BASIC CONCEPTS OF MICROECONOMICS

LEC 2

LEARNING FOR TODAY

• Problems of the economy and their solution

• Microeconomics and macroeconomics

• Concepts:

- Rationality

- Marginalism

- opportunity cost

- General and partial equilibrium

PROBLEMS OF THE ECONOMY

• WHAT TO PRODUCE?

HOW TO PRODUCE?

FOR WHOM TO PRODUCE?

LAND, LABOR, CAPITAL & ENTERPRISE

RENT, WAGES,INTEREST, PROFIT

BUY GOODS AND SERVICES

SELL GOODS AND SERVICES

Economic systems

• FREE MARKET SYSTEM

COMMAND OR PLANNED SYSTEM

MIXED ECONOMY

MICROECONOMICS V/S MACROECONOMICS

• Micro has been derived from GREEK word “

MIKROS ”which mean small .

• It is a study of the individual units of economic

system .

• In other words a small part of economy & not the

whole economy . Prof.Boulding , “micro economics seeks to explain the working of individuals, firms, households, individual prices, wages, particular industries ” .

• Merits : – A worm’s eye view of a small specific unit. – Formulating economic policies and scarce

resources of the country. – Achieve maximum output with minimum costs. – It is helpful for macro economic studies.

• Demerits– It does not give the correct pictures of the

working of the economy . – It does not provide solution to certain economic

problems– The area of study covered by it is limited . – It cannot be abruptly applied to the study of

macro economic problems .

MACROECONOMICS– Macro is been derived from the Greek word “ MAKROS

”which means LARGE .

– Macro economic is the study of large part of the

economy i.e., The whole economy.

– The study of economic behavior of the economy as a

whole & not the individual economic units of the

economy.

– Prof. Boulding , “ Marco economics deals not only with

individual quantities but with the aggregates of these

quantities , not with the individual incomes , but with

national income , not with individual prices , but with

prices level , not with individual outputs but with the

national output ” .

• Merits : – A bird’s eye-view of the entire economy . – Macro economic is more useful in solution to

economy problems. – It is quite helpful in formulation of GOVT.

Economic policies. – Study of macro economic is useful to micro

economic studies.

• Limitations : – The study of individual units becomes more

useful than study of aggregates. – It is useful for developed countries for solving

their problems but less useful or undeveloped country.

– It studies the economy in general or in detail .

CONCEPTS• RATIONALITY

• Rationality is one of the most over-used words in economics.

• Behavior can be rational, or irrational. So can decisions, preferences,

beliefs, expectations, decision procedures, and knowledge.

• Rationality ("wanting more rather than less of a good") is widely used

as an assumption of the behavior of individuals in microeconomic

models and analysis

• "rationality" simply to mean that an individual acts as if balancing

costs against benefits to arrive at action that maximizes personal

advantage

MARGINALISM

• Marginalism refers to the use of

marginal concepts in economic theory

• Marginalism has been criticized for being

extremely abstract, as “unobservable,

immeasurable and untestable”.

• Marginal utility

• Marginal utility is subjective, as the value

of an additional unit of consumption is

based on the individual's circumstances

Opportunity cost

• Opportunity cost is the cost related to the next-best choice

available to someone who has picked between several

mutually exclusive choices

• It is a key concept in economics. It has been described as

expressing "the basic relationship between scarcity and choice

• The notion of opportunity cost plays a crucial part in ensuring

that scarce resources are used efficiently

• Thus, opportunity costs are not restricted to monetary or

financial costs: the real cost of output forgone, lost time,

pleasure or any other benefit that provides utility should also

be considered opportunity costs.

EXAMPLES• A person who has $15 can either buy a CD or a shirt. If he

buys the shirt the opportunity cost is the CD and if he buys

the CD the opportunity cost is the shirt. If there are more

choices than two, the opportunity cost is still only one item,

never all of them.

• A person who decides to quit his or her job and go back to

school to increase their future earning potential has an

opportunity cost equal to their lost wages for the period of

time they are in school. Conversely, if they elect to remain

employed and not return to school then the opportunity cost

of that action is the lost potential wage increase.

GENERAL EQUILIBRIUM

• It seeks to explain the behavior of

supply, demand and prices in a whole

economy with several or many markets,

by seeking to prove that equilibrium

prices for goods exist and that all prices

are at equilibrium, hence general

equilibrium,

PARTIAL EQUILIBRIUM

• partial equilibrium is a type of economic

equilibrium, where the clearance on the

market of some specific goods is obtained

independently from prices and quantities

demanded and supplied in other markets.

In other words, the prices of all

substitutes and complements, as well as

income levels of consumers are constant.