Introduction to Microeconomics

We all witnessed the ​phenomenon​ of ​Demonetisation​ very recently.

Although it was a national event, even your household was affected.
Since you were cash-strapped, you focused on buying necessities
rather than luxuries. So ​economics​ that studies the behaviour of
individuals is Microeconomics. Let us look into the Microeconomics
further.

Microeconomics

Economics is a phenomenon taking place under our eyes

everywhere.Hence, with economics having its firm roots in every walk
of life, it becomes fairly important to explore this field of study.

Let’s us explore in the following sections the world of

microeconomics and understand how the market is affected by various
factors, how prices go on a rollercoaster sometimes, how are
individual output and individual income perceived in the microworld
of economics etc.

Browse more Topics under Microeconomics And Macroeconomics

 ● Fundamentals of Macroeconomic

The Economy

You must have observed the hustle and bustle happening around you
in ​factories​, institutions, ​organizations​ etc. All these individual units
collectively comprise of the entity termed as an economy. These
building blocks of an economy provide people with ample
opportunities to earn a livelihood to sustain themselves and also
produce goods and services for the requirement of other
individuals(i.e. their ​contribution​ to the economy).

Therefore the economy is a system that provides people opportunities

and means to sustain themselves, earn a livelihood and make use of
the available resources to produce goods and services which in turn
help in sustaining the economy.

Need of Economics

There is a need for economics because ​human​ wants can never be

satisfied completely. Take, for example, you want to buy a product
and you allocate your funds to satisfy that want. As soon as that want
is satisfied, a new want will emerge and you would wish to satisfy that
new want now.

But an individual cannot satisfy his/her all wants because of the

scarcity of resources. Consequently, the subject matter of economics
focuses upon selection of scarce ​resources​ in such a way that
maximum wants are satiated and optimum satisfaction is generated.

The Two Strands of Economic Theory

The economic theory can be applied to diverse real-life situations, but

most of these are instances of the two divisions into which the
economic theory has been categorized. These are ​Macroeconomics
and Microeconomics.

The term macro means large. Thus macroeconomics is concerned with

the economy as a whole entity and deals with generic problems of the
economy like ​inflation​, poverty etc. Macroeconomics is the study of
aggregates and concludes the general effect on the economy as a
whole, due to the summed up changes of various processes
determining the state of the economy.
The term micro means small. Hence microeconomics focuses on
individual building blocks of the economy. The subject matter here is
concerned with the individual units in an economy, like the market
demand for the particular product. It applies economic concepts at the
smallest levels of the economy and as a result, increases our
understanding of the functioning of an economy.

For example, it deals with the price of a commodity, supply of a

product etc. These two forces govern all the processes that
microeconomic theory deals with. It assumes that all macroeconomic
variables like national income, savings, etc are constant. The most
important tools in the microeconomic toolbox are – demand and
supply.

Central Problems of the Economy

The economic problem (scarcity of resources in comparison to

unlimited human wants) results in some basic problems that every
economy faces. Every economy has to choose as to how to allocate
these scarce resources for fulfilment of wants. The three central
problems of an economy are :

What to produce
Resources are scarce in nature and they also have various alternate
uses. Hence an economy needs to decide the wants that it needs to
fulfil and in this process allocate the resources for the fulfilment of the
chosen wants. When an economy decides to allocate a resource
towards one want, it does so by sacrificing another want, that is, it
chooses between various alternates for the ultimate goal of maximum
satisfaction.

More of one good generally means less of other good. After it selects
the commodities to be produced, the economy has to further decide
the quantity in which the chosen good have to be produced.

How to produce

Goods and services can be produced by employing various techniques.

It involves selection of the combined inputs to produce commodities.
The techniques of production can be classified generally as –

● Labour intensive technique – In this production technique

employs more labour and less capital.
 ● Capital intensive technique – In this production technique
employs more capital and less labour.

The kind of technique undertaken by an economy for production

depends upon the abundance of input in the economy. This means that
if there are more people available then labour-intensive technique will
be employed and if more capital is available then capital-intensive
technique will be employed.

For example, the United States employs a capital-intensive technique

because of an abundance of capital and India employs a
labour-intensive technique because of the abundance of labour.

For whom to produce

This problem is focused on the selection of people for whom goods

and services should be produced ( who will ultimately consume the
produced commodities). This problem is concerned with the
distribution of income among the factors of production.

Opportunity cost – The cost of what’s lost

Whenever we make a choice, we sacrifice what we might have gained
by choosing the next best alternative. Thus when an economy makes
choices, it incurs a virtual cost of the next best alternative foregone.
This concept of opportunity cost is the true cost of making choices in
economics.

For example, let us assume you have 10 rupees and you want to buy
an ice cream and a cold drink. But you can afford to buy only one of
the two products. Suppose you choose to buy an ice cream. Then the
opportunity cost of your decision will be the foregone satisfaction
from a bottle of cold drink.

Production Possibility Frontier (PPF)

(Source: Wikipedia)
There are a lot of resources, which can be put to alternate uses and can
be allocated to produce an arsenal of various goods and services. Also,
there can be infinite combinations of all these goods possible. Hence,
economists, in order to demonstrate the concept of PPF, assumed a
very basic economy with only two types of goods.

A production possibility frontier is a graphical representation, which

displays the various combinations of two commodities taken that can
be produced by employing given resource and technology. It helps in
deciding the optimum and feasible combinations.

Solved Example for You

Q: What does the slope of PPF indicate?

Ans: PPF is a downward sloping concave shaped curve. The

downward slope indicates that more of one good means less of other.
The concave shape indicates that more and more units of a particular
commodity need to be sacrificed in order to gain an additional unit of
another commodity.
Fundamentals of Macroeconomics

Macroeconomics is the other side of the coin called ​economics​,

microeconomics being one of the two sides. It implements the
economic theory by widening its approach, to focus on issues of the
economy as a whole unit rather than the individual units. The recent
change in ​tax​ regime by the Indian ​government​ i.e the introduction of
GST is one such example of things that fall under macroeconomics.
So let us go ahead and understand what macroeconomic theory is
about.

Macroeconomics
Macroeconomics takes the larger aspect of economics on it’s back. It
is the study of economics in regard to aggregates of an economy. It is
the part of economic theory that conceptualizes the behaviour of
aggregates of the economy and considers macrophenomenon triggered
by collective units of an economy.

It deals with generalized concepts like national income, ​GDP​, national

consumption​ expenditure etc. One such example is ​GST​, which
completely reformed the government budget and altered the
consumption expenditures of the economy because of change in
prices. We regularly hear terms like GDP when comparing the
economic states of countries.

The two main tools of macroeconomics are – aggregate supply and

aggregate demand. It is also known as the ​income​ theory.

Browse more Topics under Microeconomics And Macroeconomics

● Introduction to Microeconomics

Macroeconomics vs Microeconomics
 ● Microeconomics deals with individuals whereas
macroeconomics deals with the economy as a whole entity
consisting of collective individual units.
● Macroeconomics uses aggregate demand and aggregate supply
to explain it’s concepts whereas microeconomics employs
demand and supply​.
● Macroeconomics focuses on the determination of income and
employment in the economy, on the other hand,
microeconomics aims at the ​determination​ of the price of a
good or service and factors of production.
● In macroeconomics, the degree of aggregation is highest
because while dealing with the general aspects of the economy,
factors have to be aggregated completely. On the other side, the
degree of aggregation in microeconomics is limited.
● Macroeconomics is known as income theory. Microeconomics
is also termed as price theory.

It can be easily observed that micro and macroeconomics differ on the

application of economic theory to two different scales. Despite all
these differences, both of these are not mutually exclusive of each
other. Macroeconomics is the aggregation of economic behaviour by
individual units. Microeconomic aspects can change with changes in
macroeconomic ​aspects​ and vice versa.

The Need of Macroeconomics

It was earlier considered that concepts of microeconomics are

sufficient enough to explain economic behaviours. But then it was
observed that economic aspects differed when applied to two different
scales. The concepts of microeconomics were not able to explain
various phenomenon taking place at the highest level of aggregation.
In addition to this, there emerged various paradoxes that
microeconomics wasn’t able to explain.

For example, microeconomics explains that to earn maximum profit

producers should decrease supply when prices are low and increase
supply when prices are high, but if all individual suppliers decrease
the supply of a commodity, then collectively the overall supply would
change, and this will have effects on income, expenditure, taxation
policies etc. Thus to overcome the shortcomings of microeconomic
theory, the macroeconomic theory came into existence which focuses
on aggregates and discusses the welfare of the economy as a whole.
Solved Example for You

Q: Identify the following as Microeconomic and Macroeconomic

study :

1. Production of a sugar mill

2. Inflation rate
3. Car industry
4. Supply of money
5. Wage determination in a company
6. Allocation of resources
7. Household expenditure
8. Aggregate demand
9. Foreign exchange rate
10. Market demand for apples

Ans: Microeconomic study : 1,3,5,6,7,10 and macroeconomic study:

2,4,8,9