understanding the concept of microecnomics

1. Unit 1
Definition of Economics, Scope and
Relevance of Economics in Business,
Basic Assumptions in Economics.
Scope of Economics

2. What is Economics?
• Social science that analyzes the most efficient
way to use our limited resources.
• We have unlimited wants with limited
resources.
• We have to make a choice to give up one for
another. (The Optimal Choice)
• Factors of production are land, labour and
capital. (entrepreneur, technology)

3. What is Economics?
• Income and Employment of the economy
• Economic development

4. Some Definitions
• Adam Smith (1776)- A science which inquires
into the nature and cause of wealth of
nations.
– Central point is wealth creation
– Main importance given to material aspects.
– Rationality based on maximizing wealth creation.
– It does not consider the scarcity issues.

5. • Alfred Marshall (1890)- Economics is a science
of material welfare. It is a study of man’s
action in the ordinary business of life, how he
gets his income and how he uses it.
• It encompasses both study of wealth and
study of human welfare based on wealth.
– Wealth is not everything
– Material welfare which is concrete and tangible
can be measured by money.
– Human does not only live for monetary gain to
achieve his or her material welfare.
– It ignores the scarcity problem.

6. • Lionel Robbins (1932): Economics is a science
which studies human behavior as a
relationship between ends and scarce means
which have alternative uses
– Human wants or ends are unlimited
– The ends vary in importance
– The means are scarce
– Means have alternative uses
• Means or economic resources are made up of
labour, capital, land and also
entrepreneurship which are very fundamental
to produce goods and services.

7. • Paul Samuelson (1948)- Economics is a study
of how people and society choose, with or
without the use of money, to employ scarce
productive resources which could have
alternative uses to produce various
commodities for now and future.
– It includes the choices made by individuals as well
as society from the scarce resources to produce
various products.
– It does not give sole importance to money or
wealth.

8. • Microeconomics
– Study of small economic units such as individuals,
firms and industries.
• Macroeconomics
– Study of the large economy as a whole in
aggregates such as income, employment, output
etc.
• Trade offs
– All the alternatives that we have and to give up
when we make a choice.
• Opportunity cost- the second best choice that
you have given up when you make a choice.

9. Trade Offs
Computer
Wheat
More computer means less Wheat
Limited Resources
Production Possibility Curve

10. Trade Offs
Computer
Wheat
More computer means less Wheat
Limited Resources
A(2k,10k)
B(5k, 5k)
C(10k, 2K)

11. Trade Offs
Computer
Wheat
More computer means less Wheat
Factor of production- Land, Labour and Capital

12. Cars
Food grains
American economy
400
1000

13. Cars
Food grains
Japanese economy
400
500

14. Trade Offs
• Computer
Wheat

15. Trade Offs
• Computer
Wheat
Upgradation in Technology and Entrepreneurship

16. Major assumptions in Economics
• Society and individuals have unlimited wants
and limited resources.
• Due to scarcity, choices are to be made.
• Every choices have tradeoffs (or cost).
• The choices are made based on comparing the
marginal benefit and marginal cost.
• Everyone responds to incentives and it can be
monetary or non-monetary.

17. Some Key concepts
• Consumption- when a product whether a
tangible good or service is being exchanged
with cash or kind by a person or group of
people. (Consumer goods)
• Investment- The money spent by business
owners to improve their production or their
business. (Buying more Capital goods,
Increasing human capital through training,
buying more land)

18. • Production- It is the process of outcome of
combination of factors of production such as
land, labour, capital and entrepreneurship
forming some goods or services which are
directly related or indirectly related to the
consumers.
• Distribution- It is the process of choosing the
shares of factors of production. Rent, wage,
interest and profit.

19. Scope of Economics in Business
• There are Positive Economics and Normative
Economics.

20. Scope of Economics in Business
• There are Positive Economics and Normative
Economics.
• Positive Economics studies about ‘why it
happened’, the causes and effects of situation.

21. Scope of Economics in Business
• There are Positive Economics and Normative
Economics.
• Positive Economics studies about ‘why it
happened’, the causes and effects of situation.
• Normative Economics studies ‘what should
be’. It adds the decision making of what
should be done in certain situation.

22. Some examples
• Great Depression (1930)
• Financial crisis (2008)
• Covid-19 situation (2020)
• Inequality of wealth
– What happened?
– Why it happened?
– Is it good or bad?
– What should be done next?

23. Production Possibility Curve
• What is it?
– It is a graph showing the different possible
outcomes that can be produced with combination
of various proportion of factors of production.
• What can you learn from PPC?
– The trade offs
– The opportunity cost
– The limitations
– The inefficient outcomes

24. Computer Shirt
0 30
1 29
2 25
3 15
4 0

25. Number of Shirts
Computers
A
B
C
D
E

26. Number of Shirts
Computers
Unattainable areas beyond PPC
because of Scarce or limited resources
Underneath PPC the outcome
Will be inefficient

27. Computer Shirt Opportunity cost
0 30
1 29 1 shirt
2 25 4 shirts
3 15 10 shirts
4 0 15 shirts

28. Computer Shirt Outcomes
0 30 A
1 29 B
2 25 C
3 15 D
4 0 E

29. Changes Outcome
A to D 3 computers for 15 shirts sacrificed
B to C 1 computer for 4 shirts sacrificed
E to D 15 shirts for 1 computer sacrificed
C to A 5 shirts for 2 computers sacrificed

30. PPC with straight line curves
Car Computer
0 5
1 4
2 3
3 2
4 1
5 0

31. PPC with straight line curves
Car Computer Opportunity cost outcome
0 5 A
1 4 1 computer for 1
car
B
2 3 1:1 C
3 2 1:1 D
4 1 1:1 E
5 0 1:1 F

32. Cars
Computer
A
B
C
D
E
F

33. Number of Shirts
Computers
A
B
C
D
E

34. Computer Shirt Opportunity
0 30
1 29 1 shirt for 1 computer or 1:1
2 25 1:4
3 15 1:10
4 0 1:15

35. • Shifting of the PPC
– Change in the quantity or quality of resources
– Change in technology
– Specialization and trade
• Examples try :
• 1. Faster computer innovation
• 2. Natural disaster
• 3. Trade deal gone wrong
• 4. Unemployment rising

36. Faster computer innovation
• Computer
shirt

37. Natural Disaster
• Computer
shirt

38. Increase in Unemployment
• Computer
shirt

39. Fundamental Problems Faced by the Economy
• What to produce
– Which goods are to be produced from the limited
resources and in what quantities.
• How to produce
– The combination of the resources should be divided
either more labour intensive or more capital intensive
etc according to the need of the economy.
• For whom to produce
– Who in the economy gets the product, the
distribution part of it. In other words for who it is
being produced. E.g. Food grains for all the people
rather than a defence project weapons.

40. Types of Economy
• The fundamental question of an economy lies
different for different economy.
– Socialist Economy: In this economy the state or the
governing body decides for the people what to
produce as they see fit. No citizen rather than holding
the power can decide or suggest.
– Capitalist Economy: In this economy the market which
is free from the intervention of government or higher
authority determines what to produce based on
supply and demand.
– Mixed Economy: In this economy there is a
combination of government intervention and planning
as well as free market mechanism.

41. Consumer Theory
• Consumer- It is a group of people who uses
products such as goods or services through
exchange with cash and kind for personal,
social, family or household use.
• These group of people are mostly households
and may not represent business activities.
• The rational expectation for the consumers
are to maximize satisfaction.

42. • Consumption- When the consumers buy and
use those product such as goods and services
to achieve the satisfaction of their wants. This
process is known as Consumption.
• Types of consumption
– Direct or final consumption: Those type of
consumption which are consumed directly by the
exchange of goods or services with the producer.
– Indirect or productive consumption: Those type of
consumption which are done to achieve the final
product of consumption.

43. Importance of Consumption
• According to the Keynesian economist and so
forth the modern economist they believe that
consumption is very important for an
economy to maintain and sustain growth.
• Consumer is considered to be one of the most
important agent of economic activity to be
well functioning.

44. Diminishing Marginal Utility
• First we have to know the meaning of Utility
• Second the assumptions of Consumer theory
• Then the diagram which will explain the
Diminishing Marginal Utility.

45. Utility
• It is the quantifiable measurement of the level
of satisfaction when a consumer consumes a
product .i.e. a good or service.
• For example drinking a glass of water when
thirsty can give you a very high level of
satisfaction and that level of satisfaction is
known as the utility.
• According to the cardinal way of defining the
utility, it is quantifiable and known as Utils.

46. A glass of water
Quantity Marginal Utils Total Utility
1 8 8
2 10 18
3 8 26
4 6 32
5 4 36
6 2 38
7 0 38
8 -2 36
9 -4 32

48. A glass of water
Quantity Marginal Utils TU
1 6 6
2 8 14
3 10 24
4 10 24
5 9 33
6 7 40
7 5 45
8 1 46
9 -4 42

50. • Therefore, according to the law of diminishing
marginal utility it states that as the consumer
consumes an additional unit of the product, the
marginal utility will decrease.
• Does this law apply to money as a commodity?
– Yes, it does because after having an enormous
amount of money an individual tend to value less and
spends on unnecessary items.
– Poor spends money only on essential items.
• Utility is important in understanding the
demand curve so to determine prices, the
taxation etc.

51. Opportunity cost
Computers Wheat (kg) Opportunity cost of computer
20,000 0
18,000 5000 0.27kg of wheat
15,000 9000 --------
9000 12000 1.33 kg of wheat
0 16,000

52. Demand
• The group of people who can afford and have
desire to buy the product comes in the list of
demand.
• The curve representing the relationship
between the price and quantity demanded is
known as the demand curve.
• The law of demand says that as the price of
one particular item increases the demand will
fall for that product, keeping all other factors
constant.

53. • Demand curve
Quantity demanded of coffee
Price
of
coffee
D1
D2
P1
P2
Q1
Q2 Q3
Price of tea rises
Income rises
Expectation
Price of sugar rises

54. • Things to know in demand curve
– Demand schedule
– Law of demand
– Individual demand and Aggregate demand
– Factors affecting demand
– Exceptions of law of demand (examples)
– The increase or decrease of demand
– The demand for complimentary and substitute
goods
– The demand for normal and inferior goods
– The Elasticity of demand

55. •
Normal goods
Engel curve

56. Factors affecting demand
• Price of the product
• Price of the related goods.
– Substitutes goods
– Complementary goods
• Income
• Taste and preferences
• Trends
• Expectations
• Increase in aggregate demand

57. • Price of the product- As the price of the
normal good increase the demand for it
decrease.
• Price of substitutes- As the price of substitute
good rise the demand of the product will rise.
• E.g. coffee and tea, different flavour ice
cream.
• Price of complementary- As the price of
complementary good rise the demand of the
product will decrease.
• E.g. sugar and tea, milk and coffee.

58. • Income – positively related to demand. (
demand curve will shift)
• Taste and preferences, Expectations, Increase
in aggregate demand - Positively related to
demand. ( Demand curve will shift)

59. Exceptions of Law of demand
• Price of shares in the stock market.
• Air flight tickets during vacation
• Medicine prices
• Giffen goods (inferior goods of special case)
• Intoxicants

60. Types of demand
• Individual and market demand- A type of demand
where individual demand a product whereas market
demand is an aggregate demand where all the
consumers demand of the product is taken in that
particular period of time.
• Autonomous and derived demand- Autonomous
demand is for those type of products which are not
derived or influenced by any other product whereas
the derived demand are those products which are
influenced by some other product. E.g.
Complementary or substitute goods.
• Demand of durable or perishable goods
• Long terms and short term demands for goods

61. • Two substitute goods A and B
– Price of B increases whereas price of A remains
the same.
– Quantity of A increases
– Price of B falls, what will happen to qty demanded
of A
– Decrease in qty A

62. • Price of B falls even though the price of A
remains the same the demand for A will fall
• Price of B rises qty demanded of A will rise
Price of B
Quantity of A

63. Complementary goods
• If there are two goods A and B and they are
complementary goods.
• Then if the price of A increases then the
quantity of B will decrease. ( coffee and milk)
• If the price of B increase the demand for A will
fall.

64. • Price of A increases qty of B falls
• Price of A decrease qty of B rises
Price
of
A
Quantity of B

65. Increase in income
•
Price
Quantity demanded
P1
Q1
Price will be constant
Income increases
Demand for the product increases
D1
D2
Q2
Normal goods

66. Decrease in income
• Price
Quantity demanded
P1
Q1
Price will be constant
Income decreases
Demand for the inferior product
increases
D1
D2
Q2
Inferior goods

67. Inferior and normal goods
• Inferior goods are lower quality products
• Normal goods are relatively better than the
inferior goods.
• When your income increases demand for
normal goods rises and demand for inferior
goods decreases and vice versa.

68. • Substitute goods –
– homogenous products
– Similar pricing approx
There are two substitute goods Tea and Coffee .
• As the price of Tea increases
– The quantity demanded of the tea will fall
– The quantity demanded for coffee will rise
• Two substitute goods price-demand
relationship is positive.

69. •
Price
of
Tea
Quantity of coffee
Demand curve
Price
of
coffee
Quantity of coffee
Price of tea rises

70. • Complementary goods
• Lets assume milk and tea are complementary
goods.
• Price of milk rises
– Quantity demanded for milk will fall
– Quantity demanded for tea will also fall
• Price and demand relationship for
complementary goods are inversely related.

71. •
Price
of
Milk
Quantity of Tea
Demand curve
P
Price
of
tea
Quantity of Tea
Price of milk rises

72. Elasticity of demand
• The sensitiveness of the quantity demanded
with respect to the certain factor change.
• The price elasticity of demand is the
sensitiveness of the quantity demanded with
respect to change in price.
• For example the change in quantity demand
with respect to change in price may defer
based of the type of goods such as necessities
and luxury items.

73. Factors that determine the elasticity
• Availability of close substitutes
• Necessities vs luxury goods
• The size of the market
• Time factor

74. Computing the elasticity
• Price elasticity of demand= Percentage change in quantity demanded
Percentage change in price
• When the price change is 10% increase of the good and the quantity
change is 20% fall then the price elasticity of demand will be 20/10 = 2
• Midpoint method
Suppose the price of the product was Rs 4 and the quantity being demanded
was 120 units. If the price rises to Rs 6 then the quantity demanded
decreased to 80 units.
The formula will be
Q1 = 120 Q2= 80 , P1= Rs 4 P2= Rs 6
(Q1 – Q2)/ (Q1 + Q2)/2 = (120-80)/(200/2)= 40/100= 0.4 = -1
(P1 – P2)/(P1 + P2)/2 (4-6)/(10/2) (-2/5) - 0.4

75. • E = (2000-1900)/(2000+1900)/2
(200-250)/(200+250)/2
• E= (100)/(3900/2)
(-50)/(450/2)
• E= (100)/(1950)
(-50)/(225)
• E= (0.051) = -0.231
(-0.22)

76. • E= (800-600)/(800+600)/2
(200-250)/(200+250)/2
• E= (200)/(1400/2)
(-50)/(450/2)
• E=(200)/(700)
(-50)/(225)
• E= (0.28) = -1.27
(-0.22)

77. • E= (2100-1800)/(2100+1800)/2
(150-300)/(150+300)/2
• E= (300)/(3900/2)
(-150)/(450/2)
• E= (300)/(1950)
(-150)/(225)
• E=( 0.153)= -0.229
(-0.666)

78. The degree of price elasticity
• If the elasticity is 1 then it is called unit elastic.
• If the elasticity is greater than one then it is
elastic demand.
• If the elasticity is lesser than one then it is
inelastic

79. •
Price
Qty Demand
P1
P2
Q1 Q2

80. Q1 = 2000 Q2= 1900 , P1= Rs 200 P2= Rs 250 (Business travellers)
(2000-1900)/(2000+1900)/2 = ( 100)/(3900/2)= 100/1950 = 0.051= - 0.23
(200-250)/(200+250)/2 (-50)/(450/2) (-50)/ 225 ( - 0.222)
Vacationers
P1= 200 , P2= 250, Q1= 800, Q2=600
(800-600)/(800+600)/2 = (200)/(1400/2) = (200/700)= 0.28= -1.261
(200- 250)/(200+250)/2 (-50)/(450/2) (-0.222) (-0.222)
(Q1 – Q2)/ (Q1 + Q2)/2
(P1 – P2)/(P1 + P2)/2

81. • X and Y are complimentary goods
• (QX1 – QX2)/ (QX1 + QX2)/2 y= coffee, x= tea
• (PY1 – PY2)/(PY1 + PY2)/2

82. • P1=8 , P2=10, Q1=40 , Q2= 32 (income=
10,000)
• E= (40-32)/(40+32)/2
• (8-10)/(8+10)/2
• E= (8)/(36) = 0.22= -1
• (-2)/9 0.22
• P1=8, P2=10, Q1= 50, Q2= 45 (income= 12,000)
• E= (50-45)/(50+45)/2= (5)/47.5_= 0.105=- 0.47
• -0.22 - 0.22

83. • P1=20 , P2=35, Q1=400 , Q2= 340 movie
tickets
• E= (400-340)/(400+340)/2
• (20-35)/(20+35)/2
• E= (60)/(740)/2 =0.162 = 0.3
• (-15)/55/2 = - 0.54
• P1=20, P2=35, Q1= 300, Q2= 180 Cookies
• E= (300-180)/(300+180)/2= 120/240_= 0.5= -0.9
• -0.54 - 0.54

84. Income elasticity of demand
• Price constant and income is changing
• What will be the change in quantity
demanded?
• I1= 10,000 , I2= 12,000 , Q1= 24, Q2= 30
• E= (Q1-Q2)/(Q1+Q2)/2
(I1-I2)/(I1+I2)/2
• E= (24-30)/(24+30)/2=
• (10,000-12,000)/(10,000+12,000)/2
• E= (-6)/27 = 0.22= 1.22
• -2000/11,000 0.18

85. Cross price elasticity
Price of Milk Milk Tea
15 1 2
12 3 5
10 5 8
08 7 11
Find out the cross price elasticity of tea?

86. • P1Milk= 12 , P2Milk= 10, Q1Tea= 5, Q2Tea= 8
• E= (Q1Tea-Q2Tea)/(Q1Tea + Q2Tea)/2
(P1Milk-P2Milk)/(P1Milk+P2Milk)/2
E= (5-8)/(5+8)/2
(12-10)/(12+10)/2
E= -2/13/2= 0.3= - 1.66
2/11 0.18

87. Cross price elasticity
Price of Tea Tea Coffee (price- Rs 5)
10 2 15
08 5 13
06 7 10
04 11 8
Find the cross price elasticity of coffee? If the price of tea changes from Rs 10 to Rs 4 and
Price of coffee remains the same.
P1= 10 , P2= 4, Q1=15, Q2=8
(Q1-Q2)/(Q1+Q2)/2= (15-8)/11.5= 0.608= 0.715
(P1-P2)/(P1+P2)/2= (10-4)/7 = 0.85

88. • Cross price Elasticity is the amount of change
in quantity demanded of good A with respect
to price change in B.
• Considering that both A and B are substitute
goods or complement goods.
• In terms of substitute goods as the price of B
rises the demand for A also rises.
• +ve result , it can elastic or inelastic.
• In terms of complement goods as the price of
B rises the demand for A falls.
• -ve result, it can be elastic or inelastic.