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INTRODUCTORY MICROECONOMICS
CENTRAL PROBLEMS OF AN ECONOMY
ECONOMICS
Economics is the study of how individuals, firms and governments make choices on allocating their
limited resources to satisfy their unlimited wants.
Characteristics of Resources
1. Scarcity
Scarcity of resources means that an economy does not have sufficient resources or means to satisfy all
of its wants.
2. Alternative Uses
Alternative uses means that a resource has many available options to be put to use. But it can be used
for only one purpose at a time. For example, a plot of land can be used to construct only one out of
residential complex, school, hospital, offices etc. at a time.
Economising of Resources
It refers to the use of scarce resources in such a manner that wastage is avoided and maximum output is
obtained. Economising of resources is needed because the resources are scarce or limited and they are to
be used to satisfy wants that are unlimited.
BRANCHES OF ECONOMICS
1. Microeconomics
The branch of economics, which studies the behaviour of individual economic units is called
microeconomics. Economics activities related to a consumer, a producer, a firm an industry or price
are studied under microeconomics.
Examples of microeconomic studies:
i. Determination of the price of its products by a firm.
ii. Determination of an individuals demand for a product.
iii. Pricing of a factor of production.
2. Macroeconomics
The branch of economics, which studies the aggregates and averages related to economy as a whole is
called Macroeconomics. National Income, Employment level, General price level are studied under
macroeconomics.
Examples of macroeconomic studies:
i. Determination of national income.
ii. Determination of the level of unemployment in the country.
iii. Determination of general price level.
NATURE OF ECONOMICS
The economy has to decide which goods and services are to be produced. For example, the
economy has to decide which among the consumer goods viz. wheat, cloth, sugar etc. and which
among the capital goods viz. machines, tractors etc. it has to produce.
ii. The quantity of goods to be produced.
Once the economy has decided upon the goods and services it has to produce, the next problem it
faces is the decision about the quantity of various goods it requires to produce.
2. How to Produce?
This problem is related to select the technique of production. There are mainly two techniques of
production:
i) Labour-intensive technique: In this technique, more labour and less capital is used for
production of goods and services, for example, handloom.
ii) Capital-intensive technique: In this technique, more capital or machinery and less labour is used
for production of goods and services, for example, power loom.
3. For whom to produce?
This problem is in fact the problem of distribution of income among factors of production who will
consume the goods and services produced. It is related to how much does each individual or factor of
production earn and how much wealth or assets does each have? It determines the purchasing power
of people, which depends upon the distribution of income from output among the factors of
production.
TYPES OF ECONOMIES
1. Market Economy
It is the system where means of production are privately owned and economic activities (production,
Consumption, distribution of income etc.) are guided by the operations of market. It is also called
Capitalist economy.
Features of Market Economy
Following are some important characteristics of a capitalist economy:
i. Private property
In this system the properties are owned and managed privately by the people. This property can
be transferred to their heirs.
ii. Price Mechanism
Demand and supply forces determine the prices of the commodity. Free flow of market forces
helps the producer to decide what to produce and how much to produce, how to produce and for
whom to produce. This price mechanism decides the economic activities such as production
consumption, distribution, investment and savings.
iii. Profit motive
Enterprises engage themselves in the economic activity to earn the maximum profits.
iv. Freedom of enterprises
An enterprise has the power to own a business without intervention of State or Government. An
individual can himself take decisions regarding what to produce, where and for whom to produce.
He takes decision with respect to availability of resources on the basis of his skills and
knowledge.
v. Self interest
Self interest is the prime motive in this system. All the market elements labour, consumer,
producer etc. are centered to their own interest to maximize their satisfaction.
Introductory Microeconomics
As the Government or State has very limited control on the decision making, it is guided by the self
interest of factors in economic activity. The self interest for the producer is maximization of revenues,
minimization of cost, thereby maximization of profits. For a consumer it is maximization of
satisfaction for his consumption basket.
Solution of economic problems in a Capitalist Economy
Price mechanism works through the demand supply forces and thereby the equilibrium price and
quantities. It solves the problem as follows.
i. What to produce?
Consumers decide on the basis of their preferences at what prices they are ready to buy what
amount of a commodity. It decides the demand for goods in the market. On the other hand,
producers decide on the basis of cost of production, what commodities and what quantities they
are ready to supply at different prices in the market. This determines the supply of the
commodities. Where these two forces (i.e. demand and supply) intersect each other, the price and
quantity of the commodity is determined.
ii. How to produce?
It is the problem of choice among technique of production. A producer will always employ the
cheapest technique to minimize his cost of production. The cost technique is based on the price of
inputs used in the production. Input prices are determined by the price mechanism. On the basis
of the prices of inputs, a producer decides the technique which is less costly.
iii. For whom to produce?
This is the problem of distribution of national income among the different section of its people.
In the capitalist system the share of a factor decides its share of national income. If the labour
class has larger share the necessities or common goods will be produced and if the capitalist class
has more share in the national income more luxurious goods will be produced. In this system,
distribution of income determines the distribution of goods and services.
2. Planned Economy
In a Planned Economy the means of production are collectively owned and decision regarding
planning, production, economic development are taken by the Central Planning Authority or state.
Features
i. Collective Ownership
In this case, Government is the representative of the society and all means of production are
owned by the society. No individual has any right on the property.
ii. Central Planning
All the economic decisions are taken by the central planning authority, which decides it through
economic plans.
iii. Govt. Control
All the economic planning takes place under control of government or State. Government has the
power to implement their plans without any interruption. State has full monopoly power so there
is no competition.
iv. Social welfare
The objective of the government is to maximize the social welfare of the people and not to earn
the economic profit.
v. Lesser scope of private sector
All the essential sectors are dominated by the public sector or Govt. There is very limited scope
for private sector.