Introduction to Micro Economics.

Economics:

Economics is a social science deals with human wants and satisfaction. As a subject of study,
Economics emerged in a systematic manner after the publication of "an enquiry into the nature
and causes of wealth of nation" by the famous economist Adam Smith. Classical economics
treated the subject as the study of wealth, accumulation and spending of wealth. Later the
scope of Economics has been expanded to welfare, scarcity, choice and on all other aspects
connected with the satisfaction of human wants. The concept of growth was added to
economics by incorporating time element. This made the subject dynamic. Briefly, economics
can be defined as the study of human behaviour in relation with unlimited wants and scarce
resources.

Economy / Economics system:

All the institutions and practices that can be connected with human wants and satisfaction is
considered as an economic system. It includes socio - economic - political institutions and
practices because the system is influenced by the changes in socio economic political factors.
There for economy is the name given to all the institutions working together to satisfy human
wants.

Functions of an Economy
The functions of an economic system mainly classified into four categories:

1. Production:

Production technically means the transformation of input into output. Production of an input
which can be used for further production is also a form of production. The process of adding or
creating or transforming usefulness (utility) is the basic element in the process of production.

Economically, the term production denotes the creation of value. Value may be of two types-

(a) Use value: it is the usefulness aur utility e of the commodity.

(b) Exchange value: it is the value of a product in terms of another product. Price is the
exchange value of a commodity which is expressed in terms of money.

production is possible by joining for factors of production such as land, labour, capital and
organisation. There fore production is the process of combining 4 factors to create value or
usefulness or utility. The modification for repairing or alteration of a product is also can be
considered as production because it increases the utility of the product.

2. Consumption:
The process of using utility is termed as consumption. Utility is created through production
process and it is used through the process of consumption. The purpose of consumption is to
satisfy human wants. a rational consumer will always try to maximize utility for satisfaction by
spending less and less resources.

3. Exchange:

in an economic system, consumption units may be different from production unit. A consumer
is not in a position to produce all the product he wants. There for transfer of product from
production unit to consumption unit is necessary. "The transfer of goods and services in
between the production unit and consumption unit using a medium like money or using barter
is called exchange".

the most common form of exchange is the shifting of a product or service from production unit
to consumption unit within ultimate purpose of want satisfaction. Exchange of commodities
against commodities (C-C) was the crude form of exchange and it was termed as barter system.
Letter A medium like money came in between and the form of exchange has been changed to
commodity- money - commodity exchange(C-M-C). Now a days due to the expansion of
business activity, the conventional exchange has been restructured to money - commodity -
money exchange (M-C-M). This form of exchange is the business exchange and the purpose of
it is to increase the volume of money (making profit) through exchange process. Besides;
money itself is is considered as a commodity. The exchange of near money instruments like
share and debenture securities etc are also included in exchange process.

4. Distribution:

The process of production is done by joining different factors such as land labour, capital and
organisation. The value created through production is the result of the efforts of factors of
production. So, this final values to be distributed to various factors on the basis of contribution
made by each factor. This is called functional distribution.

The national income of a country e is the sum of all values produced and it is the result of the
working of the entire population. national income is to be divided in between the population
which provides the data related with per capita income. Distribution of national income in
between population is termed as personal distribution.

Functioning of an economic system:

The functions of an economy are production, consumption, exchange and distribution. The joint
occurrence of these functions make a system possible. The economic functions of a system
are not independent but interdependent. For example, the final purpose of production is
consumption. Production generates income. This income is distributed to individuals through
functional distribution. individual is using this income for consumption and for further
production. The equilibrium between production and consumption is done through exchange. so,
we can say that, there is strong linkage between different functions of an economy. We can also
say that the economic functions of the system are are moving in a circular manner and
therefore we cannot neglect the interdependence and interrelation between different functions
of the economy.

If the functions of the economy are performed freely without an external interference, the
system is called free market mechanism or price mechanism. If there are restrictions to control
the functioning of the system and to control the decisions of an economy, it is called a
regulated system.

Methodology of Economics
A subject can be studied in different ways. Since Economics is the study of human behaviour,
different methods of analysis are required for its proper understanding. Generally, like all other
subjects, methodology of Economics can have two different ways:

(A)Detective method and (B) inductive method.

Deductive method:

It is the theoretical formation of a concept through the movement from a general idea to the
case of individual situation. "Deductive analysis is the moment from general to particular".

in microeconomic analysis, individual cases are analysed by assuming a general common

situation. This common Idea may be on the basis of observation; earlier conclusion, perceptions
etc. For example: generally it is found that investment it is having inverse relationship with
interest rate. This general preposition can be used to evaluate the specific behaviour of an
individual investor in a situation of falling interest rate.

Inductive method:

it is the theoretical formation of a concept through the movement from an individual case to the
general conclusion. In other words, " inductive analysis is the moment from particular to
general".

A general theory aur idea can be framed by observing several individual cases in different
situations. This general conclusion is applicable to most of the cases of individual situation. For
example: the concept of demand theory can be derived by observing the behaviour of different
individuals in case of different products.
Positive and Normative Analysis

A strong debate is going on in Economics regarding the nature of the subject; whether it is
positive or normative.

A positive science deals with cos effect relationships. It explains the basic question "what it is?".
It is purely objective based analysis. It can be more absolute than relative. a positive science
deals the core of relationship between different variables by removing abnormality.

A normative science is more subjective and impersonal. It explains the question "what ought to
be?". It is more relative than absolute. it incorporates social, economic, cultural, political and
other aspects of the subject economics.

Economics have both positive and normative components. For example in demand theory the
relationship between price and quantity is assessed and identify and an inverse relationship
between price and quantity demanded. This part is positive. But to analyse the nature of the
commodity, a more detailed relative and normative analysis is required. Similarly, the nature,
the degree e and the the the intensity of the inverse relationship between price and quantity is
not similar for all products. For same product it is different in different situations. for proper
understanding of the economic problem we need to have both positive and normative
approaches.

Price of a commodity is a positive concept but the utility derived from the product is a
normative concept. Thanks is a positive concept but affordable tax rate is normative concept.
income of an individual is a positive concept but standard of living of the same individual is a
normative concept.

To increase the applicability and objectivity of a concept, it is necessary to make it more

positive than normative. Social welfare is purely enormity concert. Economic analysis makes it
positive through welfare analysis using income consumption expenditure etc. So so both
positive and normative approaches are necessary for the proper understanding of the subject.

Absolute and relative:

If a concept or a situation is treated independently, it is absolute. Income of a person marks

scored by a student, tax rate etc are some of the examples of absolute concept.

A concept or situation will become relative when we connect it with other similar situations or
variables. For example: if the consumption of a person is connected with the income of his
neighbour it is relative consumption. If the mark of a student is compared with the marks of
other students or with state average it will become relative. Relative analysis make an abstract
concept more concrete. Absolute as well as relative analysis and concepts are used in the
study of Economics. We have concepts like absolute and relative income, absolute and relative
poverty, price and relative price etc. In the conversion of money income into real income, we are
using relative analysis.
Value judgement in economics:

Value judgement is the notion of a person regarding "what is good" or "what is bad" to him in a
situation. the value judgement of a person is developed on the basis of socio economic cultural
political aspects. A scientific study or discipline should be value free and should be objective
based. Objectivity and value free nature are the basic criterias of determining the universal
applicability of a subject of study. If a subject is value free, it will be more positive.

In welfare economics, the welfare of a person or society is identified by making interpersonal

comparisons with explicit value judgement. Explicit value judgement means the value calculated
or measured using external tools. It is the application of objective based measurements for
calculating the value judgement of another person.

For example: The policy decision of increasing tax rate for alcoholic products may be treated
differently by different people on the basis of their respective value judgement. A person who
use alcoholic products may object it and a religious person may have or may not have any
opinion regarding the issue.

There are different schools of thoughts in economics. Few economist support the inclusion of
value judgement in economics. Some others think that economics must be value free.

Economic model:

An economic model is a simplified representation of real situation. in the real world the
relationship between different economic variables are highly complicated. To simplify it, we will
have to to select only one or two required variables which are to be analysed in detail by keeping
all other variables constant.

For example: In demand theory, the relationship between price and quantity demanded of a
commodity is analysed by keeping other variables such as income, taste and preference, price
of other commodity etc are constant. Here we are making an economic model by selecting the
required variables. Thus an economic model is the simplified representation of a real economic
situation.

Uses of economic model:

1. Economic models make economic analysis easy.

2. Economic models are used in policy making. : Before implementing a policy the successful
application of the same model is required, similarly a situation is analysed through model and it
can be recreated in some other areas. So They are the basic structure of of policy making.

3. Economic models are used to make economic predictions, predictions related with economic
environment, to mark fluctuations, identifying future prices etc.

4. Economic models are used to compare different policy instrument and variables.
Steps in model building:

1. Observing economic situation and identifying the problem to be analysed.

2. Identifying the variables and selecting the variables to be analysed.

3. Setting up of hypothesis.

4. Collection, analysis and interpretation of data on required variables.

5. Accept / reject the hypothesis.

6. Modification, re-modification and ri analysis based on feedback.

Basic Economic Problems

An economic problem arises because of two reasons; scarcity and choice. The problem of
scarcity was incorporated to economic science by the famous economist Lionel Robins. In any
economic system, weather capitalist socialist or mixed, the decisions have to be made about
basic economic problems such as "what, how and for whome to produce. Here the economy
need to solve the issues such as what commodity, what variety, how much, what method, how
the output is to be distributed etc.

The different dimensions of basic economic problems can be summarised as:

(1) Problem of choice of products or allocation of resources: This is the most fundamental
and primary issue. Since resources are limited, a rational choice East be made. If we
decide to produce one commodity, it will be at the cost of another commodity which
cannot be produced. So, decision regarding what commodity, what variety and how
much of each variety is highly relevant.

(2) Problem of choice of method of production: This question is regarding the mode of
production to be preferred in an economics system. Capital intensive and labour
intensive are the two prominent methods. It is normally governed by the availability and
efficiency in production. This decision is also connected with the fields of distribution,
welfare, growth and international trade.

(3) Problem of distribution of national product: The most difficult problem is the
distribution of national income. The prices of different factor inputs, the shares of
different productive factors, problem of equity, equity efficiency trade off etc are to be
[Link] still remains as a major controversy among the economist.

(4) Problem of economic efficiency: Scarcity of resources stresses the issue of efficient
use of resources. Allocation of resources can be considered efficient only if a change in
allocation does not increase total volume of product or total welfare of the economy.
Therefore economic efficiency is a combination of efficiency in production and
 distribution.

(5) Problem of the extent of utilisation of resource: To want extent the available resources
are to be used is another important issue. The underutilization of resources leads to the
problem of in efficiency. The over utilisation of resources may lead to the problem of
sustainability. A balance in between the use of different factors highly relevant.

(6) Problem of expansion of productive capacity: In the long run, the basic issue is the
balanced and study growth of the economy. Expansion in productive capacity is an
important tool to address the growth and development needs of the future.

Production Possibility curve:

"Paul A Samuelson introduced a tool to analyse various problems of an economy which is called
as production possibility curve. This is also known as production possibility frontier, product
transformation curve, marginal opportunity cost curve etc. Production possibility curve is the
locus of different combinations of two goods that an economics system can produce given the
quantities of productive resources and techniques of production"

Here it is assumed the fixity of available productive resources and techniques of production, full
employment and complete technical efficiency.

Below is given a production possibility curve of two good steel and cloth.

In the figure AF is the production possibility curve which slops downloads from left to right and
concave to the point of origin. As the economy moves from A to B, D, E, F the economy is
sacrificing some amount of steel against the production of cloth.

The slope of production possibility curve is measured by the marginal rate of transformation
(marginal opportunity cost) between these two goods. MRT between two goods is the quantity
of a commodity to be sacrificed to produce the marginal unit (last unit) of another commodity.
(In this figure MRT is increasing. MRT at point B is 2/10, at C: 4/10, D: 6/10 and so on).
The following points are to be noted with respect to production possibility curve.

 A production point on the PPC represent efficient and fulller utilisation of resources.

 A point within the production possibility curve represent under utilisation of resources.

 Moment from an inside point to the point of PPC shows and improvements in productive
efficiency.

 Expansion of productive capacity results in and outward shift of PPC.

 If marginal opportunity cost is constant or MRT constant, PPC will be a straight line. If
marginal opportunity cost is decreasing PPC will be convex to the point of origin.

From the above analysis it is clear that PPC is a tool to explain vital economic problem.