Principles of Microeconomics

ECON 1101

Chapter 01
Introduction to Microeconomics

Amina Khatun
Lecturer
Department of Economics
Faculty of Arts and Social Sciences (FASS)
Bangladesh University of Professionals (BUP)
 Learning Objectives

The objective of today’s class is to learn-

• Definition of Economics
• Ten principles of Economics
• Microeconomics vs Macroeconomics
• Some basic concepts of Microeconomics
 Wants, Needs, Scarcity, Choice, Commodity, Good, Utility, Value, Price, Capital, Costs,
Revenue, Profit, Implicit and Explicit Costs, Opportunity Cost, Production, Consumption,
Distribution, Welfare ,Ceteris Paribus etc.
• Production possibility curve
• Basic economic problems
• Circular flow of income

2
 Economics: The Meaning

• The word Economics has come from a Greek work ‘Okinomous’ meaning ‘One who
manages a household’.
• Economics is the study of how society manages its scarce resources.
• Adam Smith is considered as the ‘ Father of Economics’. His revolutionary work is the book-
The Nature and Causes of the Wealth of Nation (1776).
• According to Adam Smith- “Economics is the social science that studies the production,
distribution and consumption of goods and services”.
• According to Lionel Robbins “Economics is the science which studies human behavior as a
relationship between ends and scarce means which have alternative uses”.

3
 Economics: The Meaning

Prof. Samuelson said-“Economics is the study of how people and society end
up choosing with or without the use of money, to employ scarce productive
resources that could have alternative uses, it produces various commodities
over time and distributes them for consumption, now or in the future, among
various persons and groups in society. It analyses costs and benefits of
improving patterns of resources allocation.”

4
 Ten Principles of Economics
P 01: People face tradeoffs
• Trade off: is a situation that involves losing one quality or aspect of something in
return for gaining another quality of aspect.
• Example: a student faces trade off between studying for exam or to watch a much
awaited movie.
• Society faces trade off between efficiency and equity.
• Efficiency: society getting the most from it’s scarce resources.
• Equity: distributing economic prosperity fairly among the individuals of the
society.

5
 Ten Principles of Economics

P 02: The cost of something is what you give up to get it

• Making decision requires comparing the costs and benefits of alternative courses of
action.
• Nothing comes for free in this world. You need to give up something in order to gain
something.
• ‘Opportunity cost’ of ‘something’ is what you give up to get that ‘something’.
• Example: athletes who can earn millions if they drop out of school and play
professional sports are well aware that their opportunity cost of college is very high.
• Cricketer Sachin Tendulkar decided to quit his education in order to play professional
cricket for his country.

6
 Ten Principles of Economics

P 03: Rational people think at the margin

• A rational decision maker takes action if and only if the marginal benefit of the action
exceeds the marginal cost.
• Example: if you buy a used car, and plan to spend $10000 but the car is only priced at
$ 6000; would you still buy it if it needed $5000 in repair? Of course not; because-
a. You are a rational thinker; and
b. You would end up spending more than you planned to.

7
 Ten Principles of Economics

P 04: People respond to incentives

• Incentives: something that persuades a person to act.
• It may be punishment or reward. People responds to incentive because people make
decision by comparing costs and benefits.
• Incentives are crucial to analyzing how market work.
• Example: when gas prices rise, consumers buy more hybrid cars and fewer gas
consuming cars. Or when Cigarette taxes increase, teen smoking fall.

8
 Ten Principles of Economics

P 05: Trade can make everyone better off

• Trade allows each person to specialize in the activities he or she does best.
• By trading with others, people can buy a greater variety of goods or services.

9
 Ten Principles of Economics

P 06: Markets are usually a good way to recognize economic activity

• An economy that allocates resources through the decentralized decisions of many firms
and households as they interact in markets for goods and services.
• Market economy:
a. Allocates resources, through
b. Decentralized decisions, of
c. Firms and households as they interact.
• Households decide what to buy and whom to work for;
• Firms decide to hire and what to produce.

10
 Ten Principles of Economics

P 07 Governments can sometimes improve market outcomes

• When a markets fails to allocate resources efficiently, the government can change
the outcome through public policy- regulations against monopolies and pollution.
• Example: a dry cleaning factory can cause water pollution when they dispose off
used chemicals. Government has a task of regulating, auditing and monitoring the
activities of the market. Thus they can introduce regulating policies to protect the
environment.

11
 Ten Principles of Economics

P 08: The standard of living depends on a Country’s production

• Countries whose workers produce a large quantities of goods and services per unit of
time enjoy a high standard of living. Similarly , as a nation’s productivity grows, so
does its average income.
• Standard of living may be measured-
- By comparing personal incomes
- By comparing the total market value of a nation’s production.

12
 Ten Principles of Economics
P 09: Prices rise when the government prints too much money
• When a government creates large quantities of the nation’s money, the value of
the money falls. As a result prices increase requiring more of the same money to
buy goods and services.
• Example: when there is a lot of money in circulation in the economy, then the
income of the consumer rises and this will push up the demand for goods and
services. If purchasing power increases it leads to excess demand the producer
will not be able to fulfill the demand, and since excess doesn’t exist in the market,
the producer will increase the price. This will lea to inflation.

13
 Ten Principles of Economics

P 10: Society faces a short- run tradeoff between inflation and unemployment
• Phillips curve: show short run tradeoff between inflation and unemployment.
• Lower unemployment-higher inflation or higher unemployment- lower inflation. That
shows a negative relationship.

14
 Concept of Microeconomics
• Micro-originated from a Greek word ‘Mikros’, meaning ‘small’.
• Microeconomics is a branch of economics that studies the behavior of individuals and firms in
making decisions regarding the allocation of scarce resources and the interactions among these
individuals and firms. It generally applies to markets of goods and services.
• Microeconomics is the social science that studies the implications of incentives and decisions,
specifically about how those affect the utilization and distribution of resources.
• It shows how and why different goods have different values, how individuals and businesses
conduct and benefit from efficient production and exchange, and how individuals best coordinate
and cooperate with one another.
• Generally speaking, microeconomics provides a more complete and detailed understanding than
macroeconomics.
 Concept of Microeconomics

“Microeconomics is the study of particular firm, households, individual prices, wage, income
of industry and particular commodity”
- K. E. Boulding,

“in microeconomics we examine the trees, not the forests”

- Mc. Connel
 Microeconomics vs Macroeconomics

Microeconomics Macroeconomics
• Branch of economics that deals • Branch of economics that deals
with the behavior of individual with aggregate economic
economic units – consumers, variables such as the level and
firms, workers, and investors- as growth rate of national output ,
well as the markets that these interest rates, unemployment , and
units comprise. inflation.
 Microeconomics vs Macroeconomics

 Microeconomics studies individuals and business decisions, while macroeconomics analyzes

the decisions made by countries and governments.
 Microeconomics focuses on supply and demand, and other forces that determine price levels,
making it a bottom-up approach. Macroeconomics takes a top-down approach and looks at
the economy as a whole, trying to determine its course and nature.
 Common topics under microeconomics are supply and demand, elasticity, opportunity cost,
market equilibrium, market and forms of competition, and profit maximization.
Macroeconomics which is the study of economy-wide things such as growth, inflation, and
unemployment.
 Individual unit can take economic decisions following microeconomic theories i.e. producer
can use microeconomics in their production optimization , while macroeconomics is an
analytical tool mainly used to craft economic and fiscal policy.
 Scope of Microeconomics
Topics include-
• Supply and demand interaction
• Market equilibrium
• Elasticity
• Utility maximization
• Costs and Revenues
• Profit maximization
• Perfect competition
• Imperfect competition
• Monopoly power
• Market failure
• Government intervention
• Welfare
 Need of Studying Microeconomics

• Completing the course the students will be able to-

• Learn basic concepts and theories that shape individual’s economic decisions;
• Apply microeconomic models to explain economic decision making process by firms and
consumers;
• Explain how resources are allocated efficiently and how the structure of markets may have
an effect on this allocation;
• Show how government intervention can improve or impair the functioning of markets;
• Solve economic problems where agents are strategically interdependent on one another;
• Apply these tools to real-world examples in a correct and proficient manner.
 Basic Concepts of Microeconomics
• Wants: desires for goods and services we would like to have but may not need.
• Needs: a special kind of want, and refer to things we must have to survive, such as food, water, and
shelter.
• Scarcity: the result of people having "Unlimited Wants and Needs," or always wanting something
new, and having "Limited Resources."
• Choice: the ability of a consumer or producer to decide which good, service or resource to purchase
or provide from a range of possible options.
• Commodity: a tangible good that can be bought and sold or exchanged for products of similar value.
Example- Natural resources such as oil as well as foods like corn.
• Good: items that satisfy human wants and provide utility, but scarce in relation to its demand. All
commodities are goods, but goods subject to future speculation are commodities.
• Utility: the total satisfaction received from consuming a good or service.
 Basic Concepts of Microeconomics
• Value: the maximum amount of money an agent is willing and able to pay for a good or service, measured in
units of currency.
• Price: the quantity (usually not negative) of payment or compensation given by one party to another in return
for one unit of goods or services; generally expressed in units of some form of currency .
• Costs: an amount to be paid or given up for acquiring any resource or service.
• Revenue: the income that a firm receives from the sale of a good or service to its customers.
• Profit: the difference between the revenue received from the sale of an output and the costs of all inputs used
as well as any opportunity costs. In calculating economic profit, opportunity costs and explicit costs are
deducted from revenues earned.
 Basic Concepts of Microeconomics

• Implicit Cost: the opportunity cost of resources already owned by the firm and used in business—for
example, expanding a factory onto land already owned.
• Explicit Costs: out-of-pocket costs for a firm—for example, payments for wages and salaries, rent, or
materials.
Implicit costs are opportunity costs, while explicit costs are expenses paid with a company's own
tangible assets. Implicit costs help managers calculate overall economic profit, while explicit costs are
used to calculate accounting profit and economic profit.
• Opportunity Cost: the profit lost when one alternative is selected over another. The concept is useful
simply as a reminder to examine all reasonable alternatives before making a decision.
 Basic Concepts of Microeconomics
• Production: a process of combining various material inputs and immaterial inputs (plans, know-how) in
order to make something for consumption (output).
• Consumption: the use of goods and services by individual economic unit.
• Distribution: the way total output, income, or wealth is distributed among individuals or among the factors
of production (such as labor, land, and capital).
• Welfare: the level of prosperity and standard of living of either an individual or a group of persons. In the
field of economics, it specifically refers to utility gained through the achievement of material goods and
services.
• Ceteris Paribus: a Latin phrase that means "all other things being equal." Experts use it to explain the
theory behind laws of economics. When economists use the term Ceteris paribus, they are indicating that. all
other variables except the ones specified are assumed to be constant.
 Production Possibility Curve
Production possibility curve (PPC) or Production possibility Frontier (PPF) shows all possible
combinations of two goods or services with the given assumptions-

• Fixed resources
• Fixed technology
• Maximum efficiency
PPC shows –
• Choices
• Opportunity cost
• Efficiency
• Economics growth

25
 Production Possibility Curve
Output of Wheat

Y
A
200
B
150

0
300 400 Output of Cotton

26
 Production Possibility Curve
• Point A, B, X and Y show different choices with different combination of goods;
• The slope of the production–possibility frontier (PPF) at any given point is called the marginal
rate of transformation (MRT). The slope defines the rate at which production of one good can
be redirected (by reallocation of productive resources) into production of the other.
• PPC is concave shaped because of increasing marginal rate of transformation. It implies that
more and more units of commodity sacrificed to gain an additional unit of another commodity.
• One hundred extra tonnes of cotton involves sacrificing 50 tonnes of wheat; the opportunity
cost is ½ th of a tonne of wheat for each extra tonne of cotton; thus the slope/ MRT is ½.
• Both A and B shows efficient production. They employ the maximum capacity of country;
• Point X shows inefficient production; resources are not fully utilized;
• Point Y is unattainable with current resource and technology conditions;
• Point Y is attainable with economic growth, with increased resource or developed technology
or the both.

27
 Basic Economic Problems
• Basic Economic Problems : three basic economic questions are-
• What to produce?
• How to produce?
• For whom to produce?
Two more questions are-
• How Efficiently are the Resources being Utilized?
• Is the Economy Growing?
Can you discuss the basic economic problems with the help of PPF?
 Circular Flow of Income

• The model shows the flow of goods, services, recourse and income between different sector of
economy.
• This is the model for a closed economy.
• Two operating markets- product market and factor market
• Product market is composed of good and services; factor market comprises land, labor and
capital.
• Two operating agents- households and Firm.
 Expenditure on Goods

Land, Labor, Capital

Product Market
Circular
Factor Market
Flow of
Income

Goods and Services

Rent, Wage, Interest

 Circular Flow of Income

• Households have the means of production- land (also referred to as nature), labor and capital.
• Firms use the means of production to produce goods and services.
• The households receive money in exchange for the means of production- rent for land, wages for
labor and interest or dividend for money.
• Households purchase the goods and services from the firms; for which they pay.
• The flow of goods and resources is clockwise, but the flow of money is counter clockwise .
 References
• Book Reference
• R.S. Pindyck and D.L. Rubinfeld, Microeconomics, pp. 25-27.
• Web References
• https://www.slideshare.net/PieGS/microeconomics-introduction-and-basic-concepts
• https://www.economicshelp.org/blog/6796/economics/difference-between-microeconomics-and-
macroeconomics/
• https://www.investopedia.com/ask/answers/difference-between-microeconomics-and-macroeconomics/
• https://learn.saylor.org/course/ECON201
• https://www.economicsdiscussion.net/economic-problems/5-basic-problems-of-an-economy-with-
diagram/18173
• https://www.calltheone.com/en/consultants/circular-flow-of-income
• http://www.mpsaz.org/dobson/staff/jwmartinson/economics2/econ_notes_assignment/files/
production_possibilities_curvenotes.pdf
• https://www.rlacollege.edu.in/pdf/Eco_Presentations/3/The-PPC.pdf