MICROECONOMICS

INTRODUCTION
Prof. Shirsendu Roychowdhury

B. Com. Sem I St. Xavier’s College (Autonomous), Kolkata

 TOPICS
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 Concept of scarcity and choice

 Opportunity cost
 Three basic economic questions
 Market and Price
3 Brief Introduction to Economics
Economics was first read in ancient Greece.
Xenophon, the Greek Philosopher termed
Economics as a science of ‘household
management’. But with the change of time
and progress of civilization, the concept of
economics changed.
 Brief Introduction to Economics
4

Greek Word Two Parts Meaning

Oikos Household
Oikonomia
Nomos Management

 So the term “Economics” means ‘household

management’
 Brief Introduction to Economics
5

• “a science that enquires into the nature and causes of the wealth of
nations”
Adam
smith • i.e. how wealth is produced and how it is used

• “Economics is a study mankind in the ordinary business of life”

Alfred
• i.e. Economics studies not only the wealth but also the activities
marshall centering the wealth .

• “Science which studies human behavior as relationship between ends

Lionel and scarce means which have alternatives uses”
Robins

 Economics is the study of how societies use scarce resources to

produce valuable commodities and distribute them among different
people.
 MICROECONOMICS AND
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MACROECONOMICS

First used by
Two Schools Greek Word Meaning
Ragner Frisch

Microeconomics MIKROS Small

Major
schools of
Economics Large
Macroeconomics MAKROS
 Microeconomics and Macroeconomics
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 Microeconomics deals with the behavior of individual economic units like consumers,
workers, investors, owners of land and business firms or any individual nor entity that plays a
role in the functioning of the economy.
 Microeconomics explain why and how these units make economic decisions like
 the choices that consumers make regarding their consumption of goods and services and
how their decisions are affected by the changes in the prices and incomes.
 the decision that the firms take regarding the number of workers to hire or the decisions
of workers regarding which work to do and how much to work etc.
 how economic units interact to form larger economic units like markets and industries
 Macroeconomics deals with aggregate economic quantities like
 the level of national income, growth rate of national output,
 interest rates, unemployment, inflation etc.
 Macroeconomics involves analysis of aggregate variables. To understand these aggregate
variables we must understand the behavior of firms, consumers, workers and investors who
constitute them. Thus Macroeconomics has become increasingly concerned with
microeconomic foundations and much of macroeconomics is an extension of microeconomic
analysis.
8
CONCEPT OF SCARCITY AND
CHOICE
 SCARCITY
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 What is “scarcity”?
→some kind of restriction or limitation.
 “When the amount of something that is

available is less than the amount that is

necessary then we can say that there is scarcity
of that thing”.
 Limited Resources & Unlimited Wants.

→Resources are Scarce.

 CHOICE
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 What is “Choice”?
→“Choice” is actually what defines the decision making.
→ Selecting the Best option.
 Best implies –
→Maximizing benefit
→Minimizing loss
 “Rationality”
→an individual or economic agent must maximize his/her
benefit or minimize his/her loss.
 Now, this selection of the best option is known as “choice”
or “optimization”.
 How can it be possible ?
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1. Human wants are unlimited but they can be prioritized,

→that is it can be ordered as more important and less
important wants, or
→in other words wants can be arranged in the order of
priority .
2. Resources have alternative uses .

 Economic agents try to fulfill the most important wants.

→This is how the society tries to manage to fulfill
unlimited human wants through limited resources.
 Trade Off
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 When we are choosing one option we are leaving the other options for the time
being.
 So “Choice” involves “trade off”,
→giving up something to get some other thing.
 Thus we find that scarcity of some kind would lead to choice of the best option
which would involve trade off.
 One classic example of trade-off is between “guns and butter”.
 The more we spend on national defense (guns) to protect our country from foreign
aggressors, the less we can spend on consumer goods (butter) to raise our standard
of living at home.
 Another trade off that society faces is between efficiency and equity.
 Efficiency means that the society is getting maximum benefit from its scarce
resources, whereas equity means that those benefits are distributed fairly among
society’s members.
 When Government policies are designed often these two goals are in conflict.
13 OPPORTUNITY COST
Opportunity Cost of one item is what
you give up or sacrifice to get that
item.
 Opportunity Cost
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 Suppose a tea stall owner prepares 50 cups of tea per day

and the total cost of producing 50 cups is Rs.250.
 Suppose he sells the 50 cups of tea earning a total revenue of
Rs.300.
 Now he has given up the waiter’s job giving him a salary of
Rs.1000 per month in order to do this job.
 He started the business by investing Rs.7500 on this business
which, if he would have kept in the bank would have given
him an interest income of Rs.50 per month.
 Opportunity Cost contd..
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 Each day he is earning an accounting profit of Rs.50.

 So for 30 days his total accounting profit is Rs.1500.
 Now if he would have done a waiter’s job then he would have earned
Rs.1000 per month .
 Obviously Rs.1500 is greater than Rs.1000 and so being rational he
chooses to own the tea stall over his job as a waiter.
 Now again his total investment in this business is Rs.250 x 30 = Rs.7500.;
 If he would not have done the business then he would have kept the
money in the bank which would have given him an interest income of
Rs.50 per month.
 So by doing the waiter’s job and keeping his money in bank he would
have earned Rs.1000 + Rs 50= Rs.1050 per month and now by doing this
business he is earning Rs.1500 per month.
 Opportunity Cost contd..
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 So being rational he choose to do this business.

 So the opportunity cost of doing this business is the salary of
Rs.1000 that is sacrificed for not doing the waiter’s job along with
the interest income of Rs.50 per month that he is not getting as he
has invested his money and not kept it in bank.
 So the opportunity cost of investing his money in business is the
amount of interest income that is forgone for not keeping that
money in bank.
 So decision making or “choice” involves trade off which signifies or
reflects the opportunity cost of the agent making the decision.
17 THREE BASIC ECONOMIC QUESTIONS

1. What to produce?
2. How to produce?
3. For whom to produce?
 1. What to produce?
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 The First question that arises is What goods and services are to be
produced in society and in what quantities ?
 This question arises from the fact that human wants are unlimited, while
the resources are limited.
 In order to satisfy their wants the human beings need to consume goods
and services which give them utility.
 But since resources are limited it is not possible for the society to produce
all the goods and services that people wish to consume.
 Even a particular good or a service cannot be produced in infinitely large
quantity. Only finite amounts of a limited number of goods and services
can be produced.
 Therefore there arises this decision problem. The economy must decide
which goods and services to produce and which goods and services to
exclude from production.
 2. How to produce?
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 The second basic problem that every economy must solve is that of
deciding how to produce the goods and services that the economy has
decided to produce.
 A particular quantity of a particular good or service can be produced in
many different ways.
 The economy must choose a particular way of producing the specified
amount of the good.
 Moreover this must be done for each of the different goods and services
that the economy wants to produce.
 In the language of the economists, a particular way of producing a good
or a service or a set of goods and services is called the technique of
production.
 Therefore the question “how to produce” is also known as the problem of
“choice of techniques”. The level of technical knowledge together with
the resources available help in deciding this.
 3. For whom to produce?
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 The third question essentially refers to the problem of distribution ,

that is , among the members of the society who will receive how
much of the produced commodities .
 This problem of distribution can be solved in various ways.
 An overall central authority like the Government can dictate the
pattern of distribution , or
 the matter could be left to the existing social customs or

 conventions or through market or price mechanism.

 Whatever it be , everybody agrees that the distribution problem

should be solved in an equitable manner.
21 MARKET
Market , in economics, is defined as an
institutional arrangement that allows
buyers and sellers to interact among
themselves for the purpose of exchanging a
well defined product at a specified rate of
exchange by means of a contract which can
be formal or informal.
22

 Market is an institutional arrangement → which means it is

guided by certain rules and regulations.
 Here, the main agents are buyers and sellers.
 The buyers who comprise of the demand side of the
market and
 the sellers who comprise of the supply side of the
market.
 The buyers demand the product which is sold or supplied
by the sellers.
 The same person who is a buyer in one market might be a
seller in some other market. So this terms are used in
relative sense.
23

 In order to facilitate this process of transaction between the

buyer and the seller what is needed is a platform to interact .
 This interaction does not only mean face to face interaction
but also interaction carried out through phone calls, internet
or emails etc.
 The main thing in a market is exchange. That is the good or a
service which was owned by the sellers will be transferred to
the buyers.
 So exchanging actually means the transfer of ownership or
property right. The product here refers to a good or a service.
24

 Generally a product is defined with respect to its physical

composition, packaging and the way it is delivered to the
buyers.

 If two products are same with respect to physical

composition, packaging and way of delivery then the
products are called homogeneous product.

 If the products are different with respect to any of these then

they are called differentiated products.
25

 The rate of exchange is actually the price at

which the product will be sold (in a money
economy).
 The contract refers to the agreement that the

product will be delivered if the price is paid.

This contract can be written (formal) or
unwritten or oral (informal). This is generally
what we mean by market in economics.
 Classification of markets
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 There are various classifications of market.

When we classify market on the basis of
geographical distances we have local, regional ,
national, international markets etc.
 On the basis of commodities we have fish
market, vegetable market, meat market etc.
 Similarly in economics it is very common to
classify markets on the basis of degrees of
competition.
 Market: Classification on the basis of
degrees of competition.
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 The degree of competition refers to the power over of the agent namely the
buyer or the seller over the market price.
 If the agent have more power over the market price then degree of
competition is high.
 If the power over the market price is low then the degree of competition
is low.
 If the agent has no power over the market price then the degree of
competition is zero.
 Based on varying degrees of competition among the sellers can classify the
markets as perfectly competitive, monopolistic or monopolistically
competitive or oligopolistic.
 Based on the varying degrees of competition among the buyers we have
different market forms like monopsony, oligopsony etc.
 PRICE MECHANISM: theory of
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invisible hand
 Adam Smith in his book “wealth of nations” talked about the “theory of invisible
hand”.
 What is this invisible hand ?
 This invisible hand is also known as “Market Mechanism” or “Price mechanism”.
 That is, he meant that the “prices” in such an economy which is free from the
intervention of any supervising authority like the government, act as automatic
signals which direct the economic agents to take their economic decisions and
these decisions will collectively guide the economy to decide or find answer to
its central problems of what to produce, how to produce and for whom to
produce.
 This price mechanism is an automatic and self regulated mechanism.
 In a price mechanism the main players are the buyers and the sellers who
constitute the demand and supply side of the market respectively.
 So we need to understand the fundamentals of demand and supply in order to
understand price mechanism.