion, are not verified

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Normative Economics
It deals with opinion related to economic issues and problems.
It is subjective based . Opinion can not be proved
Different economist may offer different opinion on the
solution of economic problem.
Eg. Opinion involved value judgment
1.MGNREGA ( Mahatma Gandhi National Rural Employment
Generation Act) will one day bring an end to the problem of
unemployment in the country
2. MGNREGA is just a programme of financial aid to the
unemployment peoplein rural India. It will make the people
‘parasites and life long unproductive’
3. MGNREGA uses taxpayers money’ and should therefore, be
stopped

Thus ‘Normative economics’ is merely opinion, are not verified

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 Nature of Economics
Spencer and Siegelman point to the fact that
“Economics.. is the integration of economic theory
and business practice for the purpose of facilitating
decision-making and forward planning by
management.”

1.Micro economic
2.Macro economic
3.Normative and positive
4.Integration of economics theory & business
practices

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 Scope of Economics

Following aspects constitute its subject matter:-

 Objectives of a Business Firm

 Demand Analysis and Demand Forecasting
 Production and Cost
 Competition
 Pricing and Output
 Profit
 Investment and Capital Budgeting and
 Product Policy, Sales Promotion and Market Strategy.

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 Objectives of a Business Firm

• Short Run
• Long Run

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 Demand Analysis and Demand
Forecasting

• A major part of managerial decision making

depends on accurate estimates of demand.
When demand is estimated, the manager does
not stop at the stage of assessing the current
demand but estimates future demand as well.
This is what is meant by demand forecasting

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 Production and Cost
• The determinants of estimating costs, the
relationship between cost and output, the forecast of
cost and profit are very vital to a firm.

• An element of cost uncertainty exists because all the

factors determining costs are not always known or
controllable. Managerial economics touches these
aspects of cost analysis as an effective knowledge
and the application of which is corner stone for the
success of a firm.

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 Competition

• Types of market structure

Monopoly
Monopolistic
Oligopoly
Duopoly
Perfect Competition

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 Pricing and Output

Pricing is very important area of managerial economics.

The control functions of an enterprise are not only
productions but pricing as well

Pricing is actually guided by consideration of cost plan

pricing and the policies of public enterprises. The knowl
edge of the pricing of a product under conditions of
different market structure is also essential. The price
system guides the manager to take valid and profitable
decision.

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 Profit
• Profit forecasting is an essential function of any
management. It relates to projection of future earnings
and involves the analysis of actual and expected
behavior of firms, the sales volume, prices and com
petitor’s strategies, etc.
• Managerial economics tries to find out the cause and
effect relationship by factual study and logical
reasoning.
For example, the statement that profits are at a maximum
when marginal revenue is equal to marginal cost, a
substantial part of economic analysis

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 Investment and Capital Budgeting
• Planning and control of capital expenditures is the basic
executive function. The managerial problem of planning and
control of capital is examined from an economic stand point.
• The objective is to assure the most profitable use of funds,
which means that funds must not be applied when the
managerial returns are less than in other uses.

Example: In recent years, there is a trend towards integration of

managerial economics and Operation Research. Hence,
techniques such as linear Programming, Inventory Models,
Waiting Line Models, Bidding Models, Theory of Games, etc.
have also come to be regarded as part of managerial economics

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 Inventory Management:
• An inventory refers to a stock of raw materials
which a firm keeps. Now the problem is how
much of the inventory is the ideal stock. If it is
high, capital is unproductively tied up. If the
level of inventory is low, production will be
affected.
Example: EOQ Modal, JIT Approach

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Product Policy, Advertising ,Sales Promotion
and Market Strategy

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• How an economy work?

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 How an economy work?
• Working with a modern economy is extremely complex.
Millions of people participate and contribute to its working in
different ways and in different capacities-as producers,
workers, financiers and consumers.
• Thousand of goods and services are produced and consumed
and millions of people are engaged in production and
distribution of a single commodity.
• To present a complete picture of the economy and showing
the role of each individual participants in respect of each
commodity is an extremely difficult task, rather impossible.
However the working of a simple economy is illustrated by
the given model.

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The circular flow model of a simple
economy

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 3. The Four Macroeconomic Sectors
3.1 The Household Sector This sector includes all the
individuals in the economy. The primary function of this
sector is to provide the factors of production. The factors
of production include land, labour, capital and enterprise.
The household sectors are the consumers who consume the
goods and services produced by the firms and in return
make payments for the same.

3.2 The Firms Sector This sector includes all the business
entities, corporations and partnerships. The primary
function of this sector is to produce goods and services for
sale in the market and make factor payments to the
household sector.
3.3 The Government Sector This sector includes the
center, state, and local governments. The prime function
of this sector is to regulate the functioning of the
economy. The government sector incurs both revenue as
well as expenditure. The government earns revenue from
tax and non-tax sources and incurs expenditure for
provide essential public services to the people.

3.4 The Foreign Sector This sector includes transactions

with the rest of the world. Foreign trade implies net
exports (exports minus imports). Exports include goods
and services produced domestically and sold to the rest of
the world and imports include goods and services
produced abroad and sold domestically.
 4. The Three Markets
4.1 The Goods Market In this market the goods and
services are exchanged among the four macroeconomic
sectors. The consumers are the household, government and
the foreign sector while the producers are the firms.

4.2 The Factor Market The factors of production are traded

through this market. For the production of final goods and
services, the firms obtain the factor services and make
payments in the form of rent, wages and profits for the
services to the household sector.

4.3 The Financial Market This market consists of financial

institutions such as banks and non-bank intermediaries who
engage in borrowing (savings from households) and lending
of money.
 Model 1 - The Circular Flow of Income in a Two-Sector Model
In this model, the economy is assumed to be a
closed economy and consists of only two sectors,
i.e., the household and the firms. A closed economy
is an economy that does not participate in
international trade. In this model, the household
sector is the only buyer of the goods and services
produced by the firms and it is also the only
supplier of the factors of production.
The household sector spends the entire income on
the purchase of goods and services produced by the
firms implying that there is no saving or investment
in the economy. The firms are the only producer of
the good and services.
The firms generate income by selling the goods and
services to the household sector and the latter earns
income by selling the factors of production to the
former. Thus, the income of the producers is equal
to the income of the households is equal to the
consumption expenditure of the household. The
demand of the economy is equal to the supply
• In this model, Y = C where,
• Y is Income and C is Consumption.
• The circular flow of income in a two sector
model is explained with the help of the
following diagram, called Model 1.
 Model 2-The Circular Flow of Income in a Two- Sector Model
with Saving and Investment
• In the above model, we assumed that the household sector
spends its entire income and that there is no saving in the
economy however, in practice, the household sector does
not spend all its income; it saves a part of it. The saving by
the household sector would imply monetary withdrawal
(equal to saving) from the circular flow of income
• This would affect the sale of the firms since the entire
income of the household would not reach the firm
implying that the production of goods and services would
be more than the sale. Consequently, the firms would
decrease their production which would lead to a fall in the
income of the household and so on.
• There is one way of equating the sales of the firms
with the income generated; if the saving of the
household is credited to the firms for investment
then the income gap could be filled.

• If the total investment (I) of the firms is equal to

the total saving (S) of the household sector then
the equilibrium level of the economy would be
maintained at the original level. This is explained
with the help of the following diagram.
The equilibrium condition for a two-sector model with saving and investment
is as follows: Y = C + S or Y = C + I or C + S = C + I Or, S = I Where, Y = Income, C
= Consumption, S = Saving and I = Investment
 6. The Circular Flow of Income in a Three – Sector Model

• The three sector model of circular flow of income

highlights the role played by the government sector. This
is a more realistic model which includes the economic
activities of the government however; we continue to
assume the economy to be a closed one. There are no
transactions with the rest of the world.
• The government levies taxes on the households and the
firms and it also gives subsidies to the firms and transfer
payments to the household sector. Thus, there is income
flow from the household and firms to the government via
taxes in one direction and there is income outflow from
the government to the household and firms in the other
direction.
• If the government revenue falls short of its
expenditure, it is also known to borrow
through financial markets. This sector adds
three key elements to the circular flow model,
i.e., taxes, government purchases and
government borrowings. This is explained
with the help of the following diagram called,
Model 2.
In this model, the equilibrium condition is as follows: Y = C + I + G
Where, Y = Income; C = Consumption; I = Investment and G =
Government Expenditure
 The Circular Flow Of Income in a Four Sector Model

This is the complete model of the circular flow of

income that incorporates all the four
macroeconomic sectors. Along with the above three
sectors it considers the effect of foreign trade on the
circular flow. With the inclusion of this sector the
economy now becomes an ‘open economy’.
Foreign trade includes two transactions, i.e., exports
and imports. Goods and services are exported from
one country to the other countries and imports come
to a country from different countries in the goods
market.
• There is inflow of income to the firms and
government in the form of payments for the
exports and there is outflow of income when
the firms and governments make payments
abroad for the imports. The import payments
and export receipts transactions are done in the
financial market. This is explained with the
help of a following diagram, called Model 3
In this model, the equilibrium condition is as follows: Y = C + I + G + NX NX = Net
Exports = Exports (X) – Imports (M), Where, Y = Income; C = Consumption; I =
Investment; G = Government Expenditure; X = Exports and M = Imports
 8. Leakages and Injections in the Circular Flow of Income

The flow of income in the circular flow model does not always
remain constant. The volume of income flow decrease due to the
leakages of income in the circular flow and similarly, it increases
with the injections of income into the circular flow.

•Leakages: A leakage is referred to as an outflow of income

from the circular flow model. Leakages are that part of the
income which the household withdraw from the circular flow and
is not used to purchase goods and services. This part of the
income does not go to the goods market. There are three main
leakages and these are:
• Saving: It is that part of the income that is not used by the
household to purchase of goods and services or pay taxes. It is
kept with the financial institutions like banks that can be lend
further by the banks to the firms for investment or capital
expansion purposes.
• Taxes: Tax revenue is the income paid by the household and firms
to the government. It flows to the government rather that the
goods market.
• Imports: Import payments are made to the foreign sector for the
good and services bought from them. This is an outflow of income
from the economy.
Thus, we see that leakages reduce the volume of income from the
circular flow of income. Leakages = S + T + M Where, S = Saving; T
= Taxes; and M = Imports
Injections: An injection is an inflow of income to the circular
flow. The volume of income increases due to an injection of
income in the circular flow. There are three main injections and
these are:
•Investment: It is the total expenditure by the firms on capital
expansion. It flows to the goods market.
• Government Expenditure: It is the total expenditure of the
government on goods and services, subsidies to the firms and
transfer payments to the household sector. Transfer payments are
government payments like social security schemes, pensions,
retirement benefits, and temporary aid to needy families etc.
•Exports: Export receipts are the payment made by the foreign
sector for the purchase of domestic goods. It is an inflow of
income from the foreign sector to the financial market.
• Injections = I + G + X Where, I = Investment; G =
Government Expenditure; and X = Exports Balance of
leakages and Injections in an open economy is; S + T + M = I
+ G + X Or, (S –I) = (G – T) + (X – M)
 The Circular Flow

Household Firms
(production
 The Circular Flow

Goods
Household Firms
(production
 The Circular Flow

Factor services

Goods
Household Firms
(production
 The Circular Flow

Wages, rents, interest, profits (1)

Factor services

Goods
Household Firms
(production
 The Circular Flow

Wages, rents, interest, profits (1)

Factor services

Goods
Household Firms
(production

Personal consumption(4)
 The Circular Flow

Wages, rents, interest, profits (1)

Factor services

Goods
Household Firms
(production

Savin
gs (3)
Financial markets

Personal consumption(4)
 The Circular Flow

Wages, rents, interest, profits (1)

Factor services

Goods
Household Firms
(production

Savin (3)
gs (3)
Financial markets Investment

Personal consumption(4)
 The Circular Flow

Wages, rents, interest, profits (1)

Factor services

Goods
Household Firms
(production
ding
Taxes (2) Government(2)Government Spen
Savin (3)
gs (3)
Financial markets Investment

Personal consumption(4)
 The Circular Flow

Wages, rents, interest, profits (1)

Factor services

Goods
Household Firms
(production
ding
Taxes (2) Government(2)Government Spen
Savin (3)
gs (3)
Financial markets Investment

Impo Personal consumption(4)

rts (5
) (5)
Exports
Other countr
ies
Problems in maximizing production
and optimizing distribution

1. What to produce?
2. How much to produce?
3. How to produce?

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Problems in achieving growth, full employment
and stability

The economic problems discussed above are of

micro in nature. Apart from there are certain
macroeconomic problem of prime importance
confronted by an economy including the
problem of growth, full employment and
stability.

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1. How to increase production capacity of the economy?
Two reasons is there-
first,increasing population which leads to poverty of the
nation and poverty in it self is a cause of many social
evils. Second, some economies have grown time faster
than the others, while some others have remained
almost stagnant. The poor nations have been subjected
to exploitation and economic discrimination by
economically powerful nation.

2. How to stabilize the economy?

3.Other problem of macro nature

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2. How to stabilize the economy?
Economic fluctuation has been an important feature of
free enterprise economic. Economic fluctuation cause
wastage of resources, e.g. idleness of manpower, idle
capital stocked, particularly during the period of
depression. The global recession of 2008-2009,
originating in the US , is the live example of economic
fluctuation

3.Other problem of macro nature-Economic growth,

inflation, unemployment and foreign trade deficits.

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 How market mechanism solves the basic
economic problems

The way the basic problems of an economy are solved

depends on the nature of the economy
Socialist economy-Govt.agencies like central planning
authority.
Free enterprise/Mixed capitalist Economy- this task
is performed by the price mechanism/market
mechanism.
A market economy function through market forces of
demand and supply.

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First, price serve as signals for the producers to decide’
what to produce?’ and for the consumers to decide
‘what to consume?’ and ‘how much to consume?’

Second, price force the demand and supply condition

to adjust themselves to the prevailing prices. Now we
will see how each of the basic problems is solved by the
market mechanism or price mechanism.

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 1.What to produce?-

Goods and services produced is determined by

consumer demand. Increasing demand for a good
causes increase in its price. Rise in price increase profit
margin. The profit seeking producers will concentrate
On the production of this commodity. If they produce a
commodity that is not in demand , it will go waste and
their profit motive will be defeated. This solves the
problems of ‘what to produce?’

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 2.How to produce?
‘How to produce’ is the question of choice of technology.The
proportion of labor and capital used to produce a commodity is
also determined by the market forces, i.e. the supply of and
demand for labor and capital.
Firm produce for profit and try to maximize it. It require, among
other things, minimizing cost of production. Cost can be minimize
using more of a cheap factor and less of costly factor.
If labor is cheaper than capital then more of labor and less of
capital is used to produce a commodity. On the contrary, , if capital
is cheaper or more productive, more of capital and less of labor
used.
In fact, cost-minimizing firm combine labor and capital is such a
propoetion that minimizes the cost of production for a given
output. This solves the problem of ‘ How to Produce’?
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 3. How much to produce?
Market system solves not only the problems of ‘what to
produce? But also the problem ‘how much to produce?’ The
market forces –demand and supply- determine the quantity of a
commodity that firms have to produce, given the their objective
of profit maximization.
If the firms produce less than the quantity demanded, they
leave out the prospect of selling more and making more profit.
If firms produce more than the quantity demanded, supply
exceeds the demand . As a result price of their product goes
down. Decrease the price reduce their profit margin or may
even result in losses.
So firms cut down their production to match with the demand.
Thus , the market mechanism resolve the problem of ‘ how
much to produce?’
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 Importance of Micro Economics
• 1. Helpful in the Efficient Employment of Resources:
Microeconomics is helpful in the efficient employment of the
limited, scarce resources of a country. The principal problem
faced by the modern government is the allocation of its
scarce resources among the competing ends. It is the
burning problem of the day. Microeconomic theory explains
the condition of efficiency in both production and
consumption, which are vital to economics and highlights the
factors which are responsible the departure from efficiency.
On this basis microeconomic theory suggests suitable policies
which should be adopted by modern governments to promote
economic efficiency and thereby achieving all-round growth,
prosperity and stability in the economy.

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• 2. Understanding Free Enterprise Economy:

Microeconomics is of great importance in understanding

the working of free enterprise economy without any
central control. In such an economy there is agency to
plan and coordinate the working of the economic
system. Such decisions as to how to produce, what to
produce, when to produce, and for whom to produce
are taken independently by the producers. Similarly,
decisions as to what to consume, whom to consume
and how much to consume are decisions taken by
consumers themselves.

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• 3. Helpful in the Development of International
Trade:
Microeconomics is also helpful in the
development of international trade. It is used
to explain the gains from international trade,
balance of payment disequilibrium and the
determination of foreign exchange rate.

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4.Helpful in Understanding the Implications of
Taxation:
Microeconomics is also helpful in understanding
the implication of taxation. It helps in explaining
as to whether an income tax leads to decrease in
the social welfare or an excise duty or sales duty.
It is the imposition of an excise duty or sales tax
that leads to the decrease in social welfare
rather than income tax.

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• 5. Basis for Welfare Economics:
The greatest justification for the study of micro
economics is that it provides the basis for welfare
economics. The entire structure of welfare economics
has been built on price theory which is the
constituent(elements) part of microeconomics.
It shows how the relative prices of various products and
factors are formed.

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• 6. Provides Tools for Evaluating Economic Policies:
Microeconomics provides tools for evaluating economic
policies of the state. Microeconomic theory explains
the condition of efficiency in consumption and
production and highlights the factors which are
responsible for the departure from efficiency.
On this basis microeconomics suggests suitable economic
policies to promote economic efficiency and welfare of
the people. A Price policy is also an important tool for
economic policies. Microeconomics helps the state in
formulating correct price policies and evaluating them
in proper perspective.

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 Limitation of Micro Economics
• Study only real person, not fictious/imaginary person
• Study only human being related to society, not in isolated form
• Study only related to wealth, failed to make complete study of human
being
• Economics study only ‘measuring road of money’ means should be fall
within economics scope
• The law of economics are not complete true
The principal of economics are incomplete without the words ‘ Other things
being remaining the same’

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Thanks

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