Session I Fb 10

8/8/2019 Session I Fb 10

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Introduction to Micro-Economics

Session I


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What is Economics Economics is a science which deals with the unlimited wants

and limited resources. Making choices in the face of scarcity. If things were notlimited,

there wou

ld not

have been subject

like economics

Limited resources imply scarcity and unlimited wants lead to theproblem of choice.

Scarcity implies that, atany given point of time, an individual,organisation or a country can nothave everything in anyquantity that is desired.

So the problem of economics is to make a choice efficiently sothat use of resources is minimised and the satisfaction ismaximised.


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Contd Economic system allocates scarce

resources across the competing uses,combining and processing theseresources to produce goods andservices. It determines what to

produce, how much to produce. Itarranges for distribution of goods.,provides for future growth.


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ContdAllocation problems, scarcity, choice

Proper combination

how muc

hforeach category

Distribution who should get?

Growth

different engines of growth


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Production Possibility curve


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Production Possibility CurveAtany given point of time, the

resources available to an economy

size of working population, land,building, machinery are all given. So ifmore resources are used for one sector,less will be available for the othersectors. So a combination of goods andservices has to be decided for aneconomy.


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Production Possibility Frontier It is based on the

famous gun-butterparadox

Concepts of scarcity,choice and efficiencycan be well understoodwith the help of PPF

In PPF, guns representmilitary goods andbutter representscivilian goods.

PPF slopes downwardswhich reflects scarcityof resources. To getmore guns, society hasto sacrifice butter

PPF is concave to theorigin indicating theincreasing relative costof transferringresources from onesector to another.


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Production Possibility Frontier With given resources,

country can produceeither more of butter orof guns.(B or C)

Pt. A indicatesinefficiency

Pt. E is unattainable

with the givenresources

Movement from ppf0 toppf1 indicatesexpansion of resources


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Application of PPC Central problems of economy what, how, for whom During 2002-03 India produced 23.2 million tonnes of potato.

This was partly influenced by how muchland is used to raise aparticular crop, which is a consequence of govt policy andindividuals choice

What method to be used is also a problem of choice. Electricitycan be produced withhydro, coal or nuclear power. Agriculturecan be done by labour intensive or capital intensive method.

Who earns how much is also a choice problem for the economy.Computer engineers earn more than the historians, teachers in

US earn more than the teachers in India. This is an issue relatedto the distribution of wealthand income in the economy.


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How to solve basic economic

problems?


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Basic economic systems In market economy, 3 fundamental

problems are solved by market. Theforces of demand and supply determinewhat, how muchand for whom toproduce

In centrally planned economic system,these problems are solved by the stateor government.


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Approaches to the study of

Economics Micro economics refers to the analysis of

scarcity and choices problem faced by single

economic unit suchas firm, producer,industry. Itassumes the things to be constantother than the part ofa system under study.

Macro economics deals with the behaviour

ofaggreg

ates suc

has Gross DomesticProduct, employmentand inflation rate. It

focuses on the form and functioning of theeconomy as an aggregate system


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Distinction between micro and

macro economicsMicroeconomics

Deals with choices of

individu

als

Aggregates arising outof individual choices areconsidered Eg. totaldemand for oranges

Relative prices play improle response ofconsumers & producersto change in relativeprices is considered

Macroeconomics

Deals with economicaggreg

ates

Aggregate ofheterogeneous goods isconsidered GrossNational Product

Aggregate prices areimportant like pricelevel which combinesprices ofheterogeneousgoods


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Subject matter Microeconomics

product pricing theoryof demand

factor pricing theory

of distribution

economic welfare

Macroeconomics

unemploymentinflation

poverty

depression

underdevelopment


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Why should a manager study

micro-economics? To geta technicalhelp in making optimaland

rational economic decisions

Profit decisions ofa

firm can be e

valu

ated t

hroug

heconomic theory

Profits are functionally related to sales and revenuewhich in turn depend on demand

Demand decisions are followed by production and

supply. Price-supply decisions depend on the market

structure

Thus,various types of economic decisions takenby a manager can be evaluated through

microeconomic analysis.


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Contd.. Both the markets work on the basis of pricing

system. So the Price theory is important

subject matter of MiE. Role of Govt.- govtaffects circular flow by

purchasing and producing the goods forpublic consumption (education, defence, etc).

Through taxes it can redistribute the income.Also consumption of some of the goods canbe influenced thru commodity tax.


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Exercise IClassify the following as topics of micro or

macro

A firms decision

about

how muc

hincome tosave

Effect of govt regulation on auto emission Impact ofhigher national savings on

economic growth Firms policy ofhiring and firing workers National policy on Minimum wages Globalization for raising economic growth rate


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Demand analysis In 1973, OPEC collectively curtailed the production of

oil drastically. The supply of oil in the world fell somuch that the price of oil increased by three times.The world economic scenario has changed drasticallysince then.

Mr. X was thinking of selling two 100 yard plots in hishometown to finance his sons education in US(costing 20 lakhs). Suddenly some software factoriesmoved in and the govt began to develop the place asIT Park. The land prices went up. Mr. Xhad to sellonly one plot.


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Contd.. A successful manager understands how

market forces create both opportunities andconstraints for profitable decision-making. Ifthey understand how the markets work, theywillalso be able to predict the prices andproduction levels of goods, resources andservices for their business.

Demand supply analysis is a powerful tool foranalysing the way the market forcesdetermine prices and production in thecompetitive market.


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Demand implies 2 things

willingness to purc

hase t

hat commodity

ability to pay the price of commodity


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Determinants of demand Price ofa commodity (Px)

Prices ofa

rela

ted goods (Py)

Income ofa consumer (Y)

Tastes and preferences (T)

Advertising expenditure (A) Expectations about the future

movement of price ofa commodity (Pe)


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Demand Function Dx = f (Px, Ps, Pc, Y, T, A, Pe)

Px = negative relation under theassumption of other things remainingthe same

Ps = If price of substitute increases,

Dx

increases. So positi

ve re

lation. (Priceof coffee increases, the demand for tea

goes up)


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..Continued Pc = When commodity Xand Care jointly

demanded, they are complementary goods.

So when Pc rises, Dx falls.( Cameras and film) Y =Dx is positively related to Y ie if increase

in income causes the demand for acommodity also to increase, it is a normal

good. But ifan incre

ase in income

le

ads to

afall in the demand for a commodity, it is

called an inferior good.

A = positive relation between Dx &A


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Contd T = A change in T is not directly

measurable. But ifa good becomes

more fashionable, more healthfulpeople will buy more of it.

Pe = If consumer expects the future

price to rise, the Dx is highand viceversa


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Other factors influencing demand Some people in order to impress others, tend to buy

more ofa good when it becomes more expensive.This is called Veblen effect. For example expensive

car, fancy jacket. The law of demand does notholdtrue in this case Bandwagon effect occurs when we follow the

crowd that is if others start to use a product in a bigway, it becomes fashionable and we buy it withoutlooking at its price.

Snob effect occurs when you go against the crowd.It refers to a situation in which you want to bedifferent from the people just for the sake of beingdifferent.


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Contd.. Another effect can be in the form of network

externality defined as the benefit to a person whenthe number of other individuals using it increases.

For example if your friends, relatives do not use e-mail, your demand for e-mail will be smalland viceversa. This is positive externality

Opposite also can happen a persons benefit fromconsumption may decrease with the number of usersin a network. For example use of bus service in acity. negative externality


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exercises Rajesh used to get Rs. 5000 as pocket money which increased

to Rs. 7,000. he started going more for movies butless foreating in the nearby dhaba. There were no changes in ticketfare or dhaba food prices? Do you think both the goods are

normal for Rajesh? Which determinant of demand is at work in the following

cases?1. Demand for bus service between Delhi and Agra when the

train service between the same cities becomes cheaper.2. News that petrol prices are going to be doubled.3. Demand for land in an area where the govt is going to

establishahuge steel plant.

Documents

Session I Fb 10