FEDERAL URDU UNIVERSITY ISLAMABAD

FACULTY OF MANAGEMENT SCIENCES

(DEPARTMENT OF BUSINESS ADMINISTRATION)

Lecture # 2
Course Title: ‘Principles of Micro
Economics’
Course Instructor: Ms. Maryam Bibi
Educational Level: Bachelor
Applied from: Spring 2021
 Production Possibility Frontier (PPF)
 A production possibility frontier (PPF) shows
the maximum possible output combinations of
two goods or services an economy can achieve
when all scarce resources are fully and
efficiently employed.

 Reallocating scarce resources from one

product to another involves an opportunity
cost.
 There is always a tradeoff along the PPF. (Opportunity Cost)
 Points outside the curve are unattainable.
 We achieve production efficiency when the point is on the curve
 When a point is inside the curve, this is product inefficient.


Opportunity Cost: is the benefit, profit, or value of something

that must be given up to acquire something else.


Note: Opportunity Cost is a ratio between the decrease in

quantity of a good and an increase in quantity of another
good along the PPF.
Consider the figure for two goods shoes and hats:

Shoes

18

15

11
6

0
1 2 3 4 Hats
a)
ANALYSIS
The graph shows the supply of these goods by showing the
combination that can be produced with economy’s resources.
b) Economy produces 1 unit of hat for which she has to give up
3 (18-15) units of shoes.
c) Hence the opportunity cost of producing 1 unit of hat is
evaluated by loss to gain ratio that is, 3/1=3
d) Similarly economy produces 2 units of hats for which she
has to give up 4 (15-11) units of shoes.
Opportunity cost to produce 1 more unit of hat is,

4/1=4
So opportunity cost of producing more and more units of hats
will continually increase as more units of shoes are to be
sacrificed to have additional units of hats.
 Role of Government

Govt. intervene by producing goods and

services for public consumption.
 Defense, police and education.

 Government through taxes and subsidies

redistributes income from rich to poor.

 Through taxes, government discourage

consumption of alcohol, tobacco.

 MICRO ECONOMIC THEORY
(THE CIRCULAR FLOW OF ECONOMIC
ACTIVITY)

• Microeconomic theory deals with economic

behavior of individual decision making units
such as individual consumers, resource
owners and business firms.
• Microeconomics focuses on two economic
units households and business firms. It
examines the operation of two types of
markets i-e market for goods and services
and market for economic resources.
 Households own labor, capital, land and
.


natural resources.
 Business firms pay to households wages,
salaries interest and rent services that
household provide.
 Business firms in return produce goods and
services.
 The household then use the income they
receive from firms to buy those goods and
services. This income is cost of production of
firm.
 The expenditures of households are receipt of
firms.
Graph
 Positive & Normative Analysis
Positive analysis studies “what is”. It is concerned
with how the economic system performs the basic
functions of what to produce, how to produce, for
whom to produce and how it ratios the available
supply of goods over time.
 Normative Analysis
 It studies “what ought to be”. It is concerned
with how the basic economic functions should
be performed. It is based on value judgment.
 In the most simplest word, normative
economics focuses on value of economic
fairness. For example: Under high rate of
inflation the minimum wage rate of a labor
should be Rs. 25000.
 Determination of Prices
 Prices of goods and services are determined in the
market for goods and services.
 If household’s demand for commodity increases, its
price increases which induces firm to produce more
until shortage is eliminated.
 On the other hand household’s demands falls
responding to the high price level.
 Due to reduction in household’s demands for
commodity, price level also decreases which induced
firms to produce less until the surplus is cleared
because at lower price households purchases more of
commodity while firms produces less.