INTRODUCTION TO MICROECONOMICS

LECTURE-1

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Dr Ashikur Rahman: Senior Economist,
Policy Research Institute of Bangladesh (PRI)
 WHAT IS ECONOMICS?
Before we examine the question – what is economics? – it is essential to ask
ourselves what is science?

Science: It is study of material universe and it explains physical phenomena with

a particular logical/analytical framework that allows us to derive theories and
hypothesis that are verifiable through scientific experiments.

For example: Why does an apple fall down? Scientific explanation – Gravity. Can
we prove it through scientific experiments? Yes.

In that sense, economics is a discipline in social science that allows us to

understand how human beings, firms, corporations and national governments
behave within an economy.

We can argue that unlike natural science, it is an imperfect but an useful method
to examine issues related to the economy.
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 WHAT IS ECONOMICS?

Economics is a social science. It examines the problems that societies face because
individuals desire to consume more goods and services than are available, creating a
condition of relative scarcity.

“Economics is a science which studies human behaviour as a relationship between ends and
scarce means which have alternative uses.”
- Lionel Robbins (1932)

Perceived wants are generally unlimited, where as resources ( which are often sub-divided
land, labour, capital and entrepreneurship) are limited. To meet the problem of scarcity, a
social mechanism is required for allocating limited resources among unlimited alternatives.

Historically, four mechanisms dealt with problem of scarcity: brute force, tradition,
government and religious institutions (church), market.

In economics, we are mostly concerned with how markets deals with scarcity.
Scarcity  Compels us to make Trade-offs  Make Choices
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 WHAT IS ECONOMICS?
Scarcity has three important effects:
 The need to make choice

 The need for a rationing device – price in a market (an alternate is first come first service)

 Competition – people compete to have more of the rationing device to avail more goods
and services.
Microeconomics deal with questions of choice, allocation and distribution of resources for
individuals, firms and etc. and builds up to an analysis of society.
It deals with three fundamental questions:
I. What goods and services are produced?
II. How to produce such goods and services?
III. Who gets what?

We will see that ‘price mechanism’ ultimately solves all these three questions
simultaneously.
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 INTUITION
Example:

How did Apple decide to produce an IPAD?

First, it examined if consumers are willing to let go a portion of their

income dedicated for other goods and services to buy an IPAD? In other
words, they estimate at what price a reasonable segment of the consumers
will buy an IPAD for so that they can profit.

Second, it examined if the price of inputs (such as technology and labour)

makes it feasible to produce an IPAD

Third, allow the price of IPAD to determine who gets a new piece?
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 WHAT IS ECONOMICS?

 It is important to remember that price does not determine the

importance of goods or services

 Adam Smith  Water – Diamond Paradox?

 Who is more important for the society – Messi or a Brain Surgeon?

Price is essentially shaped by forces of supply and demand.

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 KEY CONCEPTS
Goods, Bads and Resources

 A good is anything that gives utility or satisfaction. Eg. Good Food/Cars/Bags/Books

 A bad is anything that gives disutility or dissatisfaction. Eg. Headache

 Resources are the factors of production or inputs. There are 4 types of resources

Land: Any natural resource used for production. Eg. Oil, coal, field, water.

Labour: The physical and mental attributes of people that is used for production.

Capital: Man-made resource that helps to convert raw materials into finished product. Eg. Machineries,
money

Entrepreneur: The risk-taker and organiser of land, labour and capital for production. Eg. A factory owner.
For example: Bill Gates 7
 KEY CONCEPTS
Scarcity is a situation that takes place due to unlimited wants and limited
resources to fulfil them. Everyone faces scarcity in this world.

Hidden in this statement – there lies the most important assumption in

economics.

That is, want is unlimited for human beings – and individuals try to
maximize their utility by consuming as much goods as possible. This
maximizing behaviour also determines how much education they pursue,
how much work they do and how much income they generate.
In essence, in economics we assume individuals are driven by self-
interest. Firms, on the other hand, try to maximize profit.

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 KEY CONCEPTS
Effects of Scarcity are:
1. It forces us to make choices
2. It uses rationing devices to allocate scarce resources
3. It leads to competition among people

Now, each choice that individuals undertake gives rise to what economist call:
opportunity costs

Opportunity Cost
It is the value of the next best alternative forgone for the choice made. For example, if
you have an option of either watching TV or playing games, if you choose games, then
watching TV is your opportunity cost.

Opportunity cost may increase or decrease and this will change a person’s behaviour. The
higher the opportunity cost of doing something, the less likely it is to be done and the
lower the opportunity cost, the more likely it is to be done.

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 KEY CONCEPTS

Furthermore, when we undertake choices when faced with scarcity, we

also weigh the marginal cost and benefit of attaining a product.
 Marginal Benefit: Additional/extra benefits gained from an
additional/extra consumption of a good or service
 Marginal Benefit (MB)≠ Total Benefits (except for first unit)
 MB curve is always downward sloping

MB

Quantity
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 KEY CONCEPTS
 Marginal Costs: Additional/extra costs incurred from an additional/extra
consumption of a good or service
 Marginal Cost (MC)≠ Total Costs (except for first unit)
 MC curve may be a straight line parallel to the x- axis or upward
sloping

MC

Quantity
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 KEY CONCEPTS
The concept of efficiency dictates that as long as marginal benefits of an
economic activity are greater than its marginal costs, a person gains by continuing
that activity. Moreover, the net benefits of an economic activity are maximized
when the marginal benefits of the activity is equal to its marginal costs. Efficiency
is achieved at that point.

$
MC

MB>MC MC>MB

MB=MC
MB

Optimal Level 12
 KEY CONCEPTS
Unintended effects and Trade

Not every change brings desirable and/or predictable results. Some may bring
unintended effects.
For example: Minimum Wage Law’s impact on unemployment.

Exchange or Trade: is the giving up of one thing for another. It only takes place
when one expects to be better off after the trade than before the trade

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 KEY CONCEPTS
 Microeconomics is a branch of economics that studies the behaviour of how the
individual modern household and firms make decisions to allocate limited
resources. Typically, it applies to markets where goods or services are being
bought and sold. In essence, it is about studying a tree and then making a
prediction about the nature of the forest.

“How does consumer determine how much goods or services will he or she buy?;
What level of output does a firm produce?”

 Macroeconomics is a branch of economics dealing with the performance,

structure, behaviour and decision- making of the entire economy. In other words,
it is about studying a forest and then understanding its implication for a
tress.

“What causes Inflation?; How do changes in money supply affect the economy?;
How can we accelerate economic growth”

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 ECONOMIC CATEGORIES
Positive economics is the branch of economics that focuses on facts and cause-
and-effect behavioural relationships and includes the development and testing of
economic theories.

It is about identifying various dynamics within the economy as they are.

Normative economics is that part of economics that expresses value judgments

about economic fairness or what the economy ought to be like or what goals of
public policy ought to be.
“Both are extremely important in designing policies”

For example: Normative economics will help us articulate the objective of an

economic policy. And, positive economics will help us understand how a policy
will function. For example: Should health care be free? Should there be a
minimum wage?

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