ECN1101 Micro Economics

Ms. Farida
1. List relevant micro-economic and macroeconomic factors and their impact on
business opportunities (e.g., fiscal and monetary policies, population dynamics,
emerging markets, growing influence of developing nations, political and economic
instability, inflation, fluctuating currencies,protectionism, growth of outsourcing,
and regional trading blocs)
• 1.1 Define economics and discuss the difference between
microeconomics and macroeconomics
• 1.2 Identify the three basic economics questions and the two
opposing sets of answers
• 1.3 Distinguish between positive and normative economics
• 1.4 Explain scarcity, opportunity costs, trade-offs, and choices
• 1.5 Distinguish between consumer goods and capital goods and
explore production possibility curves
• 1.6 Distinguish between absolute and comparative advantage
 What is Economics?
• Economics is a social science as it studies the behaviour of individuals
and society at large.
• Economics is the study of choices leading to the best possible use of
scarce resources in order to best satisfy unlimited human needs and
wants.
Micro v/s Macro
Three basic economic questions: resource allocation and output/income distribution
• What to produce: All economies must choose what goods and services and what quantities
of these they wish to produce.
• How to produce: All economies must make choices on how to use their resources in order
to produce goods and services. Goods and services can be produced by use of different
combinations of factors of production (for example, relatively more human labour with
fewer machines, or relatively more machines with less labour), by using different skill
levels of labour, and by using different technologies.
• For whom to produce: All economies must make choices about how the goods and services
produced are to be distributed among the population. Should everyone get an equal amount
of these? Should some people get more than others? Should some goods and services (such
as education and health care services) be distributed more equally?

• The first two of these questions, what to produce and how to produce, are about resource allocation, while the third, for
whom to produce, is about the distribution of output and income.
Discuss the resources (factors of production)
required to deliver an Economics lesson.
 Positive v/s Normative Economics
• Economists think about the economic world in two different ways: one way tries to describe and explain
how things in the economy actually work, and the other deals with how things ought to work. The first
of these is based on positive statements, which are about something that is, was or will be. – It may use
hypothesis, theory or models.
• e. g. the unemployment rate is 5%; industrial output grew by 3%
• if the government increases spending, unemployment will fall
• a higher rate of inflation is associated with a lower unemployment rate

• The second way of thinking about the economic world, dealing with how things ought to work, is based on
normative statements, which are about what ought to be. These are subjective statements about what should
happen
• The unemployment rate should be lower.
• Health care should be available free of charge.
• Extreme poverty should be eradicated (eliminated).
 SCARCITY and OPPORTUNITY COST

• Scarcity is the situation in which available resources, or factors of production, are finite,
whereas wants are infinite. There are not enough resources to produce everything that
human beings need and want.

• Opportunity cost is defined as the value of the next best alternative that must be given
up or sacrificed in order to obtain something else.

e.g. When we chose to do something, we have to give up something else we could have
done instead. E.g your decision to come to college today means you gave up some other
activity like sleeping, reading or visiting a friend. If your best or favourite alternative to
coming to college was sleeping, then the sleep time you sacrificed is the opportunity cost of
coming to college. Opportunity costs aroused in this situation because time is limited or
scarce. If it were endless, one would never have to give up/ sacrifice any activity to do
some other one.
 Examples of Opportunity Cost
• When a consumer chooses to use her $100 to buy a pair of shoes, she is also choosing not to
use this money to buy books, or CDs, or anything else; if CDs are her favourite alternative
to shoes, the CDs she sacrificed (did not buy) are the opportunity cost of the shoes.

• When a business chooses to use its resources to produce hamburgers, it is also choosing not
to produce hotdogs or pizzas, or anything else; if hotdogs are the preferred alternative, the
hotdogs sacrificed (not produced) are the opportunity cost of the hamburgers.

• Note that if the consumer had endless amounts of money, she could buy everything she
wanted and the shoes would have no opportunity cost. Similarly, if the business had endless
resources, it could produce hotdogs, pizzas and a lot of other things in addition to
hamburgers, and the hamburgers would have no opportunity cost. If resources were limitless,
no sacrifices would be necessary, and the opportunity cost of producing anything would be
zero.
• Think of three choices you have made this week and describe the
opportunity cost of each one.
 To sum up….

• Society’s wants are unlimited, but ALL resources are limited (SCARCITY).
• Due to scarcity, choices must be made. Every choice has a cost (TRADE OFF).
• Resources are the inputs used to produce goods and services wanted by people,
and for this reason are also known as factors of production.
• They include things like human labour, machines and factories, and ‘gifts of
nature’ like agricultural land and metals inside the earth. Factors of production
do not exist in unlimited abundance: they are scarce, or limited and insufficient
in relation to unlimited uses that people have for them.
PPC
• A model is a simplified representation of something in the real world.
• It represents only the important aspects of the real world being
investigated ignoring the unnecessary details.
• The production possibilities curve (or frontier) represents all combinations of the maximum amounts of
two goods that can be produced by an economy, given its resources and technology, when there is full
employment of resources and productive efficiency. All points on the curve known as production
possibilities.
PPC
• Consider a simple hypothetical economy producing only two goods: microwave ovens and computers. This
economy has a fixed (unchanging) quantity and quality of resources (factors of production) and a fixed
technology (the method of production is unchanging).
 Conditions - PPC
• All resources must be fully employed. This means that all resources are being fully used. If there were
unemployment of some resources, in which case they would be sitting unused, the economy would not be producing
the maximum it can produce.
• All resources must be used efficiently. Specifically, there must be productive efficiency. The term ‘efficiency’ in a
general sense means that resources are being used in the best possible way to avoid waste. (If they are not used in the
best possible way, we say there is ‘inefficiency’.)
• Productive efficiency means that output is produced by use of the fewest possible resources; alternatively, we can say
that output is produced at the lowest possible cost. If output were not produced using the fewest possible resources,
the economy would be ‘wasting’ some resources.
 Failing condition - PPC
• What would happen if either of the two conditions (full employment and productive efficiency) is not met? Very
simply, the economy will not produce at a point on the PPC; it will be somewhere inside the PPC, such as at point F.
At F, the economy is producing only 15 microwave ovens and 12 computers, indicating that there is either
unemployment of resources, or productive inefficiency, or both. If this economy could use its resources fully and
efficiently, it could, for example, move to point C and produce 26 microwave ovens and 25 computers. However, in
the real world no economy is ever likely to produce on its PPC.
• An economy’s actual output, or the quantity of output actually produced, is always at a point inside the PPC,
because in the real world all economies have some unemployment of resources and some productive inefficiency.
The greater the unemployment or the productive inefficiency, the further away is the point of production from the
PPC.
• The condition of scarcity does not allow the economy to produce outside its PPC. With its fixed quantity and
quality of resources and technology, the economy cannot move to any point outside the PPC, such as G, because it
does not have enough resources (there is resource scarcity).
 PPC and Opportunity cost
• Say the economy is at point C, producing 26 microwave ovens and 25 computers. Suppose now that consumers
would like to have more computers. It is impossible to produce more computers without sacrificing production of
some microwave ovens. For example, a choice to produce 31 computers (a move from C to D) involves a decrease
in microwave oven production from 26 to 15 units, or a sacrifice of 11 microwave ovens. The sacrifice of 11
microwave ovens is the opportunity cost of 6 extra computers (increasing the number of computers from 25 to 31).
Note that opportunity cost arises when the economy is on the PPC (or more realistically, somewhere close to the
PPC). If the economy is at a point inside the curve, it can increase production of both goods with no sacrifice, hence
no opportunity cost, simply by making better use of its resources: reducing unemployment or increasing productive
efficiency.
• Capital goods are man-made products used by a business
to produce consumer or other capital goods. 
• Consumer goods are products used by consumers.
Capital goods include items like buildings, machinery, and tools
Examples of consumer goods include food, appliances, clothing,
and automobiles.
Absolute advantage v/s comparative advantage
• Absolute advantage refers to the ability of one country to produce a good using fewer resources than another
country. Putting it differently, a country has an absolute advantage in a good if with the same quantity of
resources it can produce more of the good than another country.

According to the theory of absolute advantage,

if countries specialise in and export the good
in which they have an absolute advantage (can
produce with fewer resources), the result is increased
production and consumption in each country.
 Comparative advantage refers to the situation where one country has a lower opportunity cost (relative cost) in
the production of a good than another country

Coffee Robots Opportunity cost (Coffee) Opportunity cost (Robots)

Coffenia 8 4 4 units of robot = 1 8 units of coffee = 2
8 units of coffee 2 4 units of robots
Robotia 3 6 6 units of robots = 2 3 units of coffee = 1
3 units of coffee 6 units of robots 2

Coffenia has a lower opportunity cost in producing coffee and Robotia has a lower opportunity cost in producting robots.

Therefore, Coffenia has a comparative advantage in cotton production, while Robotia has comparative advantage in
robots.

A country has a comparative advantage in the production of the good that has a lower opportunity cost

According to the theory (or law) of comparative advantage, as long as opportunity costs in two (or more) countries
differ, it is possible for all countries to gain from specialisation and trade according to their comparative advantage.
•
Review time
1 Which of the following are positive statements and which are normative?
• (a) It is raining today.
• (b) It is too humid today.
• (c) Economics is a study of choices.
• (d) Economics should be concerned with how to reduce poverty.
• (e) If household saving increases, ceteris paribus, there will be a fall in household spending.
• (f) Households save too little of their income.
• Suppose a firm can produce either 5,000 units of consumer goods plus 4,000 units of producer goods or 6,000
units of consumer goods plus 3,000 units of producer goods. Explain the opportunity cost of producing the
extra 1,000 units of consumer goods. [2 marks]

• Solution
• The firm gains 1,000 units of consumer goods (from 5,000 to 6,000) at the opportunity cost of 1,000 units of
producer goods (from 4,000 to 3,000).