MICROECONOMICS

LECTURE 1:
INTRODUCTION

Economics Introduction
• The English term ‘Economics’ is derived from the
Greek word ‘Oikonomia’. Its meaning is
‘household management’. Economics was first
read in ancient Greece. Aristotle, the Greek
Philosopher termed Economics as a science of
‘household management’. But with the change of
time and progress of civilization, the economic
condition of man changes. As a result, an
evolutionary change in the definition of
Economics is noticed.
Economics Introduction
Towards the end of the eighteenth century Adam Smith, the
celebrated English Economist and the father of Economics,
termed Economics as the ‘Science of Wealth’. According to
him, “Economics is a science that enquires into the nature and
causes of the wealth of nations”. In other words, how wealth is
produced and how it is used, are the subject-matter of
economics.
(Ref: An Inquiry into the Nature and Causes of the Wealth
of Nations, generally referred to by its shortened title The
Wealth of Nations,. First published in 1776: Adam Smith was
a Scottish economist, philosopher and author as well as
a moral philosopher, a pioneer of political economy and a key
figure during the Scottish Enlightenment, also known as ''The
Father of Economics'‘ or ''The Father of Capitalism'‘. Smith
wrote two classic works, The Theory of Moral
Sentiments (1759) and An Inquiry into the Nature and Causes
of the Wealth of Nations (1776). )

Economics Introduction
In modern times more realistic definitions have been given
to economics. In social life human wants are unlimited,
but the means to satisfy those wants are scarce.
Economics studies how to use the limited resources to
satisfy the unlimited wants of men. In the words of Lionel
Robins, the modern economist, ‘Economics is a science
which studies human behavior as a relationship between
ends and scarce means which have alternatives uses’.
Lionel Robbins (1932): An Essay on the Nature and
Significance of Economic Science.
Economics Introduction
In the subsequent period Alfred Marshall defined
Economics by saying, ‘Economics is a study of
mankind in the ordinary business of life’. In other
words, according to Marshall, Economics studies
not only the wealth but also the activities
centering the wealth
(Alfred Marshall: Principles of Economics -1890)

Economics Introduction
• Economics as a social science studies how
people perform economic activities and how they
try to satisfy unlimited wants by the proper use of
limited resources. Economics is the study of how
societies use scarce resources to produce
valuable commodities and distribute them among
different people.
What is economics?
• Economics is a science which studies human
behavior as a relationship between ends and
scarce which have alternatives.
• The study of how scarce resources are or should
be allocated.
• Economics is a social science that analyzes the
production, consumption and distribution of
goods and services

Nature of Economics
Economics is a science: Science is an organized branch
of knowledge, that analyses cause and effect relationship
between economic agents. Further, economics helps in
integrating various sciences such as mathematics,
statistics, etc. to identify the relationship between price,
demand, supply and other economic factors.
• Positive Economics: A positive science is one that studies the
relationship between two variables but does not give any value
judgment, i.e. it states ‘what is’. It deals with the facts about the
entire economy.
• Normative Economics: As a normative science,
economics passes value judgment, i.e. ‘what ought to be’. It is
concerned with economic goals and policies to attain these goals.
Nature of economics
• Positive economics:
• Positive economics is concerned with what
actually happen or what would happen under
various conditions. That is what is going on.
• Atomic energy plant
• Road construction
• Building(savar) unplanned.
• Bridge

• Normative economics:
• Normative economics consider what would be the
best methods of economic organization from the
point of view of both equity and efficiency. That is
what should do.
Scope of Economics
• Micro Economics: The part of economics whose subject matter of study
is individual units, i.e. a consumer, a household, a firm, an industry, etc. It
analyses the way in which the decisions are taken by the economic agents,
concerning the allocation of the resources that are limited in nature.
• It studies consumer behavior, product pricing, firm’s behavior. Factor pricing,
etc.
• Macro Economics: It is that branch of economics which studies the entire
economy, instead of individual units, i.e. level of output, total investment, total
savings, total consumption, etc. Basically, it is the study of aggregates and
averages. It analyses the economic environment as a whole, wherein the
firms, consumers, households, and governments make decisions.
• It covers areas like national income, general price level, the balance of trade
and balance of payment, level of employment, level of savings and
investment.

Scope of Economics
• Microeconomics:
• It examines how production and consumption
are organized, what is produced and who benefits.

• Macroeconomics :
• It consider how aggregates such as output
employment and the general price level are
determine. Aggregate demand, aggregate supply,
growth rate, deflation, nominal income , real income,
national income GDP,GNP, unemployment, inflation.
Basic/ Central problems of every
Economy
Wants are Unlimited but Available Resources for fulfillment
of the wants is Limited. The Fundamental Problem of an
Economy is that all the decisions are constrained by the
Scarcity of available resources. An economy must decide
1) What to Produce?
2) How to Produce?
3) For whom to Produce? With the
available resources. These are the basic economic
Problems of an economy.

Basic Economic Problems

• What to produce
• How to produce
• For whom to produce

What to produce :
This implies that society has to decide which goods and in
what quantities are to be produced.
We can show the upper situation in a diagram
which is called production possibility curve.

• Production possibility curve shows the various

combinations of two goods which the economy can
produce with a amount of resources.
• Fundamental goods, machinery product, atom bomb,
school, hospital etc…..
How to produce :
• This means what combination of resources society
decides to produce goods.
• A combination of resources or factories implies a
technique of production.

• Labor intensive technique

• Capital intensive technique

• For whom to produced:

For whom to produce implies how the national product is
to be distributed among the members of the society.
What is demand?
• The demand for a commodity is the amount of it
that a consumer will purchase or will be ready to
take off from the market at various given
prices at a given amount of time.
• The quantity of a good or service that is
purchased by a consumer or the consumer wills
to purchase at a certain price is demand.
Demand function
The demand of a good depends upon various things,
these things are called factor influencing demand or
determinants of demand. Quantity of demand,

q d
 f ( p x , P 1 , p 2 , Y , T , N )

Law of Demand

Other things remaining constant the higher the price ,

the lower the quantity demand is and vice-versa

P↑ Q↓
P↓ Q ↑
 Law of Demand

The Law of Demand Expresses the Functional

relationship between Price and Quantity Demanded.
According to this law: When Other things remain
constant, If the Price of a commodity falls, the quantity
demanded of it will rise and if the price of the commodity
rises, its quantity demanded will decline.

Demand Schedule
Demand schedule is a list of prices and corresponding
quantities. Point Price Quantity
A 1 20
B 2 16
C 3 12
D 4 8
E 5 4
 Extension and Contraction in Demand

Increase and Decrease Demand

Increase in demand occurs due to the following
reasons :
•The fashion for a good increases or people’s taste and
preferences become more favorite for the food
•Consumer’s income increases
•Prices of substitutes of the good have risen
•Prices of complementary goods have fallen
•Propensity to consume of the
people has increased
•Owing to the increase in population and
as a result of expansion in
market the number of
consumers of the good has increased
• Determinants of demand:-
Fashion (taste and preferences)
Consumer income
Prices of substitutes goods have risen
Prices of complementary goods have fallen
Propensity to consume of the people has increased
Population expand

THE DEMAND FUNCTION (EQUATION)

• An equation that lets you know how a variable like demand is determined
is called a linear function, if it produces a straight line when it is
graphed. The demand function takes the form Qd= a – bP, and this
states how the price (P) of a good or service determines the quantity
demanded (Qd). Some basics:Qd = quantity demanded
• a = the quantity demanded when the price = 0 (because b x 0 = 0)
• P = price
• b = Tells us how steep the demand curve will be. It is the coefficient that
determines the slope of the demand curve (from steep to flat), and
measures how responsive the change in quantity demanded is to
changes in the price. Sometimes a small price change can produce a
large change in quantity demanded because, perhaps, there are a large
number of substitute goods the consumer can switch to. Sometimes a
large price change will only result in a small change in Qd because,
perhaps, the good is a necessity such as petrol. b is always negative
because, as we have seen, there is an inverse relationship between price
and the quantity demanded – the law of demand (i.e., as P increases, Qd
decreases, and as P decreases, Qd increases)
 What is market demand?
Market demand consists of several individuals. That is
market demand function is obtained by summing up the
demand function of the individuals constituting the market.

Q A
 40  2 p

Q B
 25.5  0.75 p

Q C
 30  .25 p
then,
Q D
 Q Q Q
A B C

Here
Q =demand of individual A
A

Q =demand of individual B
B

Q =demand of individual C
C

Q =market
D

demand
SUPPLY
Supply is a fundamental economic concept
that describes the total amount of a specific
good or service that is available to
consumers. The quantity supplied is the
number of units that sellers want to sell over
a specific period of time.

Law of Supply
There is direct relationship between the price of a
commodity and its quantity offered fore sale over a
specified period of time. When the price of a goods
rises, other things remaining the same, its quantity
which is offered for sale increases as and price
falls, the amount available for sale decreases. This
relationship between price and the quantities
which suppliers are prepared to offer for sale is
called the law of supply.
Supply Function

• The amount of a goods or service offered for sale . The

supply function relates supply to the factors which
determine its level.
• Supply depends upon various things which is called factor
influencing supply. This things are called Determinants of
Supply
.

Qs  f ( p , p , p ,T ,T ,T
1 2 3
, E ,W )
x 1 2

p  Own price
x

p , p  Prices of other things

1 2

T  Technology
1

T  Tax and subsidy

2

T  Time duration
3

E Input price
W Weather
 Supply schedule and supply curve
Point price supply
A 1 6
B 2 9
C 3 12
D 4 15
E 5 18

Supply
Technically, supply refers to the quantity of a commodity
that a firm is willing and able to supply at a given period of
time, at a given price. Observe that this definition has four
essential dimensions-
quantity of a commodity,
willingness to sell,
price of commodity and
period of time.
Law of Supply
There is direct relationship between the price of a
commodity and its quantity offered fore sale over a
specified period of time. When the price of a goods
rises, other things remaining the same, its quantity
which is offered for sale increases as and price
falls, the amount available for sale decreases. This
positive relationship between price and the
quantities which suppliers are prepared to offer for
sale is called the law of supply.

Law of Supply
Supply curve
Shifting of supply curve
The factors other than price affect the supply curve in a
different manner. These factors cause the supply curve to
shift. Of course, this shift is also categorized into two
which are- a leftward and rightward shift.
Note that, this shift occurs because the price is constant
when studying the effect of other factors on supply. A
rightward shift indicates a positive effect on the curve
whereas a leftward shift indicates a negative effect on the
supply curve. We have already studied the various factors
other than price and their relationship with the supply of a
commodity. The factors can either have a direct or an
inverse relationship with the quantity of commodity
supplied.

Shifting of supply curve

Movement along the Supply Curve
When the price of a commodity changes, other factors kept
constant, the quantity supplied of a commodity changes
suitably. This is because of the direct relationship between the
two. This is known as a change in quantity supplied.
Graphically it causes movement along the supply curve. A
change in price either causes supply curves to expand or
contract.
If the prices increase, other factors kept constant, there is an
increase in the quantity supplied which is referred to as an
expansion in supply. Graphically, this is represented as an
upward movement along the same supply curve.
Conversely, if the prices decrease, keeping other factors
constant, firms tend to decrease the supply. This is referred to
as a contraction in supply. Graphically, this is represented as a
downward movement along the same supply curve.

Movement along the Supply Curve

Market Equilibrium
• Definition: Market equilibrium is an economic state when
the demand and supply curves intersect and suppliers
produce the exact amount of goods and services
consumers are willing and able to consume.
This is the point where quantity demanded and quantity
supplied is equal at a given time and price. There is no
surplus or shortage in this situation and the market would
be considered stable. In other words, consumers are
willing and able to purchase all of the products that
suppliers are willing and able to produce. Everyone wins.

Market Equilibrium
When the supply and demand curves intersect,
the market is in equilibrium. This is where the
quantity demanded and quantity supplied are
equal. The corresponding price is the equilibrium
price or market-clearing price, the quantity is the
equilibrium quantity.
Market Equilibrium: Graph

Market Equilibrium
• Putting the supply and demand curves from the
previous sections together. These two curves will
intersect at Price = $6, and Quantity = 20. In this
market, the equilibrium price is $6 per unit, and
equilibrium quantity is 20 units.
• At this price level, market is in equilibrium.
Quantity supplied is equal to quantity demanded (
Qs = Qd).
• Market is clear.
Market equilibrium

Market equilibrium is a situation in which two opposition

forces (like demand and supply) are in balance.
Demand Function

Q d
 a- bp

Supply
Q s
- c+dp

Function
Q d
 Q s
 a – bp = -c +dp
or , dp+bp=a+c
or ,p(b+d)=a+c
then , p=a+c/b+d
again ,
we know ,
Q s
 -c+dp
= -c+d (a+c)/(b+d)
= (-bc-dc+ad+dc)/(b+d)
=(ad-bc)/(b+d)
Q = ad-bc/ b+d

How is equilibrium established?

How is equilibrium established?

At a price higher than equilibrium, demand will be less than

1000, but supply will be more than 1000 and there will be
an excess of supply in the short run.
Graphically, we say that demand contracts inwards along
the curve and supply extends outwards along the curve.
Both of these changes are called movements along the
demand or supply curve in response to a price change.

How is equilibrium established?

Demand contracts because at the higher price, the income
effect and substitution effect combine to discourage demand, and demand
extends at lower prices because the income and substitution effect combine
to encourage demand.
In terms of supply, higher prices encourage supply, given the supplier’s
expectation of higher revenue and profits, and hence higher prices reduce the
opportunity cost of supplying more. Lower prices discourage supply because
of the increased opportunity cost of supplying more. The opportunity cost of
supply relates to the possible alternative of the factors of production. In the
case of a college canteen which supplies cola, other drinks or other products
become more or less attractive to supply whenever the price of cola changes.
Changes in demand and supply in response to changes in price are referred
to as the signaling and incentive effects of price changes.
If the market is working effectively, with information passing quickly between
buyer and seller (in this case, between students and a college canteen), the
market will quickly readjust, and the excess demand and supply will be
eliminated.
In the case of excess supply, sellers will be left holding excess stocks, and
price will adjust downwards and supply will be reduced. In the case of excess
demand, sellers will quickly run down their stocks, which will trigger a rise in
price and increased supply. The more efficiently the market works, the quicker
it will readjust to create a stable equilibrium price.
Market Equilibrium
• Simultaneous Changes in Demand and Supply
• There are times when both demand and supply change at the
same time. For example, during a war, shortage of goods
decreases supply, while high employment levels and
total wage payments increase the demand too. The following
figure shows various scenarios of the effect of simultaneous
changes in demand and supply on the equilibrium price.
Market Equilibrium
• Market Equilibrium

Market Equilibrium
• In the figure above, DD is the original demand curve and SS is the supply curve. The point
E, where both these curves meet refers to OP – the equilibrium price and OQ – the
quantity bought and sold.
• Refer to Fig. 1 (a)
• Fig. 1 (a) shows a scenario where the increase in demand is equal to the increase in
supply. Therefore, the new demand curve, D1D1, and the new supply curve, S1S1, meet
at the new equilibrium point E1. Also, the new equilibrium price is equal to the old
equilibrium price = OP.
• Refer to Fig. 1 (b)
• Fig. 1 (b) shows a scenario where the increase in demand is more than the increase in
supply. Therefore, the new demand curve, D1D1, and the new supply curve, S1S1, meet
at the new equilibrium point E1. However, in this case, the new equilibrium price, OP1, is
higher than the old equilibrium price, OP.
Market Equilibrium
• On the other hand, if there is a fall in the demand and supply
and the fall in demand is more than the fall in supply, then the
new equilibrium price will become lower than the old
equilibrium price.
• Refer to Fig. 1 (c)
• Fig. 1 (c) shows a scenario where the increase in supply is
more than the increase in demand. Therefore, the new demand
curve, D1D1, and the new supply curve, S1S1, meet at the
new equilibrium point E1. However, the new equilibrium price,
OP1, is less than the original equilibrium price, OP.
• Conversely, if there is a fall in the demand and supply and the
fall in supply is more than the fall in demand, then the new
equilibrium price will become higher than the old equilibrium
price.

Market Equilibrium
• Solved Question on Simultaneous Changes in Demand and
Supply
• Q: Assume that in the market for good Z there is a simultaneous
increase in demand and the quantity supplied. Also, the increase in
demand is more than the increase in supply. The result will be :
• The new equilibrium price higher than the original equilibrium price.
• The new equilibrium price lower than the original equilibrium price.
• The original and new equilibrium price equal.
• No effect on the equilibrium price.
• Answer: In case of simultaneous changes in demand and supply, if
the increase in demand is more than the increase in supply, then as
we have seen in Fig. 1(b) above, the new equilibrium price becomes
higher than the original equilibrium price.
•
why is price on vertical axis and quantity on the horizontal axis?
Changes in Market Equilibrium
• If there is any change in supply, demand or both the
market equilibrium would change.
• Shift in Demand:
• The demand for a product changes due to an alteration in
any of the following factors:
• Price of complementary goods
• Price of substitute goods
• Income
• Tastes and preferences
• An expectation of change in the price in future
• Population

Changes in Market Equilibrium

Shift in Supply
The supply of product changes due to an alteration in any
of the following factors:
• Prices of factors of production(land, labor, capital and
organization)(rent, wage, interest, profit)
• Prices of other goods
• State of technology
• Taxation policy
• An expectation of change in price in future
• Goals of the firm
• Number of firms
Changes in Market Equilibrium

Increase in demand results in a right ward shift in

demand curve, to a new equilibrium point ( the
intersection point of demand and new supply curve.)

With the increase in demand, demand curve shifts

rightward.
• The new equilibrium point is E1
• It would result in rise in prices and increase in
quantity demanded.

Changes in Market Equilibrium

Increase in Supply results in a right ward shift in supply curve, leading to a new
equilibrium point( the intersection point of demand and new supply curve.)

• With the increase in supply, supply curve shifts rightward.

• · The new equilibrium point is E1
• · It would result in fall in prices and increase in quanity demanded.
Changes in Market Equilibrium

Simultaneous Increase in demand and supply results in a right ward shift in

demand curve and supply curve, leading to a new equilibrium point( the
intersection point of demand and new supply curve). The changes in both
demand and supply is a real market situation, The supply and demand curve
changes as a result of change in market conditions.

With the simultaneous increase in demand and supply, demand and

supply curves shift rightward.
· The new equilibrium point is E1
· Here, It would result in rise in price P1 and increase in quantity
demanded Q1.