Dadhi Adhikari /KCM /BBA I /Microeconomics / Lecture2

20th Aug, 2007

Introduction to Microeconomics
The subject matter of economics is broadly divided into two branches: Microeconomics and Macroeconomics. Microeconomics deals with the behavior of individual economic units and small groups of individual units such as individual consumer, worker, investor, owner of land business firm, industry or market. In other words microeconomics explains the behavior of any individual or entity that plays a role in the functioning of an economy. Microeconomics explains how and why these units make economic decisions. Microeconomics explains how economic units interact to form a larger unitsmarkets and industries

Microeconomics is called price theory also. It is because all individual units in the economy make their decision on the basis of price. Prices play two roles i. Give information ii. Provide incentive

These two roles of prices go together. If price give true information then there is always balance in the economy. But if price is unable to give true information then the plan of buyer and seller will be inconsistent. In the imperfect market scenario, price is unable to give true information.

Scope of Economics
In scope of economics we discuss i. Subject matter of economics ii. Nature of economics a. Is economics a science? b. Is it positive or normative c. Is it an art or applied science? Subject matter of economics Subject matter of economics can be drawn from the definition of economics a. Adam Smith: Study of wealth of nation b. Marshall: Economic activity of human being in ordinary business of life. c. Robbins: allocation of scarce resources d. Modern definition: Economics is the study of the allocation of scarce resources and of the determinants of employment, income and economic growth. Subject matter of economics is divided into four parts: Consumption, production, exchange and distribution. Nature of economics i. Is economics a science?

Dadhi Adhikari /KCM /BBA I /Microeconomics / Lecture2

20th Aug, 2007

Science: Science is a body of principles, theories or laws, a theory establishes a cause and effect relationship between two events, so that if we know one event (cause) we can predict the behavior of the other event (effect). Major feature of science are: i. Objective ii. precise power to explain iii. a good power of prediction iv. use of scientific method These features are also found in economics i. Economics uses scientific method to develop economic theories and laws ii. It has good power to explain iii. Economics has power to predict and this power has been growing with the development of mathematics and computers iv. It is objective However economics as a science is not as accurate as natural science. This is because; economic theories are related with human and social behaviors which are ever changing. In economics, to prove any theory, we can not create the situation in which the theory holds. But this can be done in natural science. ii. Is economics a positive or normative science? Positive Science: It is related with What is?. Explains cause and effect relationship. Normative Science: It is related with What ought to be?. It is based on value judgement Robbins advocated economics to be positive science only to make its scientific foundation strong. However some economist, such as Hawtrey, Handersan, advocates economics as a normative science. They say; economics deals with human behavior and human beings are not only logical but sentimental also. It is argued that economics is not as accurate as natural science. By this fact economics should be normative science. ii. Is economics an art? An art is a system of rules for the attainment of a given end. Economics is an art. Economists are not like a philosopher who creates knowledge for the sake of knowledge. In fact economists are like a doctor who creates knowledge and use it for healing. As an art economists are responsible for formulating economic policies. An economic policy requires three elements (i) Organization (ii) ends or goals (iii) means. Those societies who have good organization, have identified realistic goals and means to achieve them have achieved success.

Scope of Microeconomics
Microeconomics explains not total production but composition of total production and allocation of resources. Microeconomics assumes total resource as given and explains how the given resources are allocated.

Dadhi Adhikari /KCM /BBA I /Microeconomics / Lecture2

20th Aug, 2007

Allocation of resources depends on the relative prices under free market economy. Hence microeconomics explains how prices of output and inputs are determined. Microeconomics tests whether the resource allocation is efficient. Efficiency is achieved when total satisfaction in the society is maximized. Microeconomic theory explains how maximum satisfaction in the society can be achieved. Microeconomics is used for formulating and evaluating economic policy.

Limitations of Microeconomics Microeconomics can not figure out the problem of whole economy. Microeconomic conclusion may not be true for whole economy. For example saving from microeconomic perspective is good but not from macroeconomic perspective. Microeconomics is based on some unrealistic assumptions such as full employment, perfect competition etc. There are so many economic problems that can not be studied under microeconomics e.g. revenue policy, monetary policy.

Use of Microeconomics in Business

Microeconomics has very important role to play in business. The knowledge of microeconomics that is used in business comes mainly under managerial economics. In business sector, a firm takes benefit from the theory of demand, production, cost, pricing, market structure, government regulation etc. In general, a business firm uses microeconomics in two ways i. Given an existing economic environment, the principles of microeconomics provide a framework for evaluating whether resources are being allocated efficiently within a firm. ii. Principles of microeconomics helps to understand and response various economic signals Microeconomics is useful in business decision making. There are four activities in decision making process. a. Finding occasions for making decisions b. Identifying possible course of action. c. Evaluating the revenues and costs associated with each course of action d. Choosing that one course that best meets the goal of the firm. The primary role of microeconomics is to evaluate the implications of alternative course of action and choosing the best alternatives. Give an example