1.

0 FOUNDATIONS OF MICROECONOMICS
Microeconomics is a branch of economics that studies
the behavior of individuals and small impacting
household and firms in decisions regarding allocation
of scarce resources. It examines how the decisions and
behavior affects the supply and demand for goods and
services, which determines prices, quantity demanded
and

quantity

supplied.

The

fundamentals

of

microeconomics lie in the analysis of preference

relations.
Some basic concepts
Definition 1.01: Preferences relations are a set of
different choices that individuals or firms can choose
from between any two or more bundles of choices.
This choice making quality of individuals, households
and firms is based on the concept of rationality.
Definition 1.02: Rationality in economics is based on
the fact that individuals, households and firms will

always make prudent decisions. Under the rational

choice theory individuals will always act by balancing
cost against the benefits derived from purchasing or
undertaking an activity in such a way to maximize
their gains.
Definition: 1.03: Theory of supply and demand: This
assumes that markets are perfectly competitive i.e. a
situation where there are a.) Many buyers and many
sellers b.) Firms and individuals are price takers c.)
There is free entry and free exit into the markets.
However the theory works well in situations that meet
these above assumptions. In real life situations the
assumptions fail because some individuals and firms
are capable for instance to influence price and in
certain conditions influence entry of new firms into the
market.

One major advantage of perfect competitive markets is

the optimality of resource allocation.
Definition 1.0.4: Demand, Supply and Equilibrium: The
law of supply and demand states that in a competitive
market, the unit prices of a particular good will vary
until it settles at a point where the quantity demanded
by consumers will be equal to the quantity supplied
resulting

in economic

equilibrium

for price

and

quantity.
Definition: 1.0.5: Elasticity: This is the degree of
response of one economic variable to another.
Some types of elasticities in economics are a.) Price
elasticity of demand b.) price elasticity of supply c.)
Income

elasticity

of

demand

d.)

elasticity

of

substitution
Definition: 1.0.6: Consumer demand theory: This
relates preferences for the consumption of both goods

and services to individual consumption expenditures.

This

relationship

between

preferences

and

consumption expenditures is used to relate to the

consumer
consumer

demand
may

curve.
achieve

It

analyses

equilibrium

how

the

between

preferences and expenditure by maximizing their

utility subject to budget constraints.
Definition: 1.0.7: Theory of Production: This is the
study of the economic process of converting inputs
into outputs. Therefore production uses resources to
create goods or service that is suitable for exchange in
a market economy.
Production is measured as the rate of output over a
period of time. Since production itself is a flow
concept. i.e. a concept that occur over time and space.
Producers are basically saddled with three major
challenges

a.)

What to produce? [The form of the goods and

services to be created]
b.)
For whom to produce [Identify the target
market or set of customers that will purchase the
goods]
c.)
How to produce? [ The challenges of setting up
the production facility]
Factors

of

Production:

The

known

factor

of

production include a.) Land b.) Labour c.) Capital

Fixed factor of production: This is one whose
quantity cannot readily be changed e.g. a piece of
equipment,

land,

factory

space,

management

personnel. A variable factor of production is one

whose quantity and usage can be easily changed
e.g. electricity power consumption, transportation,
services, raw materials.

The Short Run: This is defined in production as a

period in which at least one of the factors of
production is fixed.
The long-run is defined in production as the period
in

which

all

factors

of

can

be

adjusted

by

management.
a.) Total product: The total products of a variable
factor of production are the outputs possible using
various levels of variable inputs.
b.) The average product is the total product divided
by the number of inputs
c.) The marginal product of a variable input is the
change in total output due to one unit change in
the variable input or the change in total output
due to an infinitesimally small change in input.
The production function is usually represented using
isoquants.
2.0

WHAT IS MICROECONOMICS

Definition

2.0.1:

It

is

the

study

of

individuals,

households and firms behavior in decision making and

allocation of scarce resources. It generally applies to
markets, goods and services and deals with individuals
and economic issues.
It can also be defined as the study that deals with what
choices people make, what factors influence these
choices and how their decisions affect the goods
market through price, supply and demand.
3.0
DECISION-MAKING UNITS
Individuals, households and firms are often regarded
as the decision making units in macroeconomics. The
study of individuals, households and firms allows us to
understand the decision making process of firms,
households and individuals.
Definition3.0.1 Individuals: These are people living in a
society that have the capability to determine their
consumption choices and efficiently allocate their
resources to satisfy their needs.

Definition 3.0.2: Households: These are made of group

of individuals living within family unit that have the
capability

of

collectively

determining

their

consumption choices and efficiently allocating their

resources to meet their collective household needs.
Definition 3.0.3: Firms are economic agents carrying
out productive activities within a society.
4.0

MICROECONOMICS

AND

MACROECONOMICS
Definition4.0.1

We

have

earlier

defined

Microeconomics as the study of individual households

and firms behavior in decision making and allocation
of scare resources. It studies a unit rather than the
whole.
Macroeconomics is derived from a Greek word that
means large uakpo. It studies the behavior of the
economy as a whole. Therefore it deals with total or

big aggregates such as National income, employment,

total consumption, and aggregate savings.
Why is microeconomics important
a.)
It helps to understand the fundamentals
of the free market economy, since it tells us how
prices of products and factors of production are
determined.
services

It

are

also

produced

various people.
b.)
It also
efficiency

describes

and

and

explains

optimality.

how

goods

distributed
the
Since

among

conditions
it

and

for

describes

economic practices that are likely to lead to

optimality and efficient allocation of resources.
Some uses of macro economics
a.)
It helps us to understand the relationship
between income and employment. Shedding light
on the forces

responsible for the level of

aggregate employment and output in an economy

b.)
It explains the determinant of output
prices

c.)

It explains the concept of economic

growth. It formulates the policy of

d.)
Business cycles: It helps us to understand
causes of fluctuations in national income and how
to formulate policies to control business cycles
e.g. through the control of inflation and deflation
e.)
It explains the concept of international
5.0

trade etc.
USES

AND

LIMITATIONS

OF

MICROECONOMICS
Uses of microeconomics
a.)
It allows for the study of individual
human, households and firms behavior.
b.)
It studies smaller units leading to a
better

understanding

to

what

with

happen

at

aggregate level.
c.)
It explains how individuals allocate their
scarce resources in an efficient manner.
d.)
It explains the concepts of free markets
and gives good understanding of the market system.
The study of micro-economics despite its advantages
has several limitations some include the

a.)

It studies a part rather than the whole of

the economy
b.)
There are also some limitations of the
assumptions of free market economy.
6.0

ECONOMY SYSTEMS

An economy system is a system of production and

exchange of goods and services as well as the
allocation of resources in a society.
It includes the combination of various institutions,
agencies entities and consumers that comprise the
economic structure of the society.
Economic systems can be distinguished along two
lines
a.)
How economic activity is co-ordinated
b.)
According to the ownership of the means of
production
How economic activity is coordinated by the market
depends largely on how the society decides on the extent
of decentralization of decisions that is made by
businesses, individual and consumers that want. And to

what extent they want decisions centralized so that

business and consumers act more in national interest.
Who owns the means of production also shapes the kind
of economic system in practice. Are they state or publicly
owned or are they owned by individuals.
Types of economy systems
a.)

Capitalist Economy Systems: This is an

economic system where the means of production is

owned by private individuals and a market economy
is employed for the coordination of business
activities. Production in this instance is geared
towards private profits rather than public needs.
b.)
Socialist Economy Systems: This is an economic
system in which the means of production is owned
by the public or state. Here production is geared
towards satisfying public needs rather than profits.
c.) Mixed Economy Systems: This is an economic
system that combines the feature of both the

capitalist and socialist economic systems. This

means that the means of production are partly
owned by the state and private individuals. It is
characterized by substantial state intervention and a
sizeable public sector along with a dominant private
sector.