ECO -101 Introduction to Microeconomics

UNIT 01
Introduction to Microeconomics, Scarcity, PPF
Absolute/Comparative Advantage

Fabliha Fairuz
Lecturer, ESS Department
ECO -101 Introduction to Microeconomics
UNIT 01

What is
Economics
Economics is defined as “the study of how people make choices under
conditions of scarcity” (Mankiw, Principles of Microeconomics). At its core,
economics analyzes how individuals, firms, and societies allocate limited
resources—such as time, money, and labor—to satisfy unlimited wants and
needs. This subject is fundamental because every decision involves trade-offs.
When you choose one option, you inherently forgo the opportunity to choose
another. For instance, a university student with a limited monthly budget
might have to decide whether to spend money on textbooks (which are
essential for academic success) or on entertainment (a non-essential luxury).
This decision-making process encapsulates the economic problem: how to
best utilize scarce resources to achieve the highest possible satisfaction or
utility.

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ECO -101 Introduction to Microeconomics
UNIT 01

The Core of Economics – Scarcity and Trade-Offs

Scarcity - Our inability to satisfy all our wants
Scarcity itself is a relative concept. neither people wants nor their abilities to produce goods and services are constant. Scarcity is the central problem in
economics. It arises because resources (such as time, money, and raw materials) are finite, while human wants are virtually infinite. This discrepancy
forces every individual and society to make choices. Powell & Parkin (Economics) emphasize that scarcity is the reason behind the need for economic
analysis—it compels us to decide which wants to satisfy and which to leave unmet. Every decision, whether large or small, involves a trade-off. For
example, if a student spends extra hours on a part-time job, they sacrifice the time they could have spent studying. Such decisions are evaluated using
the concept of opportunity cost.

Faced with Scarcity, we must choose the next best alternative. The choices that we make depend on the incentives /penalty we face.

Mathematical Example:
Suppose a student can either work for 5 hours or study. If working yields an 8-point benefit (in terms of income/satisfaction) and studying yields a 10-
point improvement in academic performance, then choosing to study means an opportunity cost of 8 points. The trade-off is clear.

Table – Trade-Off Comparison:

Activity Benefit (Points) Opportunity Cost if Not Chosen

Studying 10 8 (lost work income/satisfaction)

Part-time Job 8 10 (lost academic Improvement)

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ECO -101 Introduction to Microeconomics UNIT 01

Wants, Needs, and Human Behavior in Economics

Wants and needs are central to economic decision-making. Needs are essential items required for survival—such as
food, shelter, and healthcare—while wants are non-essential items that enhance our quality of life, such as
smartphones and designer clothing. Powell & Parkin highlight that scarcity forces individuals to prioritize needs over
wants; however, human behavior often complicates these decisions. Psychological factors, cultural influences, and
social pressures can lead individuals to spend on wants even when resources are limited. For instance, a university
student with a $200 budget might need to allocate funds for textbooks (a need for academic success) but may be
tempted by the allure of purchasing a new smartphone (a want).

Table – Comparison of Needs vs. Wants:

Aspect Needs Wants

Definition Essential for survival (basic goods/services) Non-essential items that enhance quality of life

Examples Food, shelter, textbooks Smartphones, designer clothing

Priority in Scarcity High—must be met for well-being Lower—can be deferred if resources are limited

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ECO -101 Introduction to Microeconomics
UNIT 01

Microeconomics vs. Macroeconomics

Economics is divided into two main branches: microeconomics and macroeconomics.

Microeconomics examines individual agents such as households, firms, and markets. It focuses on supply and
demand, price determination, and consumer decision-making—for example, how a student allocates a $50
budget among food, rent, and leisure.

Macroeconomics studies the economy as a whole. It looks at aggregate indicators like Gross Domestic Product
(GDP), inflation, unemployment, and fiscal policy. Powell & Parkin explain that macroeconomics addresses
large-scale economic issues and policy impacts.

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ECO -101 Introduction to Microeconomics
UNIT 01

Microeconomics vs. Macroeconomics

Aspect Microeconomics Macroeconomics

Overall economic performance and aggregate

Focus Individual decision-making and market behavior
indicators

How are prices determined? How do consumers What drives economic growth? How do policies
Key Questions
choose among alternatives? affect unemployment and inflation?

A student budgeting $50 for essentials versus

Real-Life Example National debates over interest rate adjustments
leisure

Textbook Reference Mankiw, Principles of Microeconomics Powell & Parkin, Economics

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ECO -101 Introduction to Microeconomics UNIT 01

Big Economic Question

How do choices end up determining what, how and for whom good and services get produced.
What- what we produce keeps changing over time. New Technologies allows us to be more productive at producing food and manufacturing goods.
How- Goods and services get produced by using productive resources - factors of production.
Land refers to all natural resources that are available in an economy. This includes not only physical land itself but also the resources it provides such
as minerals, water, forests, and fertile soil. These natural assets are the raw materials needed for production, and their availability and quality can
significantly influence an economy’s productivity. For instance, a country with rich mineral deposits or highly fertile agricultural land can leverage
these advantages for industrial and agricultural development.
the supply of land - the amount of physical land in existence does not change much with time. theres is certain degree of soil erosion but
certain degree of land reclamation that increases the supply. other natural resources like rain forest declining in significant rate. While some
are renewable resources and others non renewable, if not reserved there is a risk that renewable resources can be turned into non-renewable
resources if they are over exploited.
Mobility of Land- most lands are occupationally mobile, meaning they can be used for number of purposes. Lands used for farming can be
used to build houses. However, land is geographically immobile. A course of the river can be diverted and wildlife can be moved. with the help
of Capital.
Capital includes the human-made tools, machinery, buildings, and technologies that aid in production. Unlike natural resources, capital is created by
humans and can be improved and expanded over time through investment. They are not wanted for their own sake but for what they can produce.
Capital goods increase efficiency by enabling faster, higher-quality production, and they are fundamental for technological advancements and
industrial growth. For example, modern factories and computers in offices represent the capital that supports large-scale production and economic
progress.
Labor encompasses the human effort used in the production process. This factor isn’t limited to physical work; it also includes mental and technical
contributions such as expertise, skills, and knowledge. The quality of labor depends of human capital, influenced by education, training, and
experience, making it a critical determinant of productivity. In modern economies, both manual and professional skills are vital for success in various
industries, from manufacturing to services.
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ECO -101 Introduction to Microeconomics UNIT 01

Entrepreneurship is the drive and innovation that combine the other factors of production to create goods and services. Entrepreneurs take risks
by investing in new ideas, organizing resources, and developing new products or business models. They are the catalysts of change, pushing
forward innovation and competition. Their ability to identify opportunities and mobilize resources is critical for stimulating economic development
and creating jobs.

Together, these four factors—land, labor, capital, and entrepreneurship—form the core of production in any economy. Efficient allocation and
utilization of these inputs are crucial for boosting productivity, fostering economic growth, and improving the overall standard of living. This detailed
understanding of the factors of production, as emphasized in Mankiw’s Principles of Microeconomics and Powell & Parkin’s Economics, provides the
foundation for analyzing how economies operate and develop over time.

For Whom- People earn their incomes by selling the services of production of the factors of production they own.

Land- Rent
Labour - Wages
Capital -Interest
Entrepreneurship- Profit

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ECO -101 Introduction to Microeconomics
UNIT 01

The Production Possibility Frontier (PPF) and Opportunity Cost

1. Production Possibilities and Trade-offs
The PPF represents the maximum output combinations of two goods that an
economy can produce with its available resources.
Example: If all resources are used to produce cola, the economy can produce 15
million cans but zero pizzas(Point A). If all resources go into pizza production, the
economy makes 5 million pizzas and zero cola (Point F).
Moving along the PPF involves trade-offs. Producing more of one good means
sacrificing the production of another due to scarcity of resources.
2. Production Efficiency
Efficiency is achieved at any point on the PPF because resources are fully utilized.
Inefficiency occurs inside the PPF due to unused or misallocated resources.
Unused resources: Idle workers or factories.
Misallocated resources: Skilled pizza chefs working in cola factories.
3. Opportunity Cost
Law of Opportunity Cost: To produce more of one good or service, a society must
sacrifice increasing amounts of another good or service.
It's the value of the next best alternative that is forgone when making a choice.
Since resources (like time, money, labor, raw materials) are limited, choosing to
allocate them to one activity means they can't be used elsewhere.
4. Increasing Opportunity Cost
The PPF is bowed outward because resources are not equally efficient in producing all
[Link]: Moving cola factory workers to pizza shops yields small gains in pizza
but large losses in cola. Page 9
ECO -101 Introduction to Microeconomics UNIT 01

[Link] is Economic Growth?

Economic growth is the increase in an economy’s production possibilities, allowing it to
produce more goods and services over time.
In the U.S., production per person has doubled over the past 30 years, meaning the economy
has grown significantly.
Growth happens due to:
Technological change: Improvements in technology allow for more efficient production.
Capital accumulation: The increase in capital resources (like machines, tools, and human
skills) helps boost production capacity.

2. The Trade-off of Economic Growth

Economic growth isn’t free—it requires sacrificing current consumption to invest in future
productivity.
Suppose an economy can produce pizza (consumption goods) or pizza ovens (capital goods).
If all resources are used for pizza production, there’s no growth (Point A).
If some resources are diverted to produce pizza ovens (Point B), the economy sacrifices some
current pizza production but gains higher future
production capacity.
Over time, this investment leads to an outward shift of the PPF (PPF1 in Fig. 2.5), allowing for
greater future production of both pizzas and ovens.
This is a classic trade-off:
🔹 More growth in the future = Fewer consumption goods today
🔹 More consumption today = Less growth in the future

3. Why Growth Doesn’t Eliminate Scarcity or Opportunity Cost

Even with growth, resources remain limited, and choices still involve trade-offs.
On a larger PPF, societies still face decisions about what to produce—whether to focus
more on consumer goods or capital goods. Page 10
ECO -101 Introduction to Microeconomics UNIT 01

Allocative efficiency occurs when goods and services are produced at the least possible cost and in thequantities that bring the greatest
possible benefit.

Marginal Cost and the PPF:

Marginal cost refers to the opportunity cost of producing one more unit of a good. In this case, it's the cost of producing one additional pizza,
measured in terms of the opportunity cost of the other good (in this case, cola) that must be forgone to produce that pizza.
The slope of the PPF represents the marginal cost of producing one more unit of a good. As more pizzas are produced (increasing the quantity on
the x-axis), the PPF becomes steeper, which means the marginal cost of pizza increases. This is because, as you allocate more resources to pizza
production, you have to give up more and more cola to produce each additional pizza (reflecting increasing opportunity costs)

Marginal Benefit and Preferences:

Marginal benefit refers to the extra benefit or satisfaction derived from consuming one more unit of a good or service. This is tied to individual
preferences—what people value or desire.
The marginal benefit curve shows how the marginal benefit changes with the quantity consumed. As more of a good is consumed, the marginal
benefit typically decreases, which is called the principle of decreasing marginal benefit.

Example: If you’ve been eating pizza all day, you’re likely to be less willing to pay for another slice because you’ve already consumed a lot of
pizza. However, if you haven't had pizza in a long time, you might be willing to pay a higher price for an additional slice.
This decreasing marginal benefit is driven by a desire for variety. The more you have of something, the less value you place on each additional
unit.

The marginal benefit of a good decreases as the amount of the good available [Link] are used efficiently when the marginal cost of
each good is equal to its marginal benefit.

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ECO -101 Introduction to Microeconomics UNIT 01

Absolute Advantage and Comparative Advantage

Absolute Advantage:
A person or entity has an absolute advantage if they are more efficient at producing something than anyone else. This could
be because they use fewer resources or take less time to produce a good or service. Absolute advantage looks at
productivity—how much output someone can produce in a given time frame (e.g., per hour).
Example: If John Grisham can write more books or be a better lawyer than most people, he has an absolute advantage in
those activities.
Comparative Advantage:
A person has a comparative advantage in an activity if they can perform it at a lower opportunity cost than others. This
means that the person sacrifices less of other goods when focusing on the activity where they have comparative
advantage.
The key here is opportunity cost—the value of what you give up in order to do something. It explains why even if someone
has an absolute advantage in many areas, they might not necessarily have the comparative advantage in every activity.
For example, even though John Grisham is a great lawyer, if his opportunity cost (what he has to give up) to be a lawyer is
higher than being a writer, he should specialize in writing and trade for legal services if needed. This is because his
comparative advantage lies in writing, not in law.

Key Difference:
Absolute advantage is about being the best or most productive at something.
Comparative advantage is about the opportunity cost of choosing one activity over another.

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Gains from Trade AND Specialization

A person has a comparative advantage in producing a

good if that person can produce the good at a lower
opportunity cost than everyone else.
People gain by specializing in the activity in which they
have a comparative advantage and trading with others.

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Initial Situation:
Liz runs a successful smoothie business but can't meet demand.
Joe splits his time between making 5 smoothies (in 50 mins) and 5
salads (in 10 mins).Liz suggests they specialize based on comparative
advantage.

Specialization Plan:
Joe produces only salads: 30 per hour.
Liz produces only smoothies: 30 per hour.
Total production increases to 30 smoothies + 30 salads.

Trade Agreement:
They trade at a rate of 2 salads per smoothie.
Liz gives Joe 10 smoothies.
Joe gives Liz 20 salads.

Result After Trade:

Joe: 10 smoothies (bought) + 10 salads (30 produced – 20 sold).
Liz: 20 smoothies (30 produced – 10 sold) + 20 salads (bought).
Both end up with 5 more smoothies and 5 more salads than before.

Economic Insight:
Trade allows both to consume beyond their PPFs (Production Possibility
Frontiers).
Comparative advantage leads to mutual gains even if one person is
more productive overall.
The trade is beneficial because each gets goods at a lower opportunity
cost than producing it themselves.

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ECO -101 Introduction to Microeconomics UNIT 01

Positive vs. Normative Statements

Positive statements are objective and based on facts. They describe the world as it is and can
be tested or verified using data and evidence. These statements do not involve opinions or
personal beliefs. For example, "A decrease in interest rates leads to increased consumer
spending" is a positive statement because it can be measured and analyzed using economic
data.

Normative statements are subjective and based on opinions, values, or judgments about what
should happen. They cannot be tested or proven right or wrong because they depend on
personal beliefs. For instance, "The government should provide free healthcare to everyone" is
a normative statement since it reflects an opinion on what policies should be adopted rather
than an objective fact.

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Essential Reading :
Economics By Parkin
Chapter 01 - What is Economics
Chapter 02- The Economic Problem

Principles of Economics by Mankiw

Chapter 02- Thinking Like an Economist
Chapter 03-Interdependence and the Gains from Trade

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