1Micro Economics

8/10/2019 1Micro Economics

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Micro Economics

M12104

Dr. A. K. Upadhyay


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According to the father of Economics,

Prof. Adam Smith, economics is the study

of the nature and the causes of wealth of

nations. According to him economics is the

science of wealth.


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Adam Smith is usually considered the founder of

the field of microeconomics, the branch of

economics which today is concerned with the

behavior of individual entities such as markets,firms, and households. In his famous book, The

Wealth of Nations (1776), smith considered how

individual prices are set, studied the

determination of prices of land, labour, andcapital, and inquired into the strengths and

weaknesses of the market mechanism.


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Economics deals with the problem of choice,

According to Prof, Robbins Economics is a

science which studies the human behavior as a

relationship between ends and scares resourceswhich have alternative uses. There are two

basic facts because of them an economy exists.

The first fact is that the resources are limited,

and the second fact is that the human wants areunlimited. Everyone is trying to satisfy all his or

her wants with limited resources.


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Economics can be divided into two parts,

Microeconomics and Macroeconomics.Microeconomics has been derived from aGreek wordmikros and Macroeconomicshas been derived from the Greek word

makros. The meanings of mikros andmakros are small and large respectively.Microeconomics deals with the individuals,

and Macroeconomics deals withaggregates.


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The Scope of Economics

There is a conflict among the economist

about the scope of economics from the

time period of Prof; Adam Smith (Father of

Economics) to till date, this conflict can beseen in the various definitions given by

various economists.


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According to Prof, Adam Smith in his book, An Enquiryinto the nature and the causes of wealth of nations thesubject matter of economics is to enquire the nature andthe causes of wealth of nations. According to Prof,Ricardo the subject matter of economics is related withthe distribution of income and wealth.

According to Prof, Marshall the subject matter of theeconomics is to study the mankind, or in other words toincrease the social welfare. In against according to Prof,Pigou the subject matter of the economics is to maximizethe social welfare but that social welfare which ismeasurable with the measuring rod of money.


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With the help of above definitions we can

say that each and every definition gives us

incomplete information about of the

subject matter of economics, somedefinitions are very narrow, and on the

other hand some are very wide.


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The questions which have been asked by the economists arefollowings:

1. What to produce? In other words which commodity should be produced/

2. How to Produce?

Or which technology should be adopt, labour intensive or capitalintensive

3. Problem of distribution.

In other words, how the total production of the goods and theservices should be distributed among the people.

4. Are the resources are using economically?

5. Are the resources are fully utilized or unutilized or they areunutilized?

Above five questions are frequently asked by the economists. Theeconomic theory deals with the above five questions, and also try tosolve them. Lets discuss all the above questions in detail.


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What to Produce The first problem of economist is related with the

allocation of resources. This problem arises because ofthe scarcity of resources, we can not produce all thecommodities in a larger quantity, for that we dont havethe enough resources. Now what we can do, we canwithdraw some resources from the production process of

one commodity and devote them into the productionprocess of another commodity.

It depends on the desirability of the commodity, thegreater the desire of a commodity, the greater theamount of resources devoted in the production process

of that commodity. This problem can also understandfrom the view point of producer, higher the price of thecommodity, higher the production of that commodity. Theprice theory explains how the price of the commodity isdetermined.


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How to Produce The problem of how to produce is related with the choice

of technology. It depends on the availability of resources,in other words we can say that it depends on theabundant factor of production. In economics normally weconsider two factors of production labour and capital. Acountry can be labour abundant or capital abundant, the

problem how to produce is related with the choice oftechnology, like we can produce the cloth by hand-loomor by automatic-machines,


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the first one needs a larger amount of labour and a smalleramount of capital, whether the second method ofproduction needs a larger amount of capital and asmaller amount of labour. Now we can say that in thiscondition a country has to choose whether it wants to

produce the cloth with capital intensive technique orlabour intensive technique. We can study the physicalrelationship of input and output in the theory ofproduction.


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Problem of Distribution

This problem is related with the distribution of goods andservices produced among the people of the country.There is also a conflict among the economists that whichone should take more from the national product. From

the time period of Adam Smith and David Ricardo wehave this question. The production depends on theseveral factors of production like land, labour, capital etc.

Now the question arises that which one should takes thehigher share from the reward of production or from price

of the production, this is the subject matter of the theoryof distribution.


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The Problem of Economic

Efficiency

As we all know that the resources are scare, so

that they should be used efficiently. The simplest

method to measure the efficiency is, if we cannot increase the production of a commodity

without decreasing the production of the other

commodity with the help of re-allocation of the

resources, it means we are using our resourcesefficiently.


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Full Employment of Resources

It is the problem related with the utilization of the

available resources. At the level of individual

person or at the country level, this problem is

very important that whether we are fully utilizingour resources or not. At the country level to

achieve a higher rate of economic growth fully

utilization of the resources is mandatory, even a

single country can not achieve the growth targetwith miss utilization of the resources or

underutilization of the resources.


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What is a market

We have heard a lot that most of theeconomic problems are resolved throughthe market. Another question can be who

solves the fundamental questions ofeconomics like, what, how and for whom.You feel surprised to know that there is noone individual or organization or even the

government of the nation is responsible forsolving these economic problems in amarket economy.


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A market is a mechanism through which

buyers and sellers interact to determine

prices and exchange goods and services.

In a market system, everything has a

price, which is the value of the good in

terms of money


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Prices represent the terms on which people andfirms voluntarily exchange different commodities.What is true for the market for consumer goodsis also true of market for factors of production,such as land and labour.

Prices coordinate the decisions of producers andconsumers in a market. Higher price tend toreduce consumer purchases and encourageproduction. Lower prices encourageconsumption and discourage production. Pricesare the balance wheel of the market mechanism.


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Meaning of equilibrium

The term equilibrium has been often used in theeconomics. In fact modern economics issometime called equilibrium analysis.Equilibrium means a state of balance. Whenforces acting in the opposite direction, are justequal, the object on which they are acting is saidto be in state of equilibrium. Tie a cord to a pieceof stone and dangle it in the air, after oscillating

from side to side, the stone will come to rest, ifno further disturbance is caused. The stone isthen in equilibrium.


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General Equilibrium

Meaning of General Equilibrium

As we know that the partial equilibrium analysisenables us to study the relationship between

only a few variables, keeping others unchanged.But in real world nothing is constant; we cannotassume other factors constant for the partialequilibrium analysis.

It should be noted that the study ofinterrelationship between various economicagents and markets is the subject matter ofgeneral equilibrium analysis.


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Demand, Supply and

Competitive Equilibrium

The price of a commodity depends uponthe demand and the supply of thatparticular commodity. This part of the book

explains the demand of a good, supply ofa good and the determination of price withthe help of equilibrium through demandand supply. Before explaining demand,

supply and equilibrium we have tounderstand the factors which determinethe demand.


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It is necessary to distinguish between

demand and desire. A peon wants to have

a BMW, or a LCD TV. But such needs and

desire do not constitute demand. Whenthere is a willingness and ability to pay for

that desire, the desire is changed into

demand.


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In the words of Prof. Bober, By demand wemean the various quantities of a givencommodity or service which consumers wouldbuy in one market in a given period of time at

various prices, or at various incomes, or atvarious prices of related goods.

The demand of a commodity or a good dependson several factors like price of the commodity,prices of the related goods, income of theconsumers, tastes and the preferences of theconsumers and future price of the commodityand so on.


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We can put all the factors in a functional form:

QD = f (Px, Py, Ic, T&P, Fp, V)

Where QD = Quantity demanded

Px = Price of the commodity Ic = Income of the consumer

T&P= taste and the preferences of the consumer

Fp = Future price of the commodity V= Other factors.


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The entire factor plays a crucial role in determining theprice of the commodity, but economists are mainlyconcerned with the price of the commodity in pricedetermination. From the time period of Prof, Marshall, (incardinal utility theory) many economists have

propounded several theories to explain the relationshipbetween price and the quantity demand of a commodity.Cardinal utility theory explains the negative relationshipbetween price and the quantity demanded. After theexistence of cardinal utility, several other demandtheories came into existence like, Indifference CurveAnalysis, Revealed Preference Theory, Hicks logicalWeak Ordering theory, etc. In this part of the book wewill explain the concept of demand.


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Types of Demand :

Demand can be divided into three types,

1. Price Demand 2. Income Demand, and,

3. Cross demand


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Price Demand,

Price demand refers to the various quantitydemanded of a commodity or service that aconsumer will buy in a given time period at

various price levels in a market. It is assumedthat other things, such as consumers income,his tastes and prices of inter-related goods,remain unchanged.

The demand of the individual consumer isknown as individual demand and the totaldemand of the entire consumers for thatcommodity is known as market demand


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Income demand,

Income demand refers to the various quantity

demanded of a commodity or service that a

consumer will buy in a given time period atvarious levels of income. Here we assume that

the price of the commodity or the service as well

as the prices of the related goods and the tastes

and the desires of the consumer does notchange.


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Cross Demand

The cross demand of a commodity or servicerefers to the quantity demanded of a commodityor service a consumer will buy with reference tochange in price of inter-related goods or

services, and not of this good or service. These goods are either substitutes or

complementary goods. A change in the price oftea, will affect the demand for coffee.

Of these types of demand, price demand is themost commonly spoken one. Now we studydemand schedule, demand curve, etc., relatingto price demand.


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The Meaning of Demand

The demand for a commodity is the amount of thatparticular commodity that a consumer will purchase fromthe market at various given prices and in a given periodof time. According to the economics view point demand

includes desire to purchase, ability to pay andwillingness to pay. We can not consider desire topurchase as demand that is not backed by thewillingness to pay and ability to pay. For instance, topurchase an Audi or a Mercedes can be a desire to

purchase for a person of ten thousand rupees salary, wecan not consider it demand, but to purchase aMotorcycle can be consider as a demand for the sameperson.


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Law of Demand

Law of demand states the relationship between priceand the quantity demanded of a commodity. It should benoted that law of demand is one of the most importantlaws of economics, according to the law of demand, ifthe other things remain the same, there is an inverse

relationship between price and the quantity demanded.Other things stand for all the factors that we have indemand function, except price of the commodity, likeprice of related goods, income of the consumer, tastesand the preferences of the consumer, future price andsome other factors. If all these factors are constant thanthere should be a negative or inverse relationshipbetween price and the quantity demanded. We canbetter understand the law of demand with the help of atable and graph.


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Demand Schedule of an

Individual ConsumerPrice (Rs.) Quantity demanded

14 15

12 25

10 35

8 45

6 55

4 65


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The Demand Curve

D

DX

Y

0 15 25 35 45 55 65

4

6

8

10

12

14

A

B

C

D

E

F

Quantity

Price


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Now we can better understand the Law of demand with the help of

above table and graph, it is clear from the figure that when the priceis high the quantity demanded is low. According to the law ofdemand, there is a inverse relationship between price and thequantity demanded, now we can plot the price on Y Axis and

quantity demanded on X Axis, what we see in the graph that whenthe price of the commodity was 14 Rs, per unit the quantitydemanded was 15 units, when the price of the commodity decreaseto Rs, 14 per unit, quantity demanded increase to 25 from 15, and atlast when price decrease to Rs, 4 per unit, quantity demandedincrease to 65. It is clear from the figure that the slope of demandcurve is negative, because of inverse relationship between price andthe quantity demanded.

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1Micro Economics