PAPER No. : Basic Microeconomics MODULE No. : 1, Introduction of Microeconomics

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1 Subject Paper No and Title Module No and Title Module Tag 3 Basic Microeconomics 1- Introduction of Microeconomics ECO_P3_M1

2 Table of Content 1. Learning outcome 2. Introduction 3. Microeconomics 4. Basic Area of Microeconomics 5. Summary

3 1. Learning Outcomes After studying this module, you shall be able to Know how Economics and its two branches, Micro-Economics and Macro-Economics are Learn whether Economics is a Science or an Art, is Positive or Normative Identify the broad areas of Economics, such as Consumer Choice, Production Behaviour, Markets and so on, Evaluate the relation in which Economics stands in relation to other subjects. Analyze the Economics approach to the world around us-especially the Micro-economic approach. 2. Introduction To understand what Micro-economics is, one must know what Economics is. 2.1 Etymological and general meaning of Economics. Etymologically, the term Economics comes from the Greek words oikos ( house) and nomos ( management). In the present-day sense, Economics is a subject whose study assists individuals, groups, nations and even international organizations make important choices for material welfare, both short-term and long-term, under limitations or constraints of resources. Under its widespread umbrella comes the individual or the household going to the market, the firm trying to make profits, the village growing into an industrial town, the less developed country striving for development, multinational organizations and the world economy in general. 2.2 Evolution Even though the term Economics had not come into usage, there was thinking on economic issues in Western Europe in the 16 th to late 17 th centuries that go by the name Mercantilism or merchantlike thoughts. It emphasized the role of the government in following policies leading to a positive Balance of Trade, was thought to be the index of the country s prosperity. In the second half of the 18 th century, there emerged economic thoughts that go by the name Physiocracy. It emphasized the role of land and agriculture in ensuring a country s prosperity. The Mercantilists had focused on trade and commerce and accumulation of gold and silver. The Physiocrats focused on productive work, leading to the generation of agricultural surplus. In the third quarter of the 18 th century, with the publication in 1776 of An Inquiry into the Nature and Causes of the Wealth of Nations Adam Smith, Classical Economics was born. Britain was beginning to experience the Industrial Revolution. Smith emphasized Division of Labour or Specialization as the source of productivity or efficiency in factories contributing aggregatively to the nation s wealth or prosperity. J.B.Say, T.R. Malthus, David Ricardo and J.S.Mill enhanced

4 his ideas made their contributions to this new body of thought. They came from different professions but all of them had an aggregative approach, took a long-run perspective and made sweeping generalization. Together with Adam Smith, they constitute the Classical economists. Towards the end of the 19 th century, there developed a new approach, which has come to be called Neo-Classical. Economists began to study economic issues on a more individual level, asking how the price and quantity of specific goods (and services) were determined in the market, and how firms set their wages, maximizing their profits and minimizing their costs. The canvas became smaller, the conclusions less sweeping. Instead of the aggregates, the units became marginal or incremental., Instead of the entire nation, the individual consumer or producer became the focus of interest. Decisions depended on a rational weighing of costs and benefits leading to a balance or equilibrium. It is this equilibrium that became the most important objective rather than the wealth of nations, that is, growth. Menger, William Stanley Jevons and Alfred Marshall are foremost among these new thinkers who came to be called `marginalists or Neo-Classicals. 2.3 Marshall s Definition of Economics Marshall s Principles of Economics ( 1890), the pioneering work of Neo-Classical tradition, provided the following definition of Economics: "a study of mankind in the ordinary business of life; it (Economics) 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 wellbeing. 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." This definition established the character of the subject as for a long time to come. Economics studied human beings as they go about their everyday life. 2.4Robbins s Definition In 1932, in Lionel Robbins Essay on the Nature and Significance of Economic Science, Lionel Robbins highlighted another aspect of the subject, choice under conditions of scarcity. "Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses." First, resources or means of production ( land, labour, capital goods such as machinery, technical knowledge) are scarce or limited. Secondly, what is applied to the production of a certain commodity or service is unavailable for the production of another, alternative one. But human wants for the consumption or use of goods and services ( food, clothing, housing, education, entertainment ) are countless and unlimited. So people or organizations must chose among them. Economics is the study of how people (or organizations) can choose to use the scarce or limited resources to produce various good and services and distribute them to various members of society for them to consume. Contemporary Economics is largely built upon this Robbinsian understanding of Economics. 2.4 Is Economics a Science or an Art? If we look at the above two equally famous definitions, we see that while Marshall regards it as a `study of mankind, which is what Humanities is, Robbins sees it as a Science.

5 Most universities award Bachelor of Arts and Master of Arts degrees for the study of Economics. In contrast, the London School of Economics offers BSc and MSc degrees to its students of Economics. Indeed the scope of Economics is so wide that it is difficult to label it as either science or art. It is perhaps a mixture of both. As Nobel Prize winner Paul Samuelson put it, Not only is Economics at once art and a science, economics as a subject can combine the attractive features of both the humanities and the sciences (Economics, 7 th edn, Chapter 1,p 4). But even if the epithet `science is given to Economics, it remains a Social Science. It is, to use Marshall s words, `the study of mankind, of people as members of a society or nation or economy, acting and interacting among themselves in the complex process of production and exchange, consumption and distribution. There is, of course, the concept of a Robinson Crusoe Economy where the country has just a single person performing all the economic activities by himself. The name is borrowed from the title of a book by Daniel Defoe on a man shipwrecked on an island. But this is merely an analytical tool to facilitate the understanding of the complex reality of an actual economy. Essentially, the subject Economics is social in character. 2.5 Is Economics Positive or Normative? In 1953 Milton Friedman, in his Essays in Positive Economics, said that economists should not be Normative, that is, pass moral strictures or make `value judgments. They should be Positive, that is, make propositions or statements such as: If the price of a commodity goes up, its quantity consumed falls, other things remaining the same rather than: You stupid consumer! Don t go on buying more and more of this commodity when the price of it was going up. Even policy prescriptions or recommendations should be expressed in a calm, categorical way, such as : If there is inflation and the government prints more notes, the inflation is likely to get aggravated, instead of: The government should not do a mad thing like printing more notes when there is inflation in the country. 2.6 What subjects does Economics relate to? Mathematics and Statistics are tools of Economics, used for theoretical as well as empirical study. Pioneers like Alfred Marshall used verbal exposition as well as graphs to make their points, say, about the Demand Curve or the various Cost Curves. But in contemporary times it is impossible to study Economic Theory without knowledge of Mathematical Techniques such as geometry, algebra, calculus, set theory, matrices. However, Samuelson assures that it is only for the higher reaches of economic theory that mathematics is needed. For a general understanding, it is enough to be alert and informed... Logical reasoning is the key to success in the mastery of basic economic principles, and shrewd weighing of empirical evidence is the key to success in mastery of economic applications. ( Economics, 7 th edn, Ch 1. p 5). Economics is both theoretical and empirical. For empirical analysis, the application of Statistics to Economics has led to the emergence of Econometrics. Most contemporary research in Economics is with the help of Econometrics.

6 Political Science too helps in the study Economics which originally was called `Political Economy. Knowledge of history and geography too are essential for a grasp of Economics. Sociology and History too are related areas. Economic History and Economic Geography have developed as subjects in their own right. Other subjects or courses that have emerged from Economics are: Commerce, Business Economics, Business Administration, Business Management. Undergraduate courses in Commerce and Business Economics compulsorily include courses/papers in Economics. 3. Micro-economics 3.1 The Term Micro-economics In Greek, the words `micro and `macro mean small and huge, respectively. Micro-Economics is the branch of Economics that studies economic issues in small, individual details, as if under a microscope. In contrast, Macro-Economics studies economic issues in aggregative and overall forms, looking at the broad picture. Classical economists like Adam Smith, J.B.Say, and David Ricardo had been concerned with the nation or the country as a whole, and drew their conclusions on an aggregative basis. Their analysis was more macro than micro in nature. Neo-Classical economists like Alfred Marshall, Menger, W. S. Jevons were concerned with households and firms as individual rather than aggregative entities and used `marginal (small additional or incremental) units in their methodology..the `margin was the concept they used in their technique of study. The old-fashioned Neo-Classical theory of Marginal Utility, for example, says that the price of a commodity is decided by the additional `utility that an small additional unit of it yields. Micro-economics is Economics using the perspective of small, micro units. 3.2 The term Macro-economics So far as modern Macro-economics( as distinct from Classical Economics which was macro in character), It started with John Maynard Keynes, after the Great Depression of the 1930s. During this Depression, both Europe and America suffered along with their colonies in various parts of the world. There was accumulation of unsold stock, closure of production units and widespread unemployment, Both employers and employees were affected. Keynes analyzed the phenomenon in terms of Aggregate Demand falling short of Aggregate Supply and argued that under such circumstances if the Government of a country played an active role and stepped up its own expenditure, Aggregate Demand would be boosted and Depression corrected. This was the beginning of modern Macro-Economics. Later John Hicks, Milton Friedman, Lucas and others have developed Macro-Economics to a very-well developed body of thoughts with many policy implications. 3.3 Micro vs. Macro Is there any issue of Micro-economics versus Macro-economics? Is either of the two more fundamental or important? Most universities make the students first take a course in Micro- Economics and then go on to Macro-Economics. However some universities are now offering both courses in the same semester or academic year.

7 So far as undergraduate and even post-graduate studies are concerned, it is essential for students to first grasp the concepts of Micro-economics and then go over to those of Macro-economics. For example, the concept of the `margin is first learnt through Marginal Utility, Marginal Rate of Substitution, Marginal Productivity etc. and only subsequently used through Marginal Propensities to Consume and Save. The concept of Consumer Equilibrium has to be learnt prior to its application in the box diagrams used, say, in the Heckscher-Ohlin Theorem of International Trade Theory. So far as public policy making (governmental or even corporate) is concerned, macro-economics is more relevant. However, as Paul Samuelson has emphasized, that there is no essential opposition between Macro-Economics and Micro-Economics. Macroeconomics deals with the big picture with the macro aggregates of income, employment, and price levels. But do not think that microeconomics deals with unimportant details. After all, the big picture is made up of its parts. ( Economics, 7 th edn, p 362). He has also pointed out that both subjects are vital to the understanding of the subject ( Economics, 7 th edn, p 362). 4. Basic Areas of Micro-economics Micro-economics falls into several broad areas. 4.1 Consumer Choice and Demand This deals with how an individual consumer( person or household) chooses what quantities he/she should buy at certain market prices so as to maximize satisfaction, i.e., how a Demand Curve or function is arrived at, for the individual and for the Market. 4.2 Production Cost, Revenue, Profit This relates to how a productive unit, say, the firm, chooses, on the basis of cost considerations and revenue prospects, what quantity to produce and sell so as to maximize profits, i.e., how a Supply Curve or function is arrived at both individual and Market levels. 4.3 Market - Structure and Strategy Markets can be of various forms or structures, beginning,monopsony). In addition to standard tools of Geometry and Calculus, Game Theory is often used to analyze the various strategies suitable for the various markets. So after the analysis of Consumption and Production, comes the analysis of Markets. 4.4 Factor Payments, Risk, Uncertainty This relates to the determination of payments for the various factors of production, such as rent, wages and profits, in terms of marginal productivity, reward for risk-taking etc. 4.5 Welfare Economics

8 This relates to the maximization of satisfaction or welfare for the society rather then the individual. It encompasses situations of Market Failure, caused often by Externalities, as well as problems caused by information that is Asymmetric. 4.6 International Trade Like two or more individuals, countries too can come together in relations of production and exchange. This inter-national trade too is analyzed in Micro-economic, beginning with the theories of the Mercantilists and Adam Smith to more modern ones. The treatment however is different from that of Open Economies in macro-economics, say, by Mundell-Fleming. 5. Summary The subject of Economics helps individuals, groups, nations and international organizations make important choices for material welfare, both short-term and long-term, under limitations or constraints of resources Economics has evolved right from the 16 th century. The early economic thinkers were Mercantilists, Physiocrats and Classicals. Then came Neo-Classical and Keynesian economists. Alfred Marshall of the Neo-Classical tradition, provided the following definition of Economics: "a study of mankind in the ordinary business of life. Another Neo-Classical economist named Lionel Robbins defined it as " a science which studies human behavior as a relationship between ends and scarce means which have alternative uses." Economics is both a science and an art and is positive rather than normative. It is related to various subjects like History, Geography, Political Science, Sociology as well as Mathematics. Economics can be broadly divided into two branches. Micro-Economics is the branch that studies economic issues in small, individual details, as if under a microscope. Macro-Economics, on the other hand, studies economic issues in aggregative and overall forms, looking at the broad picture. Both branches are equally important. Micro-Economics includes areas such as Consumer Choice, Production, Market, Factor Payment, Risk, Uncertainty, Welfare and International Trade.