ECO 101: Principles of Microeconomics

Fundamentals of Economics

Ice Breaking

• Main objective is to know each other in the class.

• Please introduce yourself. Talk about you for two minutes.

Concepts:• Meaning of ‘scare resources’ is meant ‘supply is

not abundant’. Scare resources (goods) should have some sorts of ‘price’.

• The law of scarcity states that goods are scare because there are not enough resources to produce all the goods that people want to consume.

• Scare goods are economic goods. Economic goods should have some sort of price.

How to read a graph ?

• Graph is very important in Economics.• It is a technique to present a relationship

between two variables visually.

Draw a graph using the Table

X Y10 515 1020 1525 2030 25

How to explain/ read the graph ?

Production Possibility Frontier (PPF)• A curve that illustrates the alternative combinations

of two goods that an economy can produce with given resources and technology. A production possibilities frontier (PPF) represents the boundary or frontier of the economy's production capabilities. As a frontier, it is the maximum production possible given existing (fixed) resources and technology. Producing on the curve means resources are fully employed, while producing inside the curve means resources are unemployed. The law of increasing opportunity cost is what gives the curve its distinctive convex shape.

Scenario X unit Y unit

A 4 1B 6 2C 7 3

3

2

1

0 1 2 3 4 5 6 7 X Unit

Y -Unit

A

B

C

Production Possibility Frontier (PPF)

It means if you want more of X-unit, you give up Y-unit to be on the PPF curve

D

E

An economy can operate on Points D and A but not on E. A is efficient, D is inefficient point of an economy.

Inefficient point

Scenario Rice/per acre Wheat /per acre

A 5 0

B 4 6

C 3 12

D 2 16

E 1 19

F 0 21

- 3 kg wheat

+ 1 kg rice

Opportunity cost of 1 more kg rice = giving up 3 kg wheat i.e. OC of one more kg rice is 3 kg wheat. Similarly, as one goes for more rice per acre, opportunity cost (i.e. giving up of wheat increase) this is called increasing opportunity cost.** What is the economic rational for increasing OC?

- 4 kg wheat

OPPORTUNITY COST AND INCREASING OPPORTUNITY COST

Slope• The slope of a line is measured by calculating

the change in the value measured on the vertical axis divided by the change in the value measured on the horizontal axis.

• For the production possibilities frontier to the right, this is the change in the quantity of Y divided by the change in the quantity of X.

Y Y

X X

A

A

BB

C

DC

D

Exercise: calculate slope of the PPC on A, B, and C points.

Slope = CD/BC or rise/run, or Change of Y divided by change of X.

Slope = CD/BC or rise/run, or Change of Y divided by

change of X.

Key points to remember are:(a) Slope can be expressed as a number.(b) If the line is straight, its slope is constant

everywhere.(c ) The slope of the line indicates whether

the relationship between x and y is direct or inverse.

(d) Direct relationship occur when variable move in the same direction; inverse relationship occur when variable move in the opposite directions. Thus a negative relationship indicates the x-y relationship is inverse.

Few definitions of Economics

• Economics asks what goods are produced, how these are produced, and for whom they are produced

• Economics analyzes movements in the overall economy.

• Economics is the study of commerce among nations.

• Economics is the science of choice.• Economics is the study of money.

Main Branches of Economics

Economics

Macroeconomics

Microeconomics

What is Microeconomics

Microeconomics is concerned with the behaviour of individuals units. Examples of units are – individuals (producers, and consumers), firms, workers, producers etc.

Law of diminishing return• In economics, diminishing returns (also called diminishing marginal

returns) refers to progressive decrease in the marginal (per-unit) output of a production process as the amount of a single factor of production is increased, while holding the amounts of all other factors of production constant.

• For example, the use of fertilizer improves crop production on farms and in gardens; but at some point, adding more and more fertilizer improves the yield less and less, and excessive quantities can even reduce the yield. A common sort of example is adding more workers to a job, such as assembling a car on a factory floor. At some point, adding more workers causes problems such as getting in each other's way, or workers frequently find themselves waiting for access to a part. In all of these processes, producing one more unit of output per unit of time will eventually cost increasingly more, due to inputs being used less and less effectively.

Units of labour Total output (Units) Extra output added by additional unit of labour

0 0

1 2000 2000

2 3000 1000

3 3500 500

4 3800 300

5 3900 100

Law of Diminishing Returns

The values are diminishing

According to the law of diminishing returns, as additional units of labour are added, with land and other inputs held fixed, the extra output tends to decline.

Why law of diminishing returns works ?

• The primary reason is that the marginal product of variable input declines with fixed input. The fixed input imposes a capacity constraint on short-run production. For example while adding additional workers in a fixed area of land to produce rice, the extra production attributable to these workers is bound to fall as the capacity of the fixed input (land) is exhausted. In fact, adding too many workers actually results in a negative marginal product, meaning total product decreases.

Three Basic Problems of the Economy ?

1. What commodities are to produced ?2. How shall goods be produced ?3. From whom shall goods to be produced ?

Market solves these economic problems. Here market is not a place. Markets are mechanism by which buyers and sellers meet to exchange things.

In a market system, everything has a price, which is the value of the good in terms of money. Prices represent their terms on which people and firms voluntarily exchange different commodities.

Price coordinate the decisions of producers and consumers in a market. Higher price encourages producers and discourage consumers and vice versa.

How a market solves basic economic problems ?

What things will be produced is determined by the consumer in their daily purchase decisions.

How things are produced is determined by the competition among different producers.

For whom things are produced is determined by supply and demand in the factor markets for factor of production.

How an economy flow ?What this this ?

What this this ?