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Introduction to Micro Economics: Assignment

   

Added on  2021-06-07

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CHAPTER – 1INTRODUCTIONTO MICROECONOMICS© The Institute of Chartered Accountants of India

2INTRODUCTION TO MICRO ECONOMICSCOMMON PROFICIENCY TESTLearning ObjectivesAt the end of this Chapter, you will be able to :know what Economics is about.know about the nature of Economics.understand the various methods of studying Economics.understand the basic problems of an economy.understand how different economies solve their basic economic problems.get an insight into the tool of Production Possibilities Curve.1.0WHAT IS ECONOMICS ABOUT?Consider the following situation.It is your birthday and your mother gives you ` 1000 as birthday gift. You are free to spend themoney as you like. What will you do? You have many options before you, like :Option 1:You can give a party to your friends and spend the whole money on them.Option 2:You can buy yourself a dress for ` 1000.Option 3:You can go for a movie and eat in some restaurant.Option 4:You can buy yourself a book and save some money.What do you notice? You have so many options before you. You will have to go for one optionor a combination of one or more options. But why can’t you have everything? Given the choiceyou would like to spend not only on your friends, but would also like to see movie, eat in therestaurant, buy a dress and a book and save some money. But you cannot. Why? Because youhave only 1000 Rupees with you. Had your mother given you ` 2000, you might have satisfiedmore of your demands. Thus you are in dilemma. Similar dilemma is faced by every individual,every society and every country in this world. Life is like that. Because we cannot have everything all at once, we are forever forced to make choices. We can use our resources to satisfyonly some of our wants, leaving many others unsatisfied.These two fundamental facts that(i)Human beings have unlimited wants; and(ii)The means of satisfying these wants are relatively scarce form the subject matter ofEconomics.The term ‘Economics’ owes its origin to the Greek word ‘Oikonomia’ meaning ‘household’.Economics is, thus, the study of how we work together to transform scarce resources intogoods and services to satisfy the most pressing of our infinite wants and how we distributethese goods and services among ourselves.This definition of Economics, in terms of using scarce resources to satisfy human wants, iscorrect but it is incomplete. It brings to our mind the picture of a society with fixed resources,skills and productive capacity, deciding what specific kinds of goods it ought to produce and© The Institute of Chartered Accountants of India

GENERAL ECONOMICS3how they ought to be distributed. Yet two of the most important concerns of modern economiesare not fully covered by this concept.’On the one hand, the productive capacity of modern economies has grown tremendously.Population and labour force have increased, new sources of raw materials have been discovered,and new and better plant and equipments have been made available on farms and in factoriesand mines. Not only has the quantity of available productive resources increased, their qualityhas also been greatly improved. Education and newly acquired skills have raised the productivityof labour force, and led to the discovery of completely new kinds of natural resources likepetroleum and atomic energy. On the other hand, the resulting growth in production andincome has not been smooth. There have been periods in which output not only failed to growbut also actually declined sharply. During such periods, factories and workers remained idledue to insufficient demand.Economics, therefore, concerns itself not just with how a nation allocates to various uses itsscarce productive resources, important as that may be. It also deals with the process by whichthe productive capacity of these resources is increased and with the factors which in the pasthave led to sharp fluctuations in the rate of utilisation of resources.In the day-to-day events, we come across several economic problems like changes in price ofindividual commodities as well as general price level changes; economic prosperity and higherstandards of living of some people despite general poverty of the masses; problems ofunemployment of certain class of persons or in some areas. These are some of the mattersconnected with economic analysis. The study of Economics will help in analysing the possiblecauses contributing to these problems and might suggest a number of alternative courses, whichcould be adopted for tackling these problems. However, it is necessary to remember that mosteconomic problems are of complex nature and are are affected by several forces, some of whichare rooted in Economics and some in political set up, social norms, etc. The study of Economicscannot ensure that all the problems will be tackled but, surely, it would enable a student toexamine a problem in its right perspective and would help him in finding suitable measures totackle the same.1.1DEFINITIONS AND SCOPE OF ECONOMICSSeveral definitions of Economics have been given by different writers. For the sake ofconvenience, let us classify the various definitions into four groups :1.Science of wealth2.Science of material well-being3.Science of choice making and4.Science of dynamic growth and developmentWe shall examine each one of these briefly.1.Science of wealth.Although the activity of acquiring and increasing material wealth is as old as civilisation, adisciplined study of the wealth producing activities commenced about 235 years back (in 1776)when Adam Smith, the father of Economics, published “The Nature and Causes of Wealth ofNations”. He defined Economics as:© The Institute of Chartered Accountants of India

4INTRODUCTION TO MICRO ECONOMICSCOMMON PROFICIENCY TEST“An inquiry into the nature and causes of wealth of nations.”Adam smith insisted that Economics deals with the acquisition, accumulation and expenditureof wealth. Since his definition gives prominence to the wealth aspect, it is called ‘wealthdefinition’.Many other classical economists also defined Economics in terms of wealth. For exampleaccording to J B Say, Economics is a“Science which deals with wealth”The definition of Economics, as a science of wealth, has some merits. The important ones are :(i)Stress on Wealth : It highlighted an important problem faced by each and every nation ofthe world, namely creation of wealth.(ii)Addressing the Problems of Economic Growth : Since the problems of poverty,unemployment etc. can be solved to a greater extent when wealth is produced and isdistributed equitably; it goes to the credit of Adam Smith and his followers to haveaddressed to the problems of economic growth and increase in the production of wealth.(iii) Attention to important Economic issues : By considering the problems of production,distribution and exchange of wealth, classical economists focused attention on theimportant issues with which Economics is concerned.The study of Economics as a ‘Science of Wealth’ has been criticised on several grounds. Themain criticisms levelled against this definition are;(i)It is too materialistic : Adam Smith and other classical economists concentrated only onmaterial wealth. They totally ignored creation of immaterial wealth like services of doctors,chartered accountants etc.(ii)Neglect of Welfare : The advocates of Economics as a ‘science of wealth’ concentratedtoo much on the production of wealth and ignored social welfare. This makes their definitionincomplete and inadequate.2.Science of material well-being. Under this group of definitions, the emphasis is on welfareas compared with wealth in the earlier group. Alfred Marshall, the neo-classicist, raisedEconomics from its ignoble position to a noble one. It was he who shifted the emphasis fromwealth to welfare. According to him,“Economics is a study of mankind in the ordinary business of life. It examines that part ofindividual and social action which is most closely connected with the attainment and with theuse of the material requisites of well-being. Thus, it is on the one side a study of wealth and onthe other and more important side a part of the study of man.”Another definition:“The range of our inquiry becomes restricted to that part of social welfare that can be broughtdirectly or indirectly into relation with the measuring rod of money” A.C. PigouIn the first definition, Economics has been indicated to be a study of mankind in the ordinarybusiness of life. ‘By ordinary business’ we mean those activities which occupy a considerablepart of human effort. The fulfilment of economic needs is a very important business whichevery man ordinarily does. Professor Marshall has clearly pointed out that Economics is the© The Institute of Chartered Accountants of India

GENERAL ECONOMICS5study of wealth, but more importantly it is the study of man. Thus, man gets precedence overwealth. There is also emphasis on material requisites of well-being. Obviously, the materialthings like food, clothing and shelter, are very important economic objectives.The second definition by Pigou emphasises social welfare but restricts it to only that part of itwhich can be related with the measuring rod of money. Money is a general measure ofpurchasing power by the use of which the science of Economics can be rendered more precise.Marshall’s and Pigou’s definitions of Economics are wider and more comprehensive as theytake into account the aspect of social welfare. However, their definitions are criticised on thefollowing grounds.(i)Neglect of Immaterial things : Economics is concerned with not only material things butalso with immaterial things like services of singes, teachers, actors etc. Marshall and Pigouchose to ignore them.(ii)The concept of welfare is very vague : Robbins criticised the welfare definition on theground that it is very difficult to state which things would lead to welfare and which willnot. He is of the view that we would study in Economics all those goods and serviceswhich carry a price, whether they promote welfare or not.3.Science of choice making. Prof. Lionel Robbins of the London School of Economics gavea new definition to Economics in his famous book “Nature and Significance of Economics”which he brought out in 1931. According to Robbins, Economics studies the problems whichhave arisen because of the scarcity of resources. Nature has not provided mankind sufficientresources to satisfy all its wants. Therefore, people have to choose for which ends or for whichwants the resources are to be utilized. Robbins gave a more scientific definition of Economics.His definition is as follows :“Economics is the science which studies human behaviour as a relationship between ends andscarce means which have alternative uses”.The definition deals with the following four aspects :(i)Economics is a science : Economics studies economic human behaviour scientifically. Itstudies how humans try to optimise (maximize or minimize) certain objectives under givenconstraints. For example, it studies how consumers, with given income and prices of thecommodities, try to maximize their satisfaction.(ii)Unlimited ends : Ends refer to wants. Human wants are unlimited. When one want issatisfied, other wants crop up. If man’s wants were limited, then there would be noeconomic problem.(iii) Scarce means : Means refer to resources. Since resources (natural productive resources,man-made capital goods, consumer goods, money and time etc.) are limited, the economicproblem arises. If the resources were unlimited, people would be able to satisfy all theirwants and there would be no problem.(iv)Alternative uses : Not only resources are scarce, they have alternative uses. For example,coal can be used as a fuel for the production of industrial goods, it can be used for runningtrains, it can also be used for domestic cooking purposes and for so many other purposes.Similarly, financial resources can be used for many purposes. The man or society has,© The Institute of Chartered Accountants of India

6INTRODUCTION TO MICRO ECONOMICSCOMMON PROFICIENCY TESTtherefore, to choose the uses for which the resources would be used. If there was only asingle use of the resource, then the economic problem would not arise.It follows from the definition of Robbins that Economics is a science of choice. An importantthing about Robbin’s definition is that it does not distinguish between material and non-material,and between welfare and non-welfare. Anything which satisfies the wants of the people wouldbe studied in Economics. Even if a good is harmful to a person, it would be the subject matterof Economics if it satisfies his wants.No doubt, Robbins has made Economics a scientific study and his definition has become popularamong some economists. But his definition has also been criticised on several grounds. Importantones are :(i)Impersonal and colourless : Robbins has made Economics quite impersonal and colourless.By making it a complete positive science and excluding normative aspects, he has narroweddown its scope.(ii)Ignored Macro-Economic concepts : Robbins’ definition is totally silent about certainmacro-economic aspects, such as determination of national income and employment.(iii) No focus on Economic growth and development : His definition does not cover the theoryof economic growth and development. While Robbins takes resources as given and talksabout their allocation, it is totally silent about the measures to be taken to raise theseresources i.e. national income and wealth.(iv)Problem of abundance : Some critics are of the opinion that economic problem can alsoarise due to other reasons like abundance. For example, abundance of human resource(i.e. over population) is a major problem for many economies.4.Science of dynamic growth and development. Although the fundamental economicproblem of scarcity in relation to needs is undisputed, it would not be proper to think thateconomic resources - physical, human, financial-are fixed and cannot be increased by humaningenuity, exploration, exploitation and development. A modern and somewhat modifieddefinition is as follows :“Economics is the study of how men and society choose, with or without the use of money, toemploy scarce productive resources which could have alternative uses, to produce variouscommodities over time and distribute them for consumption now and in the future amongstvarious people and groups of society”.Paul A. SamuelsonThe above definition is very comprehensive because it does not restrict to material well-beingor money measure as a limiting factor. But it considers economic growth over time.Prof Henry Smith also gave an all inclusive definition of Economics. According to him,Economics, is the “the study of how in a civilized society one obtains the share of what otherpeople have produced and of how the total product of society changes and is determined”. Bycivilized society it is meant that there are some legal institutions as well as rights of propertyand other established norms in the society.Jacob Viner has given a pragmatic definition of Economics.According to him, “Economics is what Economists do”. In other words, Economics is whateconomists do and what they have been doing.© The Institute of Chartered Accountants of India

GENERAL ECONOMICS7Micro and Macro-EconomicsThe subject-matter of Economics has been divided into two parts - Micro-Economics and MacroEconomics.Micro EconomicsThe term Micro Economics is derived from the Greek word ‘mikros’, meaning “small”. Accordingto Prof. Boulding, “Microeconomics is the study of particular firms, particular households,individual price, wages, income, individual industries and particular commodities”. InMicro-Economics we study the economic behaviour of an individual, firm or industry in thenational economy. It is thus a study of a particular unit rather than all the units combined. It isbasically concerned with the mechanism of allocation of given resources. Further, it is a partialequilibrium analysis as it seeks to determine price and output in an industry independent ofthose in other industries. We mainly study the following in Micro-Economics :(i)product pricing;(ii)consumer behaviour;(iii)factor pricing;(iv)economic conditions of a section of the people;(v)study of firms; and(vi)location of industry.Thus, when we are studying how a producer fixes the prices of his products, we are studyingMicro-Economics. Similarly, when we are studying why an industry is located at a particularplace, we are studying Micro-Economics.Macro EconomicsThe term Macro Economics is derived from the Greek word ‘makros’, meaning “large”.It is the study of overall economic phenomena or the economy as a whole, rather than itsindividual parts.According to Mc Connel, “Macroeconomics examines the forest and not the trees. Thus itanalyses and establishes the functional relationship between large aggregates”.Thus, in Macro-Economics, we study the economic behaviour of the large aggregates such asthe overall conditions of the economy such as total production, total consumption, total savingand total investment. It includes :(i)national income and output;(ii)general price level;(iii)balance of trade and payments;(iv)external value of money;(v)saving and investment; and(vi)employment and economic growth.Thus, when we study why we continue to have balance of payments deficits, or why the valueof rupee vis-à-vis dollar is falling or why saving rates are high or low in a particular country,we are studying Macro-Economics.© The Institute of Chartered Accountants of India

8INTRODUCTION TO MICRO ECONOMICSCOMMON PROFICIENCY TESTFor better understanding of the two concepts, a columnar difference is given.It may be noted that the classification of Economics into micro and macro-economics is purelyfor analytical purpose.In fact, there is really no opposition between micro and macro economics. Both are absolutelyvital and in most cases they play a complementary role, e.g. national income cannot growunless the production in individual firms and factories rises.It is difficult to distinguish between the two terms as belonging to water-tight compartments.What is macro from the national standpoint is micro from the world point of view. Similarly,what is micro from a national angle becomes macro from a regional angle. Unless, we definewhat is the whole we cannot say about a phenomenon whether it is micro or macro.1.2NATURE OF ECONOMICSUnder this, we generally discuss whether Economics is science or art or both and if it is ascience, whether it is a positive science or a normative science or both.Economics – As a science and as an art :Often a question arises whether Economics is a science or an art or both.(a)Economics is a science : A science is commonly defined as a systematised body ofknowledge about a particular branch of the universe.A subject is considered science if:-it is a systematised body of knowledge which studies the relationship between causeand effect.-it is capable of measurement.-it has its own methodological apparatus, and-has the ability to forecast.Micro economics1.It studies individual economic units2.Micro-economics is basically concernedwith the mechanism of allocation of“given” resources. Further, micro-economics is a partial equilibriumanalysis as it seeks to determine price andoutput in an industry independent ofthose in other industries. Moreover,micro-economics analysis looks into thedetermination of relative prices.3.Examples :a) individual demandb) price of a productMacro economics1.It studies aggregate economic units2.Macro-economics is a generalequilibrium analysis as it takes intoaccount the disturbance in equilibriumprice and quantity in one market whichcould lead to a disturbance in theequilibrium prices and quantities in allother markets. Macro-economicsanalyses the determination of absoluteprices3.Examples :a) aggregate demandb) general price levelc) national income© The Institute of Chartered Accountants of India

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