Microeconomics Chapter 1 2

What is an Economy?
You have observed many activities happening around us in our daily life. For
instance, we may have seen factories, mines, shops, offices, flyovers, railways,
etc. all these institutions and organizations may be collectively called an
economy.
Vital Processes of an Economy

Economy is a system which provides living to the people. For this objective to be
fulfilled, it is necessary that every economy should undertake three economic
activities.
1.Production
2.Consumption
3.Investment or Capital Information
These economic activities are known as the essentials or the vital processes of an
economy.
WHY STUDY ECONOMICS?
1.We go to cinema hall to watch a movie. We go to a restaurant to eat. We attend

school to get educated or to be able to earn a living. It means, every activity is
conducted for a specific reason. Economics is studied because it enables us to
understand different aspects of the economy.
SCARCITY
01
Scarcity refers to the limitation of supply in relation to demand for a commodity.
02
It refers to the situation, when wants exceed the available resources. As a result,
goods are not readily available and society does not have enough resources to
satisty all the wants of its people. Scarcity is universal,
I.e. every individual, organization and economy faces scarcity of resources.
03
Scarcity of resources calls for economizing of resources. Economizing of resources
refers to making optimum use of the available resources.
Economic Problem
Economic Problem is a problem of choice involving satisfaction of unlimited wants
out of limited resources having alternative uses.
Reasons for Economic Problem

1.Scarcity of Resources
Resources (le, land, labour, capital, etc.) are limited in relation to their demand
and economy cannot produce all what people wan. It is the basic reason for
existence of economic problems in all economies.
2.Unlimited Human Wants
Human wants are never-ending, le, they can never be fully satisfied. As soon as one
want is satisfied, another new want emerges. Wants of the people are unlimited and
keep on multiplying and cannot be satisfied due to limited resources.
3.Alternate Uses
Resources are not only scarce, but they can also be put to various uses. It makes
choice among resources more important. For example, petrol is used not only in
vehicles, but also for running machines, generators, etc. as a result, economy has
to make choice between the alternative uses of the given resources.
Meaning of Economics
Economics is a social science which studies the way a society choose to use its
limited resources, which have alternate uses, to produce goods and services and to
distribute them among different groups of people.
Positive economics studies the facts of life, le., it deals with 'things as they
are'.
Positive Economics (or Science)
Positive economics deals with what are the economic problems and how are they
actually solved.
For example, India is an overpopulated country or prices are constantly rising.
Positive economics remain strictly neutral with respect to ultimate ends. It avoids
economic value judgement. For example, a positive economic theory might describe
that manufacturing and sale of cigarettes is injurious to health, but it does not
provide any instruction or judgement on what policy ought to be followed to avoid
cigarettes in an economy.
Normative
Economics (or
Science)
Normative economics tells us 'what ought to be'. Normative economics deals with
what ought to be or how the economic problems should be solved.
For example, India should not be an overpopulated country or prices should not
rise.
Normative economics discusses what are desirable things and should be realized and
what are undesirable things and should be avoided. It gives decisions regarding
value.
Microeconomics
Microeconomics is that part of
economic theory, which studies the behaviour of individual units of ane economy.
For example
Individual income, individual output, price of a commodity, etc.
Its main tools are
Demand and Supply.
Macroeconomics
Macroeconomics is that part of
economic theory which studies the behaviour of aggregates of the economy as a
whole.
For example
National Income, aggregate output, aggregate consumption, etc.
Its main tools are
'Aggregate Demand' and 'Aggregate Supply'.
Central Problems of an Economy Production, distribution and disposition of goods

and services are the basic economic activities of life.
In the course of these activities, every society has to face a scarcity of
resources. Because of this scarcity, every society has to decide how to allocate
scarce resources. It leads to the following central problems, that are faced by
every economy.
Allocation of Resources
(Studied Under Microeconomics)
The problem of allocation of resources is studied under 3 heads:
Allocation of resources refers to the problem of assigning the scarce resources in
such a manner so that maximum wants of the society are fulfilled. As resources are
limited in relation to the unlimited wants, it is important to economize their use
and utilize them in the most efficient manner.
01
What to produce
02
How to Produce
03
For Whom to produce
What to Produce
This problem involves selection of goods and services to be produced and the
quantity to be produced of each selected commodity. Every economy has limited
resources and thus, cannot produce all the goods. More of one good or service
usually means less of others.
For Example
Production of more sugar is possible only by reducing the production of other
goods.
Production of more war goods is possible only by reducing the production of civil
goods.
How to Produce
This problem refers t to selection of technique to be used for production of goods
and services. A good can be produced using different techniques of production. By
technique', we mean which particular combination of inputs to be used. Generally,
techniques are classified as:
Labour intensive techniques (LIT) and Capital intensive techniques (CIT).
In Labour intensive technique, more labour and less capital (in the form of
machines, etc.) is used.
In Capital intensive technique, there is more capital and less labour utilization.
Opportunity Cost
Opportunity Cost is the cost of next best alternative foregone. For example,
suppose you are working in a bank at the salary of & 40,000 per month. Further
suppose, you receive two more job offers:
01
To work as an executive at & 30,000 per month; or
02
To become a journalist at & 35,000 per month.
In the given case, the opportunity cost of working in the bank is the cost of next
best alternative foregone, i.e. € 35,000. The amount of other goods and services,
that must be sacrificed to obtain more of any one good, is called the opportunity
cost of that
Production Possibility
Frontier (PPF)
Production Possibility Frontier (PPF) refers to graphical representation of
possible combinations of two goods that can be produced with given resources and
technology.
Alternately, PPF is the locus of various possible combinations of two goods that
can be produced with given resources and technology.
Assuptions for PPF

The amount of resources in an economy is fixed but these resources can be
transferred from one use to another;
uptions for FPF
With the help of given resources, only two goods can be produced;
The resources are fully and efficiently utilized;
Resources are not equally efficient in production of all products.
So, when resources are transterred from production of one good to another, the
productivity decreases;
The level of technology is assumed to be
constant.
Marginal Opportunity Cost

OC refers to the number of a commodity sacrificed to gain one additional unit of
another commodity.
In the case of PPF, MOC is always increasing, i.e. more and more units of a
commodity have to be sacrificed to gain an additional unit of another commodity.
Why Increasing
MOC Operates?
Increasing MOC operates because productivity and efficiency of factors of
production decrease as they are shifted from one use to another.
Let us understand this with the help of an example: Suppose an economy produces
only two goods (say, guns and butter). A worker is employed in production of guns
because he is best suited for it. If economy decides to reduce production of guns
and increase production of butter, then worker will be transferred to production of
butter.
However, he is not that efficient in production of butter as he was in guns. As a
result, his productivity in butter will be low and MOC will increase.
Marginal Rate of Transformation

MRT is the ratio of number of units of a commodity sacrificed to gain an additional
unit of another commodity.
Can PPF be a Straight Line?

PPF can be a straight line if we assume that MRT is constant, i.e. the same amount
of a commodity is sacrificed to gain an additional unit of another commodity. It is
possible only when we assume that all the resources are equally efficient in
production of all goods. In such case, PPF will be a straight line as shown.
Change in PPF
01.Shift in PPF
PPF will shift when there is a change in productive capacity (resources or
technology) with respect to both the goods.
02.Rotation in PPF
PPF will rotate when there is a change in
productive capacity (resources or technology) with
respect to only one good.

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Microeconomics Chapter 1 2

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What is an Economy?

Vital Processes of an Economy

WHY STUDY ECONOMICS?

1.We go to cinema hall to watch a movie. We go to a restaurant to eat. We attend

Reasons for Economic Problem

Central Problems of an Economy Production, distribution and disposition of goods

Assuptions for PPF

Marginal Opportunity Cost

Marginal Rate of Transformation

Can PPF be a Straight Line?

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