CHAPTER 1

INTRODUCTION TO
MICROECONOMICS

IDAYAZRA SURI
DEPARTMENT OF COMMERCE
POLITEKNIK NILAI
 CHAPTER 1 INTRODUCTION TO MICROECONOMICS

After studying this chapter, you should be able to:

DPB 10053 1.1 Elaborate microeconomic in general

MICROECONOMICS
1.1

1.2 Elaborate economic problems

1.2

1.3 Elaborate World economy system

1.3
1.1 Elaborate microeconomic
in general
 Definition of Economics “ 4

“Economics as a field of social science that studies the behavior

• A field of social science that studies the behavior of individuals and society in the distribution
and allocation of limited factors of production to maximize the production of goods and service
s to fulfill man’s unlimited wants and demand.

• A study of how people use their limited resources to fulfill unlimited want

• Adam Smith – the study of nation’s accumulation of wealth.

• Alfred Marshall, Lord Beveridge, Canna & Pigou -economics as a science of material welfare.
• Keynes – field of social science that studies the management of limited production resources,
determinants of national & efficiency
Economic Activity:
Science of wealth an activity that helps people make
economic gains
Economics as a Science of material welfare

Science of scarcity & choice

“It’s a recession when your neighbor loses his job; it’s a depression when you lose your own.”
― Harry S. Truman
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MICROECONOMICS MACROECONOMICS
❑ overall study of a country’s economic
➢ Studies of small economic units i.e:
activities and main economic sectors.
individuals & firm
❑ also known as the theory of income
➢ The focus of microeconomic studies or
determination
price theory is how economic
❑ Macroeconomic analysis focuses on the
agents such as individuals, household,
economy as a whole.
Field of firms and producers make economic
❑ Focus on a general price level, not on the p
decisions to achieve their respective
Economics goals
❑
rices of individual items.
Problems are focused on consumption and
➢ Also discusses how the prices of goods
investment as the main variables in the
and factors of production, wages, rents
theory of national income.
and interest rates are determined.
❑ Monetary studies involve studies on banks
and national financial institutions.

MICROECONOMICS MACROECONOMICS
Studies individual income Studies national income
Analyzes demand & supply of labour Analyzes total employment in the economy
Deal with households' & firms’ decision Deal with aggregate decision
BACK
Studies individual prices Studies overall price level
Analyzes demand & supply of goods Analyzes aggregate demand & aggregate supply
Economic Resources – Also known as factors of production (input) 6
• Resources are raw or man-made materials used in the production process of goods &
services (output) 2. Labour
• Physical and intellectual services
4 factors of production used to produce goods & services: • Labourers:
❖ may be skilled or unskilled
❖ are unique and have feeling
1. Land
❖ offer services but are not to be
• Naturally occurring resource
exploited
(free gift of nature)
❖ can be moved from one
• Supply of land inherently fixed on
location to another
location and geography
❖ differ in efficiency and
• Value of land is dependent on quality
productivity
and location
Payments of resources: Wages
Payments of resources: Rent

3. Capital 4. Entrepreneur
• Consists of assets such as money, • A person with the skills and ability
equipment, machinery and raw to organize production and bear
materials risks
• Capital can be moved from one • Manages a firm and functions as a
location to another, and can be leader, planner and coordinator of
increased or decreased the firms' activities

Payments of resources: Interest/dividend Payments of resources: Profit

 Types of Goods 7

Goods “Things which are tangible (clothes, food, drinks etc/ non tangible (air & sunshine)”
Tangible goods: used to satisfy society’s wants / to produce other goods

ECONOMIC GOODS (scarce goods):

FREE GOODS (non scarce goods)
01 a) Consumer/finished/final goods 02 • Naturally occurring goods. Unlimited
• Goods produced & used to satisfy society’s & available without any cost.
wants • Essential for life. eg:air & water
i. Durable goods (cars, television,
furniture)
ii. Perishable goods (vegetables, 03 PUBLIC GOODS
fruits & fresh produce) • Non-excludable & not subject to
b) Capital goods decision made by individuals
• Funded by government
Used by consumers to produce other eg:powerhouses
goods. Eg: printing machines to produce
PRIVATE GOODS
books & magazine. 04
c) Intermediate goods • Owned by households
• Cannot be used without
Not become finished goods & need permission from the owner
to be furthered processed eg: palm • eg: houses, cars, land etc
oil, steel, timber
 8

Types of Goods
Inferior goods Normal goods
i. Goods which demand decrease • Goods used by consumers in order to
when income increase beyond a make their lives comfortable. Eg: furniture,
05 certain level. 08 table etc
ii. Eg: public transport & second
hand cars.
Luxury goods
Giffen goods Goods which demand increases more
06 • Goods which demand increase with
the rise in price
09 than proportionally as income increase.
Eg: jewellery.
• Eg: low quality rice, frozen food

Necessity goods Merit goods

• Goods which essential to People can excluded from
07 consumers’ daily needs. Eg coffee,
10 consuming these goods.
tea. Eg: state education, public health
care.
1.2 Elaborate economic problems
THE CONCEPTS OF ECONOMIC PROBLEMS 3
 11
3 CONCEPTS OF ECONOMIC PROBLEMS
1. Problems of Scarcity 2.Problems of Choice 3.Problems of Opportunity Cost
Occur When there is scarcity
choice have to be made
“the cost of one choice in terms of the
• when goods and services are limited • Everyone cannot have what he or best forgone alternative”
compared to man’s unlimited wants & she wants, so they have to choose
desires. from the available alternatives. • If you cannot obtain what you need,
• due to limited supply of natural resou • Arise when we are faced with then you have to choose among the
rces, time, energy, finances & factors problems of scarcity alternatives.
of production. • Consumers need to make choices in • Arises from limited factors of
Individuals: have problems of scarcity order to maximize satisfaction, production.
of time for recreation, study and while producers need to make
entertainment as well as scarcity of choices in order to maximize profits Eg: individual may have 2 options:
money to pay for fees and to purchase • Unlimited demand is managed to purchase a shirt or a pair of shoes
according to priorities and rational if choose to purchase shoes the
food, drinks and clothes.
choices based on an individual’s opportunity cost is the shirt
Firms: scarcity of capital caused by (he/she is not able to purchase)
limited economic resources.eg: a firm current budget.
may not have sufficient capital to carry Opportunity Cost also defined as the cost
out international projects. of not selecting the “next best” alternative
Government: scarcity of financial
resources & revenue to build basic
amenities for society such as schools,
clinics &roads.
 12

3 BASIC ECONOMIC PROBLEMS

What and how much to

1 produced?

How is output produced?

2

For whom should the

3 product be produced?
Basic Economic Problems 13

1 What and how much to produced?

• To overcome this basic economic problem, a
producer must identify the quantity of demand in
the market.
❖ In a market economy, the interaction of self-interested
buyers and sellers determines the mix of goods and services • If there is a high demand for a particular good,
that are produced. the producer will increase production of the good. If
❖ There are insufficient available economic resources to fulfill there is a low demand, the producer must
man’s unlimited wants. decrease the production.
❖ The determination of the goods to be produced by a
country determines the pattern of allocation of available • Due to limited factors of production, excess
economic resources to the various economic activities production in wastage of factors of production.
❖ The pattern of allocation of economic resources is
determined to ensure that available economic resources are • Therefore, the government’s main aims to
efficiently used to produced goods and services to yield ensure sufficient production of goods and services.
maximum satisfaction to the economy as a whole.
❖ Due to limited factors of production, not all goods that a
society demands can be produced.
Basic Economic Problems 15

2 How is output produced?

• In a market economy, profit-maximizing producers will be

expected to select a mix of resources that result in the
lowest possible level of cost
• Production techniques are divided into labour-intensive
and capital-intensive techniques
• If the cost of labour is less than the cost of capital, the
producer selects the labour-intensive production method.
 Basic Economic Problems 16

3 For whom should the product be produced?

• This basic economic problems deals with the issue of who gets what?
• This is determined by the interaction of buyers and sellers in both output and resource markets.
• Producer produces a good for people who can afford the cost of the good.
• People with a lower income can afford fewer goods.
• To ensure that society as a whole can afford goods that are produced, government should introduce a
fair distribution system.

BACK
1.3 Elaborate World economy
system
 18

ECONOMIC SYSTEM

Capitalism (free market)/ Socialism/ central planned/

market economy/ command economy
free enterprise/ laissez-faire 1 2

3 4
Mixed economy Islamic Economy
 19

Capitalism/ free market economy/

laissez-faire
1
“An economic system where individuals and sellers make economic decisions using a
price system”. Individuals make all the decisions without any government
intervention

Characteristics

• Freedom of enterprise and choice- Individuals free to set up business and provide
the goods and services they want
• Consumers’ sovereignty - Consumers free to decide which goods and services to
purchase.
• Government intervention - Government intervention limited to the protection of
private property and provision of public goods.
• Price system - Price mechanism (free operation of Dd & Ss forces without any
intervention.
 Economic decisions in capitalism
20
What to produce
Capitalism/ free market / laissez-faire An entrepreneur will only produce goods
& services for which there is a demand
from consumers so as to enjoy higher
1 profits. Production depends on the goods
demanded by the consumer
Advantages/merits of Disadvantages/demerits of
capitalism capitalism How many to produce
Based on price mechanism which was
determined by consumers’ demand and
• Production according to the needs • inequality of distribution of wealth supply
of consumers and income
• economic freedom • inflation and high How to produce
• efficient utilization of resources unemployment rate Firms can produce any product or provide
• variety of consumer goods • lack of social welfare any service using more than one method.
• enhanced trade, business and • unnecessary variety & The method depends on the relative price
research and development wasteful competition of the Resources involved. As resources
• automatic incentives • misallocation of become scarce relative to demand, prices
• flexibility resources social costs will rise and discourage their usage.
Only the cheapest method of production &
the most efficient techniques will be
adopted in the production

For whom to produce

Answered through the price system
Goods and services are obtained by
anyone who can afford them
 Economic decisions in socialistic
What to produce 21
• planning authorities decide what to pro
Socialism/ command economy/ planned system duce
• collect detailed statistics on the
2 resource availability in the country &
• all the economic decisions are made by the government or a central authority link it with national priorities
• no private property rights since the government officially owns all resources
How many to produce
• no rights for public to determine
what product & the quantity that
Characteristics should be arise. Prefer to basic
public facilities
• Public ownership of resources- All resources owned & operated by
the state How to produce
• Central planning – CP responsible for making economic decisions • central planning authority decides
for society. Plans & allocate resources between current consumption on the techniques to be used in the
& investment for the future production of different goods &
• Price mechanism of lesser importance – Fixed by government & services whether used traditional or
not determined by Dd & Ss. modern technique
• Central control & ownership – Government controls production,
consumption & the distribution of goods & services. For whom to produce
• the distribution of various
commodities among citizens is done
through a set of administered fixed
processes. The purpose is to
reduce inequalities in the distribution
of income
 Economic decisions in socialistic
22

Socialism/ command economy/ planned system

2
Advantages Socialism
Disadvantages Socialism
• production according to • lack of incentives and
basic needs initiatively by individuals
• equal distribution of • loss of economic
income and wealth freedom and consumer
• better allocation of sovereignty
resources • absence of competition
• no serious unemployment or • waste of economic
recession / inflation resources
• rapid economic development
• social welfare
 23

Mixed economy
3
• 3
combination between capitalism and socialism
• both public and private sectors play a role in the economy

Characteristics

• public and private ownership of resources

• price mechanism and economic plans in making economic decisions
• government helps to control income disparity
• government intervention in the economy
• co-operation between the government, public & business sectors
 24
Economic decisions in
mixed economy
Mixed economy
3 What to produce
• decided by both the public & private se
3 ctors
• goods produced and the services
Advantages Mixed Economy
provided depend on the consideration
• More options/choice of social welfare and economic growth
(government produce public Disadvantages Mixed
good, private sector produce Economy
How many to produce
private goods) • Conflict of opinion
• public sectors provide goods and
• Quality of live is higher between private
services based on price mechanism
• Efficient resource allocation sector & government
• government will provide public
• Social welfare prioritized • Uneven distribution
facilities
• Prevention of control of of income
monopolies • Possibility of market How to produce
• Guaranteed economic stability & income disability • public and private sectors will
compared to free market (due to quota system) decide on the techniques of
mechanism production to be used
• Incentives to work
• Prohibitions of illegal activities For whom to produce
• the distribution of goods & services
is also decided by the public &
private sectors
 25

Islamic Economy
4
• 3 of social science that studies the unlimited desires of individuals to use available
Branch
resource to achieve happiness on earth & in the afterlife.
Advantages Islamic Economy
Characteristics Islamic Economics System • Priorities safety & happiness
• Eliminates economic activities
Resources ownership Allah absolute title and human merely acting as trustee to explore having elements of interest
source that was awarded. (riba)
Decision maker Individual and manufacturer based on principle and Islam principle. • Ensures social welfare
• Prohibits monopolies
Pricing consumer and manufacturer(market power) that based on • Distributes wealth & income
principle and Islam principle. fairly

Freedom of profit free profit as long as does not involve riba’.

Freedom of choice individual and independent private manufacturer making choice
as long as does not violate principle and Islam principle.

Production objective Profit turnover and social welfare emphasized according to BACK
principle and Islam principle
 TUTORIAL
• What are the differences between
microeconomics and
macroeconomics?
• Explain the four factors of
production.
• Discuss the differences between
the capitalism and socialism.
• Identify advantages and
disadvantages of mixed economy
and Islamic economy.
 TUTORIAL
CHARACTERISTICS CAPITALISM / CENTRALLY MIXED ECONOMIC ISLAMIC
FREE MARKET PLANNED ECONOMIC

1 OWNERSHIP OF Privately owned by ind Owned by the Partly owned by individuals & Allah is the sole
RESOURCES ividuals or the government private sector while partly owner. Man acts as
private sector owned by the government trustee to utilize
resources

2 DECISION MAKER

3 PRICE DETERMINATION

4 FREEDOM TO OBTAIN
PROFITS

5 FREEDOM OF CHOICE

6 PRODUCTION OBJECTIVE
END OF CHAPTER