Lecture # 01 Principles of Microeconomics

Introduction to Principles of Microeconomics

Recommended Books Text Book Reference Books Dr. Muhammad Hussain Chuadhry “Economic Theory” Volume.1 Reference Books Ferguson & Gould’s “Microeconomic Theory” 6th Edition Robert S. Pindyck and Daniel L.Rubinfeld “Microeconomics” (Latest Edition) Habib Ullah Vaseer “Fundamentals of Economics” Part -1

Topics covered in Lecture # 01 What is Economic Theory Two types of Economic Generalizations Classification of Economic Theory Microeconomics versus Macroeconomics Basic Problems of Microeconomic Theory Limitations of Microeconomics

What Is Economic Theory Economic theory consists of well recognized and widely acceptable explanations regarding the economic conditions and behavior of economic units in the real world. For example: Theories regarding the behavior of consumers and firms The theories regarding the determination and fluctuations of income and employment in an economy

What Is Economic Theory (Continued) Economic theory is initiated from a hypothesis which is an untested explanation of the mutual relationship existing among some key variables. For example: There is a positive correlation between the availability of hours for work and the productivity of employees.

What Is Economic Theory (Continued) A hypothesis assumes the status of a theory if: It is capable of logically explaining certain phenomenon and with its help, certain predictions can be made and those predictions prove to be true during recurrent testing.

What Is Economic Theory (Continued) An economic theory attains the status of an Economic law or a principle if it is established through repeated testing and when the explanation provided by it is universally recognized to be true. For example, the principle “under perfectly competitive conditions, price tends to be equal to the average cost in the long-run”.

Economic generalizations There are two types: 1. Analytical or Deductive Generalizations: State those conclusions which are logically deduced from certain assumptions. For example: Quantity demanded varies inversely with price.

Economic generalizations (Continued) 2. Empirical or Inductive Generalizations: The statements of relations observed to hold between real world economic data. For example: Price declines lead to increases in consumption. Empirical generalization is valid only in particular instances and it may not prove to be true in general.

Classification of Economic Theory Economic theory can be classified into Positive economics and Normative economics. 1. Positive Economics: The economics that analyses the actual functioning of the economy. For example: Unemployment is rising in Pakistan.

Classification of Economic Theory (Continued) 2. Normative Economics: Deals with “what ought to be” or “what should be”. Economists suggest policies and make recommendations for economy based on personal and subjective judgments. For example: The government should increase the minimum wage to reduce poverty.

Microeconomics The area of economics which studies the behavior and activities of various small economic units of the economy. Microeconomics deals with three fields: Theory of production Theory of price Theory of distribution

Macroeconomics The area of the economic theory which studies and theorizes about the economy as a whole. Also known as National Income theory or Employment theory or Aggregative Economics. Economists while studying macroeconomics divide the whole economy into four sectors: Household sector Business sector Government sector Foreign sector

Basic Problems of Microeconomic Theory The function of allocation of resources is concerned with the microeconomics. Economic system has to make efforts to solve four basic problems which are: Determination of Output Composition or determination of what to produce Allocation of Resources and Organization of Production Distribution of the product Maintenance and Expansion of the Productive Capacity of the Economy

Determination of Output Composition Every economic system has to decide what goods and services to produce and in what quantities to produce them.

Determination of Output Composition (Continued) The demand for goods and services by the consumers determines the composition of output. The consumers while spending their incomes help in determining the relative prices of goods and services.

Allocation of Resources and Organization of Production This involves two things: Withdrawing resources from industries whose goods are valued less by the consumers and moving them towards industries where goods are valued more by the consumers. Deciding about techniques of production or deciding in what combinations resources be used.

Distribution of the Product Output or product distribution among different individuals of the society depends on the personal income distribution. The income available to an individual is dependent on the following two factors: The amount of factor resources owned by the individual. The factor prices received by these resources The factor or resource prices are determined in the market through forcers of demand and supply.

Maintenance and Expansion of the Productive capacity of the Economy Maintenance of the productive capacity is mainly possible through replacement of the depreciated capital goods. Expansion of the productive capacity is possible through continuously increasing the quantities of the productive resources of the economy.

Limitations of Microeconomics Microeconomics is subject to the following limitations: Unrealistic assumption of full employment and given general price level Failure to reflect broad picture of the Economy Abstraction of Reality Based on simplifying assumptions Unfinished business