Economics-I: Micro

Economic Analysis
Paper Code: BA LLB 113
 Unit-I: Introduction to Economics
a. Definition, methodology and scope of economics
b. Forms of economic analysis – Micro vs. macro, partial vs. general,
static vs. dynamic, positive vs. normative, short run vs. long run
c. Basic concepts and precepts – economic problems, economic
rationality, optimality
d. Economic organization – market, command and mixed economy
e. Relation between economics and law – various dimensions.
 What is Economics?
• Father of Economics: Adam Smith

• Derived from two Greek words oikou (a house) and nomos (to manage).

• “An inquiry into the nature and causes of the wealth of nations” - Adam Smith

• “Economics is the science which studies human behaviour as a relationship between ends
and scarce means which have alternative uses” - Prof. Robbins

• “The study of how men and society choose, with or without the use of money, to employ
scarce productive resources which could have alternative uses, to produce various
commodities over time and distribute them for consumption now and in future among
various people and groups of society.” - Paul A. Samuelson
 Definition

Economics is that branch of social science which is concerned with the study
of how individuals, households, firms, industries and government take
decision relating to the allocation of limited resources to productive uses, so
as to derive maximum gain or satisfaction. Simply put, it is all about the
choices we make concerning the use of scarce resources that have alternative
uses, with the aim of satisfying our most pressing infinite wants and distribute
it among ourselves.
 The study of economics

• Why scarce resources are exchanged?

• How consumers and producers behave as they interact with each other in
markets, in their attempt to achieve mutually beneficial exchange?

• The role of government in compensating for the limitations of markets in

achieving mutually beneficial exchange?
 Nature of Economics
1. Economics is a science: Science is an organized branch of knowledge, that analyses cause and
effect relationship between economic agents. Further, economics helps in integrating various
sciences such as mathematics, statistics, etc. to identify the relationship between price, demand,
supply and other economic factors.
• Positive Economics: A positive science is one that studies the relationship between two
variables but does not give any value judgment, i.e. it states ‘what is’. It deals with facts
about the entire economy.
• Normative Economics: As a normative science, economics passes value judgement, i.e.
‘what ought to be’. It is concerned with economic goals and policies to attain these goals.
 Nature of Economics
2. Economics is an art: Art is a discipline that expresses the way things are to be done, so
as to achieve the desired end. Economics has various branches like production, distribution,
consumption and economics, that provide general rules and laws that are capable of solving
different problems of society.

Therefore, economics is considered as science as well as art, i.e. science in terms of its
methodology and arts as in application. Hence, economics is concerned with both
theoretical and practical aspects of the economic problems which we encounter in our day
to day life.
 The methods used by economists
Economists, like other social scientists, are not able to undertake controlled
experiments in the way that chemists and biologists are. Hence, economists have
to employ different methods, based primarily on observation and deduction and
the construction of abstract models.
• Describe and measure the exchanges they observe
• Explain how interactions arise and create costs and benefits
• Propose hypotheses, construct, and apply ‘models’ to test these hypotheses.
• Gather data to put into the model
• Predict behaviour based on these models.
Economic laws can be derived on the basis of deductive or inductive reasoning.
Deductive Method: The deductive method involves reasoning from a few fundamental pro­positions, the truth of which is
assumed.
• Starts from the general and moves to the particular.

• Begins with general assumptions and moves to particular conclusions.

• Develops a theory, and then examines the facts to see if they follow the theory.

Inductive method: The inductive method involves collection of facts, drawing conclusions from them and testing the
conclusions by other facts.
• Starts from the particular and moves to the general.

• Begins with particular observations and moves to general explanations.

• Collects observations, then develops a theory to fit the facts.

For example:
The down­ward sloping demand curve, for example, can be deduced from general assumptions about how people try to
maximise their satisfaction from the purchase of goods and services. On the other hand, demand curves can be built up
empirically, that is by observing actual customers reacting to market price changes, and when market researchers, census-
takers and opinion pollsters collect neces­sary information, the data can be used inductively to make economic predictions.
 Scope of Economics
• Microeconomics: The part of economics whose subject matter of study is individual units,
i.e. a consumer, a household, a firm, an industry, etc. It analyses the way in which the
decisions are taken by the economic agents, concerning the allocation of the resources that
are limited in nature.

It studies consumer behaviour, product pricing, firm’s behaviour. Factor pricing, etc.

• Macro Economics: It is that branch of economics which studies the entire economy, instead
of individual units, i.e. level of output, total investment, total savings, total consumption,
etc. Basically, it is the study of aggregates and averages. It analyses the economic
environment as a whole, wherein the firms, consumers, households, and governments make
decisions.

• It covers areas like national income, general price level, the balance of trade and balance of
payment, level of employment, level of savings and investment.
 Scope of Economics
• The fundamental difference between micro and macro economics lies in the scale of study.
Further, in microeconomics, more importance is given to the determination of price,
whereas macroeconomics is concerned with the determination of income of the economy
as a whole.

• Nevertheless, microeconomics and macroeconomics are complementary to one another, as

they both aimed at maximising the welfare of the economy as a whole.

• From the standpoint of microeconomics, the objective can be achieved through the best
possible allocation of scarce resources. Conversely, if we talk about macroeconomics, this
goal can be attained through the effective use of the resources of the economy
 Forms of economic analysis
• Micro vs. macro
• Partial vs. general
• Static vs. dynamic
• Positive vs. normative
• Short run vs. long run
Difference between Microeconomics and
Macroeconomics
Basis Microeconomics Macroeconomics

Definition Microeconomics is that part of economic theory Macroeconomics is that part of economic theory
which studies the behavior of individual units of which studies the behaviour of aggregates of the
an economy. economy as a whole.

Tools of Analysis Demand and Supply. Aggregate Demand and Aggregate Supply.
Main Objective It aims to determine price of a commodity or It aims to determine income and employment level
factors of production. of the economy.
Basic It assumes all the macro variables to be constant, It assumes that all the micro variables, like
Assumptions i.e., it assumes that national income, decisions of households and firms, prices of
consumption, saving, etc. are constant. individual products, etc. are constant.

Other Name It is also know as ‘Price Theory’. It is also known as ‘Income and Employment
Theory
Examples Individual Demand, Firm’s Output. National Income, National Output.
 Economy: Meaning

• 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.
 Meaning of Economic Problems
“The economic problem is the problem of choice or the problem of
economizing, i.e., it is the problem of fuller and efficient utilization of
the limited resources to satisfy maximum number of wants.
Economic Problems of an Economy

Allocation of Resources
(a) What Goods to Produce and How Much to Produce?: An economy has to
make a choice of the wants which are important for the economy as a whole.
(b) How to Produce?: A technique of production which would maximise
output or minimise cost should be used.
(c) For Whom to Produce?
 Economic Rationality

Rationality is the behavior pattern of economic agents. The concept

implies that the economic agents are capable of calculating pain and/or
gain involved in an economic activity and they are always in pursuit of
net gain, i.e. they decide, rationally, for optimality
 Optimality
• Optimality is the result or consequence of rationality.
• Optimality implies that economic agents works for the achievement of
maximum satisfaction by employing limited resources in such a way
that they get maximum possible utility out of it.
 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.
 Equilibrium
• Equilibrium means the state of rest or absence of change.
• In Economics, equilibrium is just treated as a tendency for the market forces of
demand and supply to balance themselves in course of time
• In the words of Marshall, "When the demand price is equal to the supply
price, the amount produced has no tendency either to be increased or to be
decreased; it is in equilibrium''.
Partial Equilibrium
The analysis of the part of economic isolated and insulated through
assumptions from the influence of the changes in the rest of the economy
It is based on ceteris peribus i.e. all other related variables are constant

General Equilibrium
Such analysis takes into account the inter relationships and inter dependence
between the various elements of an economy.
It takes an comprehensive and realistic view of the economic system and
focuses on the simultaneous determination of equilibrium of all the markets.
Static Analysis
• When an economic phenomenon is studies under static conditions

• Static ignore the passage of time, therefore macroeconomic variables like size of economy, national income,
consumption, saving, investment etc remains unchanged over the reference period

• It cannot explain the process of change in a model so the entire economic process in a static economy
reproduced itself year after year at the same level of output and employment

• In this method, analysis is limited to single position of equilibrium only.

• The primary objective of constructing static model is to make generalization or theoretical prepositions
regarding the relationship between the related variables in static conditions.

• Static analysis can identify the equilibrium positions and describe in general terms how the system will move
to this position.

• It can indicate the position for the model for a given period but cannot explain the actual process step by step
or period by period, that the system follows over time to reach equilibrium position and also cannot reveal
exactly what the position will be in any other period.
Dynamic Analysis

• When macroeconomic phenomenon is analyzed under dynamic conditions.

• Such analysis trace the change in the value of macroeconomic variable as they move through successive
disequilibrium position towards the single equilibrium position over time.

• It takes into account the time lag involved in the process of adjustment.

• It studies the nature and magnitude of change.

Short run vs. long run

If some constraints or factors are fixed, while other are variable, it is considered short run
analysis.
If all constraints are variable, it is called long run analysis.

For example: flexible manufacturing system is a short run adjustment. But continuous
technology progress is a long run development.
 Positive Economics
• It expresses what is.
• It is based on cause and effect of facts.
• It deals with actual or realistic situation.
• It can be verified with actual data.
• In this value judgements are not given. It is neutral
between ends.
• It deals with how an economic problem is solved.
• Economists of positive school are Adam Smith and
his followers.
• Observe these examples:
(a) What determines the price rise?
(b) Government has adopted policies to
reduce unemployment.
(c) The rate of inflation in India is 6
per cent.
(d) Chemistry.
Normative Economics
• It expresses what should be.
• It is based on ethics.
• It deals with idealistic situation.
• It cannot be verified with actual data.
• In this value judgements are given.
• It deals with how an economic problem should be
solved.
• Economists of normative school are Marshall,
Pigou, Hicks, Kaldor Scitovsky.
• Compare these examples:
(a) What is a fair price rise?
(b) Unemployment is worse than inflation.
(c) The rate of inflation should not be more than
6 per cent.
(d) Ethics.
 Types of Economy
Market Economy
• relies entirely on the free market and free market trends
• no involvement or interference from the government or any such
controlling power
• entire economy is determined by the laws of demand and supply
• Realistically there are no perfect free market economies in the world.
Every economy has some level of government regulation as it is
necessary
Command Economy:
• A command economy is the opposite of a free market economy.
• There is one centralized power, which in most cases is the government and government makes
all decisions regarding the economy i.e. which goods and services will be produced, in what
quantities, prices of the goods
• A command economy is a characteristic trait of a communist country. Countries like Cuba,
China, and the previous USSR are practical examples of this command economy system.
• Such economies are also known as Planned Economies because the government plans all the
forces of the economy, nothing is decided by the free market.
• In such a planned economy there is no competition. The government has a monopoly in almost
all the businesses and sectors. All businesses follow the regulations and instructions of the
government and are not influenced by the forces of the economy.
• One of the biggest disadvantages of such a command economy is that the government cannot
plan or provide for all its citizen’s individual needs. And so this often leads to rationing. In an
ideal world under such a command economy the government should be able to provide a living to
all its citizens. However, the reality is different.
Mixed Economy:
• A mixed economy is a perfect mixture between a command economy and a free
market economy.
• The economy is free of government intervention. But the government will regulate
and oversee specific sensitive areas of the economy like transportation, public
services, defence etc.
• Such an economy is known as a dual economy. The best examples of such a mixed
economy are India and France.
• Such a mixed economy allows private businesses the freedom to operate in the
economy with minimum oversight.
• At the same time, the government can regulate the economy so it does not
adversely affect the public interests.
• Both public sector and private sector can co-exist peacefully in one economy.
• It is the perfect blend of socialism and capitalism.
 Concept of Margin and Increment
Marginal Incremental

It is expressed in terms of a unit change It is expressed in terms of bulk change

Refers to change in one independent variable Refers to the change in more than one independent
change

All marginal concepts are incremental But all incremental concepts are not marginal
 PSDA (Unit 1)
• Why there is a need to study the field of Economics with the field of
law?
• What is the interrelationship between Economic Laws and
Government Laws?

Submit this assignment in a hard copy by 04-11-2022