Micro Economics Meaning Nature and Scope

Micro Economics Meaning Nature And Scope

Economics is the study of those activities of human beings, which are concerned, with the satisfaction of unlimited wants by using the limited resources. Micro means the millionth part. The term micro has been taken from the Greek word mikros meaning small. Under microeconomics we study the individual units like a consumer, a firm, an industry, price determination of a particular commodity etc. In short the microeconomics deals with the study of the economic problems of a single unit like a firm or small economic units or resource owners. The main objective of microeconomics is to study the principles, policies and the problems relating to the optimum allocation of resources. From the theoretical point of view it tells us the functioning of a free enterprise economy. It explains us how through the market mechanism goods and services produced in the economy are distributed.

Nature and scope of Micro Economics

In the nature of economics we may consider whether it is a science or an art. Science not only means the collection of facts but it also means that the facts are arranged in such a manner that they speak for themselves. It means that some laws are discovered through these facts. Thus science is a systematic body of knowledge concerning the relationship between causes and effects of a particular phenomenon.

Characteristics of a science

1First of all the facts are observed. E.g. when price rise the demand contracts.

2The facts in this step are properly classified. Like if price falls how much the demand has fallen.

3After the compilation of facts and having knowledge about the magnitude of a problem a law is framed keeping onto consideration the cause and effect of a fact. E.g. Law of demand

4The final feature of science is by applying the scientific laws to real life. It is verified whether they are valid or not.

Thus from the above discussion it could be concluded that economics is a science. But some economists believe that it is not an exact science.

Whether it’s a social science or a natural science

Arguments in favour of social science

Economics is a systematic study. It is the study of the interrelated activities like production consumption and exchange of wealth.
Laws of economics show a cause and effect relationship between them
Laws of economics are based on real experiences of life.

Arguments against economics as a natural law

1The laws of economics are not the exact laws. Like law of economics does not operate if there is a change in the income of the person or a change in price of substitute goods.

2Economics laws are far from universal applicability. These laws cannot be applied in all situations and at all the times.

3The laws of economics cannot be verified in the laboratories. Inthe exceptional cases even the information or the results obtained through the application can prove to be futile.

Thus economics is not a natural science. It is a social science.

Economics As A Positive Or A Normative Science

Positive science is that science which studies an accurate and true description of events as they happen. Thus it deals with what, how and why. Normative science is suggestive in nature. Normative science tells us what ought to be.

Economics as a positive science

1Positive science is logical whereas normative science is emotional. Therefore it is more exacts it is based on the logic.

2If economics studies only the realities of the real world then the chances of the disagreement are less, as the case would be if it studies both.

3The economists cannot make the rational judgments if they try to analyze both what is and what ought to be.

Economics as a normative science

1.Economics would offer more meaningful conclusions if it gives suggestions too long with the facts.

2.Economics will be more useful if it is fruit bearing too along with the light bearing. Most of the people study economics for the fruits and not for the light merely.

3if the economist synchronizes the analysis of economic problems with concrete economic policies he would save time. Else it would be difficult if one person finds the solutions and the other tries to justify those solutions.

Thus the argument can be put to an end only by saying that it is both the positive as well as a normative science

Arguments in favour of economics as an art

Many economists like Marshall, Pigou etc. believe that economics is an art also besides being a science

Economics as an art

Economics offer a solution to the problems of human beings. It tells us how we can make the judicious use of our resources.
It is through the art that we can verify the economic laws. For example the law of demand
The doubts can be removed by dividing the economics into science as well as an art.

Arguments against art

1Science and art are different. If economics is science it cannot be art and if it is an art it cannot be a science.

2 Economic problems are influenced by social and political nature. Therefore economics cannot be considered from the economic point of view only.

UTILITY

It’s the want satisfying power of a commodity.

Utility is subjective. It depends upon the human wants.
Utility keeps on changing with time and place.
It need not be always useful.
Utility has nothing to do with the morality.

Measurement of utility

It can be measured both in terms of money as well as in terms of units. If two persons pay different sum of money for the same amount of commodity then it is the measurement in terms of money.

Marshall, Jevons and Menger etc have tried to measure it in terms of cardinal numbers. Pareto, Allen, Hicks etc. measured it in ordinal an term that is Indifference curve approach.

Utility has three concepts:

Initial utility
Marginal utility
Total utility

Marginal utility can further be divided into Positive Marginal Utility or Zero Marginal Utility or Negative Marginal Utility

Quantity /

Total utility

Marginal utility

0 / 0 / -
1 / 8 / 8
2 / 14 / 6
3 / 18 / 4
4 / 20 / 2
5 / 20 / 0
6 / 18 / -2

Opportunity costs

Opportunity costs may be defined as the expected returns from the second best use of the resources which are foregone due to the scarcity of resources. E.g. if with a sum of Rs. 1 lakhs one can purchase two machines. One yields a profit of Rs.20000 and the other a profit of Rs. 10000. Now the buyer will forego the use which is less productive. It can also be termed as economic rent

(Rs.20000 – Rs 10000 = Rs. 10000)

Explicit and Implicit costs

Marginal and Incremental costs

It is the change in Total costs due to the production of one more or one less unit of a factor of production.

MC = TCn – TCn-1

Incremental costs refer to the total additional costs associated with the decisions to expand output or to add a new variety of product etc. In the long run when firms expand their production they hire more of men, machinery and equipments. These expenditures are included in the incremental costs. These costs also arise due to change in the product lines, addition or introduction of a new product, replacement of worn out plant and machinery, replacement of old techniques of production with a new one etc.

Sunk costs are those costs, which cannot be increased or decreased by varying the rate of output. Example once it is decided to make incremental investment expenditure and the funds are allocated, all the preceding costs are considered to be the sunk costs as these costs cannot be recovered when there is a change in the market decisions.

EQUILIBRIUM

Equilibrium is a state of balance. In fact sometimes the modern economics is also called as an equilibrium analysis. When the forces act in the opposite direction is in the state of rest they are called as to be in the equilibrium. Equilibrium can be a stable equilibrium, unstable equilibrium or a neutral equilibrium.

1) Stable equilibrium is that equilibrium in which the object concerned after having been disturbed reverts back to the original state.

2) In an unstable equilibrium a slight disturbance further evokes disturbance.

3) In the neutral equilibrium the disturbing forces neither bring it back nor they

can take it away from the equilibrium position.

Short term or the long-term equilibrium

In the short run demand plays an important role in the determination of price and in the long run both demand and supply plays an important role.

Partial and general equilibrium

Partial equilibrium excludes certain variable and studies a few selected items at a time. This method takes into consideration the impact of one or two variables and keeps all others constant. E.g. demand and supply depends upon many variables but for the sake of simplicity we study only a few aspects.

In case of general equilibrium analysis

An analysis that treats various individual units and markets as interrelated and attempts to trace the consequence of an economic event is called the general equilibrium. In the process of making the decisions the consumers as well as the firms affect the prices of the commodities. The changes in the prices serve as signals to various consumers and firms that affect their decisions accordingly. In this way the changes in the prices will go on bringing the changes in the quantities supplied and demanded until equilibrium in all the markets is not achieved simultaneously.

Static and dynamic approaches

The word static generally means a position of rest but in economics it means a state in which there is a continuous, regular, certain and constant movement without any change. According to Clark there is an absence of the following five types of changes 1) size of population 2) supply of capital 3) methods of production 4) forms of business organization and 5) the wants of the people.

Harrod is of the view that static analysis is concerned with the lack of investment in the economy. In static economics we do not study about the sequences, lags etc. its like ordinary demand and supply theory. Example people continue to be born and die but births equal deaths so there is no change in the numbers but the composition of population is changing. The major drawback is that it takes us far from the actual picture assuming the variables constant.

Economic dynamics is a process of change through time.

The economy is at point A and in the

normal course of action it would have

Dgone to the point B but changes make it go

C. Again had there been no changes it would

have gone to D but again the changes lead it

towards E.

E C

Harrod’s view

c d

t t2

time

From a to b, that is upto the time period t, there is a static growth in the national income but between b and c there is the govt. investment and through the operation of the multiplier there is an increase in the income. This movement between b and c is the subject matter of economic dynamics to Harrod.

Although the dynamic analysis is better than the static analysis but in real life we make use of the comparative static situation in which we compare one equilibrium position with the other and ignore the time element.

MICRO ECONOMICS AND BUSINESS

Microeconomics explains how an individual business firm decides to fix the price and output of their product and what factor combination do they use to produce them. Microeconomics is concerned with the choosing of an appropriate course of action from the number of alternatives present for a business. Microeconomics tells us how to make a rational choice in allocating the scarce resources of the firm while making the decisions regarding price, output, technology, advertising expenditure etc. A business has to make the following decisions with the use of microeconomics

Price output decisions that is how much qty. is to be produced and at what prices it is to be sold.

Demand Decisions that is to estimate the correct demand so that there is neither the shortage of the product not there is any surplus.

Choice of a technique of production that is what type of technique is to be used whether the capital-intensive technique or the labour intensive technique.

Even the advertisement decisions of the firm are projected with the help of microeconomics. A firm will spend on that mode of advertising which has the maximum reach and which has the least costs.

In the long run the firm has to decide about the location of the plant, size of the plant or the choice of the production technique etc.

It also tells a business about the investment decisions that is what is the rate of investment over the years or is it profitable to takeover the other firms of not.

THEORY OF DEMAND

The demand in economics means both the desire to purchase as well as the ability to pay for the good.

Demand is different from the quantity demanded. Demand is the quantities that the buyers are willing and able to buy at alternative prices during the given period of time whereas quantity demanded is a specific amount that buyers are willing and able to buy at on price.

Nature of demand for a product

With the normal goods the demand has a negative relationship. It means as the price of a commodity falls the quantity demanded for the product goes up.

x D Price P1 P D Q1 Q Qty y

The law of demand operates due to the following reasons

1Law of diminishing marginal utility

2Income effect

3Substitution effect

4Different uses

5Size of consumer group

Exceptions to the law of demand

1Goods having the prestige value or the articles of distinction

2Giffen goods

3In case of emergencies

4Ignorance

INDIVIDUAL DEMAND AND THE MARKET DEMAND

Individual demand is the quantity demanded by an individual person at different possible prices at a given point of time.

Market demand is the quantity demanded by all the persons in the market at different possible prices at a point of time.

A’s demand B’s demand Market demand

PricePrice d1Price D d d1 D

QuantityQuantityQuantity

Determinants of demand

The demand for X commodity is affected by the following factors

1Price of the commodity

2Prices of related goods

3Income of the consumer

4Tastes and preferences of the consumer

5Expectation of a price change of the commodity

6Population

7Income distribution

8Bandwagon Effect: it is also called cromo effect. It means that people undertake certain tasks as other as also doing like that. People try to follow the crowd without examining the merits of a particular thing.

9Snob Effect: preference for the goods because they are different from the good the community preferred. It is the demand for the exclusive goods.

Elasticity of demand and its determinants

Elasticity is a measure of the responsiveness of one variable to the change in other.

Ed can be

Price Elasticity of demand
Income elasticity of demand
It can be cross elasticity of demand

Methods to measure the price elasticity of demand

1Total expenditure method as given by Marshall

T E > 1

Price E = 1

E E < 1

Total expenditure

2Proportionate method

Ed = (-) P Q

Q  P

3Point elasticity method

In case of a linear demand curve

M E =  Price . A E >1

. P E =1

. B E <1 O N Qty

4Arc elasticity method

Determinants of elasticity of demand

Nature of the commodity
Availability of substitutes
Postponement of the use
Income of the consumer
Habit of the consumer
Time period
Joint demand
Goods with the different uses

Demand as a multivariate function or a dynamic demand function

The demand in the long run is not only influenced by the price rather it is influences by all other factors that we have assumed constant in the short run. The long run demand for the product depends on the composite impact of all its determinants operating simultaneously. To estimate the long run demand we have to take into consideration all the relevant factors. A demand function, which describes the relationship between demand and all its variables, is known as the multivariate demand function.

Dx = f ( Px, M, Py, T, A )

Theory of consumer behaviour

Different theories have been developed time to time to explain the consumer behaviour. The major breakthrough was achieved in the form of cardinal utility analysis. Marshall gave this theory.

According to this theory as a consumer goes on consuming more and more units of a commodity the utility derived from each successive unit goes on diminishing.

Assumptions;

1Utility is measurable in cardinal numbers.

2Marginal utility of money remains constant

3Marginal utility of every commodity is independent

4There is a continuous consumption f the commodity.

5Every unit of the commodity consumed is same in size.

6No change in the price of the commodity and its substitutes.

7No change in the tastes character, fashion and habits of the consumer.

Cups of coffee consumed everyday / Total utilty (utils) / Marginal utility
1 / 12 / 12
2 / 22 / 10
3 / 30 / 8
4 / 36 / 6
5 / 40 / 4
6 / 41 / 1
7 / 39 / -2
8 / 34 / -5

______

Exceptions

1Good book or poem

2Misers

3Drunkards

4Initial units

Importance

Basis of laws of consumption

Varity in consumption

Difference in value in use and value in exchange

Basis of progressive taxation.

Criticism

Cardinal measurement of utility is not possible.

Marginal utility of money is not constant.

Every commodity is not an independent commodity

Unrealistic assumptions.

Law of equi marginal utility or law of substitution

This law was again developed by Marshall. It is also known as the Gossen’s second

law. According to this law, a consumer allocates his limited income in such a way that the last unit of money spent on different commodities gives the consumer the same level of satisfaction.

Assumptions

Same as above + consumer is a rational person

Rupees spent / MU of Mangoes / MU of Milk
I / 12 / 10
II / 10 / 8
III / 8 / 6
IV / 6 / 4
V / 4 / 2

MU of mangoesMU of milk

------

Importance

In the field of consumption

In the field of production

In the field of exchange

Distribution of income between saving and consumption.

Criticism

Consumers are not fully rational

Minute calculations are not possible

Ignorance of the consumer

Influence of fashions, customs and habits.

Cardinal measurement of utility is not possible

Constancy of marginal utility of money is not possible

Indifference curve analysis

Hicks and Allen gave this approach. An IC is a locus of all such points located on an indifference curve, which gives the consumer the same level of satisfaction. The different points on the depicted IC show the same level of satisfaction.