Module 1 Microeconomics Principles PDF

Micro Economics Module 1 Micro Economics principles 1 What is Economics ? Economics is a social science concerned with the production, distribution, and consumption of goods and services. It studies how individuals, businesses, governments, and nations...

Micro Economics Module 1 Micro Economics principles 1 What is Economics ? Economics is a social science concerned with the production, distribution, and consumption of goods and services. It studies how individuals, businesses, governments, and nations make choices about how to allocate resources. Economics focuses on the actions of human beings, based on assumptions that humans act with rational behavior, seeking the most optimal level of benefit or utility. 2 What Is Rational Behavior? Rational behavior refers to a decision-making process that is based on making choices that result in the optimal level of benefit or utility for an individual. Most classical economic theories are based on the assumption that all individuals taking part in an activity are behaving rationally. 3 What Is Rational Behavior? Rational choice theory is an economic theory that assumes rational behavior on the part of individuals. Rational behavior may not involve receiving the most monetary or material benefit, because the satisfaction received could be purely emotional or non-monetary. 4 Scarcity Scarcity refers to a basic economic problem—the gap between limited resources and theoretically limitless wants. Scarcity is the foundation of the essential problem of economics: the allocation of limited means to fulfill unlimited wants and needs. 5 Trade-Offs A situational decision that involves diminishing or losing one quality, quantity, or property of a set or design in return for gains in other aspects. In simple terms, a tradeoff is where one thing increases, and another must decrease. In economics, a trade-off is defined as an "opportunity cost" 6 The fundamental Problem of Economics The fundamental economic problem is the issue of scarcity and how best to produce and distribute these scare resources. 7 The fundamental Problem of Economics 8 Microeconomics Branch of economics that deals with the behavior of individual economic units—consumers, firms, workers, and investors—as well as the markets that these units comprise. Macroeconomics Branch of economics that deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation. 9 The Themes of Microeconomics Trade-Offs Consumers Labor Firms/Individuals 10 Consumers Consumers have limited incomes, which can be spent on a wide variety of goods and services, or saved for the future. Labor Workers also face constraints and make trade-offs. First, people must decide whether and when to enter the workforce. Second, workers face trade-offs in their choice of employment. Finally, workers must sometimes decide how many hours per week they wish to work, thereby trading off labor for leisure. Firms Firms also face limits in terms of the kinds of products that they can produce, and the resources available to produce them. 11 Recap Economics It studies how individuals, businesses, governments, and nations make choices about how to allocate resources. Economics focuses on the actions of human beings, based on assumptions that humans act with rational behavior, seeking the most optimal level of benefit or utility. Microeconomics Branch of economics that deals with the behavior of individual economic units—consumers, firms, workers, and investors—as well as the markets that these units comprise. 12 Economy The word economy comes from the Greek word oikonomos, which means “one who manages a household.” households and economies have much in common 13 Scarcity Society has limited resources and therefore cannot produce all the goods and services people wish to have Eg: Covid Vaccine households and economies have much in common Each member of a household cannot get everything she/he wants, each individual in a society cannot attain the highest standard of living to which she/he might aspire. 14 Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by an all-powerful dictator but through the combined choices of millions of households and firms. Economists study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. How people interact with one another: Eg: The multitude of buyers and sellers of a good together determine the price at which the good is sold and the quantity that is sold. 15 Economists analyze the forces and trends that affect the economy as a whole Eg: growth in average income, the fraction of the population that cannot find work, and the rate at which prices are rising 16  Gregory Mankiw, Principles of Economics, describes 10 principles of Economics How People Make Decisions 1. People face trade-offs 2. The cost of something is what you give up to get it 3. Rational people think at the margin 4. People respond to incentives How People Interact 5. Trade can make everyone better off 6. Markets are usually a good way to organize economic activity 7. Governments can sometimes improve market outcomes How the Economy as a Whole Works 8. A country's standard of living depends on its ability to produce goods and services 9. Prices rise when the government prints too much money 10. Society faces a short-run tradeoff between Inflation and unemployment. 17 How People Make Decisions 1. People face trade-offs Making decisions requires trading off one goal against another We have to trade one thing for another thing — there’s no other option Examples: People are willing to trade 3 years of college work for the ability to become an entrepreneur/ manager The governments spend money in defence instead of school Efficiency – Getting the maximum benefit of scarce resources Equality – Benefits are distributed equally amongst the population. 18 How People Make Decisions 2. The cost of something is what you give up to get it Once you spend your money on something, you can't spend it again on something else. Cost The monetary value of goods and services that producers and consumers purchase Opportunity cost The cost of the next best alternative use of money, time, or resources when making a choice) during your life cycle 19 How People Make Decisions 3. Rational people think at the margin Thinking within the margins means trying to get the best result Rational people think within the margins Rational people – people who systematically and purposefully do the best they can do to achieve their objectives. Marginal Benefit > Marginal Cost = decision will be made. All things being equal, the better option is better. 20 How People Make Decisions 4. People respond to incentives Incentive – something that induces people to act People make decisions by comparing costs and benefits, their behavior may change when the costs or benefits change Unintended consequences Eg: The price of some good goes down Wednesday offers at Domino’s, Topic crucial in exam 21 How People Interact 5. Trade can make everyone better off Trade allows each person to specialize in the activities he/she does best and to enjoy a variety of goods and services at lower cost Eg: Columbia in Coffee Japan in Automotive sector 22 How People Interact 5. Trade can make everyone better off Country X produces 10 apples and has $100 Country Y produces 10 oranges and has $100 Both apples and oranges cost $10 each Country X wants 3 oranges Country Y wants 7 apples. Everyone benefits with trade. 23 How People Interact 6. Markets are usually a good way to organize economic activity Market Economy Economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services Eg: Firms decide what they will produce Households decide where to work People decide what they buy 24 How People Interact 6. Markets are usually a good way to organize economic activity Market economy- Competitive market Command economy- Government decides what/how/to whom 25 How People Interact 7. Governments can sometimes improve market outcomes Two reasons to intervene the economies: Efficiency and equity Eg: Regulatory bodies (RBI, SEBI) When there are market failure 26 How People Interact 7. Governments can sometimes improve market outcomes Market failure – a situation in which a market left to its own fails to allocate resources efficiently Externality: The impact of one person’s action on the well-being of another person Eg: Intervention, monopoly, inequality 27 How the Economy as a Whole Works 8. A country's standard of living depends on its ability to produce goods and services Citizens of high income countries have more TV sets, cars, better health care, better nutrition. Almost all variation in living standards attributable to differences in country's productivity 28 How the Economy as a Whole Works 8. A country's standard of living depends on its ability to produce goods and services Productivity: the quantity of goods and services produced by each output of labor The only way to increase the standard of living is through increasing productivity 29 How the Economy as a Whole Works 9. Prices rise when the government prints too much money Inflation: An increase in the overall levels of prices in the economy 30 How the Economy as a Whole Works 10. Society faces a short-run tradeoff between Inflation and unemployment. Inflation for many countries is primordial activity for the economy Why is so hard to control it ? 31 How the Economy as a Whole Works 10. Society faces a short-run tradeoff between Inflation and unemployment. Inflation occurs when the government prints money. When money is created there is a need to spend it which thereby increase demand. Higher demand means that firms can charge more, and in the short run encourages firms to higher more employees. More hiring = lower unemployment. 32 Thinking Like an Economist See how economists apply the method of science Consider how assumptions and models can shed light on the world Learn two simple models – the circular flow and production possibilities frontier 33 Thinking Like an Economist Every field of study has its own terminology Mathematics Psychology Law Economics supply | opportunity cost | elasticity | consumer surplus | demand | comparative advantage | deadweight loss 34 Thinking Like an Economist Economics trains you to.... Think in terms of alternatives Evaluate the cost of individual and social choices Examine and understand how certain events and issues are related 35 Thinking Like an Economist The Economist as a Scientist Economists try to address their subject with a scientist’s objectivity The economic way of thinking Economics makes use of the scientific method Involves thinking analytically and objectively Economics makes use of the scientific method Economists.. Devise theories Collect data Analyze the data to verify or refute their theories 36 The Economist as a Scientist The economic way of thinking... Involves thinking analytically and objectively Makes use of the scientific method 37 Thinking Like an Economist The Scientific Method Develops theories, collects, and analyzes data to prove the theories. Uses abstract models to help explain how a complex, real world operates. Observation, Theory and More Observation! 38 The Economic Way of Thinking Includes developing abstract models from theories and the analysis of the models. Uses two approaches: Descriptive (reporting facts, etc.) Analytical (abstract reasoning) 39 Two Roles of Economists Scientists and Policy makers When they are trying to explain the world, they are scientists When they are trying to change the world, they are policymakers 40 Role of assumptions Assumptions can simplify the complex world and make it easier to understand for example, we might assume that the world consists of only two countries and that each country produces only two goods Economists make assumptions in order to make the world easier to understand The art in scientific thinking is deciding which assumptions to make Economists use different assumptions to answer different questions 41 Thinking Like an Economist Factors of Production the inputs used to produce goods and services Land Labor Capital Entrepreneur/entrepreneurship 53 Thinking Like an Economist Economists use models to simplify reality in order to improve our understanding of the world Two of the most basic economic models include: The Circular Flow Diagram The Production Possibilities Frontier 54 First Model: The Circular-Flow Diagram The circular-flow diagram is a visual model of the economy that shows how money flow through markets among households and firms. 55 First Model: The Circular-Flow Diagram Firms Produce and sell goods and services Hire and use factors of production Households Buy and consume goods and services Own and sell factors of production 56 The Circular-Flow 57 The Circular-Flow Diagram Markets for Goods and Services Firms sell Households buy Markets for Factors of Production Households sell Firms buy Factors of Production Inputs used to produce goods and services Land, labour, and capital 58 Second Model: Production Possibilities Frontier The production possibilities frontier is a graph that the economy can possibly produce and the available production technology. The production possibilities frontier is a graph that shows the various combinations of output— for example, cars and computers— that the economy can possibly produce given the available factors of production and the available production technology that firms use to turn these factors into output. 59 Production Possibilities Frontier Resources are scarce, not every conceivable outcome is feasible. no matter how resources are allocated between the two industries, the economy cannot produce the amount of cars and computers represented by point D. 60 Concepts Illustrated by the Production Possibilities Frontier Efficiency Tradeoffs Opportunity Cost Economic Growth 61 A Shift in the Production Possibilities Frontier 62 A Shift in the Production Possibilities Frontier Technological advance in the computer industry enables the economy to produce more computers for any given number of cars. As a result, the production possibilities frontier shifts outward. If the economy moves from point A to point G, then the production of both cars and computers increases. 63