Micro-01-01 - notes on PPC PDF

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

Syllabus: 2020-21 : Unit-01 : 4 Marks Meaning of microeconomics and macroeconomics Positive & Normative Economics What is an economy? Central problems of an economy: what, how and for whom to produce; concepts of production possibility frontier and opportunity cost.

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Q. What is a Resource/Economic Resource ? Resource is anything that needs to be consumed to obtain a benefit from it.

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Q. What is Economics? Economics is a social science which studies the way the society chooses to use its limited resources, which have alternative uses, to produce goods and services and distribute them among different groups. Economics is a study of choices to be made from available alternatives.

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Q. Define microeconomics giving examples. Ans. Micro-economics studies the behavior of individual economic units, or parts, that make up economic system. It is a study of how individual economic units i.e. firms, households and industries, make economic decisions. E.g. - Relation between price and demand of a good, price and supply of a good, price determination etc.

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Q. Define macroeconomics giving examples. Ans. Macroeconomic studies the behavior of the economy as a whole. It is study of how an economy or the people makes decisions. E.g. – national aggregates, aggregate demand, inflation, unemployment, poverty etc.

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Distinction between Microeconomics & Macroeconomics

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Microecomonics It studies microeconomic units firms, households and industries. It studies & solves how individual units make decisions i.e. make choices.i.e. what to produce, how to produce & for whom to produce. It studies relationships like relation between price and demand of goods, price and supply of goods, profit maximization by firm, price determination in an industry etc. It studies the demand & supply of individual goods & services separately in an economy

Macroecomonics It studies the behaviour of the economy as a whole. It studies & solves economic problems of economy as a whole like inflation, unemployment, poverty etc. It studies the ways and means to achieve growth and development in an economy.

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It studies aggregate demand and aggregate supply of all goods & services in an economy Examples Examples 1. Relationship between price of a commodity 1. National Income Determination & its demand 2. Government Budget Formulation 2. Supply by a firm 3. Wage Rate Determination 3. Price determination by an industry 4. Balance of Payments Studies 4. Profit maximization Notes : XII : Microeconomics : 01-01

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

K What is an economy? Economy means the whole collection of production units operating in a defined area of region by which people of that area get their living. An economy is a system which tries to balance the available resources of a country (land, labor, capital and enterprise) against the wants and needs of consumers. It deals with three key issues: 1. what is produced 2. how it is produced, and 3. for whom to produce Q. What is the basic problem of an economy? The goods & services usable to carry out production in an economy are called its resources. These are broadly classified as Land, Labor, Capital and Entrepreneurship. These are also called factors of production. The resources available to an economy are scarce whereas the wants of the society is unlimited. The scarcity of resources implies that the society have to choose the resources & use them in the best possible manner.

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What is Economic Problem? Economic problem is the problem of choosing an alternative among the available alternatives to satisfy human wants. Q. What are causes that lead to an economic problem? Ans. Economic problem occurs because of unlimited wants of society, scarcity of resources as to satisfy these unlimited wants and alternative uses of these resources. Q. What is problem of scarcity? Ans. Limited/Scarce Resources: (Problem of Scarcity) Wants of society are unlimited. Resources available to the economy are not enough to satisfy all the wants of the society. Therefore resources available to the economy are scarce or limited. e.g. is the available land enough to satisfy the needs of the society, we do not have enough capital to fund all the projects of the economy

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Q. What is problem of Alternative uses? Ans. Alternative Uses of Resources. (Problem of Alternative uses) An economic resource can be put to more than one use at a time i.e. possible alternative uses. But at one time one resource will be used for only one use. e.g. Capital is a resource. Capital at one time can be put to more than one use. Capital can be used for making consumer goods. The same capital can be used for making defense goods. That means capital at one time can be put to more than one use. It is the problem of “What to produce with these capital goods”.

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Why economics is called Social Science ? Economics is the scientific study of problem of choice. It involves the study of human economic behavior to solve the problem of choice using scientific formulation of theories, logical reasoning and scientific observations. The human behavior aspect and the scientific approach make economics a social science.

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Notes : XII : Microeconomics : 01-01

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

What do you mean by ‘Unlimited Wants’? Ans. Human wants are unlimited. Human beings are never satisfied with what they are getting. With the rise in income levels the human wants grow further. It is a never ending cycle of rise in income and rise of wants. Therefore human wants are always unlimited. What do you mean by ‘Limited Resources’? Ans. Resources available to society are limited because people want more goods & services than there are means to produce them. Land the gift of nature is fixed. The labor available to economy is limited to the human capital of the country. Capital in an economy is also not everlasting. Entrepreneurship skills available in the economy are also limited. No economy has enough resources to satisfy all the wants of the society. What are central problems in an economy? Ans. . Economics is a science that deals how (i) to choose to use its limited resources (each resource has alternative use) (ii) to produce goods and services and (iii) to distribute the produced goods & services among different groups of society. In all these aspects it is compulsory for the society to make choice. This problem of choice is described as What to produce, How to produce and For whom to Produce. These problems are basic and common to all types of economics or central to all types of economics. Therefore these are termed as central problems of the economy.

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What is problem of ‘What to produce’ ? The problem „What to produce‟ is the problem of making a choice between the commodities to be produced. The resources at the disposal of a society are scarce, therefore, society has to make a choice which goods and services are to be produced and in what quantities. A society should allocate the scarce resources in such a way that maximum production is achieved from the limited resources. It is a production decision taken by the producer. Example : The decision about the allocation of resources between the production of consumer goods or capital goods is of utmost importance from the point of view of economic, growth. In a market economy, consumer preferences influence the production decision of the firms. This problem arises because Resources to produce goods and services are scarce and have alternative uses. e.g. A piece of land is a resource and it can be used to grow rice, wheat. This problem decides What type of goods and services to be produced using scarce resources? e.g. What to grow on a particular piece of land? It may be wheat or rice or both. What quantity of goods and services to be produce using scarce resources? e.g. How much wheat and how much rice to be produced on that piece of land ?

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What is the problem of ‘How to produce’? Ans: The problem of „How to produce‟ means which method of production or which combination of resources is to be used for the production of goods. Since the resources are scarce, a nation should use the techniques of production (i.e. resource combination) which are most efficient and economical. The society has to choose the least cost combination of producing the goods. Example: Cloth can be produced with either handlooms (labor intensive technique) or power looms (capital intensive technique). The society, depending upon its resources and the state of technology available to it should use the most efficient method of production.

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Notes : XII : Microeconomics : 01-01

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

This problem arises because a good or service can be produced by employing many combinations of resources. Any combination of resource to produce is termed as technique of production. This problem decides What resource combinations or technique of production should be used to produce a good or service.

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For whom to produce ? Ans: The main objective of producing a commodity in a country is its consumption by the people of the country. Since resource are scarce and human wants are unlimited, even after employing all the resources of a country, it is not possible to produce all the commodities which are required by the people. Therefore, an economy has to decide as to for whom goods and services should be produced. Goods & services are produced for those who have the income to buy them. Income earners earn their income in form of wages, rent, profits & interest. Therefore this problem is the problem of distribution of income among the income earners. This problem arises because resources available to the economy are scarce and it is not possible to produce all the commodities which are required by the people. This problem amounts to distribution of income & wealth in the society. It is a problem of distribution of national product or national income in the society.

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Notes : XII : Microeconomics : 01-01

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

Economy Traditional Government Controlled Market

What to Produce What people needed to survive Whatever the Government decides Whatever people wants to buy and sell using market forces of demand and supply of goods & services

How to Produce Farming, Hunting & Gathering However the Government decided Supply & demand for resources (factors of production)

For whom to produce Make the products for own(self) use. Products are distributed class wise. People have to queue up to get goods. Determined by how much a person wants to pay for it.

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OPPURTUNITY COST Economics is a study of choices made from available alternatives. The alternatives mean opportunities. E.g. The producers have the opportunity to produce wheat or rice on a piece of land. The consumers have the opportunity to buy Pepsi or Coke with the money he is having. The resources available for producers to produce, consumers to consume are limited. At any point of time one resource can be engaged in one opportunity only. Every time an opportunity is taken up another opportunity has to be foregone. That means that to avail an opportunity another opportunity has to be sacrificed. The value of sacrificed/foregone resource is the opportunity cost of the opportunity availed or taken up. Example : A worker has two options to work in factory A at a wage rate of Rs.200 per day and to work in factory B at Rs.180 per day. Worker chooses to work for factory A. The next best alternative for him is to work for factory B at the rate of Rs.180 per day. For him the opportunity cost of working in factory A is Rs.180 i.e. the value of next best alternative available for him. The opportunity cost of using a given resource is defined as the value of next best use to which that resource could be put i.e. the value of next best alternative foregone. PRODUCTION POSSIBILITY CURVE The production possibilities (PP) curve is a graphical medium of highlighting the central problem of 'what to produce'. It is an economic model that solves the problem of scarcity assuming that the economy devotes all its resources in production of two goods. It decides in the end what goods will be produced and in what quantities. To decide what to produce and in what quantities, it is first necessary to know what is obtainable. The PP curve shows the options that are obtainable, or simply the production possibilities. In other words it can be said that PPC represents the full potential of the economy. The concept of PP curve is based on the following assumptions:

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1. The amount of resources available is fixed. 2. The technology of production remains unchanged. 3. The resources are fully employed. 4. The resources are efficiently employed.

Notes : XII : Microeconomics : 01-01

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

5. All the resources are not equally efficient in production of all products. i.e. if resources are transferred from production of one good to another, the cost increases. In other words marginal opportunity cost increases.

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Efficiency in production means productivity i.e. output per unit of an input. Suppose 1. the input be a worker. 2. an economy produces only two goods X and Y. 3. a worker is employed in production of X because he is best suited for it.

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Now the economy decides to reduce production of X and increase that of Y. The worker is transferred to Y. He is not that efficient in production of Y as he was in X. His productivity in Y will be low, and so the cost of production is high. It implies that if the resources are transferred from one use to another, the less and less efficient resources will be transferred leading to rise in the marginal opportunity cost which is technically termed as marginal rate of transformation (MRT).

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What is MRT? (Marginal Rate of Transformation or Marginal Opportunity Cost) MRT is defined as the ratio of the number of units of a good sacrificed to produce an additional unit of the other good, in a two good economy.

E MRT is the rate at which the quantity of output of one good is sacrificed to produce one more unit of the other good. A simplified example. Let us assume that only two goods are produced in an economy guns and butter. The guns symbolize defense goods and butter, the civilian goods. This example symbolizes the problem of choice between civilian goods and war goods In case all the resources are engaged in the production of guns, there will be a maximum amount of guns that can be produced per year. Let it be 15 units (one unit may be taken as equal to 1000, or one lakh and so on). At the other extreme suppose all the resources are employed in production of butter only. Let the maximum amount of butter that can be produced is 5 units. These are the two extreme possibilities. In between there are others if the resources are partly used for the production of guns and partly for production of butter. Given the extremes and the in-between possibilities, a schedule can be prepared. It can be called a production possibilities schedule. Let the schedule be:

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Notes : XII : Microeconomics : 01-01

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

Production Possibilities Schedule A PP schedule records the various combinations of the two goods that can be produced with the fixed resources assuming that the resources are fully and efficiently employed. Possibilities A B C D E F

Guns (units) 15 14 12 9 5 0

Butter (units) 0 1 2 3 4 5

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MRT =Change in Guns/Change in Butter

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1G : IB 2G : IB 3G : IB 4G : IB 5G : IB

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In the table the possibility A is one extreme. The society devotes all the resources to guns and nothing to butter. Suppose the society wants one unit of butter. Since resources are limited and fully and efficiently employed, to produce one unit of butter some of the resources engaged in production of guns have to be transferred to the production of butter. Let the resources worth one unit of gun are enough to produce one unit of butter. This gives us the second possibility with MRT = 1G/IB. Now suppose that the society wants another unit of butter. This requires transfer of more resources from the production of guns. Now we require transfer of resources worth 2 units of guns to produce one more unit of butter. The MRT rises to 2G/IB. MRT rises because now less efficient resources are being transferred. In this way MRT goes on rising.

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Production Possibility Curve

D U C A T I By converting the schedule into a diagram, we can get the PP curve. Refer to the figure I which is based on the PP schedule. Butter's production is shown on the x-axis and that of guns on the y-axis. We can measure MRT on the PP curve. For example MRT between the possibilities C and D is equal to CG/GD. Between D and E it is equal to DH/HE, and so on.

Diagrammatically, the slope of the PP curve is a measure of the MRT. Since the slope of a concave curve increases as we move downwards along the curve, the MRT rises as we move downwards along the curve. Notes : XII : Microeconomics : 01-01

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KSHITIJ EDUCATION Specialized Institute for Mathematics, Computer Science & Commerce 9810860991, 9910061580,47008740

Characteristics of PP Curve A t PP curve has two characteristics: (1) Downward sloping from left to right : (why ?) PP curve is based on assumption that resources available to economy are fixed. Therefore to produce more units of one goods, the resources from other good must be shifted from another good. It implies that in order to produce more units of one good, some units of the other good must be sacrificed. That is why the PP curve is downward sloping from left to right. (2) Concave to the origin : (why ?) PP curve is concave to origin because the Marginal rate of transformation(MRT) increases as we move downwards from left to right along the PP curve. MRT is defined as the ratio of the number of units of a good sacrificed to produce an additional unit of the other good, in a two good economy.

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Why does MRT always increase ?

I Increasing MRT implies that more and more quantity of a good will have to be sacrificed to produce one more unit of another good. MRT increases because it is assumed that all the factors of production are not equally efficient in production of all the goods. As more quantity of a good is produced, it requires more resources. All the resources are already fully employed in production either of the two given goods. To increase production of a good res...