Microeconomics

Microeconomics
“Quick refresher”

By

Muhammad Usman Qazi

This blog is for beginners or those who need a quick refresher

Table of Contents

Introduction      

o    Introduces the terminology and definitions

What is Economics?

o   Branches of Economics

Consumer/Buyer Point Of View

o   Who is consumer/buyer?

o   What is satisfying power?

o   Marginal Utility

o   Diminishing Marginal Utility

o   Total utility

o   Opportunity costs

o   Desire / Demand 
o    What is Demand 

o    Law of Demand 

Introduction

Before going directly to microeconomics topic, first we need to understand the following terminologies:

“Wants and needs”

“Resource / Economic Resources”

 “Concept of Scarcity”

“Trade off / Opportunity cost”

“What is Economics”?

“Economic Models”

“What is Economy?

 “Wants and needs”

A need is something you have to have, something you can't do without,  like food. If you don't eat, you won't survive for long.

A want is something you would like to have. It is not absolutely necessary, but it would be a good thing to have, like music.you don't need music to survive.

Some categories have both needs and wants. For instance, food could be a need or a want, depending on the type of food.

You need to eat protein, vitamins, and minerals.. These basic kinds of foods are needs.

Ice cream is a want. You don't really need to eat ice cream to survive. Still, ice cream tastes good to many people. They like to eat it. They want it, but they don't need it. 

“Resource / Resources or Factors of Production”

Resource is a source or supply from which benefit is produced or transformed to produce benefit and in the process of this activity, it may be consumed or made unavailable.

Resource is defined in economics as “a service or other assets used to produce goods and services that meet human needs and wants”.

Individual Resources                        Resources or Factors of Production

         Time                                                Land I,e farm land, animals, forests, water, minerals (paid rent)

         Money                                             Capital i.e buildings, machinery and equipment (paid interest)

         Skill                                                  Labour i.e both the physical and mental      contribution of a worker (paid wages).

 Entrepreneurship i.e this individual combines the other resources and provides a goods or services (rewarded profit)

. Note: Money is often called capital, but it is  not an economic resource, it is just enables or facilitates the purchase of one of the resources.

 “Concept of Scarcity (کمی)”

You can’t always get what you want because resource is scarce ie less (قلیل) 

Scarcity (also called paucity) is the fundamental economic problem of having seemingly unlimited human wants in a world of limited resources.

It states that society has insufficient productive resources to fulfill all human wants and needs.

The notion (خیال۔ وہم۔ تصور) of scarcity is that there is never enough (of something) to satisfy all conceivable human wants, even at advanced states of human technology.

Scarcity involves making a sacrifice i.e giving something up, or making a tradeoff, in order to obtain more of the scarce resource (i.e less resource) that is wanted.

Example,

Although air is more important to us than gold, it is less scarce simply because the production cost of air is zero. Gold on the other hand has a high production cost. It has to be found and processed, both of which require a great deal of resources.

 “Trade off / Opportunity cost”

Give up something for something else is called TRADE OFF, while the thing that is given up is called OPPORTUNITY COST. 

It means trade off is a process of selection while opportunity cost is thing that is sacrificed/not selected.

“Opportunity Cost: The Real Cost of Something Is What You Must Give Up to Get It”

Scarcity

      ↳   Making choices

                                   ↳ Opportunity Cost

            

 “Economic Models”

Economists use graphs or other short-cuts as tools to explain the concepts, these tools are called Economic models.

What is Economy?

The way in which goods and services are made, sold, and used in a country or area, in-other words, the economy is the production and consumption activities that determine how scarce resources are allocated in an area.

What is Economics?

Economics is about every day activities, it deals with people and is a reflection of how they interact with each other as they go about making decisions/choices in the face of scarcity (what should they choose and what should they left) regarding their lives.

Economics means that you have resources in economy and how will those resources be allocated. Suppose you have Rs. 1000/- (I,e resource) and you are going to allot it on whole amount on watching movies or purchase of books or partially spent money on both for books and movie, economics basically means society have scarce resources i.e resources are very less

"Economics is the study of how individuals and firms make decisions with limited resources as to best satisfy their wants, needs, and desires."

Everything in life has two sides i.e Birth-Death, Head-Tail, Morning-Evening etc

So in Economics, it always has to consider two sides to any arguments I,e consumer/buyer point of view and supplier/seller point of view. These both point of views will be discussed one by one in detail.

“Branches of Economics”

Under Economics we study, following two major branches of economics

Microeconomics          

Microeconomics deals largely with the decision-making behavior of individual consumers and firms in markets,               

                              .

Macroeconomics

Macroeconomics focuses largely on the aggregated behavior of all consumers and firms in 

an economy.

Consumer/Buyer Point of View

As mention in the above definition of microeconomics that decision- making behavior of individual and firms in the market are dealt. In this section we will study the individual (consumer / buyer) decision-making behavior, how does he/ she respond and deal with the change of prices and other factors? How does he/she make a choice within his/her scarce resource?

The other section from firm (seller/supplier) point of view will also be discussed in detail later on.

Who is Consumer / Buyer?

A consumer is a person who buys goods and services to derive the satisfaction of wants and his aim is to derive maximum satisfaction (i.e sense of happiness) of his expenditure.

What is satisfying power? i.e how much satisfied?

In economics utility is satisfying power or capacity of commodity to satisfy human wants.

Utility depends upon the intensity of want for the commodity and it can be measured in units of happiness called UTILS (also called cardinal approach).

Utils can decrease as the number of products or services as consumption increases. Suppose, the first slice of pizza may yield 10 utils, and the second slice of pizza may yield 6 utils, as more pizza is consumed, the utils may decrease more because people become full. This will help consumers understand how to maximize their utility by allocating their money between multiple types of goods and services as well as help companies understand how to structure tiered pricing.

The economic utility of a good or service is important to understand because it will directly influence the consumer’s demand, and  price of that good or service.

Always keep remember that-------- Utility ≠ Usefulness

Example: a cigarette has sense of happiness for smoker, while smoking is not good for health.

Marginal Utility:

The additional satisfaction derived from the consumption of an additional unit of a commodity is called marginal utility.

i.e MU= Utility of one unit

 Diminishing Marginal Utility:

The tendency for marginal utility to decrease as the quantity consumed of a good increases.

Total Utility:

The sum total of all utilities derived from the consumption of all the units of a commodity is called total utility.

TU = Sum of all Marginal Utilities

i.e TU = ∑MU

Following Table will show, how a consumer consumes oranges and gets Marginal Utility i.e 0 orange gives 0 utils, 1 orange gives 20 utils marginal utility, 2^nd orange gives 15 utils, 3^rd orange gives 10 utils and 4^th gives 5 utils, means as  oranges are consuming,  marginal utility diminishing or decreasing  and  then in third column, total utility calculated by sum total of all utilities:

Units consumed                               MU                              TU

(Oranges)                                          (Utils)                          (Utils)

0                                                          -                                   -

1                                                          20                                20 (0+20=20)

2                                                          15                                35 (20+15=35)

3                                                          10                                45 (35+10=45)

Graphically representation:

Although total utility usually increases as more of a good is consumed, marginal utility usually decreases with each additional increase in the consumption of a good. This decrease demonstrates the law of diminishing marginal utility. Because there is a certain threshold of satisfaction, the consumer will no longer receive the same pleasure from consumption once that threshold is crossed. In other words, total utility will increase at a slower pace as an individual increases the quantity consumed.

Take, another example, a chocolate bar. Let's say that after eating one chocolate bar your sweet tooth has been satisfied. Your marginal utility (and total utility) after eating one chocolate bar will be quite high. But if you eat more chocolate bars, the pleasure of each additional chocolate bar will be less than the pleasure you received from eating the one before - probably because you are starting to feel full or you have had too many sweets for one-day.

The above table shows that total utility will increase at a much slower rate as marginal utility diminishes with each additional bar. Notice how the first chocolate bar gives a total utility of 70 but the next three chocolate bars together increase total utility by only 18 additional units.

In order to determine what a consumer's utility and total utility are, economists turn to consumer demand theory, which studies consumer behavior and satisfaction. Economists assume the consumer is rational and will thus maximize his or her total utility by purchasing a combination of different products rather than more of one particular product.

Thus, instead of spending all of your money on three chocolate bars, which has a total utility of 85, you should instead purchase the one chocolate bar, which has a utility of 70, and perhaps a glass of milk, which has a utility of 50. This combination will give you a maximized total utility of 120 but at the same cost as the three chocolate bars.

Opportunity Costs:

As discussed earlier that there are not enough resources to satisfy everyone’s desires because human desires may be unlimited and resources are not. So we have to make trade-offs i.e we have to make sacrifices and choose one thing over another.

We make choices by considering both the costs and benefits of each activity. We have to always make sure that benefits of our choices are greater than costs. Every choice in life has opportunity costs. Every decision involves the sacrifice of the benefits of an alternative that was not chosen.

There are so many situations where you have to choose one product or one service over another. You choose one perfume instead of another. Suppose If you deposit money in a bank instead of buying a car, the cost of earning interest would be the missing value of having a car in my garage.

Suppose if I have chosen a Head & Shoulder Shampoo over a Sunsilk Shampoo, the cost of having Head & Shoulder shampoo includes the missing value of having sunsilk shampoo, this value of missed opportunity incurs costs, this cost is called opportunity cost.

I shall illustrate the above scenario in a economic model i.e graph, the axes represents the quantities white cars on OX axes and  red cars on OY axes.two alternate products.

The graph/model illustrates the trade-offs when choosing one of these products instead the another, if you chose to have 7 of white cars, you can not chose any of red cars, you can see white cars 7, and red cars =0 and vice versa white=0 & red cars=7.

However there are some combinations of these two products, you can choose one of them  i.e white cars=4 & red cars=3, there would be all possible combinations.i.e white cars=1& red cars=6, white cars=3 & red cars=3 and so on……….

Demand / Desire:

Economics is all about understanding how incentives and disincentives affect typical human behavior. Here we will discuss that how does a consumer behave differently in the market? when prices increase or decrease  because different commodities have different prices.

What is Demand?

Demand refers to the amount of good or service that consumer/buyer is willing and able to buy at specified price.

Law of Demand:

As prices for a good or service rises (increases) demand falls (decreases) as prices falls (decreases) demand rises (increases).

Suppose you have buying one 250 ml bottle of mineral water for Rs. 6 every day. One day you have found that price has gone down to Rs.5. so you will buy two bottles, again when prices will decrease, you will increase the buying quantities, 

Same as the prices will increase you will decrease the buying quantities of bottles i.e  on price of Rs. 1, you are willing to buy 7 bottles, when price goes up to Rs. 2, you will decide to buy 6 bottles, finally price goes up to Rs. 7 then you will be able to afford only 1 bottle. . Following is the table / schedule for your better understanding:

Price (Rs.)                 Quantities in units (Q)

7                                              1                                 

6                                              2

5                                              3

4                                              4

3                                              5

2                                              6

1                                              7

we will illustrate this behavior in the following graph where on OX represents quantities of mineral water bottles (Q) and OY represents the Price (P):

The above curve is downward sloping, which indicate the inverse relationship between the price and quantity.which also reflects the Law of Demand i.e when price is increasing, the quantity demanded is decreasing and when the price is decreasing, the quantity demand ed is increasing.

To be continued.........