Microeconomics is a branch of economics that studies the behavior of individuals and small impacting organizations in making decisions on the allocation of limited resources www.unitedworld.edu.in

1. INTRODUCTION TO
MICROECONOMICS

2. WHAT IS MICROECONOMICS?
•Economics deals with human activities
•Behavior of individual units
•When Consuming
•How we choose what to buy
•When Producing
•How we choose what to produce
•Markets
•The interaction of consumers and producers
•Economics deals with the present as well as future
expectations
•Individual units are motivated by self-interest
•The same individual may be a consumer, producer and an
employee of different products

3. DIFFERENT FROM
MACROECONOMICS
•Microeconomics: deals with individual economic units;
•Variables: markets, prices, quantities consumed and
produced
•Macroeconomics: deals with aggregate economy
•Variables: Economic growth, inflation, unemployment
Microeconomics is the foundation for macroeconomics

4. SCOPE OF MICROECONOMICS
•Products and resources may not always be economic
•Marriage
•Crime
•Addiction
•Environment
Decisions by individuals result in social
outcomes

5. Allocation of Scarce Resources• Consumers allocate given income across goods and services
• Firms allocate funds across labor, capital and raw materials as
well as products
• Workers allocate time between leisure and work
• Prices & Opportunity costs
Rolling Stones: “You can’t always get what you want” (1969)

6. ALLOCATION OF SCARCE
RESOURCES
•Planned economy – resources allocated by the government
•Market economy – resources allocated by individual economic
units

7. TRADE-OFF
•Consumers – to allocate income among various items of
consumption
•Workers – to allocate time between work and leisure
•Firms – to allocate resources between products or process of
production

8. OPPORTUNITY COST
•The income that one gives up by not choosing the second best
option; derivative of trade-off
•Example: Choosing to join a MBA course instead of joining a
call center after college.
•What is the trade-off?
•What is the opportunity cost of not joining a call center?
There ain’t such thing as free lunch: Milton Friedman
(1975)

9. WHY SHOULD A FIRM STUDY
MICROECONOMICS?
•Understand consumer preferences and trade-offs
•Predict demand for products and responsiveness of demand to
prices
•Understand the competitiveness of the market
•Estimate costs of production, cost declines and economies of
scale
•Scale of production required to break-even and maximize
profits
•Design a pricing, investment and employment strategy
•What are the uncertainties in the market and expectations?
•What is the effect of government policy?

10. MICROECONOMICS IN CORPORATE
DECISION MAKING
•Tata Motors, which was a commercial vehicle
manufacturer, launched the Tata Indica in the
1990s, positioned as a competitor of midsize cars
sold by Maruti and Hyundai.
•It was followed by Tata Sumo, a SUV, where
competitors were Mahindra & Mahindra and
later Toyota Innova.
•Next, Indigo and Indigo Marina were launched
in the sedan segment.
•In 2009, the Tata Nano, the cheapest car in the
world was launched.

11. DECISION-MAKING PROCESS
•Consumer demand:
•How would customers react to the product designs,
performance of the new products?
•How strong would the initial demand be and how fast
would it grow?
•How would demand respond to price changes?

12. DECISION-MAKING PROCESS
(CONTD.)
•Technology decisions
•Allocation of resources between labor, machines, etc
•Scale of production

13. DECISION-MAKING PROCESS
(CONTD.)
•Cost decisions
•What is the production cost?
•How would cost depend on the scale of production?
•How would wages, prices of steel and other raw materials
affect costs?
•How much and how fast could costs decline as the
production process gained expertise?

14. DECISION-MAKING PROCESS
(CONTD.)
•Pricing decisions:
•Should Tata Motors charge a lower price for the no-frills
Tata Nano than competing products and high prices for
leather seats in the sedans or make these options
standard for all cars and charge higher prices for all
models?
•What would be the competitor reaction? Would they cut
prices?

15. DECISION-MAKING PROCESS
(CONTD.)
•Risk analysis
•Uncertainty over future price of petroleum
•Uncertainty over wages
•Political uncertainty
•Public policy

16. WHY IS MICROECONOMICS
IMPORTANT FOR GOVERNMENT
POLICY?
• Effect of personal income tax on consumer
spending
•Effect of corporate income tax on company profits
•Effect of government spending on infrastructure on
firm revenues
•Effect of trade policies on firm competitiveness
•Effect of industrial policies on firm competitiveness
•Effect of other policies on demand and supply, e.g.
effect of emission standards on demand for new cars

17. THEMES OF
MICROECONOMICS
•Prices – trade-off depends on prices; prices depend on demand
and supply
•Markets – collection of buyers & sellers that interact to
determine prices
•Industry – collection of firms that sell the same or closely
related products. Market includes more than one industry
•Equilibrium – condition of stability when there is no tendency
to change

18. WHAT IS A MARKET?
Market Definition
Which buyers and sellers should be included in a given market
Market Extent
Defines the boundaries of the market
Geographic
Range of products

19. EXAMPLES OF MARKETS
Geographic boundaries
Fish: Sunderbans vs Delhi
Housing: Mumbai vs a Kolkata neighborhood
Range of Products
Fuel: regular, super, & diesel
Cameras: SLR’s, point & shoot, digital
Markets for Prescription Drugs
Well-defined markets - therapeutic drugs
Ambiguous markets - painkillers

20. EQUILIBRIUM
•Condition which is stable and
has no tendency to change
•Consumer – utility maximized subject to
budget constraint
•Firm – Profit maximized subject to minimum
costs and maximum revenue

21. MICROECONOMICS AND
PRICES
The role of prices in a market economy
How prices are determined
Competitive markets
Because of the large number of buyers and sellers, no
individual buyer or seller can influence the price.
Example: Most agricultural markets
Non-competitive markets
Markets where individual producers can influence the price.
Example: OPEC

22. NORMATIVE ANALYSIS
Positive Analysis
Positive analysis is the use of theories and models to predict
the impact of a choice.
For example:
What will be the impact of an import quota on foreign cars?
What will be the impact of an increase in the gasoline
excise tax?
Normative Analysis
Normative analysis addresses issues from the perspective of
“What ought to be?”
For example:
Consider the equity and efficiency trade-off of an increase
in the gasoline excise tax versus import restriction on
foreign oil.

23. THEORIES AND MODELS
•Qualitative versus quantitative
•Quantitative analysis of economic variables
• Complex relationship between economic units
•Study of individual economic units and aggregate
economy
•Theories and models used to study situations in
comparison to equilibrium conditions

24. MICROECONOMIC THEORIES
& MODELS
Theories are used to explain observed phenomena in
terms of a set of basic rules and assumptions.
For example
The Theory of the Firm
The Theory of Consumer Behavior
Effect on government policies on economic units
Models are mathematical representations of theories
used to make predictions
Validating a Theory
The validity of a theory is determined by the quality of its
prediction, given the assumptions.

25. SIMPLIFYING ASSUMPTIONS
•All scientists build models based on assumptions, so do
economists
•This allows the model to focus on the most important
explanations for a particular phenomenon
•No economic model is literally true
•Some assumptions are easy to criticize
•The test of a model is its usefulness

26. WHY ECONOMISTS DISAGREE
•Even with scientific method, still room to
disagree
•Differences in scientific judgment lead to
disagreements on positive questions
•e.g. Look at the same data but come to a different
conclusion
•Likely began from different assumptions; may be able to
resolve by empirically testing assumptions
•Can’t resolve normative disputes that arise from
differences in values

27. REAL VERSUS NOMINAL
PRICE
Nominal price is the absolute or current dollar price of a good
or service when it is sold.
Real price is the price relative to an aggregate measure of
prices or constant price.
The Consumer Price Index (CPI) is an aggregate measure.
Real prices are emphasized to permit the analysis of
relative prices.

28. CALCULATING REAL PRICE
yearcurrent
yearcurrent
yearbase
PriceNominalx
CPI
CPI
PriceReal =
(base year = 100)

29. CALCULATING THE REAL
PRICE OF MILK
Nominal Price Real Price of Milk
Year of Milk CPI in 1970 dollars
1970 .40 38.8 .40 = 38.8/38.8 x .40
1980 .65 82.4 .31 = 38.8/82.4 x .65
1999 1.05 167.0 .24 = 38.8/167.0 x 1.05

30. CALCULATING REAL PRICES:
AN EXAMPLE - EGGS & COLLEGE
1.04x
163
38.8
EggsofPriceReal 1970
=
1998 (1970 = 100)
$4,573$19,213x
163.0
38.8
==
Real Price of a
College Education
1998 (1970 = 100)

31. AN EXAMPLE - EGGS &
COLLEGE
1970 1975 1980 1985 1990 1998
Consumer Price Index
(1983 = 100) 38.8 53.8 82.4 107.6
130.7 163.0
Nominal Prices
Eggs $0.61 $0.77 $0.84 $0.80 $0.98 $1.04
College Education $2,530 $3,403 $4,912 $8,156 $12,800 $19,213
Real Prices ($1970)
Eggs $0.61 $0.56 $0.40 $0.29 $0.30 $0.25
College Education $2,530 $2,454 $2,313 $2,941 $3,800 $4,573

32. AN EXERCISE
1960 1970 1980 1990 2000 2004
CPI 100 130.58 158.56 184.95 208.98 214.93
Retail price of butter (Rs) 80 90 85 102 110 120
Real price of butter (Base
1960=100) 80.00 68.92 53.61 55.15 52.64 55.83
a) Calculate the real price of butter in 1960 rupees
b) Has the real price increased/ decreased/ stayed the same since 1960?
c) What is the % change in the real price (1960=100) from 1960 to 2004?
d) Convert the CPI into 1990=100 and determine the real price of butter in 1990 rupees
e) What is the % change in real price (1990 rupees) from 1960 to 2004? Compare this with
your answer in (b). What do you notice? Explain

33. SOLUTION
1960 1970 1980 1990 2000 2004
CPI 100 130.58 158.56 184.95 208.98 214.93
Retail price of butter (Rs) 80 90 85 102 110 120
Real price of butter (Base
1960=100) 80.00 68.92 53.61 55.15 52.64 55.83
% change in real price from 1960
to 2004 -30.21
Real price of butter (Base
1990=100) 147.96 127.47 99.15 102.00 97.35 103.26
% change in real price from 1960
to 2004 -30.21

34. EQUATION OF A LINE
Slope-intercept form of a linear line is
Y=mx +c
M= slope
C= intercept
Y
X
C
M

35. EQUATION OF A CURVE
Y = f(x)
Slope of the curve = slope of the tangent at the point
Y
X
y2
y1
x1 x2
A
B
Slope at point A = y2/x1
Slope at point B = y1/x2
Slope at point A > slope
at point B
Point A is steeper than
point B

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