MICROECONOMICS

(ECO 162)
INTRODUCTION TO
MICROECONOMICS
 HISTORY ON DEFINITION OF
ECONOMICS
i. Economics is a science that studies human behavior as a relationship
between ends and scarce means which have alternative uses
L.Robbins (1894-1984) .
ii. Economics is a study of how people use their limited resources to try to
fulfill their unlimited wants and involves alternative or choices K.E.
Case and R.C. Fair.
iii. Economics is the science of how a particular society solves its
economic problems Milton Friedman (1912)
iv. Economics is the study of mans actions in the ordinary business of
life; it examines that part of individual and social action which is most
closely connected with the attainment and with the use of the material
requisites of well-being. Thus it is on one side a study of wealth and on
the other and more important side, a part of the study of man - Alfred
Marshall (1824-1924)
 DEFINITION OF ECONOMICS
Economics is a social science study which
concern on how human being allocates the
limited resources in order to fulfill the unlimited
needs and demands.
Economic can be subdivided into two branch;
macroeconomic and microeconomic.
Microeconomic analyzes the specific economic
units in details such as households, firms and
government.
Macroeconomics, on the other hand, analyzes
the aggregate behavior of the entire economy.
MICROECONOMICS
VS MACROECONOMICS
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S ce ? Price of su
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pr increase!

Build more shirts

hospitals or Price of
e,
schools? decreas
GOVERNMENT buy
should I s? OPEN ECONOMICS
les
p ac t o f doing more or
Im
ional
internat How does
trade.
inflation
What is occurs?
the
unempl
oyment
rate in u en c ed
l
Malaysi h at inf st rate
a? W intere e?
the ecreas
HOUSEHOLDS to d FIRMS
 BASIC ECONOMIC CONCEPTS
Three main economic concepts involves;
i. Scarcity (land, labour, capital and enterprise)
. Occurs as human wants are always greater than the
available resources.
. The most important concept in economics. If there is no
scarcity, then there will be no economics study.
ii. Choice
. When scarcity exists, choices are to be made out of the
available alternatives.
iii. Opportunity cost (Second Best-Forgone alternative)
. The second-best alternative that has to be forgone for
another choice which gives more satisfaction.
 ECONOMIC CONCEPTS
This economics concept is simple :
Because the resources are scarce, therefore choices
have to be made. Once choices are made, there will
be an opportunity cost as the value of the next-best
choice (alternative) available.
What is the opportunity cost by choosing to study at
university???
 BASIC ECONOMIC PROBLEMS
What to produce?
What kind of product/services are going to be produces.
Depends on the type and quantity of goods and services needed
by the countries
How to produce?
What resources are going to be used, what techniques are going
to be used to produce.
Depends on the cheapest method of production (Labor VS
Machine).
For whom to produce?
How will nation distribute income to reduce the gap between
rich and poor.
Depends on the distribution of income in the society.
 PRODUCTION POSSIBILITIES CURVE (PPC)

Since with scarcity problem, no country in this world can produce

unlimited numbers of goods.
Therefore, an economy will produce goods depending on various
combinations of factors of production.
PPC shows the various possible combination of goods and services
produced within a specified time period with given technology and
resources.
Assumptions to illustrate PPC includes;
i. Full-employment
. The economy is operating in full employment and full efficiency
ii. Fixed resources
. The amount of available economic resources or factor of production are fixed
iii. Technology constant
. State of technology and method of production does not change
iv. Production of two goods
. Assuming that the country is producing only two type of goods
PRODUCTION POSSIBILITIES CURVE

Foods (Million units)

A
15
0
B Y
12
0

C
90
X
60

D
30

10 20 30 40 50 Clothes (Million units)

Figure 1.1 : Production Possibilities Curve
 PRODUCTION POSSIBILITIES CURVE

i. Point inside the PPC (Point X)

. These combinations of foods and clothes are attainable and can be
produced.
. However, it shows the resources are not fully utilized and the production
has not reached its maximum level.
ii. Points Outside the PPC (Point Y)
. This point which lies outside the PPC is unattainable due to limited
resources
. Shows the concept of scarcity.
iii. Points along the PPC (Point A, B, C and D)
. Combination are attainable and efficient.
. Shows the second basic economic concept of choices.
 PRODUCTION POSSIBILITIES CURVE

iv. Movement from one point to another point

. Illustrate the third basic economic concept of opportunity cost.
. E.g. movement from point A to B
. Point A (100 X, 50 Y) to Point B (50 X, 75 Y) : In order for this
country to produce an additional of 25 millions units of good Y, it has
to forgone 50 millions units of good X.

Good Y

B
75

A
50

50 100 Good X
 PRODUCTION POSSIBILITIES
CURVE
v. Shifts of the PPC
a) Outward shift (Increase in output): Due to improvement in
the new technology, increase in resources and technology,
economy growth and increase in population.
b) Inward Shift (Decrease in output) : Due to natural disaster,
reduction in factors of production and

Corn Corn Corn

 PRODUCTION POSSIBILITIES CURVE

vi. Shape of the PPC

. The shape of PPC depends on the types of opportunity
cost.
. Opportunity cost is calculated based on how much one
good is forgone to obtain other good.
. Basically, there are three types of opportunity cost;
i. Increasing opportunity cost
ii. Constant opportunity cost
iii. Decreasing opportunity cost.
 Production Possibilities Curve:
Increasing Opportunity Cost
Increasing opportunity cost means
that when a country produces
Good Y
more of one good, it has to forgone
more amounts of another goods.
Figure 1.2 shows that 1 unit
increase in Good X from 1 to 2
6 units had to forgone 1 unit of Good
Y.
5
Additional unit of Good X from 2
4 to 3 units involves 2 units of Good
Y.
2 This is called increasing
opportunity cost as more units of
Good Y are forgone for additional
Good X unit of Good X.
PPC is concave due to
1 2 3 4 increasing opportunity cost.
Figure 1.2 : Increasing Opportunity Cost
 PRODUCTION POSSIBILITIES CURVE: Constant Opportunity Cost

Good Y

6 A Constant opportunity cost

means that when a country
produces more of one good, it
has to forgone the same
B amounts of another goods.
4 Figure 1.3 shows that same
amount of Good Y is forgone
for each additional unit of
Good X.
2 C
PPC is linear as the
opportunity cost is
constant.
D
2 4 6
Figure 1.3 : Constant Opportunity Cost Good X
 PRODUCTION POSSIBILITIES CURVE: Decreasing Opportunity Cost

Decreasing opportunity cost occurs

Good Y when a country produces more of
one good, it has to forgone lesser
4 A amounts of another goods.
Figure 1.4 shows that 1 unit increase
in Good X from point A to B involves
two units of Good Y forgone.
An additional increase of Good X
from point B to C forgone 1 units of
Good Y and number of Good Y
2 B
forgone continues to decrease.
This is called decreasing opportunity
cost as lesser units of Goods Y are
forgone for additional unit of Good
C X.
1
D PPC is convex due to
1 2 3 Good X decreasing opportunity cost
Figure 1.4 : Decreasing Opportunity Cost
 PRODUCTION POSSIBILITIES
CURVE
i. Apr 2010 (Part B, Q 2)
ii. Apr 2006 (Part B, Q2)
 ECONOMIC SYSTEMS
Economic system is a way of organizing the relationship
among individuals, firms and government to make
choices on the basic economic questions.
The three basic economic problems (what to
produce, how to produce and for whom to
produce) are solved depending on the economic
system chosen by the society.
Basically, there are four types of economic system which
have been practiced, namely;
i. Capitalist economy system
ii. Socialist economy system
iii. Mixed economy system
iv. Islamic economy system
 i. CAPITALIST MARKET
SYSTEM
A capitalism is an economic system where individuals
without government intervention take all the main
economic decision.
Also known as market economy, free enterprise system
and laissez-faire.
This economy is characterized as economic freedom,
where an individual can act at their own wishes without
any control from the government.
The example of countries practicing the capitalist
economic system are the United States of America (USA),
France, Canada, Japan, and Britain.
 CAPITALIST MARKET SYSTEM:
CHARACTERISTICS
i. Government intervention
. There is no intervention by the government in the making of
economic decisions.
. Government only exist as the law enforcer and set the rules
and regulation to ensure the stability of economic condition
of the country.
ii. Private ownership of resources
. Every individual in the country has a right to acquire
resources.
. This enable individual to own resources as well as to
establish any enterprise at their choices.
. They are free to trade, invest and organize to produce within
the countrys legal framework.
 CAPITALIST MARKET SYSTEM:
CHARACTERISTICS
iii. Consumers sovereignty
. Consumer is the king concept is practiced in this
system.
. Consumers taste and preference will affect the
production of goods and services.
iv. Competition
. Market economy also characterized as highly
competitive among the producers to obtain the highest
profit.
. In order to attract more customers, producers will use
various marketing strategies to sell their products
better.
CAPITALIST MARKET SYSTEM:
CHARACTERISTICS
v. Price System
. Price system is a system used to make economic
decisions.
. In this system, price mechanism is practiced. It means
that the price is determine according to the force of
demand and supply and without any intervention.
. All economic processes of consumption, production,
exchange, savings, investment and distribution will
work according to this price mechanism and is labeled
as invisible hand by Adam Smith.
 CAPITALIST MARKET SYSTEM:
ADVANTAGES
i. Production according to the needs of
consumers
. Producers are producing goods and services according to
the tastes of consumers, which maximize the consumers
needs and satisfaction.
ii. Economic freedom
. It means the right to earn and retain property as well as
freedom of enterprises and choices of occupation.
. Thus, it will lead to the sourcing of the countrys
manpower in different units of production.
iii. Resources are efficiently utilized
. Competition creates efficiency in producing quality goods
at lower cost since techniques are more efficient.
 CAPITALIST MARKET SYSTEM:
ADVANTAGES
iv. Varieties of consumer goods
. Competition takes place in various aspects such as
shape, colour, design and packaging of the products.
. Thus, consumer will enjoy a wide variety of the same
product.
v. Enhance trade, business and R&D
. Entrepreneurs or producers will always look out for
new innovations to compete with other producers to
provide high quality goods.
 CAPITALIST MARKET SYSTEM:
DISADVANTAGES
i. Inequality of distribution of wealth and
income
. Since with no government intervention, the system of
private property widens the gap between the rich and
the poor.
. Thus, this will lead to unequal distribution of income
among the societies.
ii. Inflation and high unemployment rate
. Disparity of demand and supply of labour occurs as it is
governed by the invisible hand
. Unstable business fluctuation will cause high
unemployment rate during the depression.
 CAPITALIST MARKET SYSTEM:
DISADVANTAGES
iii. Lack of social welfare
. In market economy, social welfare is ignored as the
business entrepreneurs do not provide any pension,
social security or accident benefits to their employees.
iv. Unnecessary variety and wasteful
competition
. Too much of competition will lead to unnecessary high
cost of production.
. This happen as some producers will highly advertised
their products in order to attract consumer due to stiff
competition in this market system.
 CAPITALIST MARKET SYSTEM:
DISADVANTAGES
v. Misallocation of resources
. In this system, producers objective is to maximize
profit and therefore only produce outputs which give
higher profits.
. This will lead to production of luxury goods (for rich
people) and resulting surplus as well as lack of
production for the poor people.
vi. Social cost
. Workers may face social cost (health problem) arising
from the polluted environment caused by improper
disposal of factory wastes since producers' intention is
to increase the private profit and welfare of the workers
is often neglected.
HOW CAPITALIST MARKET SYSTEM SOLVE
BASIC ECONOMIC PROBLEM
i. What to produce?
. In this economic system, production depends on the goods
demanded by the consumer.
. An entrepreneur will only produce goods and services where
there is demand from consumer in order to gain higher profit.
ii. How to produce?
. Depends on the techniques of production whether to use labor
intensive, capital intensive or combination of both techniques.
. Cheapest method of production will be adapted not only to
maximize profit but also to achieve efficiency.
iii. For whom to produce?
. This problem will be solve through price system.
. Goods and services are obtained by anyone who can afford.
 ii. SOCIALIST MARKET SYSTEM
Socialist market system is a centrally planned economy
where government or central authority makes all economic
decision.
Any private individual has no right to make their own
economic decisions.
There will be no private property rights since all resources
are owned by government.
Also known as command economy and planned economy.
There are only few countries which practice this economic
system such as Russia, Cuba, Laos, Vietnam and North
Korea.
 SOCIALIST MARKET SYSTEM:
CHARACTERISTICS
i. Public ownership of resources
. All resources are owned and operated by the state or
the government in the interest of society as a whole.
. This is to ensure equal opportunity for all citizens
regardless of their income.
ii. Central planning authority
. Central Planning Authority acts as government and
responsible for making economic decision for the
society.
. Government will plan and allocate the resources
between current consumption and investment for the
future.
 SOCIALIST MARKET SYSTEM:
CHARACTERISTICS
iii. Less importance of price mechanism
. Market forces are less important in this economic
system.
. Prices are fixed by the government and not determined
by the forces of demand and supply.
. Private profits are not allowed and public interest is
emphasized.
iv. Central control and ownership
. Government intervenes in all aspect of economic
activities including production, consumption and
distribution of goods and services.
 SOCIALIST MARKET SYSTEM:
ADVANTAGES
i. Production according to the basic of society
. Government produced goods and services according to the
societies basic needs such as foods, clothes and building
material.
. Production is not by the purchasing power of rich society
but more concern on the society as a whole.
ii. Equal distribution of income
. There will be no difference between rich and poor as
this system provides equal opportunity for all citizens
in earning income.
. Wealth is also equally distributed since private
enterprise are limited.
 SOCIALIST MARKET SYSTEM:
ADVANTAGES
iv. No serious unemployment/recession or
inflation
. Since the economy is taken fully care by the
government, there will be no serious economic
problems as the governments main objectives is to
maintain the stability of economic.
v. Social welfare
. Government will provide all citizens of the country full
social security such as pensions, accident benefits and
others.
. With all concerns from government, labor dispute and
wastage of resources do not exist in socialist system.
 SOCIALIST MARKET SYSTEM:
DISADVANTAGES
i. Lack of incentives and initiatives by
individuals
. There is absence of profit motive in individuals.
. Thus, this will lead to economic inefficiency since jobs
are provided by the government and individuals are
not motivated to work harder.
ii. Loss of economic freedom of consumers
. There is no choice given to consumer and they accept
whatever the public enterprise produce.
. Since with the limited number of private enterprises,
there are limited variety of goods and services as well
as restricted available choices.
 SOCIALIST MARKET SYSTEM:
DISADVANTAGES
iii. Absence of competition
. Since there are limited private enterprise exist in this
market system, there will be less R&D activities occurs.
. Thus, quality of products will be low since there is no
competition.
iv. Waste of economic resources
. Government might produce goods and services that are
not required by the people such as military
equipments.
. This will lead to overproduction of certain goods and
underproduction of certain other goods.
 HOW SOCIALIST MARKET SYSTEM SOLVE
BASIC ECONOMIC PROBLEM
i. What to produce?
. In this economic system, planning authorities decides what to produce.
. The Central Planning Authority will collect detailed statistics on the
resources availability and fix up with national priorities.
ii. How to produce?
. The Central Planning Authority will also decides on what techniques to
be used in the production of goods and services.
. The choice is between traditional or modern techniques.
iii. For whom to produce?
. The distribution of national product is decided by Central Planning
Authority.
. The distribution of various commodities is done through a set of
administered fixed prices. (Necessities good are fixed at lower price
while luxurious good are fixed at higher price)
. This is to ensure low inequalities in the distribution of income among
societies.
 iii. MIXED MARKET SYSTEM

Mixed market system is an economic system

which has a mix of capitalist and socialist
systems to solve basic economic problems.
A mixed economy is where both public and
private sectors play their roles in the economy.
Most of the countries in the world practiced this
type of economic systems. This includes
Malaysia, Singapore, Thailand, Germany, South
Africa and many others.
 MIXED MARKET SYSTEM:
CHARACTERISTICS
i. Public and private ownership of resources
. Private enterprise conduct business freely.
. The government encourages private sectors by
providing infrastructure and facilities.
ii. Price mechanism and economic plan used to
make economic decisions.
. Price mechanism is used on pricing of goods and
services.
. However, government will intervene in setting up
prices on certain commodities.
. This includes sugar, oil, rice where government
declared as controlled items .
 MIXED MARKET SYSTEM:
CHARACTERISTICS
iii. Government intervention
. Government will not intervene in the economy except for
particular industries.
. Government uses the legislation for unsafe goods,
categorized as illegal products such as military items,
drugs, etc.
. Government also uses direct provision such as education,
defense and health to increase standard of living.
. Besides, government also control the income disparity
through income taxes and welfare payment.
. Government will also control the existence of monopolies
in order to avoid customers being exploited by monopolist.
 MIXED MARKET SYSTEM:
ADVANTAGES
i. More stable economics
. Since there is a lot of government intervention, the economic will
be more organized. Thus, economic condition will be more stable.
ii. Lower social cost
. Externalities such air, noise and water pollution will be lower due
to government intervention.
. Thus, social cost will be lower as government enact laws to ensure
production methods used caused least harm to the environment.
iii. Narrow gap between rich and poor
. Government intervention through imposing progressive tax will
help to narrow down the gap between the rich and the poor.
. Higher income earners are taxed more than lower income earners.
 MIXED MARKET SYSTEM:
ADVANTAGES
iv. Social welfare
. The government will provides public goods at an
affordable price in order to enable lower income
earners to benefit the public goods as well.
. Government will ensure that public and private
enterprise provide all citizens of the country full social
security such as pensions, accident benefits and others.
 HOW MIXED MARKET SYSTEM SOLVE
BASIC ECONOMIC PROBLEM
i. What to produce?
. In this economic system, what to produce decided by the public and
private sectors.
. The goods and services produced depends on the consideration of
social welfare as well as economic growth.
ii. How to produce?
. The private sector will choose the most efficient and cost-effective
techniques of production (labor intensive vs. capital intensive) while
government will enact laws to combat inefficiencies arising from
externalities.
iii. For whom to produce?
. The distribution of goods and services is also decided by the public
and private sectors.
. Price mechanism is not fully functional in mixed economies.
. Government intervene directly through price control and indirectly
imposing indirect taxes and subsidies.
 iv. ISLAMIC MARKET SYSTEM
Economic activities in Islam are not seen from the
materialistic aspect only but also the spiritual aspect in this
world and the life hereafter.
The only objective of the Islamic Economic System is to
achieve Al-Falah, which means success in ones life in the
world and also the life hereafter.
The basic philosophical foundation in the Islamic Economic
System includes;
a) Tauhid
b) Rububiyyah
c) Tazkiyyah
d) Khalifah
e) ukhuwwah
 ISLAMIC MARKET SYSTEM:
PHILOSOPHICAL
a) The concept of Tauhid
. The concept of believing that in Islam there is only one God
to be worshipped which is Allah SWT.
. The belief of Tauhid is divided into two, namely;
i. The relationship between man and Allah SWT
(Habluminallah)
ii. The relationship among mankind (Habluminannas)
b) The concept of Rububiyyah
. The concept of believing that Allah SWT alone is the creator
and the most powerful.
. He also gives bounties and organizes mans economies
activities for genuine interest to achieve Al-Falah in this
world and the life hereafter.
 ISLAMIC MARKET SYSTEM:
PHILOSOPHICAL
c) The concept of Tazkiyyah
. The concept of purification of man.
. Islam believes that before one indulges in any economic
activities, he must mould pure and good soul.
. For example, one can purify his wealth by giving out tithe
(Zakat) and donating (Sedekah) to the poor.
. When the wealth of the rich reaches a certain stated amount, it
must be levied with zakat, which aims to help the poor.
d. The concept of khalifah
. The concept of vicegerent that man is the servant of Allah SWT.
. In Islam, men are created as trustees and they are responsible
to prosper the land and always to be in servitude to Allah SWT
set by the Islamic Law (syariah)
 ISLAMIC MARKET SYSTEM:
PHILOSOPHICAL
e) The concept of Ukhuwwah
. The concept of brotherhood in Islam.
. Islam believes that all men are brothers and they must
love and respect each other and be responsible.
. Those who are willing to sacrifice for their brothers
show the sign of faith.
. Oppression, extortion and miserliness do not exist in
the Islamic Economic System.
 HOW ISLAMIC MARKET SYSTEM SOLVE
BASIC ECONOMIC PROBLEM
i. What to produce?
. In this economic system, what to produce are decided through
the principles of Syariah as been stated in Al-Quran and As-
sunnah.
. The goods and services produced must be permissible (halal) and
in accordance with the classification of goods in Islam.
ii. How to produce?
. The producer will choose the most efficient and cost effective
methods of production. (labor vs. capital intensive)
iii. For whom to produce?
. In distributing the goods and services, the need of the poor
should come first instead of the rich.
. This, however, does not mean that the needs of rich are being
ignored. It just that the production of luxury goods for the rich
should come later than the need of the poor.
END OF CHAPTER 1

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