micro economics part 1

8/2/2019 Micro Economics Part 1

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MICRO ECONOMICS FORBUSINESS


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Click to edit Master subtitle style

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Definition of Economics : Economicscan be defined as the study of efficientutilization of scarce resources to satisfyunlimited human wants. Adam Smith the Father of Economics

defined - as a science of wealth. Hetitled his book as Enquiry into theNature and cause of the Wealth of Nations

Dr. Amartya Kumar Sen our IndianEconomist awarded the 1998 NoblePrize in Economic Sciences for hiscontribution to Welfare Economics


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Wants-efforts-satisfaction are the subject matter of economics. Wantsare starting point of economic activity.Economics is a social science and artEconomics deals the various aspects of production, distribution,consumption of limited resources in an economy in order to satisfy humanwants efficiently.Economics explains the day to day activities of people like spendingbuying etc.


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The two most important areas in the society today are businessand the economics, they act a two pillars in the development of anycountry. The economics of business growth widened too much in recentyears. Distinction between Economic Growth and Economic Development. Resources are limited but human wants are unlimited.Scarcity of Natural resources,scarcity of Human resources andscarcity of Capital resources


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Market Economy USA(Firms and consumers decides in freemarket economy) Command Economy USSR (Gove decides) Mixed Economy Public sector vs. Private Sector ( India )

Usefulness of Economics for Human Life :a. Intellectual valueb. Human Behaviorc. Economic Systemd. Planninge. Study of Economic Problemsf. Business mang. Statesmenh. Consumersi. Laborers

j. Citizensk. International Economic Problems like Foreign trade, Inflationand Unemployment etc..


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Economics classified into Micro and Macro EconomicsMicro Economics Macro Economics

1. Studies the economicbehavior of individualentities such asIndividuals, firms, households etc.

2. Explains the Interrelationships betweenEconomic Units likeconsumers,commodities , firms,industries, markets .

3. Analyses the conditionsfor efficiency inconsumption andproduction.

4. Describes product pricingwhich explains theories of demand, production andcost.

5. Understanding MicroEconomics helps a greatdeal in individual decision

1. Studies Economy as awhole

2. Explains total Nationalincome, Aggregatedemand and supply,General Price level, Totalemployment etc.

3. Fluctuations and trends inthe overall economicactivity in a country orbetween countries in theworld.

4. Describes the theory of income and employment,inflation, Economicgrowth etc..

5. Macro economics studyvital in the formation andexecution of economicpolicies by Govt.


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Micro and Macro Economics both deals with the Economic issues.Scope and Purpose of Micro Economics , Price Theory studies:a) How resources are allocated to the production of goods and services.b) How the goods are distributed.c) How efficiently they are distributed.

These problems are determined by relative prices of goods and services. Therefore Micro Economics called as Price Theory or Value Theory .

I. A study of interacting units : Interaction between consumersmarket, Producers market, Resources Owners Market.

II. A study of welfare Economics : Studies how efficiently goods andservices are distributed.


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Importance of Micro Economics1. Explain how prices are determined: like wages, interests, profit and

rent are determined.2. Explains the conditions of efficiency in production and distribution.3. Provide tools for Economics for policies.4. Helps in the efficient employment of resources.5. Helps business executives: to attain maximum productivity with

resources.6. In understand the problems of taxation.7. Helpful in International trade and Foreign exchange.8. To examine the conditions of economic welfare: Elimination wastages

and bring maximum social welfare.As per the above Micro Economics is highly important.


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Limitations of Micro Economics1. Based on unrealistic assumptions2. Neglects the whole gives an incomplete picture3. It may be misleading.


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Production Possibility Curve

The PPC helps us understand theproblem of scarcity better , byshowing what can be produced with

given resources and technology.

Assumptions in Constructing a

PPCa) The economic resources available

for the use in the year are fixed.b)

These economic resources can beused to roduce two broad classed


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Production possibilityschedule and Curve

ProductionPossibilities Rice (in tons) Cloth (in 000meters)

ABCDEF

0+4 tons7 tons10 tons11 tons12 tons

15000 meters14000 meters12000 meters9000 meters5000 meters0


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To increase the production of oneitem, we have to forgo the

production of some units of theother item.An increase in the production or

consumption of one good can beachieved only through theopportunity cost of the other good.Opportunity costs are result of scarcity.Best Example: A child with Rs.10in hand can purchase a soft drink ora candy bar, both of which each


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DEMAND

Demand means the desire for acommodity or service backed bywillingness as well as ability to pay.(Mere desire is not demand)When we speak of demand, wemust also state the price, the placeand time. Demand is always at aprice.

The quantity demanded differs frommarket to market. At the same price

demand may be more in market A


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Demand and Supply Analysis

Based on purchasing power statistics, India is ranked as fourth largesteconomy in the world and ranked 3rd in terms of GDP (GrossDomestic Product is a measure of countries overall economic output)in Asia (after Japan & China) and the second largest economy (after

China) among developing countries with high potential for economicdevelopment, inspite of political uncertainty, infrastructuralbottlenecks and burocratic hassles.

That is why Multinational company such as Mc Donalds entered theIndian market in mid 1990s and offered food products, which werenot customarised to the Indian tastes. The company over estimated

the demand for its products and almost all its operations ran intolosses.Later the company made some changes in its minimum, which weremore suited to the tastes and preferences of the Indian customersand captured the good market share in the Indian fast food market.


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This example is the significance of analyzing the forces of demand andsupply for any product. The demand for its product plays a major role toachieve the object of a firm is to maximize its revenues and profits.

Law of Demand: states that an inverse relationship exists between theprice of a good and its quantity demanded, keeping other factors constant.Benham , the Economist stated - Usually a larger quantity of a commoditywill be demanded at a lower price than at a higher price


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Changes in DemandCurve

The demand curve always slopes downwards fromleft to right to indicate that demand for a productincrease where there is decrease in price of particular product .


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Demand Schedule Table

The demand Schedule shows thatdemand is more at the lower price.Demand extends as the price falls

and vice versa.

Price of coffee per kilo (inRs)

Quantity Demanded (in kilos)

Rs. 15Rs.10Rs.5

100003000040000

Rs.3 80000


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Reasons why demand curve slopes downwardsThe demand curve sloped downwards from left to right because demand

expands at a lower price . The reasons are :1) Income Effect (old buyers buy more): Eg- A spend 1 rupee on apple

if the price of the apple is 1 rupee A can get only one apple.If the price falls to 0.50 paise, A can buy 2 apples for the same rupee.Fall in the price means a saving in the money or increase in real income.

This is called income effect.2) Substition effect: When the price of a commodity falls it becomes

cheaper Eg: If tea is very much cheaper than coffee, people mayprefer to use tea instead of coffee. Therefore the demand for teaincrease when the price falls. It is called Substitution effect.


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3) New Buyers : People who couldnot buy when the price is high begin

to buy the commodity when theprice falls. Thus the demand will bemore at a lower price because newbuyers purchase the commodity.4) Different Uses: There arecertain commodities that can beput to several uses like Wheatcan be used as food, for cattlefeed, for manufacture of alcoholetc. If the price is high it will be

used only as an article of food


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Individual Demand : Individual

demand is the demand of an individualconsumer for a product in a given periodof time. A consumer purchased acommodity in a market at differentplaces relates to Individual demand.

Market Demand : It is the sum of demand of all individual consumers in

the market for a product in a given


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Determinants of Demand The demand for a commodity depends

on several factors:1) Price of the commodity2) Population3) Income4) Tastes and preferences5) Weather conditions6) Price of substitutes (Tea / coffee)7) Discovery of substitutes ( discovery of

paper bags reduced demand of jute

bags)


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ange n uan yDemanded vs

Change in Demand Quantity demanded changes whenthe price of the good changes. If theprice of the good increases quantitydemanded decreases. So demandcurve is not shifting.

A change in demand occurs whenone or more of the determinants of demand changes. Determinants of demand include consumerpreferences, Income, and the price

h d d d f


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A change in demand, due to factorsother than price is classified as shiftin demand.


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Elasticity of Demand Elasticity is a measurement of the

rate of change in demand for a givenchange in the price. Prof. Marshall defined: The elasticity

of demand in a market is great orsmall according to the amountdemanded increases much or littlefor a given fall in the price anddiminishes much or little for a givenrise in price.

PRICE(P)

Quantity Demand(Q)

Total Expenditure(P x Q)

Nature of Elasticity

Rs. 4 1000 units Rs. 4000 Elastic DemandRs. 3 4000 units Rs. 12000Rs. 2 6000 units Rs. 12000 Unit ElasticityRs. 1 8000 units Rs. 8000 Inelastic Demand


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Income Elasticity of DemandIncome Elasticity demand changes

due to change in income also.Income Elasticity is the rate of change in the demand for a givenchange in the income. An increasein real income increases thedemand for product, other factorsremaining the same.If the percentage change in demandis greater than the percentagechange in income it is high income

elasticity of demand.


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Price Elasticity of Demand Defined as the percentage change in

quantity demanded of a product dueto the percentage change in its price,other things remain constant.

Ep= Percentage change in Quantitydemanded Percentage change in price

If demand for petrol reduces by 2%as a result of an increase in petrolprice by 10%. The price elasticity of

demand for petrol is


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Usually the Govt. tries to raise incomethrough indirect taxes such a exciseduty or sales tax, which raises theprice of the product sold in themarket. Here the analysis of priceelasticity plays crucial role.

For Eg: If the Govt. increases the taxon plastic goods, its price willincrease. The raise in price reducesthe demand for that commodity.

Cross Price Elasticity of Demand:is the ratio of percentage change inthe quantity demanded for product to


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Cross Price elasticity can be positiveor negative based on the change inthe price of a substitute orcomplementary products. If twoproducts are good substitutes, thevalue of cross elasticity is positive.For Ex: Close substitute products :Pepsi and coke. If the price of Pepsiincreases, its customers may switch

to coke. The change in the price of Pepsi and demand for coke aremoving in the same direction hencethe cross elasticity is positive.For complementary products like Tea


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Revenue Concepts : Total revenuemeans total profits received by a firmfrom the sale of product.

Additional revenue received resultfrom the sale of extra unit of productis called Marginal Revenue.

Total revenue per unit of a productsold is Average Revenue.

A clear understanding of costdemand price in micro level helps usthe revenue of the particular firm toanalyze future demand forecastingand rofit ratio.


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SUPPLY: In economics the supply of product refers to the various

quantities of the product, which aseller is willing and able to sell atdifferent prices in a given period of time.

LAW OF SUPPLY: states that other

factors remaining constant, higher theprice, greater the quantity suppliedand lower the price, lower the quantitysupplied. Price and qualities suppliedare positively related.


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u uChocolates Situation Price

( Rs. Per box)Quantity Supplied

(Million boxes peryear)

A 50 22

B 40 15

C 30 9

D 20 4E 10 0

In situation E, when the price per boxis Rs.10, No firm is willing to produceand sell chocolates. Hence thequantity supplied is Zero. As the

price increases he manufacturers are


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The Supply Curve: At a very lowprice, the chocolates manufacturersmight want to use their factories forproducing other types of relatedproducts. But as the price of thechocolates increases themanufacturers find it more profitableto shift to chocolates. Higher the priceof chocolates the greater the amount

of chocolates supplied (upward raisingcurve). Higher the price, the larger is the

supply.


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Exceptions:1) Price Changes: If sellers think

that the price in the future going tofall, they sell more at lower price.More supply at the price is contraryto the Law.

2) Labor supply: Some laborersmay be satisfied with a certainminimum income. Until they get

that minimum income they workmore as wages raise. After thatthey work less.


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5) Govt. Policy Taxation: If taxesincrease supply will fall. If taxes arereduced supply may increase.

6) In the case of AgriculturalCommodities, failure of rains,droughts, floods, fires, etc. willreduce supply.

7) Means of communication andTransport: Improvement in the

means of communication andtransport increase supply.

8) Labor Troubles: S trikes, Lockouts,

labor troubles may reduce supply.


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Elasticity of Supply: The law of supply states that supply increase asthe price raises and falls as the pricefalls. But the change in supply inresponse to the change in price willnot be the same for all commodities.Elasticity of supply is themeasurement of the change.Formula :

Es= % change in the quantity suppliedof a product

% change in its price

Factors that determine elasticity of

Market Equilibrium in economics


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Market Equilibrium in economicsmeans situation where the supply of an item is exactly equal to itsdemand. Since neither there issurplus nor shortage in the market,there is no tendency for the price of

the item to change. It is the point atwhich quantity demanded andquantity supplied are equal.

THEORY OF CONSUMER


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THEORY OF CONSUMERBEHAVIOUR

Consumer behavior is the study of when, why, how and where people door do not buy product. Product meansthing produced by labor or effort orresult of an act or a process isproduct. Consumer behavior blendselements from economics,

psychology, sociology, socialanthropology. It attempts tounderstand the buyer decision makingprocess, both individually and in

r .


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b) Indirect Consumption : Use of machinery, raw materials etc. iscalled Indirect Consumption orproductive consumption . Thesegoods are used to produce goodswhich satisfy human wants.C) Wasteful Consumption : Thewaste of materials throughaccidents such as fire or flood is

called Wasteful consumption. Whenindividual or community use goodsthat are not very useful, they aresuppose to indulge in wasteconsum tion.


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TOTAL UTILITY: The amount of utility a person derives from theconsumption of a particular product iscalled Total Utility. In the initial stageof consumption the total utilityincreases after consumption of certainnumber of units the total utilitybecomes constant and beyond that itstarts reducing. We can say that at a

particular point of consumption, theconsumer maximizes his satisfactionwhich is known as satisfactionquantity. Further consumption of thatparticular product decreases his

Quantity of Total Utility Marginal Utility


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Quantity of product

Consumed

Total Utility Marginal Utility

0 0 -1 5 52 8 33 10 24 10 05 9 -1

6 7 -2 When first two units of a product are

consumed total utility increases. When

the consumer consumes the third unit,total utility reaches its maximum point10. The utility remains constant evenafter the consumption of the fourthunit but when the consumer starts

T t l Utilit C


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Total Utility Curve

Total utility is the total benefit that aperson gets from the consumption of agood or service. Total utility generally

increases as the quantity consumed of

Marginal Utility Theory


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Marginal Utility TheoryIt economics the marginal utility of agood or service is the utilitygained( or lost) from an increase (ordecrease) in the consumption of thatgood or service. In the above table, itis clear that every increase in theconsumption of a product reduces itsmarginal utility.

Law of Diminishing Marginal Utility:A law of economics states as aperson increases consumption of a

product while keeping consumption of

M i l U ili C


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Marginal Utility Curve

The general tendency for marginalutility to decrease as the quantity of agood consumed increases the principleof diminishing marginal utility

A i


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Assumptions :1) No time Interval, continuous

assumption : The consumption of the commodity should be continuouswithout and time gap.

2) Identical Units : The unit of thecommodity consumed should be of the same quality same size, tastecolor etc. They must be identical in all

respects.3) Standard Units : The size of the

units consumed should not be too

small or too large. For Eg: The


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9) No change in the ConsumersOther Positions: When we can not

buy a horse a carriage may be lyinguseless with us. But when we buy ahorse the utility of carriage goes up.

Therefore the law assumes that thereis no change in the consumers stockof other goods.

10) Goods should be of OrdinaryType: The law may not apply toextraordinary goods like diamonds.

11) Goods should be Divisible: In thecase of durable and indivisible

Indifference Curve Theory


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Indifference Curve Theoryand its Application

An indifference curve reveals thevarious combinations of two productsor services to which the customer isindifferent at a particular level of income. Any combination of productsor services on an indifference curvewill give the same level of utility.

Assumptions :Indifference Curves have aNegative Slope : Indifference slopes

downwards to the right which reveals

Combination of two products that yield


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Combination of two products that yieldsame level of Utility:

Utility Quantity of Applesconsumed

Quantity of Orangesconsumed

20 11 2

20 9 6

20 6 9

20 2 11

Indifference Curve Diagram


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Indifference Curve Diagram

This shows three indifferenceschedules of the consumer L1, L2 andL3. L2 shows a higher level of satisfaction than L1. Similarly L3shows higher level of satisfaction thanL2. The consumer may have different

indifferent schedules each showing a

Consumer Surplus


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Consumer Surplus Consumer surplus is a measure of the

welfare that people gain from theconsumption of goods and services, ora measure of the benefits they derivefrom the exchange of goods.

Consumer surplus is the differencebetween the total amount thatconsumers are willing and able to buy for a good or service(indicated bythe demand curve) and the totalamount that they actually do pay (i.e.

the market price for the product) The

CONSUMER SURPLUS IS THE


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CONSUMER SURPLUS IS THEDIFFERENCE BETWEEN THE PRICE THATA CONSUMER IS PREPARED TO PAY AND

THE ACTUAL PRICE PAID.

Consumer Surplus is the difference

between price to consumer has to payand the price the consumer prepared topay. Eg: He may be prepared to pay of

Rs.200 for a ticket of the movie which

Applications of Consumer Surplus:


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Applications of Consumer Surplus:Consumer surplus is useful for

designing Govt. policies andimplementing welfare programmes.

The Govt. can use the concept of consumer surplus to fix taxes since the

rich or the upper middle class peoplehave more consumer surpluscompared to the rest. Consumer

surplus also reveals the purchasingpattern of the economy. For Eg: Moretaxes can be levied on costly or luxurygoods since they would be brought byconsumers who have more surplus.

Consumer Price Index: A CPI


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Consumer Price Index: A CPImeasures changes through time in theprice level of consumer goods andservices purchased by households.CPI in India comprises multipleservices classified based on differenteconomic groups therefore a series:

The CPI UNME (Urban non- MannualEmployee), CPI AL (Agricultural Labor),

CPI RL (Rural Labor) and CPI IW(Industrial Worker). While the CPIUNME series is published by theCentral Statistical Organization, theothers are ublished b the

THEORY OF PRODUCTION


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THEORY OF PRODUCTIONAND COST

Production : Production refers to theoutput of goods and services producedby businesses within a market. Thisproduction creates the supply thatallows our needs and wants to besatisfied.

1) Short run Production: The short runis a period of time when there is atleast one fixed factor input. This isusually the capital input such as plant

and machinery and the stock of

What is Production Function:


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What is Production Function:Production function deals with themaximum output that can beproduced with a limited and givenquantity of inputs.

Th i f P d ti it


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The meaning of Productivity: When economists and Govt. Ministerstalk about productivity they arereferring to how productive labor is.But productivity is also about otherinputs. For ex: A company couldincrease productivity by investing innew machinery with latesttechnological progress, which reduces

the number of workers required toproduce the same amount of output. The Govt. objective is to improvelabor and capital productivity.

micro economics part 1

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