Introduction to the Basic Elements of Modern Microeconomics.

Introduction to the Basic Elements of Modern Microeconomics. 

INTRODUCTION

This course provides the student with an introduction to the basic elements of modern microeconomics. The course provides coverage of the institutional background and the history of significant microeconomic ideas and issues in Kenya and around the world. It will develop an understanding of how microeconomics relates to practical life. Students are expected to apply the knowledge in other economics units. The study employs extensive use of diagrams and mathematical expressions in the illustration of concepts.

On successful completion of this unit, students should be able to:

• Demonstrate understanding of the fundamental methodology and principles of

Microeconomic theory and practice;

• Comprehend and critically appraise economic decisions made by governments,

Businesses and households;

• Use a range of skills to access, interpret and apply economic information in real

world situations

• Use and apply mathematical skills as appropriate – data analysis, graphs; etc;
• Have a basis for further undergraduate study in economics and business

1: Introduction

· Meaning of economics · Scarcity and choice · The concept of opportunity cost · Scope of economics · Economic methodology · Distinction between microeconomics and macroeconomics

Topic 2: The price theory

· Theory of demand · Theory of supply · The concept of equilibrium · Application of price theory

Topic 3: Theory of the consumer

· The cardinal utility theory · The ordinal/indifference curve theory · Substitution and income effects · Revealed preference hypothesis · The consumer surplus · Derivation of a household’s demand curve

Topic 4: Theory of the firm

· Theory of production · Theory of costs

Topic 5: Market structures

· Perfect/pure competition · Monopoly · Monopolistic competition · Oligopoly

2

THE MEANING OF ECONOMICS.

Economics is a social science that has been in existence for about two centuries. Various economists have tried to define it differently. Three types of definition can be identified.

a) Wealth definition

b) Welfare definition

c) Scarcity definition

a) Wealth definition

Adam smith and his disciples J.B. Say, Walker, J.S. Mill defined economics as an inquiry into the nature and courses of wealth of nations. Such a definition has been criticized as follows.(i) The definition is very selfish: it restricts economics to the study of wealth alone. The definition does not state clearly how man comes into the study.(ii) Since economics is defined in terms of material commodity, it doesn’t consider service e.g. services offered by doctors, teachers, etc.

b) Material welfare definition of economics

Alfred Marshall and his disciples, Pigou and Cannon defined economics as the study of man’s activities in the ordinary business of life. It tries to study how man acquires and uses his resources aimed at improving the welfare of mankind. In this definition, it can be noted that on the one hand, economics is the study of wealth and on the other hand, and more important, a study of man.Critism of the definition (i) The definition excludes the study of services, that is, it only takes human material welfare.(ii) Speaks of study of man’s activities during ordinary business of life. The question remains, how about during extra ordinary business life?

c) Scarcity definition of economics

Leonel Robbin (1933) improved upon the above definition and explained economics as the study of human behavior (as a relationship between scarce resources which have alternative uses) The definition has characteristics that are currently addressed in economics namely Limited/scarce resources Alternative uses Unlimited wants Scarcity: when we say that a resource is scarce, it means that it is there but cannot meet the demand. The scarce productive resource would include, land, labor, capital, entrepreneurship, and by extension technology used in the production process.

3 Alternative uses: some resources may be having more than one use. For example milk can make butter, cheese, chocolate etc.Unlimited wants: human needs are unlimited and they are recurrent in that when you satisfy a need today, the same need has to be satisfied tomorrow. They are also competitive in that they compete for the limited resources.Based on the above definition, economists today agree on a general working definition of the discipline. They conclusively define economics as the study of how man can use his scarce resources to satisfy his needs.Thus, we study economics in order to solve economic problem, which is that of allocating scarce resources among competing and unlimited wants in such a manner that greatest satisfaction is derived. To do this, the society will have to make a choice on what combination of goods and services to produce and what therefore to sacrifice. The quality that one foregoes/sacrifices in order to consume more of another is what is known as opportunity cost.The concept of scarcity and opportunity cost.Here we shall illustrate how two goods would be produced using the available scarce resources.

A 1 A

1 BB 1 O PPF Maize (Bags) Beans (Bags) N* M*

The slope of the PPF is marginal rate of transformation (MRT) The straight PPF represents constant opportunity cost. This means that factors of production can be usedin production of the two commodities equally efficiently

4 For increasing opportunity Cost, the following diagram is used;

C D Maize (bags) Beans (bags)

Illustrated by a PPF concave to the origin.For simplicity assume that a country has same resources to enable her produce only two goods, namely beans and maize. If all resources are used to produce beans, OA units will be realized worth zero (0) units of maize. On the other hand, if all resources are used to produce maize, OB units will be produced with zero (0) units of beans.Thus the line joining point A and B is the production possibility frontier (PPF) or curve. The frontier joins together different combinations of goods (beans and maize) which a country can produce using all available resources and efficiently.All points inside PPF like M are attainable though they reflect under utilization or inefficiency in the use of resources.All points outside PPF like N are unattainable because resources are scarce.Thus points along AB are attainable and reflect efficient production.Suppose initially production was at point A, then only beans would be produced, to produce OB, units of maize would thus require OA units of beans be sacrificed.Quantity OA, units of beans which has to be forgone to produce OB units of maize is the opportunity cost of producing the maize. Sacrificing of production of one good for the other is as a result of scarcity of resources.