Introduction to Microeconomics

The One Thing

Microeconomics explains how scarcity forces individuals, firms, and markets to make choices about allocating limited resources among competing uses. The production possibility frontier provides a model for analysing choice, opportunity cost, efficiency, resource allocation, and economic growth.

Who and What

• Economics: The study of how people and societies use scarce resources to satisfy unlimited wants.
• Microeconomics: The branch of economics concerned with individual consumers, producers, firms, and particular markets. It includes consumer behaviour, production, cost, market demand, supply, and price determination.
• Macroeconomics: The branch of economics concerned with aggregate economic variables and the economy as a whole, including national income, total employment, inflation, general price level, aggregate demand, unemployment, money, and economic growth.
• Economy: A system in which people and institutions produce, distribute, exchange, and consume goods and services.
• Scarcity: The condition in which resources are limited compared with human wants.
• Choice: The decision to select one alternative from several possible uses of scarce resources.
• Opportunity Cost: The value of the next best alternative given up when a choice is made.
• Economic Problem: The problem arising because resources are scarce, have alternative uses, and must satisfy unlimited human wants.
• Central Problems of an Economy: The basic questions of what to produce, how to produce, and for whom to produce.
• What to Produce: The decision about which goods and services should be produced and in what quantities.
• How to Produce: The decision about which production technique or combination of resources should be used.
• For Whom to Produce: The decision about how produced goods and services should be distributed among people.
• Resources or Factors of Production: Land, labour, capital, and entrepreneurship. Land includes all natural resources; labour means human effort; capital includes produced means of production; and entrepreneurship coordinates resources and bears risk.
• Production Possibility Frontier: A curve showing the maximum possible combinations of two goods that can be produced with given resources and technology.
• Production Possibility Set: All possible combinations of goods that can be produced with available resources and technology.
• Efficient Combination: A combination lying on the production possibility frontier, where available resources are fully and efficiently used.
• Inefficient Combination: A combination lying inside the production possibility frontier, indicating that some resources are unemployed or used inefficiently.
• Unattainable Combination: A combination lying outside the production possibility frontier, which cannot be produced with current resources and technology.
• Marginal Opportunity Cost: The amount of one good that must be sacrificed to produce one additional unit of another good. The opportunity cost can be expressed as:

Opportunity Cost = Quantity of Good Sacrificed / Quantity of Good Gained.

• Positive Economics: The study of facts and cause-and-effect relationships that can be tested or verified.
• Normative Economics: The study of economic statements involving opinions, values, or judgments about what ought to be.
• Market Economy: An economic system in which prices and private decisions play a major role in allocating resources.
• Centrally Planned Economy: An economic system in which major economic decisions are taken by a central authority.
• Mixed Economy: An economic system in which both markets and government participate in resource allocation.

Causes and Consequences

• Human wants are unlimited, while resources are scarce and have alternative uses. This creates the basic economic problem and makes choice unavoidable because no economy can satisfy all wants with limited resources.

• Since selecting one use of a scarce resource prevents the selection of another, every choice involves an opportunity cost. The opportunity cost is the value of the next best alternative that is given up.

• Scarcity and opportunity cost create the three central problems of every economy: what to produce, how to produce, and for whom to produce. These problems are common to all economies, although market economies, centrally planned economies, and mixed economies solve them in different ways.

• The decision about what to produce determines which goods and services are produced and in what quantities. The decision about how to produce determines the production technique or combination of resources used. The decision about for whom to produce determines how goods and services are distributed among people.

• Resources or factors of production consist of land, labour, capital, and entrepreneurship. Land provides natural resources, labour provides human effort, capital provides produced means of production, and entrepreneurship coordinates resources and bears risk.

• The production possibility frontier is usually drawn for two goods while resources, technology, and the quantity of factors remain fixed. It shows the maximum combinations that can be produced and therefore illustrates scarcity, choice, opportunity cost, efficiency, and economic growth.

• A point on the PPF represents productive efficiency because available resources are fully and efficiently used. A point inside the PPF represents underutilisation or inefficient use of resources, while a point outside the PPF is unattainable with existing resources and technology.

• Movement along a PPF represents a choice between two goods and involves opportunity cost. The slope of the PPF represents the opportunity cost of producing one more unit of one good in terms of the other.

• If resources are not equally suitable for producing both goods, the PPF generally slopes downward and is concave to the origin. This shape reflects increasing opportunity cost as more of one good is produced.

• An outward shift of the PPF indicates economic growth, improved technology, or an increase in available resources. An inward shift indicates a fall in resources, technological deterioration, or destruction of productive capacity.

• Microeconomics focuses on individual units and particular markets, whereas macroeconomics focuses on economy-wide variables. The two branches are connected because individual economic decisions contribute to wider economic activity, while macroeconomic conditions influence consumers, firms, and markets.

• In a market economy, prices and private decisions guide resource allocation. In a centrally planned economy, a central authority makes major economic decisions. In a mixed economy, markets and government jointly participate in allocating resources.

What Gets Asked

• Explain how scarcity, alternative uses of resources, and unlimited wants create the basic economic problem.
• Distinguish between microeconomics and macroeconomics, including their principal areas of study.
• Explain the three central problems of an economy and compare how market economies, centrally planned economies, and mixed economies address them.
• Interpret points on a production possibility frontier, including efficient combinations, inefficient combinations, and unattainable combinations.
• Explain how movement along a PPF demonstrates choice and opportunity cost, including the equation Opportunity Cost = Quantity of Good Sacrificed / Quantity of Good Gained.
• Evaluate the causes and implications of outward and inward shifts of the PPF, including economic growth, improved technology, changes in available resources, technological deterioration, and destruction of productive capacity.