Introduction to Microeconomics

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Microeconomics is a branch of economics that studies the behavior of individuals and small impacting organizations in making decisions on the allocation of limited resources
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Introduction to Microeconomics

  1. 1. INTRODUCTION TO MICROECONOMICS
  2. 2. WHAT IS MICROECONOMICS? •Economics deals with human activities •Behavior of individual units •When Consuming •How we choose what to buy •When Producing •How we choose what to produce •Markets •The interaction of consumers and producers •Economics deals with the present as well as future expectations •Individual units are motivated by self-interest •The same individual may be a consumer, producer and an employee of different products
  3. 3. DIFFERENT FROM MACROECONOMICS •Microeconomics: deals with individual economic units; •Variables: markets, prices, quantities consumed and produced •Macroeconomics: deals with aggregate economy •Variables: Economic growth, inflation, unemployment Microeconomics is the foundation for macroeconomics
  4. 4. SCOPE OF MICROECONOMICS •Products and resources may not always be economic •Marriage •Crime •Addiction •Environment Decisions by individuals result in social outcomes
  5. 5. Allocation of Scarce Resources• Consumers allocate given income across goods and services • Firms allocate funds across labor, capital and raw materials as well as products • Workers allocate time between leisure and work • Prices & Opportunity costs Rolling Stones: “You can’t always get what you want” (1969)
  6. 6. ALLOCATION OF SCARCE RESOURCES •Planned economy – resources allocated by the government •Market economy – resources allocated by individual economic units
  7. 7. TRADE-OFF •Consumers – to allocate income among various items of consumption •Workers – to allocate time between work and leisure •Firms – to allocate resources between products or process of production
  8. 8. OPPORTUNITY COST •The income that one gives up by not choosing the second best option; derivative of trade-off •Example: Choosing to join a MBA course instead of joining a call center after college. •What is the trade-off? •What is the opportunity cost of not joining a call center? There ain’t such thing as free lunch: Milton Friedman (1975)
  9. 9. WHY SHOULD A FIRM STUDY MICROECONOMICS? •Understand consumer preferences and trade-offs •Predict demand for products and responsiveness of demand to prices •Understand the competitiveness of the market •Estimate costs of production, cost declines and economies of scale •Scale of production required to break-even and maximize profits •Design a pricing, investment and employment strategy •What are the uncertainties in the market and expectations? •What is the effect of government policy?
  10. 10. MICROECONOMICS IN CORPORATE DECISION MAKING •Tata Motors, which was a commercial vehicle manufacturer, launched the Tata Indica in the 1990s, positioned as a competitor of midsize cars sold by Maruti and Hyundai. •It was followed by Tata Sumo, a SUV, where competitors were Mahindra & Mahindra and later Toyota Innova. •Next, Indigo and Indigo Marina were launched in the sedan segment. •In 2009, the Tata Nano, the cheapest car in the world was launched.
  11. 11. DECISION-MAKING PROCESS •Consumer demand: •How would customers react to the product designs, performance of the new products? •How strong would the initial demand be and how fast would it grow? •How would demand respond to price changes?
  12. 12. DECISION-MAKING PROCESS (CONTD.) •Technology decisions •Allocation of resources between labor, machines, etc •Scale of production
  13. 13. DECISION-MAKING PROCESS (CONTD.) •Cost decisions •What is the production cost? •How would cost depend on the scale of production? •How would wages, prices of steel and other raw materials affect costs? •How much and how fast could costs decline as the production process gained expertise?
  14. 14. DECISION-MAKING PROCESS (CONTD.) •Pricing decisions: •Should Tata Motors charge a lower price for the no-frills Tata Nano than competing products and high prices for leather seats in the sedans or make these options standard for all cars and charge higher prices for all models? •What would be the competitor reaction? Would they cut prices?
  15. 15. DECISION-MAKING PROCESS (CONTD.) •Risk analysis •Uncertainty over future price of petroleum •Uncertainty over wages •Political uncertainty •Public policy
  16. 16. WHY IS MICROECONOMICS IMPORTANT FOR GOVERNMENT POLICY? • Effect of personal income tax on consumer spending •Effect of corporate income tax on company profits •Effect of government spending on infrastructure on firm revenues •Effect of trade policies on firm competitiveness •Effect of industrial policies on firm competitiveness •Effect of other policies on demand and supply, e.g. effect of emission standards on demand for new cars
  17. 17. THEMES OF MICROECONOMICS •Prices – trade-off depends on prices; prices depend on demand and supply •Markets – collection of buyers & sellers that interact to determine prices •Industry – collection of firms that sell the same or closely related products. Market includes more than one industry •Equilibrium – condition of stability when there is no tendency to change
  18. 18. WHAT IS A MARKET? Market Definition Which buyers and sellers should be included in a given market Market Extent Defines the boundaries of the market Geographic Range of products
  19. 19. EXAMPLES OF MARKETS Geographic boundaries Fish: Sunderbans vs Delhi Housing: Mumbai vs a Kolkata neighborhood Range of Products Fuel: regular, super, & diesel Cameras: SLR’s, point & shoot, digital Markets for Prescription Drugs Well-defined markets - therapeutic drugs Ambiguous markets - painkillers
  20. 20. EQUILIBRIUM •Condition which is stable and has no tendency to change •Consumer – utility maximized subject to budget constraint •Firm – Profit maximized subject to minimum costs and maximum revenue
  21. 21. MICROECONOMICS AND PRICES The role of prices in a market economy How prices are determined Competitive markets Because of the large number of buyers and sellers, no individual buyer or seller can influence the price. Example: Most agricultural markets Non-competitive markets Markets where individual producers can influence the price. Example: OPEC
  22. 22. NORMATIVE ANALYSIS Positive Analysis Positive analysis is the use of theories and models to predict the impact of a choice. For example: What will be the impact of an import quota on foreign cars? What will be the impact of an increase in the gasoline excise tax? Normative Analysis Normative analysis addresses issues from the perspective of “What ought to be?” For example: Consider the equity and efficiency trade-off of an increase in the gasoline excise tax versus import restriction on foreign oil.
  23. 23. THEORIES AND MODELS •Qualitative versus quantitative •Quantitative analysis of economic variables • Complex relationship between economic units •Study of individual economic units and aggregate economy •Theories and models used to study situations in comparison to equilibrium conditions
  24. 24. MICROECONOMIC THEORIES & MODELS Theories are used to explain observed phenomena in terms of a set of basic rules and assumptions. For example The Theory of the Firm The Theory of Consumer Behavior Effect on government policies on economic units Models are mathematical representations of theories used to make predictions Validating a Theory The validity of a theory is determined by the quality of its prediction, given the assumptions.
  25. 25. SIMPLIFYING ASSUMPTIONS •All scientists build models based on assumptions, so do economists •This allows the model to focus on the most important explanations for a particular phenomenon •No economic model is literally true •Some assumptions are easy to criticize •The test of a model is its usefulness
  26. 26. WHY ECONOMISTS DISAGREE •Even with scientific method, still room to disagree •Differences in scientific judgment lead to disagreements on positive questions •e.g. Look at the same data but come to a different conclusion •Likely began from different assumptions; may be able to resolve by empirically testing assumptions •Can’t resolve normative disputes that arise from differences in values
  27. 27. REAL VERSUS NOMINAL PRICE Nominal price is the absolute or current dollar price of a good or service when it is sold. Real price is the price relative to an aggregate measure of prices or constant price. The Consumer Price Index (CPI) is an aggregate measure. Real prices are emphasized to permit the analysis of relative prices.
  28. 28. CALCULATING REAL PRICE yearcurrent yearcurrent yearbase PriceNominalx CPI CPI PriceReal = (base year = 100)
  29. 29. CALCULATING THE REAL PRICE OF MILK Nominal Price Real Price of Milk Year of Milk CPI in 1970 dollars 1970 .40 38.8 .40 = 38.8/38.8 x .40 1980 .65 82.4 .31 = 38.8/82.4 x .65 1999 1.05 167.0 .24 = 38.8/167.0 x 1.05
  30. 30. CALCULATING REAL PRICES: AN EXAMPLE - EGGS & COLLEGE 1.04x 163 38.8 EggsofPriceReal 1970 = 1998 (1970 = 100) $4,573$19,213x 163.0 38.8 == Real Price of a College Education 1998 (1970 = 100)
  31. 31. AN EXAMPLE - EGGS & COLLEGE 1970 1975 1980 1985 1990 1998 Consumer Price Index (1983 = 100) 38.8 53.8 82.4 107.6 130.7 163.0 Nominal Prices Eggs $0.61 $0.77 $0.84 $0.80 $0.98 $1.04 College Education $2,530 $3,403 $4,912 $8,156 $12,800 $19,213 Real Prices ($1970) Eggs $0.61 $0.56 $0.40 $0.29 $0.30 $0.25 College Education $2,530 $2,454 $2,313 $2,941 $3,800 $4,573
  32. 32. AN EXERCISE   1960 1970 1980 1990 2000 2004 CPI 100 130.58 158.56 184.95 208.98 214.93 Retail price of butter (Rs) 80 90 85 102 110 120 Real price of butter (Base  1960=100) 80.00 68.92 53.61 55.15 52.64 55.83 a) Calculate the real price of butter in 1960 rupees b) Has the real price increased/ decreased/ stayed the same since 1960? c) What is the % change in the real price (1960=100) from 1960 to 2004? d) Convert the CPI into 1990=100 and determine the real price of butter in 1990 rupees e) What is the % change in real price (1990 rupees) from 1960 to 2004? Compare this with your answer in (b). What do you notice? Explain
  33. 33. SOLUTION   1960 1970 1980 1990 2000 2004 CPI 100 130.58 158.56 184.95 208.98 214.93 Retail price of butter (Rs) 80 90 85 102 110 120 Real price of butter (Base  1960=100) 80.00 68.92 53.61 55.15 52.64 55.83               % change in real price from 1960  to 2004   -30.21                      Real price of butter (Base  1990=100) 147.96 127.47 99.15 102.00 97.35 103.26               % change in real price from 1960  to 2004   -30.21       
  34. 34. EQUATION OF A LINE Slope-intercept form of a linear line is Y=mx +c M= slope C= intercept Y X C M
  35. 35. EQUATION OF A CURVE Y = f(x) Slope of the curve = slope of the tangent at the point Y X y2 y1 x1 x2 A B Slope at point A = y2/x1 Slope at point B = y1/x2 Slope at point A > slope at point B Point A is steeper than point B
  36. 36. http://www.unitedworld.edu.in/ Campus Ahmedabad Campus: Karnavati Knowledge Village, A/907,Uvarsad, S.G.Highway, Gandhinagar Kolkata Campus: Infinity Benchmark Tower 10th Floor, Plot - G1, Block - EP& GP, Sec - V, Salt Lake, Kolkata. Reg. Office: 407, Zodiac Square, 4th Floor Opp. Gurudwara, S.G. Road, Bodakdev, Ahmedabad.

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