ECO302

Introduction to
Principles of
Microeconomics
Text Book
 Dr. Muhammad Hussain Chuadhry “Economic Theory”
Volume.1

Reference Books
 Ferguson & Gould’s “Microeconomic Theory” 6th Edition
 Robert S. Pindyck and Daniel L.Rubinfeld “Microeconomics”
(Latest Edition)
 Habib Ullah Vaseer “Fundamentals of Economics” Part -1
 What is Economic Theory
 Two types of Economic Generalizations
 Classification of Economic Theory
 Microeconomics versus Macroeconomics
 Basic Problems of Microeconomic Theory
 Limitations of Microeconomics
Economic theory consists of well recognized and widely
acceptable explanations regarding the economic
conditions and behavior of economic units in the real
world.
For example:
 Theories regarding the behavior of consumers and
firms
 The theories regarding the determination and
fluctuations of income and employment in an economy
 Economic theory is initiated from a hypothesis which is
an untested explanation of the mutual relationship
existing among some key variables.

 For example: There is a positive correlation between

the availability of hours for work and the productivity
of employees.
A hypothesis assumes the status of a theory if:
 It is capable of logically explaining certain
phenomenon and
 with its help, certain predictions can be made and
 those predictions prove to be true during recurrent
testing.
An economic theory attains the status of an Economic
law or a principle if it is established through repeated
testing and when the explanation provided by it is
universally recognized to be true.

For example, the principle “under perfectly competitive

conditions, price tends to be equal to the average cost in
the long-run”.
 There are two types:
1. Analytical or Deductive Generalizations:
State those conclusions which are logically deduced from
certain assumptions.

For example: Quantity demanded varies inversely with

price.
2. Empirical or Inductive Generalizations:
The statements of relations observed to hold between real
world economic data.

For example: Price declines lead to increases in

consumption.

Empirical generalization is valid only in particular

instances and it may not prove to be true in general.
Economic theory can be classified into Positive
economics and Normative economics.

1. Positive Economics:
 The economics that analyses the actual functioning of
the economy.
For example:
Unemployment is rising in Pakistan.
2. Normative Economics:
 Deals with “what ought to be” or “what should be”.
 Economists suggest policies and make
recommendations for economy based on personal and
subjective judgments.

For example: The government should increase the

minimum wage to reduce poverty.
 The area of economics which studies the behavior
and activities of various small economic units of the
economy.

Microeconomics deals with three fields:

1. Theory of production
2. Theory of price
3. Theory of distribution
 The area of the economic theory which studies and
theorizes about the economy as a whole.
 Also known as National Income theory or Employment
theory or Aggregative Economics.
 Economists while studying macroeconomics divide the
whole economy into four sectors:
1. Household sector
2. Business sector
3. Government sector
4. Foreign sector
 The function of allocation of resources is concerned
with the microeconomics.
 Economic system has to make efforts to solve four
basic problems which are:
 Determination of Output Composition or determination of what to
produce
 Allocation of Resources and Organization of Production
 Distribution of the product
 Maintenance and Expansion of the Productive Capacity of the
Economy
 Every economic system has to decide what goods and
services to produce and in what quantities to produce
them.
 The demand for goods and services by the consumers
determines the composition of output.
 The consumers while spending their incomes help in
determining the relative prices of goods and services.
This involves two things:
i. Withdrawing resources from industries whose goods
are valued less by the consumers and moving them
towards industries where goods are valued more by
the consumers.
ii. Deciding about techniques of production or deciding
in what combinations resources be used.
 Output or product distribution among different
individuals of the society depends on the personal
income distribution.
 The income available to an individual is dependent on
the following two factors:
i. The amount of factor resources owned by the
individual.
ii. The factor prices received by these resources
The factor or resource prices are determined in the
market through forcers of demand and supply.
 Maintenance of the productive capacity is mainly
possible through replacement of the depreciated capital
goods.
 Expansion of the productive capacity is possible
through continuously increasing the quantities of the
productive resources of the economy.
Microeconomics is subject to the following limitations:
1. Unrealistic assumption of full employment and given
general price level
2. Failure to reflect broad picture of the Economy
3. Abstraction of Reality
4. Based on simplifying assumptions
5. Unfinished business