Micro-Economic Theory

and Management

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 Course Contents

 An Introduction: Nature and Scope of

Economics
 Demand and Supply Analysis
 Theory of Consumer Behviour
 Theory of Production
 Market Structure

Professional Skill Development Activity and Examinations

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References
 Principles of Microeconomics: H L
Ahuja

 Macro-Economic Theory: M L Jhingan

 Macroeconomics: Theory and Policy:

Dwivedi

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 Module 1
Nature and Scope of Economics

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An Introduction
 Economics
◼ Definitions
◼ Basic Economic Problem
◼ Factors of Production
◼ Branch: Microeconomics and Macroeconomics
◼ Scope and Limitations of economics
 Opportunity Costs and Marginal decision
 Approaches to Economic Analysis,
 Production Possibility Frontiers

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Economics
 Economics is the study of how individuals and
societies choose to use the scarce resources.

 Economics is the study of scarcity and its implications

for the use of resources, production of goods and
services, growth of production and welfare over time,
and a great variety of other complex issues of vital
concern to society.

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Economics
 Our activities to generate income are
termed as economic activities which are
responsible for the origin and
development of Economics as a subject:
Inquiry into the nature and cause of
wealth of nations (Adam Smith)
 It is, in total, concerned with the
production, consumption, distribution
and investment of goods and services

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Selected Definitions of
Economics
 Adam Smith: Economics is termed as the “science of
wealth”, that is, the economy of a nation depends on the
wealth generated through the goods and services.
 Alfred Marshall: Economics is defined as the “means to
ends”. Here, the means are the goods and services that are
available. The ends refer to the needs and requirements by
people that are satisfied through the means
 Paul Samuelson: The study of how people and society
choose, with or without the use of money, to employ scarce
productive resources which could have alternative uses, to
produce various commodities over time and distribute them
for consumption now and in the future among various
persons and groups of society

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Why Economic Problem Arises
 Unlimited Wants (budget/income
constraint)
 Scarce Resources – Land, Labour,
Capital (limited means - Goods are
limited and wants are limitless).
 Resource Use (alternative uses)
 Choices (multiplicity of wants and
different priorities)

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The Twin theme around which Economics
Revolve: Scarcity & Efficiency
 Scarcity
◼ Means that people want more than is available
◼ Scarcity requires choice
◼ When there is scarcity and choice, there are costs
(Most of economics is based on the simple idea that
people make choices by comparing the benefits of
options)
 Efficiency
◼ Denotes the most effective use of a resources in
satisfying people’s wants and need. It is the optimal
allocation of resources with minimal waste and
inefficiency.

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Basic Economic Problems

 What to produce

 How much to produce

 How to produce

 For whom to produce

What to produce
 This problem involves selection of goods
and services to be produced

 Every economy has limited resources and

thus, cannot produce all the goods

 Do we opt for capital goods or consumer

goods?
How much to Produce
 How much quantity to be produced of each
commodity

 More of one good or service usually means less of

others.

 Allocate the resources in a manner which gives

maximum aggregate satisfaction/benefit/profit.

 It depends on the principle of marginalism

How to produce
 The production of a good is possible by various
methods. For example, you can produce cotton cloth
using handlooms, power looms or automatic looms.
While handlooms require more labour, automatic
looms need higher power and capital investment
(Labour or capital intensive).

 The choice depends on the availability of different

factors of production and their prices.

 Usually, a society opts for a technique that optimally

utilizes its available resources
For whom to produce
 Can a society satisfy each and every human
wants? Certainly not.

 Selection of the category of people who will ultimately

consume the goods, i.e. whether to produce goods for
more poor and less rich or more rich and less poor.

 Goods are produced for those people who have the

paying capacity. The capacity of people to pay for
goods depends upon their level of income.
Factors of Production
Resources used in the production
of goods and services

Four factors of production:

1. Natural and Physical Resources
2. Labor
3. Capital
4. Entrepreneurs

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Factors of Production
Natural and Physical Resources
Materials supplied by nature (such as land, water, mineral
deposits, and trees)

Labor (or Human Resources)

Physical and mental capabilities of people as they contribute
to economic production

Capital
Funds needed to create and operate a business enterprise

Entrepreneur
Person who operates business or makes the decisions
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Micro and Macro economics

 Microeconomics studies how

individuals and firms make decision or
economic choices in particular markets
and the implications of such interactions
 Macroeconomics studies the behavior
of economic aggregate like GDP, total
consumption, unemployment, inflation,
growth rate of the economy.

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Three Major Aspects in Micro-
Economics
 Opportunity cost
A potential forgone profit from a missed opportunity—the result of
choosing one alternative and forgoing another.

 Marginalism
The process of analysing the additional or incremental benefits or
costs arising from a choice or decision

 Market Efficiency
A perfect, complete, costless, and instant transmission of
information.
Opportunity Cost
 Choice involves sacrifice: as more food you
choose to buy, the less money you will have to
spend on other goods
 Production/Consumption of one thing involves
sacrifice of alternatives
 Scarcity forces us to make tough decisions
 The cost of using an economic good is the cost
of foregoing the next best alternative to which
that resource could have been put - Way of
putting a cost on economic decisions
 Opportunity cost– the cost expressed in
terms of the next best alternative sacrificed
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Opportunity Cost

 The alternative of producing one unit of

commodity “x” is the amount of commodity
“y” that must be sacrificed in order to use
resources to produce “x” rather than “y”
 Opportunity cost of choosing a decision
(e.g., choosing X over Y) is the sacrifice we
make by not choosing Y.
 Costs that were never incurred: Associated
with the “road not taken”

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 What is the OC of you coming to
class today?

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Marginal decisions
 Most decisions are not just whether you do
something or not, but how much of
something you do
 How much of something depends on the
evaluation of decision at the margin- what
is the additional benefit and additional cost
of doing it? Additional money spent, time
spent on some activity.
 Examine trade-off- a comparison of
additional benefits of doing something
rather than something else
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Rational Choices
 Choices that involve weighing up the
benefit of any activity against its
opportunity cost
 Choosing items that gives you the
best value for money- the greatest
benefit relative to cost (what to
produce)
 Rational decision making involves
weighing up the marginal benefit and
marginal costs of any activity
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Scope of Economics
 Economics covers a wide range of
subjects from individual decision-
making to global economic policies.
The scope is generally divided into
“Microeconomics” and
“Macroeconomics”.

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Microeconomics
 This branch of economics studies the behaviour of
individuals and firms in making decisions regarding
the allocation of limited resources.
◼ Consumer Theory: How individuals make
decisions about what to consume.
◼ Producer Theory: How firms decide on
production and pricing. Market
◼ Structures: Analysis of perfect competition,
monopoly, and oligopoly.
◼ Welfare Economics: How the allocation of
resources affects social welfare.

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Macroeconomics
 Macroeconomics deals with the economy as a
whole, focusing on aggregate indicators.
◼ National Income Accounting: Measurement of a
country’s economic performance through GDP,
GNP, etc.
◼ Monetary Policy: Central bank decisions
regarding money supply and interest rates.
◼ Fiscal Policy: Government decisions on spending
and taxation.
◼ International Economics: Trade, exchange rates,
and globalisation.

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Development Economics,
Environmental Economics and Others..
 Focuses on the economics of developing
countries, poverty alleviation, and economic
growth strategies.
 Studies how economic activities impact the
environment and how policies can mitigate
negative effects like pollution and resource
depletion.
 Other branches include Mathematical
Economics, International Economics, Financial
Economics etc.

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Limitations of Economics
 Economics is limited because it is a complex social
science heavily influenced by unpredictable human
behavior, relies on simplifying assumptions that don't
always hold true in the real world, and lacks controlled
laboratory experiments to test theories.

 Furthermore, it struggles with data collection challenges,

often focuses too much on monetary value at the
expense of social/environmental factors, and can be
subject to the ideological biases of economists
themselves.

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Limitations of Economics
 Assumption of Rationality
 Ceteris Paribus condition
 Static Analysis
 Measurement Challenges
 Predictive Limitation
 Externalities and Public Goods

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Production-Possibility Frontier
 The production possibility frontier shows
the maximum amounts of production
that can be obtained by an economy,
given its technological knowledge and
quantity of inputs available.
OR
 PPF show the different combinations of
goods and services that can be
produced with a given amount of
resources.
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 Production Possibility
Frontiers
If it devotes all
Capital Goods Assume a
resources to country
capital
goods it could two
can produce
produce
types ofa goods
maximum
Ym of Ym.
with its resources
If– itcapital
devotesgoods
all its
resources
and consumer to
If the countryYo
is A consumer
goods goods it
at point A on the could produce a
PPF It can maximum of Xm
produce the
combination ofY1Yo BIfresources
it reallocates its
(moving round
capital goods and the PPF from A to B) it can
Xo consumer produce more consumer
goods but only at the
goods expense of fewer capital
goods. The opportunity
Xo X1 Xm Consumer
cost of producing anGoods
extra
Xo – X1 consumer goods
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is Yo – Y1 capital goods.
 Production Possibility
Frontiers
It can only produce at
points outside the PPF
if it finds a way of
expanding its
resources or improves
Capital Goods the productivity of
those resources it
already has. This will
push the PPF further
Y1
C outwards.

.
Yo

Production B
inside the PPF
– e.g. point B
means the
country is not
using all its
resources
Xo X1 Consumer Goods
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 Utility/Benefits of PPF
 Helps in economy’s choice between
current consumption goods and
investment or capital goods
 At times also shows the crucial economic
notion of tradeoffs
 Productive Efficiency: occurs when an
economy cannot produce more of goods
without producing less of another good.
 Reasons for inside shift of PPF
◼ Business cycle and depression
◼ Inefficiency and dislocation, strikes, political
changes and revolution

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Approaches to Economic
Analysis
 The main objective of economic analysis is
to observe the findings like productivity,
efficiency, and effectiveness of ongoing
functions within an economy.
 There are two prominent types of methods
of economic study or analysis:
◼ Deductive Method
◼ Inductive Method
Deductive method
• The deductive method involves reasoning from a few fundamental
propositions, the truth of which is assumed.

• The study starts by assuming factual information or rudimentary

facts and then arriving at a concrete result or conclusion by
following logical reasoning or analytical abilities.

• In a nutshell we can say that in this method we start our study from
a general assumption and conclude our analysis with specific
objects, which means we go from general to specific.

• Therefore, the common rule to remember in the case of deductive

methods is to move from general inputs to a particular assumption
and, eventually, constructive theories.
Stages involved in Deductive
methodology
 Three stages or phases are recognized in
the Deductive method :
◼ Observation of the given topic

◼ Making hypotheses using Logical reasoning

◼ Experimentation of the hypothesis through

more similar observations.
Advantages and Disadvantages
 Advantages of the Deductive method :
• Simple and convenient: This method is observation based
and is fairly easy to practice.
• Avoids the necessity of experimentation: Experiments are
essential and indispensable in subjects like physics,
chemistry, etc unlike in the case of economics where the
method works as an alternative to experiments.

 Demerits of deductive reasoning :

• Based on assumptions: There is a higher chance of going
inaccurate conclusions leading to invalid predictions.
• Unrealistic approach: The method works on the basis
general to specific using imagination of including all under
the same umbrella, hence real-life problems cannot be
solved by imaginative or utopic solutions.
Inductive method
• The inductive method involves collection of facts,
drawing conclusions from them and testing the
conclusions by other facts.
• Analysts or theorists advance from a practical outlook
to a scientific problem in order to be more accurate in
finding the most accurate solution using theoretical
knowledge and practical applications.
• The Induction method is processed in two forms
• Statistics
• Experimentation
• This method is basically observed with statistical forms
of investigations. It involves a lot of facts including
numbers, quantities, and formal terms.
Advantages and Disadvantages
 Advantages of the inductive method :
• More pragmatic: It is a very practical and applicable method, and it is
simply descriptive.
• More Accurate: It is subject to verification a number of times as it is based
upon facts and statistics.
• Laws and theories under the inductive method may not be universal but are
condition specific.

 Demerits of the inductive method :

• If in case the analysts or theorists do not possess a balanced and stable
judgment, then this method is unhelpful as they will be extracting
insufficient data.
• Unavailability of facts: since this method works upon the facts and their
experimentation, it is often difficult to collect primary data and facts and
their access for experiments.
• The Inductive method is an incomplete method alone. It can be used if
combined with deductive methods or deductive reasoning.
Comparision

Basis Deductive Method Inductive Method

Application Universal Situation Specific

Technique Abstract Practical

Analytical, Prior, or Abstract Historical, Empirical, or

Other names
Method Posterior Method

Facts are followed by Logical Practical Scenario to Scientific

Procedure
Reasoning Techniques

Confirmation of the Making of

Results the Hypothesis Generalized Results
 Thank You

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