2- Chapter Microeconomics chapter 2.pptx

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1. Prepared By: Waheedullah Hemat Year: 2025 Intermediate Microeconomics

2. Chapter 2 Introduction to Microeconomics

3. The objectives of the Chapter This chapter aims to present the two main branches of economics, introduction and scope of microeconomics as a social science. Within this chapter, the following topics are introduced. Introduction of Microeconomics and Macroeconomics What is Microeconomics as a social science Introduction and scope of Microeconomics The Nature of Economic Theory Uses of Economics Theory Limitations of Economic Theory Economics Theory and Economic Policy Failure of Economics Theory

4. Two Main Branches of Economics Microeconomics and Macroeconomics The establishment of microeconomics as a separate domain within economics can be traced back to the late 19th century. Alfred Marshall's important work, "Principles of Economics" (1890), placed a strong emphasis on the analysis of individual markets, the interaction of supply and demand, the concept of utility, and the behaviors of both firms and consumers . Keynesian economics, as outlined in his book "The General Theory of Employment, Interest, and Money" (1936), became the basis for macroeconomics. Macroeconomics expanded to include topics like inflation, employment, fiscal policy, monetary policy, and economic growth . Microeconomics in brief examines the economic behavior of individuals at the micro-level, surrounding consumers, firms, and resource owners

5. Continue… M icroeconomics analyzes the following sides of the economic system. How individual consumers and producers make their choices. How their decision and choices affect the demand and supply. How consumers and producers interact to settle the prices of goods and services in the market. How total output is distributed among those who contribute to production, i.e., between landlords, Labour, capital, suppliers and the entrepreneurs.

6. Differences between Microeconomics and Macroeconomics

7. Continue… Microeconomics Macroeconomics Meaning Microeconomics is the discipline of Economics concerned with the study of individual, household, and corporate behaviour in decision making and resource allocation. Macroeconomics is the discipline of Economics that studies the overall behaviour and performance of the economy. The most essential parameters investigated in macroeconomics include GDP, unemployment, inflation, and growth rate. Area of study Microeconomics is the study of a specific market section of the economy. Macroeconomics is the study of the entire economy, which includes numerous market areas. Relates to Microeconomics relates to various issues such as demand, supply, factor pricing, product pricing, economic welfare, production, consumption, and more. Macroeconomics relates to various issues like national income, distribution, employment, general price level, money, and more.

8. Continue… Microeconomics Macroeconomics Scope Microeconomics scope is to addresses a variety of concerns, including demand, supply, factor pricing, product pricing, economic welfare, production, consumption, and others. Macroeconomics scope is to covers several issues like distribution, national income, employment, money, general price level, and more. Significance Microeconomics is useful in managing product prices as well as the pricing of production components (labour, land, entrepreneur, capital, and others) within the economy. Macroeconomics is maintains price stability in the aggregate and addresses significant economic challenges like as deflation, inflation, rising prices (reflation), unemployment, and poverty in general.

9. What is Microeconomics As previously stated, microeconomics primarily examines how individual economic actors, such as consumers, producers (firms), and resource owners, address the challenge of enhancing their gains given their limited resources. It also examines the influence of their decisions on market dynamics, pricing, and production . Microeconomics investigates into the mechanisms by which individuals make these decisions.

10. Continue… It investigates how consumers determine "what to consume" and "how much to consume" in order to maximize their overall satisfaction within their budget limitations. Likewise, it scrutinizes how individual firms make choices regarding "what to produce," "how to produce," "for whom to produce," and what pricing strategies to employ in order to maximize their profits while working with their limited resources. Microeconomics focuses on studying how choices are made at the micro-level, which involves individual decision-makers.

11. Continue… In the words of Lerner, microeconomics can be associated to viewing the economy through a microscope. When watched from this microscopic perspective, decision-makers are categorized according to their economic roles as consumers, producers, or resource owners . A comprehensive examination of how consumers, producers, and resource owners make economic choices. The study of consumer behavior leads to the development of theories related to consumer behavior, consumption, and demand. On the other hand, investigating producer behavior leads to theories of production, supply, and cost analysis

12. Continue… Oxford Reference defines microeconomics as follows: 'Microeconomics analyses the choices of consumers (who can be individuals or households) and firms in a variety of market situations. Its aim is to explore how choices should be made and to provide an explanation of choices that are made.’ As a social science, most definitions of microeconomics are acceptable, and we cannot reject any of them. However, the perspective of economists who define microeconomics may differ. In the original 1960 version of the Journal of Economic Literature's subject field classification, micro and macroeconomics were grouped as subsets under a broader category of 'theory.' But in a significant revision of the system in 1991, they were elevated to major independent categories.

13. Scope of Microeconomics The scope of microeconomics is to examine and study the individual units of the economy, such as individual consumers, individual firms, and small groups of units like numerous industries and markets in the economy. The scope of microeconomics mainly comprises three theories: the theory of product pricing, the theory of factor pricing, and the theory of economic w elfare. The theory of product pricing examines the determination of prices for consumption goods, considering both demand and supply aspects.

14. Continue… The demand side studies consumer behavior, while the supply side considers production costs and conditions. In the theory of factor pricing, the focus is on determining the prices or rewards given to factors of production for their contributions. Finally, the theory of economic welfare is at the core of microeconomic analysis, exploring how to distribute given quantities of goods and services among different consumers to maximize overall economic welfare.

15. The Nature of Economic Theory

16. Continue… The nature of economic theory pertains to the fundamental characteristics, principles, and qualities that define the field of economics and provide guidance for the development of economic theories. It serves as a keystone of the discipline of economics and holds a essential role in understanding, dividing, and explaining economic phenomena . And also the nature of economic theory denotes to the fundamental characteristics and principles that motivate the study of economics. Economic theory is a framework used by economists to examine and understand how economies work, make predictions about economic behavior, and provide guidance for policymakers.

17. Steps of Economic Theory Economic theory, like other scientific theories, goes through an organized development and enhancement process.

18. Continue… Identifying a Research Problem: The first step in the preparation of a theory is the selection of the problem which must be mentioned clearly and correctly. And this step, is identifying a specific economic issue or problem that deserves investigation. This could be a real-world economic phenomenon, a problem, or a question that economists seek to understand or explain. The problem to be explored may be very extensive like poverty, unemployment, inflation, etc.

19. Continue… Collection of Data: The second phase involves the gathering of data or information related to the issue in hand. Data collection serves as a foundational stage within the research process, regardless of whether it relates to economic analysis, scientific investigations, or other research endeavors. This process involves the compilation of information that aligns with your research objectives. This particular stage is often referred to as descriptive economics. Numerous economic principles find their roots in this particular observation, examples being the law of diminishing returns, the Malthusian theory of population, the Marshallian price theory, among others.

20. Continue… Data Classification: After the data collection phase, the research information undergoes a series of essential steps, including counting, categorization, and analysis. The process of classification is a method for gaining insights into the collected information. It involves organizing data or facts based on their shared characteristics. The concept of data classification plays a pivotal role in the domains of information analysis and research, providing a systematic framework for grouping data into specific categories or types. This systematic approach greatly contributes to a deeper understanding and interpretation of the available information. For example, if the research objective involves examining patterns in population growth and distribution, data listing, classification, and subsequent analysis are vital components in the pursuit of scientific inquiry.

21. Continue… Hypothesis Development: Hypothesis development represents a crucial phase within the scientific research process. It involves the formulation of a tentative statement or informed estimation that proposes a potential connection between two or more variables. This hypothesis functions as the groundwork upon which research is conducted and its validity tested. During this phase, hypotheses are made to address specific economic phenomena under examination. A hypothesis is essentially a proposed solution to a problem, serving as a means to explain facts by uncovering their underlying patterns.

22. Continue… Testing Hypothesis: The subsequent phase involves the evaluation of the previously formulated hypothesis. It is essential that the hypothesis be structured in a manner that allows for conclusions to be drawn from it, leading to a determination of whether it adequately explains the considered facts or not. The testing of the hypothesis involves subjecting it to rigorous scrutiny using well-established methods of logic and statistics, which can then be further subjected to confirmation. Moreover, the hypothesis must offer a solution to the initial problem that prompted the investigation. This necessitates prediction, which can pertain to events in the past, present, or future, as long as such events were not known prior to or at the time of prediction. A hypothesis that has undergone successful testing and verification transforms into a theory.

23. Continue… Verification of Theory: The verification of a tested hypothesis or theory represents an essential stage in the research process. It serves as the determinant of the validity of a proposed theory and its ability to endure empirical examination. This verification process involves subjecting the theory to a sequence of tests, experiments, and observations aimed at gauging its precision and explanatory capacity. When a theory is proven to be incorrect, it is rightly rejected. However, it is crucial to recognize that the rejection of a theory does not extract it useless.

24. Continue… Formulation of Solutions: When a theory has been successfully verified and shown to be accurate, the next step is to generate potential solutions or recommendations for addressing the problem under examination. This process is applicable across various fields, ranging from the realms of science and engineering to the scopes of business and daily life. It involves the identification and development of strategies, plans, or methods designed to tackle specific challenges or attain desired goals. This final stage is especially relevant to applied economics and requires the application of value judgments in the formulation of solutions.

25. Uses of Economics Theory To Provide Economic Instruments: Economic theory offers a valuable set of tools and frameworks that empower individuals, businesses, and policymakers to divide, comprehend, and involved economic scenarios. These economic instruments serve diverse purposes, helping stakeholders in making well-informed choices, making effective policies, and tackling economic complexities. Economic theory equips economists with a range of tools to scrutinize economic challenges and phenomena.

26. Continue… To Describe Economic Phenomena: Economic theory plays a essential role in reading and explaining real-world economic phenomena. Through the process of perception, it selects relevant facts, categorizes them, and interprets them in the context of existing knowledge. This approach enables the identification of causal relationships among different variables, ultimately confirming the validity of an economic problem or inquiry. For example, consider the task of identifying the root causes of unemployment within a country. In this scenario, data and facts are gathered, quantified, analyzed, and categorized. Subsequently, these findings are interpreted through the lens of our understanding of unemployment's nature.

27. Continue… To Predict Economic Events: Economic theory serves as a foundation for making predictions about unobserved economic events, demonstrating a remarkable ability to provide accurate insights into real-world economic challenges. For example, when we observe that an increase in the supply of wheat does not lead to a drop in its price, considering the usual demand for wheat, economic theory allows us to speculate on potential factors such as adverse weather conditions or the anticipation of disruptive events like war. Moreover, economic theory plays a crucial role in assessing the performance of different sectors within the economy and the economy as a whole.

28. Continue… To Formulate and Understand Economic Policies: Economic policies benefit from this process by aiding in their development and comprehension. Consider a scenario in which an economist is tasked with providing guidance on reducing unemployment. This issue aligns with the broader objectives of poverty alleviation and addressing income and wealth inequality. However, it may conflict with the objective of maintaining price stability. Consequently, the economist must carefully assess the trade-off between sustaining a certain level of unemployment with minimal inflation. Selecting the problem of unemployment is the initial step in theoretical economic analysis, which is critical for policy formulation.

29. Limitations of Economic Theory Economic theory, although a powerful tool for understanding and analyzing economic systems, it has share of limitations that must be recognized to make informed decisions and policies. One significant constraint of economic theory lies in its simplifying assumptions. To make complex economic concepts manageable. economists often employ simplifications that may not accurately mirror real-world details. These simplifications can lead to overly simplistic models and predictions that do not fully capture the complexities of the economy. Therefore, too much should not be expected of economic theory. It has its limitations.

30. Steps of Limitations of Economic Theory

31. Continue… Exact Data is Not Available: Economic theory, often described as a toolbox, assumes the presence of accurate and accessible data. Unfortunately, obtaining such data can be a challenging endeavor. In essence, a theory is built upon factual foundations, and if these facts are inaccurate, the theory itself becomes unsound. The absence of reliable and exact data poses a substantial obstacle in the realms of economic analysis and decision-making. When data is incomplete, outdated, or unreliable, our capacity to make well-informed economic evaluations and policy decisions is severely compromised. Furthermore , the collection and interpretation of data can sometimes be subjective, introducing an element of chance that can render economic theories less realistic.

32. Continue… Accurate Predictions Not Possible: Achieving precision in economic predictions is often elusive, and the likelihood of accuracy in economic forecasts is considerably lower compared to the predictability seen in the physical sciences. In the realm of science, researchers can conduct experiments within controlled laboratory settings, allowing for precise predictions. However, economists face a fundamental challenge when it comes to accuracy because they lack the ability to conduct controlled experiments on economic phenomena. Despite these challenges, economic analysis remains indispensable in shedding light on key insights, recognizing emerging trends, and guiding decision-making processes. When making policy or investment decisions, it is essential to take into account this uncertainty and consider a field of potential situations.

33. Continue… Human Behaviour on Rational: Economic theory revolves around the actions of individuals, and it acknowledges that these individuals do not consistently exhibit rational behavior. Their choices and actions are often more strongly influenced by the prevailing social and legal structures of their society than by pure economic principles. Unlike laboratory experiments where one can control variables in a test tube, it is impossible to isolate a group of consumers or businesspeople to observe their reactions to specific changes. In essence, human behavior can diverge from strict rationality, posing significant implications for economics and decision-making. Economic theory typically assumes that people act logically, consistently striving to maximize their own well-being or utility.

34. Continue… Unrealistic Assumptions: Economic theories are built upon a set of assumptions, but it's worth noting that some of these assumptions can be very idealistic. For example, one common assumption is that individuals, both as consumers and producers, act rationally. However, in practice, we often observe that people do not consistently exhibit rational behavior. When this assumption of rationality is challenged, it can lead to inaccuracies in predictions based on economic models. In essence, economic theories provide valuable insights and simplified representations of economic phenomena but may not capture the full complexity of real-world human behavior and economic systems.

35. Continue… Not Fully Applicable to Economic Policies: Economic theories are not fully appropriate to economic policies. The application of economic theory to economic problems, regardless of time and place, has led to the failure of many economic policies implemented with good intentions. Firstly, the applicability and correctness of an economic theory depends upon the fact whether the assumptions of the theory are in keeping with the actual economic conditions on which the economist wants to apply it. If the assumptions are not in agreement with the actual economic situation, the results may wrong. For instance, if we try to apply the profit maximization theory of the firm on a particular industry, our conclusions might turn out to be wrong if the conditions of perfect competition do not prevail in practice in that industry.

36. Continue… Secondly, another reason for the failure of economic theory to be useful in policy is the existence of particular situations in the country which happen to be different from those considered in the theory. Such a situation arises when effort is made to apply economic theories meant for developed countries on the developing economies. Thirdly, and economic theory which is the basis of a policy measure at one time in the economy is “a dynamic, changing organism”. An economic theory which is correct today may become obsolete tomorrow and the policy based on this might also become useless.

37. Economics Theory and Economic Policy Economic policy, often referred to as applied economics, takes economic theory and translates it into practical actions. It involves the real-world application of economic principles to analyze and address the specific economic conditions of a given society. Economic theory and policy are closely interconnected, with economic theories providing the intellectual foundation upon which policies are built. The success of economic policy centers on its alignment with economic theories. Policies are most effective when they are formulated based on sound economic theories. Understanding economic theories is essential for crafting government policies, and economists are often called upon to play a central role in this process.

38. Continue… In essence, economic theory and applied economics are intertwined, with economic theories providing the framework for understanding and shaping economic policies, while economists are instrumental in both analyzing and formulating policies to address various economic objectives and challenges. 1- Economists need to be knowledgeable in the objectives of economic policy. These objectives typically encompass goals such as fostering economic growth, achieving full employment, maintaining price stability, alleviating poverty, and ensuring a fair distribution of income and wealth. 2- Suppose the economist asked to offer advice about the ways in which unemployment can be reduced. This goal is complementary and overlaps the goals of removal of poverty and equitable distribution of income and wealth. But it conflicts with the goal of price stability. So he will have to think out how much unemployment can be sustained with a minimum of inflation.

39. Continue… 3- Economist will have to collect data, or if they are already available, arrange and interpret in the light of the existing theories of unemployment in order to find out the cause of unemployment. 4- Then economist has to propose alternative means of achieving the given goal of lowering the level of unemployment “in other worked, when faced with evaluating a policy measure for achieving some goal, the must ask whether other measures that are feasible at the time and place would better achieve the desired goal” 5- Economist should point out the probable effects of these measures on the economy. “This entails a clear cut understanding of the economic impact, costs and political feasibility of alternative programmes”

40. Failure of Economics Theory The shortcomings of economic theories have sparked debates and concerns within the economics field. While these theories offer valuable frameworks for understanding and separating economic phenomena, they are not exempt from limitations and deficiencies. Economic theories frequently rely on simplifying assumptions that may fail to convey the complexities of real-world economic systems. Individual assumptions of complete information or rational behaviour, for example, may not hold true in all contexts. Testing economic theories can be difficult because controlled experiments are not always possible in economics. The field mainly relies on observational data, which might be subject to bias and limits.

41. Major Highlights Microeconomics encompasses the study of consumer behavior, production and cost theories, commodity pricing theory, factor pricing theory, and the optimal allocation of output and production factors, known as welfare economics. These theories constitute the core focus of microeconomics. Macroeconomics is the branch of economics that studies the behavior and performance of an economy as a whole. It emphases on the aggregate changes in the economy such as inflation, growth rate, gross domestic product and unemployment. The scope of microeconomics is to study the individual units of the economy, such as individual consumers, individual firms, and small groups of units like numerous industries and markets.

42. Continue… The nature of economic theory denotes to the fundamental characteristics, principles, and attributes that define the field of economics and guide the development of economic theories. Economic theory is a foundational element of the discipline of economics and plays a vital role in understanding, analyzing, and explaining economic phenomena. Economic theory provides us with tools of economic analysis, helps in explaining economic phenomena, in predicting economic events, in adjudicating the performance of the economy, and in formulating economic policies. Economic policy applies economic theory to analyze and shape real-world economic conditions. Economic theory and policy are interconnected, with policy relying on theoretical foundations for success. Economic theory is crucial for comprehending government policy measures, and economists are tasked with formulating these policies.

43. Questions 1. Define microeconomics? 2. Define macroeconomics? 3. What is the difference between microeconomics and macroeconomics? 4. What is the scope of microeconomics? 5. Explain the nature of economic theory? 6. Write the steps of economic theory? 7. What is the uses of economics theory? 8. Explain the limitations of economic theory? 9. Explain economics theory and economic policy?

44. Further Reading AHUJA, H. L. (2017). Advanced Economic Theory Microeconomic Analysis (Second Edition ed.). New Delhi : S Chand And Company Limited. Andolfatto , D. (2008). Macroeconomics Theory and Policy (Second Edition ed.). University Library of Munich, Germany . Blaug , M. (2023, May 17). economics . Retrieved from Encyclopedia Britannica: https://www.britannica.com Dwivedi, D. N. (2016). Microeconomics Theory and Applications (Third Edition ed.). Delhi: Vikas Publishing House Pvt Ltd. Retrieved from www.vikaspublishing.com Jain, V. (n.d.). Fundamentals of Economics. Delhi: NEERAJ PUBLICATIONS. Retrieved from https://www.neerajbooks.com/ JHINGAN, M. (2016). Microeconomics (Eighth Edition ed.). Delhi: Vrinda Publications (P) LTD. Retrieved from www.vrindaindia.com LIPSEY, R., & CHRYSTAL, A. (2012). Economics (Twelfth Edition ed.). New York: Oxford University Press Inc. VERMA, K. (2013). Micro-Economic Theory (Third Edition ed.). Jalandhar Delhi: Vishal Publishing Co. Retrieved from www.vishalpubco.com

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