Introduction to

Microeconomics

Economics
Holidays Homework

Naman Aneja
XI-B
 What Is Economics?

The word ‘Economics’ was derived from two Greek words oikou (a house) and nomos (to
manage). Thus, the word economics was used to mean home management with limited
funds available in the most economical manner possible.
It is a social science that studies the manner in which the society chooses to use its limited
resources which have alternate uses to produce goods and services and distribute them
among different groups.
Branches of Economics
 Microeconomics
The word ‘Micro’ is derived from the Greek word mikros meaning small. Microeconomics
deals with small segments of the society. Microeconomics is defined as the study of behaviour
of individual decision-making units, such as consumers, resource owners and firms. It is also
known as Price Theory since its major subject-matter deals with the determination of price of
commodities and factors. It solves the three central problems of an economy, i.e., what, how
and for whom to produce. Subject-matter of microeconomics is vast.

Limitations of Microeconomics
Microeconomics fails to explain the functioning of an economy as a whole. It cannot explain
unemployment, poverty, illiteracy and other problems prevailing in the country.
 Macroeconomics
Meaning
The word ‘Macro’ is derived from the Greek word makros meaning large.
Macroeconomics deals with aggregative economics. Macroeconomics is defined
as the study of overall economic phenomena, such as problem of full
employment, GNP, savings, investment, aggregate consumption, aggregate
investment, economic growth, etc. It is also known as Theory of Income and
Employment since its major subject-matter deals with the
determination of income and employment. The study of macroeconomics is
used to solve many problems of an economy like, monetary problems, economic
fluctuations, general unemployment, inflation, disequilibrium in
the balance of payment position, etc.

Limitations of Macroeconomics
Some of the major limitations of macroeconomics are:
(i) Macroeconomics ignores structural changes in an individual unit of the aggregate. The
conclusions drawn on the basis of aggregate variables may be misleading.
(ii) As Hicks puts it, “most of macro magnitudes which figure so largely in economic discussions
are subject to errors and ambiguities.”
 Economics
Positive Or A Normative Science

Basis Positive economics Normative economics

Meaning It deals with what is or how an It deals with what ought to be or how
economics problem facing a society an economic problem should be solved
is
actually solved.

Verification It can’t be verified with actual data It cannot be verified with actual data.

Purpose It aims to make a real description of It aims to determine the ideals

an economic activity

Suggestive It is based upon the factors and It is based upon individual’s opinion
therefore, not suggestive and therefore, not suggestive.

Examples Prices have been rising in India. Rich people should be taxed more.
Economy
An economy is a system in which people earn their living by performing different
economic activities like production, consumption and investment. In other words, an
economy refers to the whole collection of production units in an area (geographical area or political
boundary) of a country by which people get their living. An economy is classified into market economy
and planned economy. These economies can be subdivided into closed economy and open economy.

Economic Problems And

Its Emergence
Economic problem means problem of choice arising due to limited
resources having alternative uses and unlimited human wants.
Main causes of economic problems:
1. Human wants are unlimited
2. Resources are limited
3. Resources have alternative uses
 Central Problems of the
Economy
Any economy faces below mentioned problems:

1. “What to produce and in what quantity?”

Capital goods or Consumer goods, Luxury goods or Inferior goods

2. “How are theses goods produced?”

Problem of choice of method of technique
-Capital Intensive or Labour Intensive

3. “For whom to produce?”

Distribution of total output of goods and services produced in the economy
depending upon the distribution of income and thereby, the ability to pay
 Production Possibility Schedule
PP schedule refers to tabular presentation of different possible combinations of two goods that
an economy can produce with given resources and available technology.

Production Possibilities X Y Marginal Opportunity

Cost
P 0 21 --
A 1 20 1
B 2 18 2
C 3 15 3
D 4 11 4
E 5 6 5
P’ 6 0 6

It shows that, with given resources, an economy can produce either zero unit of X and 21 units of Y or 1 of X
and 20 of Y or 2 units of X and 18 units of Y or 3 units of X and 15 units of Y or 4 of X and 11 of Y or 5 of X
and 6 of Y or 6 units of X and zero units of Y.
The figure illustrates a production possibility curve. Good X is shown on
the x-axis and good Y is shown on the y-axis. PP' is the required
production possibility curve. It shows, the maximum amount of good X
produced, given the amount of the other good. In panel (A), each
alternative possibility, i.e., (0, 21), (1, 20), (2, 18), (3, 15), etc., are plotted
and points P, A, B, C, D, E and P' are joined by line segments. In panel
(B), a smooth PPC is drawn which is based on the assumption that in
reality infinite production possibilities exist.

• The economy can either produce OP of good Y or OP' of good X or

any other combination shown by points A, B, C, D or E. All points on
the curve are attainable. The problem is that of choice, i.e., to choose
among the attainable points on the curve. It depends upon tastes
and preferences of an individual. This is the basic problem of an
economy.
• Any point inside the curve, such as point F, indicates unemployment
of resources or inefficient use of resources.
• Any point outside the curve, such as point G, is unattainable given
the scarcity of resources. An economy always produces on a PPC.
 Production Possibility Curve

Production Possibility Curve is a curve which shows the

various combinations of two goods which an economy can
produce with fuller and efficient utilization of its given
resources and available technology.

It is also known as Transformation Curve or Production

Possibility Frontier. It is an important tool to solve the
central economic problems.
 Assumptions of PPC
(a) Economy produces only two goods, X and Y. (Examples of goods X and Y can be gun and
butter, wheat and sugar cane, cricket bats and tennis rackets or anything else.)

(b) Amount of resources available in an economy are given and fixed.

(c) Resources are not specific, i.e., they can be shifted from the production of one good to the
other good.

(d ) Resources are fully employed, i.e., there is no wastage of resources. Resources are not lying
idle.

(e) State of technology in an economy is given and remains unchanged.

(f ) Resources are efficiently employed (efficiency in production means output per unit of an
input).
 Properties of PPC

(a) PPC slopes downward.

A production possibility curve slopes downward from left to right because under the condition of full
employment of resources, production of one good can be increased only after sacrificing production of
some quantity of the other good. It is so because resources are scarce. Due to this, production of both
goods cannot be increased at the same time. That is why PPC slopes downward.

(b) PPC is concave to the origin.

A production possibility curve is concave to the point of origin because of increasing marginal rate of
transformation (MRT) or increasing marginal opportunity cost (MOC). Slope of PPC is defined as the
quantity of good Y given up in exchange for additional unit of good X.
[Slope of Production Possibility Curve] =∆Y / ∆X
= Amount of Good Y lost / Amount of Good X gained
= MRT or [Marginal Opportunity Cost
 Marginal Opportunity Cost (MOC)

The Marginal Opportunity Cost is defined as the ratio of a

good sacrificed for the production f an additional unit of
other good. The rate of this unit sacrificed is called MOC.
MOC = ∆Y / ∆X, here ∆X = 1
Shape of PPC
The shape of PPC depends on
Marginal Opportunity Cost, as
stated below:
1. If MOC is rising, then PPC
will be concave to the
origin.
2. If MOC is constant, then
PPC will be a downward
straight line.
3. If MOC is falling, then PPC
will be convex to the origin.
 Shift of PPC
PPC will shift to the right when:
(a) New stock of resources are discovered.
(b) There is an advancement in technology.
For example: When training institutes come
up, they provide training which raises
efficiency of workers. PPC shifts outside.

PPC will shift to the left when:

(a) Resources are destroyed because of
national
calamity like earthquake, fire, war, etc.
For example: When maggi product was
destroyed.
(b) There is use of outdated technology.
In Fig. 1, there is an outward shift of the production possibility curve from PP' to
P1P1' It shows economic growth of an economy. Economic growth has shifted the
production possibility curve outwards and made it possible for an economy to
produce more of both the goods. The economy has not stagnated but has
developed over a period of time. In a reverse situation, if due to earthquake and
floods mass destruction takes place then the country will stagnate. The PPC
curve will shift inwards as P2 P'2.

In Fig. 2, improvement in technology takes place only in one good,

good X. There is no improvement in the technology of producing
good Y. Thus, more of good X can be produced. Production
possibility curve PP' expands to PP1, showing economic growth.

In Fig. 3, improvement in technology takes place only in good Y.

Thus, economy produces more of good Y. Production of good X
remains the same. Production possibility curve PP' expands
outward to P1P', showing economic growth.
 Opportunity Cost
Opportunity cost is defined as the cost of alternative opportunity given up or
surrendered. For example, on a piece of land both wheat and sugarcane can be grown
with the same resources. If wheat is grown then opportunity cost of producing wheat
is the quantity of sugarcane given up.

In the given figure, movement along production

possibilities frontier, PP1, shows a decrease in the output
of food and increase in output of clothing. For example,
movement from point A to point B shows decrease in
food production from F1 to F2 (∆F) and increase in the
production of clothing from C1 to C2 (∆C). It implies
that ∆C amount of clothing can be produced only by
sacrificing ∆F amount of production of food. It means
that ∆F amount of food becomes an opportunity cost
for ∆C amount of clothing.