Eco2301( MicroEconomics)

Introduction
 Definition of Economics
 Distinction between Micro and Macro Economics
 Scientific Method of economics
 Theoretical Foundation of Economics
 Positive and Normative Economics
 The concept of Equilibrium
 Static and Dynamic Economics
DEFINITIONS OF ECONOMICS
Economics, like other social science disciplines, has several definitions given by
different economic scholars. The modern definitions are in terms of scarcity and
choice. Examples, Mcconnell and Brue (1993) asserted that economics is
concerned with the efficient use or management of limited productive resources to
achieved maximum satisfaction of human material wants. Robbins defined
economics as “the social science which studies human behavior as a relationship
between ends and scarce means which have alternative uses”. The definition
emphasizes the following:
 Economics is a social science because it studies human behavior
 Ends or wants are unlimited. When one want is satisfied others crop up to
take its place.
 Resources are scarce, by scarce, it means limited in supply
 The Scarce means are capable of being put to alternative uses.
 Since wants are unlimited and the resources needed to satisfy these wants
are limited one has to choose among his wants.
 The issue of choice brings the issue of opportunity cost which is the cost in
terms of alternative forgone.

Robbins definition has widest acceptability compared to the other definitions of

economics but it is not free from criticisms. Some of the criticisms of the Robbin’s
definitions are:

 The definition neglects the problems of economic growth and stability which
are the cornerstones of present day economics
 Robbins’s definition possesses little practical usefulness as it fails to analyse
the causes of general unemployment of resources. Under employment of
resources is caused not by scarcity of resources but by their abundance. It is,
therefore, only in a fully employed economy that the problem of allocation

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 of resources among alternative uses arises. Thus the scarcity definition of
Robbins, applicable as it is to a fully employed economy, is unrealistic for
analyzing economic problems of the real world.
Despite these criticisms, Robbin’s scarcity definition is still the most widely
accepted definition of economics.
MICRO AND MACRO ECONOMICS
The field of economics is divided into two broad areas: Micro economics and
macro economics. Until 1930s there was little need to distinguish between the two
branches; economists concentrated their attention almost exclusively on what is
now known as micro economics. A new interest in macro economics arose after
1936, the year John Maynard Keynes published “the General Theory of
employment, interest and money”
What is Micro Economics?
Micro economics analyses the objectives and decisions of individual economic
units-consumers, firms and government agencies. For example, Micro economics
seeks to explain how the single firm determines the sale price for a particular
product, what amount of output will maximize its profits, and how it determines
the lowest cost combination of labour, materials, capital equipment and other
inputs needed to produce its output. It is also concerned with how the individual
consumer determines the distribution of his or her total spending among the many
products and services available so as to maximize utility. It also concerns with the
wage of a particular labour and the outputs of a particular industry. In general,
Micro economics is the study of single or small group of individual economic
units.
What is Macro Economics?
Macro economics deals with the study of relations between broad economic
aggregates. It studies the functioning of the economy as a whole, including how the
economy’s total out put of goods and services, the price level of goods and services
and the total employment of resources are determined and what cause these
magnitudes to fluctuate. Macroeconomics deals with the problems of
unemployment, economic fluctuation, inflation, deflation, international trade and
economic growth.
Limitation of macro Economics
1. Fallacy of composition – aggregate economic behavior is the sum total of
individual activities. But what is true of individual is not necessarily true of
the economy as a whole
2. To regard aggregates as homogenous – macroeconomics regards the
aggregates as homogenous without considering their internal composition
and structure.
3. Statistical and conceptual difficulties.
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 Distinction Between macro and Micro Economics
Micro economics can be distinguished from macro economics on the following
grounds:
1. Micro economics is the study of economic actions of individuals and small
group of individuals. It includes the study of a particular household,
particular firms, particular industry, particular commodities and particular
prices. While macroeconomics deals with aggregates of these quantities, not
with the individual incomes but with national income, not with individual
prices but with general price levels, not with individual output but with the
national output.
2. The objective of micro economics on the demand size is to maximize utility
whereas on the supply side is to maximize profits at the minimum cost. On
the other hand, the main objectives of macroeconomics are full employment,
price stability, economic growth and favourable balance of payments.
3. The basis of micro economics is the price mechanism which operates with
the help of demand and supply forces. These forces help to determine
equilibrium in the market. On the other hand, the bases of macroeconomics
are the national income, output employment and general price level which
are determined by aggregate demand and aggregate supply.
4. Micro economics is based on the partial equilibrium analysis which helps to
explain equilibrium conditions of an individual, a firm, an industry and a
factor. On the other hand, macroeconomics is based on the general
equilibrium analysis, which is equilibrium for the entire economy.
SCIENTIFIC METHOD OF ECONOMICS
Scientific method is a structured way of investigating and explaining
operation of the world by observation, experimentation, hypothesis, verification,
generalization, theories and laws.
Economic science or positive economics is the application of scientific
method to economic analysis. Some of these methods are:

Observation:- Science depends on accumulation of knowledge acquired through

systematic observation. Economics uses this method to gather economic
information.
Hypothesis:- A hypothesis is a reasonable proposition about the working of the
world that is inspired or implied by a theory and which may or may not be true. A
hypothesis must pass the real world data test to become a principle.
Data collection and classification:- To prove whether a hypothesis is true or not
one needs to collect data. Mass or unorganized data needs to be classified in order
to see patterns, similarities, changes etc.

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Verification or Testing:- To know if a hypothesis is right or wrong comparison is
made with data- empirical observation drawn from the real world. Example, people
increase their consumption whenever their incomes rise. Is it because they are now
richer or is it because of their habit? Both statements are hypotheses. The only way
to know the truth is through verification and testing to compare the hypotheses
with what actually happen.
Principles: Principles are generally accepted verified, fundamental of law of
nature. To be a fundamental law of nature, a principle must capture a cause-and-
effect relation about the working of the world.
Theory: The end result of the scientific method is the theory. A theory is a
scientifically accepted, interrelated body of general principles used to explain and
understand some aspect of the world. A theory offers an explanation for events. It
explains WHY things happen.
Economic is called a science because it applies the scientific methods
mentioned above in its analysis.
Limitations of Economics in the application of Scientific methods
 Economics deals with human behavior and human being some time acts
irrationally. This makes experiment difficult.
 Economics uses some assumptions which are sometimes unrealistic e.g. All
things being equal or ceteris paribus. All things cannot be equal.
 Exact quantitative prediction is not possible
POSITIVE AND NORMATIVE ECONOMICS
Positive economics refers to objective economic statements that explain that if
certain conditions hold, then certain things can be expected to happen. Normative
economics refers to economic statements that involve value judgments or
subjective conclusions let us consider some examples. What policies will reduce
unemployment? And what policies will prevent inflation? Are positive ones, while
the question ‘should we to be more concerned about unemployment than about
inflation?” is a normative one. The statement “A government deficit will reduce
unemployment and cause inflation is a positive hypothesis. The statement
“unemployment is worse evil than inflation is normative.
Most of the apparent disagreements among economists involve normative,
value-based policy questions. Most economic controversy reflects differing
opinions or value judgments as to what our society should be.
Disagreement may occur on positive issues, however, and these differences are
important in economics. In macroeconomics there always have been many schools
of thought, each with a somewhat different perspective on how the economy works
e.g Keynesian and classical economists.

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 THE CONCEPT OF EQUILIBRIUM
Equilibrium of a system is defined as a situation in which the forces
determining the state of the system are in balance so that there is no tendency for
the variables of the system to change. It is a state where there is complete
agreement of the economic plans of the various market participations so that no
one has a tendency to revise or alter this decision. A market, or an economy or any
other group of persons or firms is in equilibrium when none of its members feels
impelled to change his behavior.
Partial and general equilibrium
The concept of equilibrium can be broadly grouped into partial and general
equilibriums. Partial equilibrium is equilibrium determined within a specific
individual unit within a system for example consumer equilibrium, producer’s
equilibrium and so on. General equilibrium on the other hand is the equilibrium for
the entire system or economy.
STATIC AND DYNAMIC ECONOMICS
In Economics static means the study focused only on a particular period of time.
It is similar to taking a photo when you press the button for a shot then the photo is
just at particular point of time. For example, we say the market is in equilibrium
when demand and supply equate one another, which is graphically represented by
the intersection point of demand and supply curves. This is a static analysis since
we just only see the picture at a point of time. Does the equilibrium point remain
there for long? Is there any force that can push which makes the equilibrium to
move to a new position or disequilibrium? Or simply before arriving at the
equilibrium what is the path that demand and supply have to change? These
questions cannot be answered by static analysis.

Dynamic Economics focused on changes of time and how the equilibrium

changes with time. It is the same as watching the movie. You can see how the
image inimates and moves. Dynamic analysis allows us to see the path of
variables; how the variables change with time. It helps us to see whether the
equilibrium will be reached or not or whether the variables will converge to a point
which we called stable or steady state or they will diverge.
Differences between Static and Dynamic Analysis
The main differences between static and dynamic analysis are the following;
1. Time element: In static economic analysis time element has nothing to do.
All economic variables refer to the same point of time. Static economy is
also called a timeless economy. It is one where we do not worry about
dating. On the contrary, in dynamic economics, time element occupies an
important role.

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 2. Process of change: static analysis does not show the path of change. It only
tells us about the conditions of equilibrium. On the contrary, dynamic
economic analysis shows the path of change. Static economics is called a
“still picture” where as the dynamic economics is called a “movie”
3. Equilibrium: static economics studies only a particular point of equilibrium.
But dynamic economics studies the process by which equilibrium is
achieved. As a result, there may be equilibrium or may be disequilibrium.
Therefore, static analysis is a study of only equilibrium. Whereas dynamic
equilibrium analysis studies both equilibrium and disequilibrium.
4. Study of reality: Static analysis is far from reality while dynamic analysis is
nearer to reality. Static analysis is based on the unrealistic assumptions of
perfect competition, perfect knowledge, etc. Here all the important economic
variables like fashion, population, method of production, etc are assumed to
be constant. On the contrary dynamic analysis takes these economic
variables as changeable.