CHAPTER 1
INTRODUCTION TO MICRO ECONOMICS
v Definitions
v Central problems of an
economy
v Production possibility
curve
v Organization of
economic activities
v Positive and normative
economics
Introduction to
micro economics
The term economics is derived from
the Greek word ‘Oikonomia’ which means household management. Economics came to
be accepted as a full-fledged social science with the publication of Adam
Smith’s Wealth of Nation in 1776.
Definitions
Wealth Definition
In
his book, ‘An enquiry in to the Nature and cause of wealth of nations’, (1776)
Adam smith defined economics as science of wealth. According to him, economics
is a study o the nature of wealth, its generation and spending.
Welfare Definition
Economics
is a study of mankind in the ordinary business of life. It examines that part of individual and
social action which is most closely connected with the attainment and the use
of material requisites of well being. - Alfred Marshall (Principles of Economics, 1890)
Scarcity Definition
Economics
is a science which studies human behavior as a relationship between ends and
scarce means which have alternative uses.
- Lionel Robbnins (The nature and
significance of Economic Science,1936)
Growth Definition
Growth
definition is put forwarded by Paul A Samuelson.
Production,
consumption and distribution of goods and services are the basic economic
activities of life.
Central problems of an
economy
Human wants are unlimited. The
resources to satisfy them are scarce. The resources have alternative uses. The
problem of scarcity of resources leads to the problem of choice. It is the
scarcity of resources in relation to their demand give rise to the central
problems of an economy which can be summarized as follows
1. What to produce
2. How to produce
3. For whom to produce
1. What to produce and in what
quantities
Since the resources are limited, the
economy must decide what combination of goods and services are to be produced
and in what quantities. If it decides
produce more units of one good, it has to reduce the production other
commodities.
2. How to produce
There are two alternative techniques
for producing a good – labour intensive technology and capital intensive
technology. In labour intensive technology, more labour and less capital is
used to produce a good. While in capital intensive technology more capital and
less labour is used. The choice of
technique depends on the availability of labour and capital their price.
3. For whom to produce
This question is concerned with the
distribution of goods that are produced in the economy i.e., how the national
income is allocated among the factors of production. It is known as functional
distribution of income.
Thus allocation of scarce resources
and the distribution of the final goods and services are the central problems
of any economy
Production Possibility
Frontier or PPC
A production possibility curve (PPC)
is the locus of different combinations of the commodities that an economy can
produce with the full use of the available resources and technology.
Production Possibilities
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possibilities
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Good
1
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Good
2
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A
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|
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Organization of
economic activities
The central problems of an economy
can be solved through the free interaction of the individuals and firms and
also through the planned intervention of the government.
1. The centrally planned economy
(Socialist Economy)
In a centrally planned economy, the
central problems are solved through the government or the planning authority.
Since the resources are owned by the government in the socialist economy, it
can decide what to produce. The items which have social utility will be given
priority.
2. The Market Economy (Capitalist economy)
In a capitalist economy all
resources are owned by private ownership.
In such an economy the central problems are solved through the price
mechanism. The market forces demand and
supply solve the central problems
Mixed
economy
In a mixed economy, public sector
co-exists with the private sector. Here
the decisions regarding the central problems are taken jointly by the planning
and price mechanism.
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Economics
systems
|
Mechanisms
to regulate the economy
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·
capitalism
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Price
mechanism
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·
socialism
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Government
or planning authority
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·
mixed
economy
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Both
planning and price mechanism
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Positive and Normative Economics
Positive Economics analyses the
cause and effect relationship between two variables. It states ‘what it
is’. There is no chance for value
judgment.
Normative Economics describes ‘what
ought to be the things’. Normative economics is concerned with the welfare
prepositions and involves value judement.
INTRODUCTION
The term ‘macro’ is derived from the
Greek word ‘Makros’ which means large. Ragnar Frisch coined the term Macro
Economics. Macro Economics is a branch
of economics which studies the economy as a whole. It is known as aggregate economics. It covers
the variables like total employment, total consumption, aggregate demand,
general price level etc.
Difference between micro and Macro
Economics
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Micro economics
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Macro Economics
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Studies
the small units of the economy
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Studies
the economic system as a whole
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Technique
of analysis is partial equilibrium analysis
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Technique
of analysis is general equilibrium analysis
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Also
known as price theory
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Also
known as income theory or aggregate economics
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Gives
a worm’s eye view
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Provides
bird’s eye view
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Subject
matter – demand theory, market equilibrium, factor price determination etc
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Subject
matter – general price level, money supply, monetary and fiscal policies,
trade cycles, national income etc.
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Emergence
of Macro Economics
Adamsmith, the founding father
of modern economics had rejected the necessity of Macro Economics analysis. Classical
economists assumed a free economy – nominal intervention of government. They
believed in full employment and in Say’s
Law of Market i.e., supply creates its own demand, which was the founding
stone of classical economics.
The
Great
Depression of 1929 created a huge economic crisis in European countries
and USA. It affected other countries of
the world. Due to the Depression,
production fell down. Unemployment rose severely. It rose from 3% in 1929 to
25% in 1933 in USA. Production fell
about 33%.
The Depression proved that the
classical notion of full employment and automatic working of the economy were
wrong. Classical theory failed to explain
the problem of long lasting unemployment in the economy. Keynes published his famous book ‘General
theory of employment interest and money’ in 1936. It was an attempt to explain this
phenomenon. A revolutionary change in
the field of economics was brought about this publication. With this Macro Economics emerged and became
popular. This tremendous change in the
field of economics is termed as Keynesian Revolution. Keynes is regarded as the
father of Macro Economics.
Importance of Macro Economics
1. Helps to understand the
functioning of the economy
2. Helpful in the formulation of
economic policies
3. Tries to solve the problem of
general unemployment
4. Helpful in planning
5. Useful in the analysis of
business fluctuations
6. Helpful in comparison
7. Useful in studying growth and
development
Subject matter of Macro
Economics
1. National income and related
concepts
2. General price level – inflation
and deflation
3. Business cycles
4. Government
5. Economic growth and development
6. Monetary and fiscal policies
7. Money supply and banking
8. International trade
Economic
agents
Economic agents are individuals or institutions which take
economic decisions independently. Example - Consumers, producers, government,
banks etc. Macro Economics studies the
behavior of Macro Economic agents.
Factors
of production
Factors of production are
inputs used in the production of goods and services. There are four factors of
production.
1. Land
2. Labour
3. Capital
4. Organization or management
Factor
prices
It is the reward or remuneration given to the factors of
production for their contribution to the production process.
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Factors
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Reward
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Land
Labour
Capital
organization
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Rent
Wage
Interest
Profit
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Capitalist
economy
It is an economic system in which the means of production
are owned and operated by private individuals.
The main characteristics of economic activities in a capitalist economy
are
1. Private ownership of means of
production
2. Production is for market – i.e.
profit motive
3. Sale and purchase of labour at
wage rate
4. Nominal intervention of government
in the market
Sectors
in a capitalist economy
There are four important sectors in a capitalist economy.
Their interrelationship drives the economy.
1. Household
2. Firm
3. Government
4. External sector
- Household sector
It is single individual or group of individuals who take
decisions relating to his or her consumption.
- Firm
Firm is a production unit. They produce goods and services to earn
profit.
- Government
It is the state who frame and enforce law and deliver
justice. Sometimes government undertakes
production.
- External sector
It simply means the economic relation with the rest of the
world. External trade can be
1. Exports and imports of goods
and services
2. International capital flow.
All these four sectors of the economy
are important from the Macro Economic perspective.
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