Introduction to Micro-Economics

"Micro-economics is the study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular commodities."

Teaching Points
1.1     Introduction
1.2     Historical review of Micro Economic
1.3     Meaning & definitions of Micro Economics
1.4     Scope and subject matter of Micro Economics
1.5     Features of Micro Economics
1.6     Features of Micro Economics

Teaching Objectives
To enable the students to understand meaning, nature, scope & subject matter of Micro Economics.

Adam Smith
"The Father of Economics."

The real tragedy of poor is the poverty of their aspiration – Adam Smith

1.1     Introduction :
The study of Economics is divided into two parts viz Micro Economics and Macro Economics. The terms Micro Economics and Macro Economics were first coined and used by Ragnar Frisch of Oslo University in 1933 and since then they have been adopted by the economist all over the world.

The term Micro Economics is derived from the Greek word 'mikros' which means a small-a millionth part. Thus in Micro Economics we analyse the economic behavior of small individual economic units such as individual consumer, individual producers etc.

The term Macro Economics is derived from the Greek word 'makras' which means large. Thus in Macro Economics we analyse the behavior of the economy as a whole and we study the large aggregates of the economy, such as total national income, total national output, total consumption, aggregate investment etc. In other words, Micro Economic analysis is individualistic while Macro Economic analysis is aggregative.

Knowledge of both the approaches is essential for complete understanding of the working of the economic system. But in the beginning, it is necessary to know the precise meaning, scope & subject matter of these two branches. In this chapter, we will discuss important aspects of Micro Economics. While Macro Economics will be explained in chapter VII of this text book.

1.2     Historical Review of Micro Economics :
From the historical point of view Micro Economic analysis was developed first. Micro approach is relatively traditional approach. Origin of this approach can be traced back to era of classical economist.

Adam Smith 'The Father of Economics' is considered as founder of Micro Economics. In his book "Wealth of Nations'' published in 1776, he discussed how prices of individual commodities and the factors of production are determined. Micro Economic approach is also seen in the writings of David Ricardo and J. S. Mill.

But Micro Economic analysis in fact was developed & popularized by Dr. Alfred Marshall, the neo-classical economist. He is considered as a real architect of Micro Economics. Dr. Marshall's 'Principles of Economics' was published in 1890 and considered as leading work on economics. Most of his analysis in this book is based on Micro Economic approach. Marginalism principle used by Marshall became an important & indespensible tool of microanalysis. Prof Pigou, J.R. Hicks, Prof. Samuelson, Mrs. Joan Robinson, Chamberlin are the other economist who have participated in the development of Micro Economics.

1.3     Meaning and Definitions of Micro Economics
Micro means a small part of a thing. Micro Economics thus deals with a small part of the national economy. It studies the economic actions and behavior of individual units such as individual consumer, individual producer or firm, the price of a particular commodity or factor etc.

Let us discuss some important definitions of Micro Economics to understand it's meaning, nature & subject matter.

(1)     According to Kenneth Boulding "Micro Economics is the study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular commodities."
It means Micro Economics is a study of economic activity of households as a consumption unit, individual firms & industries as production unit and individual prices, wages, incomes and their determination.

(2)     In the words of Maurice Dobb, "Micro Economics is in fact a microscopic study of the economy".         

It means in Micro Economic analysis each individual unit is examined separately in detail.

1.4     Scope and subject matter of Micro Economics
         Micro Economics basically deals with
         i)        Theory of product pricing
         ii)       Theory, of factor pricing (Microtheory of distribution) .
         iii)      Theory of economic welfare

1.       Product Pricing
The theory of product pricing explains how the relative prices of cotton cloth, rice, car and thousands of other commodities are determined.

Price of a commodity depends upon the forces of demand and supply. Therefore, analysis of demand and supply side is necessary in order to explain the process of determination of price.

Study of demand side covers the analysis of consumer's behavior and study of supply side, covers the analysis of conditions of production, cost and behaviour of firm & industry.

So, theory of product pricing is subdivided into theory of demand & theory of production & cost.

2.       Factor Pricing
Theory of factor pricing i.e. Theory of distribution explains how wages (price for the use of labour) rent (payment for the use of land), interest (Price for the use of capital), profits (the reward for the entrepreneur are determined.

3.       Theory of welfare
Theory of welfare basically deals with efficiency in the allocaton of resources. Efficiency in the allocation of resources is attained when it results in maximization of satisfaction of people. Economic efficiency involves three efficiencies :

i)        Efficiency m production - Efficiency in production means producing maximum possible amount of goods, from the given amount of resources.

ii)       Efficiency in consumption - Efficiency in consumption means distribution of produced goods & services among the people for, consumption, in such away as to maximize total satisfaction of society.

iii)      Efficiency in the direction of production i.e. overall economic efficiency - Efficiency in the direction of production means production of those goods which are most desired by the people.

Micro economic theory shows under what conditions these efficiencies are achieved.

We may conclude that Micro Economics is mainly concerned with price theory and allocation of resources. It seeks, to examine the following basic economic questions:

         a)       What goods are produced with and in what quantities?
         b)       Who will produce them & how ?
         c)       To whom & how the wealth so produced shall be distributed?
         d)       How shall resources be allocated to production & consumption in efficient manner?

All these questions are in the domain of Micro Economics. Above discussion on subject matter of Micro Economics explains the scope of it.

The study of Micro Economics is mainly confined to price, theory, and resource allocation. It does not study the aggregates relating to whole economy. This approach does not stud national economic problems such as unemployment, poverty, inequality of income etc. Theory of growth, theory of business fluctuation, monetary and fiscal policies etc. are beyond the limit of Micro Economics, so it's scope is limited, compared to that of Macro Economics.
1.5     Features of Micro Economics

1.       Study of individual units
         Micro Economics is the study of behaviour of small individual economic units, like particular households, individual firms, individual prices etc.

2.       Price Theory
Micro Economics is called price theory because it is primarily concerned with determination of prices of goods and factors of production.

3.       Slicing method
Micro Economics splits the economy into small individual unit and then studies each unit separately in detail: Thus it is said that Micro Economics uses Slicing method.

4.       Partial equilibrium
Micro Economic analysis is a partial equilibrium analysis. Partial equilibrium analyses equilibrium position of individual consumer individual firm, individual industry etc. Partial equilibrium analysis isolates an individual unit from other forces and proceeds with the assumption. "Other things remaining the same" (Ceteris paribus). This approach neglects the interdependence between economic-variables.

5.       Microscopic approach
Micro Economics is .the microscopic study of the economy. In the words of Prof. A.P. Lerner, "It is looking at the economy through microscope, as it were to see how the millions of cells in the body of economic - the individuals or households as consumers, and individuals or firms as producers play their part in the working of whole economic organism".

In Micro Economic theory, we discuss how the various cells of economic organism, such. asthousands of consumers, thousands of producers or firms, thousands of workers and resource suppliers in the economy; do their economic activities and reach their equilibrium state. In other words in Micro Economics, we attempt only a microscopic study of the national economy. We do not study the national economy in its totality.

6.       Analysis of resource allocation and economic efficiency
Micro Economics deals with the allocation of resources among competing groups. Micro Economics explains how relative prices of commodities and factors of production determine the allocation of resources in turn determines
(a)      What goods will be produced & in what quantities ?
(b)     How, they will be distributed ?

It means Micro Economics also deals with the problem of income distribution.

         Micro Economics also examines whether the given allocation of resources is efficient i.e. whether it results in economic welfare of society.

7.       Use of marginalism principle
Micro Economics uses marginalism principle as a tool of analysis. Marginal means change brought about in total, by an additional unit i.e. marginal unit. All important micro economic decisions are taken at the margin. So this concept is of crucial importance in all areas of Micro Economics.

8.       Based on certain assumptions
Micro Economics assumes laissez fair policy, pure capitalism, full employment, perfect competition etc. which do not exist in reality. Also most of the theories are based on the 'ceteris paribus' assumption i.e. Other things being constant. The assumption makes the analysis simple, but at the same time, it neglects the interdependence between economic variables. The assumption makes the theories static and neglects changing economic world.

9.       Limited Scope
Micro Economics studies individual economic units & not the whole economy. It does not deal with the nation-wide problems like unemployment, inflation, deflation, poverty, balance of payment situation, economic growth etc. So its scope is limited.

10.     Analysis of market structures
Micro Economics analyses different market structures i.e. perfect competition, monopoly oligopoly, monopolistic competition etc and describes how prices & quantities are determined in different markets.

1.6     Importance and usefulness of Micro Economics :

1.       To understand the working of free market economy
Micro economic theory helps in understanding the working of free market economy.

2.       Explains price determination & allocation of resources
It explains how the relative prices of various products & factors are determined and further explains why prices of these various products & factors are found different.

Also it explains the process of allocation of resources for the production of various goods & allocation of total production among the various consumers.

3.       It helps businessman in decision making
The knowledge of price theory is useful to businessman in deciding policies regarding the prices, cost of production, investment, attainment of maximum productivity etc. Also, with the-help of Micro Economics the businessman can estimate demand for his product.

4.       Useful to government
It is useful to government in framing economic policies, Micro Economic analysis is useful in determining tax policy, public expenditure policy, price policy, efficient allocation of resources etc.

5.       Helpful in international trade & public finance
Many aspects of international trade like effects of tariff determination of exchange rate, gains from international trade etc. can be explained with the help of micro economic analysis. It is useful in public finance to analyse incidence and effect of particular tax.

6.       Model Building
Micro Economics builds simple model which helps us in understanding complex economic situations. Development of various terms, concepts, terminologies, tools of economic analysis is valuable contribution of Micro Economics to the science of economics.

7.       Basis of welfare economics
Micro Economics examines the conditions of economic welfare. It explains how best results can be obtained through avoidance of wastage of resources.

Thus micro economic analysis has great theoretical and practical importance.

Q.1)   (A)     Fill in the blanks with appropriate alternative given in the brackets.
                  1)       The terms Micro & Macro Economics were first used by ...............
         (Adam Smith / Robbins / Ragner Frisch / Marshall)

                  2)       Micro Economics is a study of ................
                            (Whole economy / general- price level / National Output /
                            Individual economic unit)

                  3)       Micro Economics is also called as ...............
                            (Income theory / Price theory / Growth theory / Employment
                            theory)

                  4)       Micro Economic analysis adopts .......... Method
                            (lumping / aggregative / Slicing / inclusive)

                  5)       Micro Economics is a ............... equilibrium approach.
                            (partial / general / total / multi-variable)

(B)     Match the following
                  Group 'A'                                             Group `B',
                  1)  Adam Smith                                    A)  Aggregates
                  2)  Micro Economics                             B)  Prof. Boulding
                  3)  Macro Economics                             C)  Father of Economics
                  4)  Dr. Marshall                                    D) Individual units
                                                                            E)  Economic efficiency
                                                                            F)  Principles of Economics

         (C)     State whether the following statements are TRUE or FALSE
         1)       Dr. Marshall is known as the 'Father of Economics'.
         2)       Micro Economics studies theory of firm.
         3)       Micro Economics deals with allocation of resources.
         4)       Micro Economic theory assumes full employment.
         5)       Micro Economics theory suggest policies to solve problem of inflation.

Q.2)   (A)     Define or Explain the following concepts.
1)       Micro Economics
2)       Partial equilibrium
3)       Economic efficiency
4)       Individual economic unit
5)       Resource allocation


B)      Give reasons or explain the following statements
1)       Micro Economics is also known as price theory.
2)       Micro Economics studies individual economic unit.
3)       Micro Economics analyses partial equilibrium.
4)       Micro Economic theories are based on certain assumptions.
5)       Marginalism principle is used as a tool , of analysis in micro economics.

Q.3    Write short notes on :
         i)        Features of Micro Economics
         ii)       Subject matter of Micro Economics
         iii)      Historical review of Micro Economics
         iv)      Importance of Micro Economics

Q.4    Answer the following questions
         i)        Explain the meaning of Micro Economics with the help of few important definitions.
         ii)       What is the scope & subject matter of Micro Economics?
         iii)      What is, the importance of Micro Economics?
         iv)          What are the features of Micro Economics?
         v)       What are the basic economic questions dealt with by Micro Economics?

Q.5    Do you agree with the following statements ? Give reasons.
         i)        Micro Economics studies behaviour of individual economic unit.
         ii)       Micro Economics is known as income theory.

Q.6    Answer in details
         1)       Explain the features of Micro Economics.
         2)       Explain the scope and subject matter of Micro Economics.

Project :
1)       Visit vegetable market in your nearby area & collect the data regarding the changes in demand & supply of selected vegetable and study price fluctuation in them, over a period of month.

2)       Visit a farmer & collect information about his agricultural product on the basis of coast, investment, price & profit. Analyse the problems faced by him.

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ECONOMICS TEXT BOOK

Determinants of Aggregates

Demand Analysis

Producer's Behaviour

Elasticity of Demand

Introduction to Macro Economics