Microeconomics Introduction The term economics owes its origin to the Greek word oikonomia meaning Household. The definition of economics in terms of using scarce resources to satisfy sat isfy human wants is correct but it is incomplete. On one hand the productive capacity of modern economics has grown tremendously. Population and labor force have increased; new resources of raw material have been discovered. While on the other hand, the resulting growth in production and income has not been smooth. Economics, therefore, concerts itself not just with how a nation allocates to various uses its scarce productive resources, important as that may be. It also deals with the process by which the productive capacity of these recourses is increased and with the factors which in the past have led to sharp fluctuations in the rate of utilization of resources. The study of economics will help in analyzing the possible causes contributory to these problems and might suggest a number of alternative courses, which could be adopted for tackling these problems. Economics cannot ensure that all the problems can be tackled.
The term “micro” is derived from Greek word “Mikros” meaning small. Microeconomics Microeconomics is the study of “particular firms, particular households, individual, price, wages, incomes, individual industries and particular commodities,” according to K.E.Boulding. The subject matter of micro economics fundamentally covers the following areas: Theory of value (product pricing and factor pricing) Theory of Economic Welfare.
According to Maurice Dobb, Dobb, “micro economics is a microscopic microscopic study of the economy.” Adam smith is considered considered as the founder of microeconomics microeconomics (The Wealth of Nations).
Micro economic theory is often called as the t he ‘Price Theory’ or the ‘value theory’ because it is primarily concerned with determination of relative prices of different goods. Its approach is always specific or non aggregative.
Themes of Microeconomics Much of microeconomics is about limits-the limited incomes that consumers can spend on goods and services, the limited budgets and technical know-how that firms can use to produce things, and the limited number of hours in a week that a worker can allocate to labor and leisure. But microeconomics is also about ways to make the most of these limits. More precisely, it is about allocation of scarce resources. In a planned economy such as that of Cuba, North Korea, or the former Soviet union< these allocation decisions are made by the government. Firms are told what and how much to produce, and how to produce it; workers have little flexibility in choice of jobs, hours worked, or even where they live; and consumers typically have a very limited set of goods to choose from. As a result, many of the tools and concept of microeconomics are of limited relevance in those countries.
Trade-offs Microeconomics describes the trade-offs that consumers, workers, and firm face, and shows how these trade-offs are best made. The following are the various types of trade-offs
Consumers Consumers have limited incomes, which can be spent on a wide variety of goods and services, or saved for the future. Consumer theory describes how consumers, based on their preferences, maximize their well-being by trading off the purchase of more of some goods for the purchase of less of others.
Workers Workers also have to face constraints and make trade-offs. They face trade-offs in their choice of employment. Some chose to work for larger companies while some chose to work with smaller companies. Finally, workers must decide how many hours per week they wish to work, thereby trading off labor for leisure.
Firms Firms also face limits in terms of the kinds of products that they can produce, and the resources available to produce them. For example, iBall Company is very good at producing computers and headphones, but it does not have the ability and capital to produce pharmaceuticals or airplanes. The theory of firms describes how these trade-offs can best be made.
Prices and Markets A second important theme of microeconomics is the role of prices. All of the trade-offs described above are based on the prices faced by consumers, workers, or firms. Microeconomics also describes how the prices are determined. In a centrally planned economy, prices are set by the government. In a market economy, prices are determined by the interactions of workers, consumers and firms. These interactions occur in markets and a good price is determined.
Equilibrium Equilibrium refers to a condition which is stable and has no tendency to change. If a person or an economic entity considers a situation as the “best attainable” under the prevailing conditions, it implies that any change from it is undesirable. For example, a firm attains equilibrium when it maximizes profit, given the cost and revenue conditions. The concept of “Equilibrium” is very important for economic analysis.
Ceterisparibus Economists use the term ceteris paribus as a ''short hand'' for all other variables remaining the same. What are these other variables? Some of the factors that affect demand include consumers' incomes, their tastes and preferences; the season... there are many factors that affect demand. We will investigate some of these in more depth later. Demand, in a market economy, means the behavior of consumers who are able to buy the commodity. If you have no money, your tastes and preferences are simply ignored. When we talk about demand, we are talking about effective demand.
Theories and Models Like any science economics is concerned with the explanations of observed phenomena. The explanations and prediction are based on theories. Economic theories are also the basis for making predictions. When evaluating a theory, it is important to keep in mind that is invariably imperfect. This is the case in every branch of science. In physics, for example, Boyle’s law relates the volume, temperature, and pressure of a gas. This law has assumptions and conditions as well. The situation is the same in economics. For example, because firms do not maximize their profits all the time, the theory of the firm has had only limited success in explaining certain aspects of firms’ behavior, such as the timing of capital investment decisions. The theory does explain a broad range of phenomena regarding the behavior, growth, and evolution of firms and industries, and has thus become an important tool for managers and policymakers.
Equilibrium In economics, economic equilibrium is a state of the world where e conomic forces are balanced and in the absence of external influences the (equilibrium) values of economic variables will not change. It is the point at which quantity demanded and quantities supplied are equal. Market equilibrium, for example, refers to a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. This price is often called the equilibrium price or market clearing price and will tend not to change unless demand or supply change. When the price is above the equifferent points of economic equilibrium. In most simple microeconomic stories of supply and demand in a market a static equilibrium is observed in a market; however, economic equilibrium can exist in non-market relationships and can be dynamic. Equilibrium may also be multi-market or general, as opposed to the partial equilibrium of a single market. In economics, the term equilibrium is used to suggest a state of "balance" between supply forces and demand forces. For example, an increase in supply will disrupt the equilibrium, leading to lower prices. Eventually, a new equilibrium will be attained in most markets. Then, there will be no change in price or the amount of output bought and sold — until there is an exogenous shift in supply or demand (such as changes in technology or tastes). That is, there are no endogenous forces leading to the price or the quantity. Not all economic equilibria are stable. For an equilibrium to be stable, a small deviation from equilibrium leads to economic forces that returns an economic sub-system toward the original equilibrium. For example, if a movement out of supply/demand equilibrium leads to an excess supply (surplus, or glut), that excess induces price declines which return the market to a situation where the quantity demanded equals the quantity supplied. If supply and demand curves intersect more than once, then both stable and unstable equilibria are found. Most economists e.g., Paul Samuelson, caution against attaching a normative meaning (value judgments) to the equilibrium price. For example, food markets may be in equilibrium at the same time that people are starving (because they cannot afford to pay the high equilibrium price).
Demand Dr. Alfred Marshall has defined “Demand as the desire for a commodity, backed by the ability to buy and willingness to pay for it, at a given price during particular period of time.” DEMAND = DESIRE + ABILITY TO BUY + WILLINGNESS TO PAY There are various determinants of demand. Some of them are as following Fashion: some goods are demanded on account of fashion, goods out of fashion will cease to have demand. Utility: demand for any commodity arises because of its utility to the consumer. The higher the utility, the greater is the demand for it and vice versa. Quality of a commodity: the better the quality of the good, the more will be the demand for it and vice versa. Good's own price: The basic demand relationship is between potential prices of a good and the quantities that would be purchased at those prices. Generally the relationship is negative meaning that an increase in price will induce a decrease in the quantity demanded. This negative relationship is embodied in the downward slope of the consumer demand curve. The assumption of a negative relationship is reasonable and intuitive. If the price of a new novel is high, a person might decide to borrow the book from the public library rather than buy it. Or if the price of a new piece of equipment is high a firm may decide to repair existing equipment rather than replacing it. Price of related goods: The principal related goods are complements and substitutes. A complement is a good that is used with the primary good. Examples include hotdogs and mustard, beer and pretzels, automobiles and gasoline. (Perfect complements behave as a single good.) If the price of the complement goes up the quantity demanded of the other good goes down. The other main categories of related goods are substitutes. Substitutes are goods that can be used in place of the primary good. The mathematical relationship between the price of the substitute and the demand for the good in question is positive. If the price of the substitute goes down the demand for the good in question goes down. Personal Disposable Income: In most cases, the more disposable income (income after tax and receipt of benefits) you have the more likely you buy. Tastes or preferences: The greater the desires to own a good the more likely you are to buy the good. There is a basic distinction between desire and demand. Desire is a measure of the willingness to buy a good based on its intrinsic qualities. Dema nd
is the willingness and ability to put one's desires into effect. It is assumed that tastes and preferences are relatively constant. Consumer expectations about future prices and income: If a consumer believes that the price of the good will be higher in the future he is more likely to purchase the good now. If the consumer expects that her income will be higher in the future the consumer may buy the good now. In other words positive expectations about future income may encourage present consumption.
Demand Curve: In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule. The demand curve for all consumers together follows from the demand curve of every individual consumer: the individual demands at each price are added together. Demand curves are used to estimate behaviors in competitive markets, and are often combined with supply curves to estimate the equilibrium price (the price at which sellers together are willing to sell the same amount as buyers together are willing to buy, also known as market clearing price) and the equilibrium quantity (the amount of that good or service that will be produced and bought without surplus/excess supply or shortage/excess demand) of that market. In a monopolistic market, the demand curve facing the monopolist is simply the market demand curve. According to convention, the demand curve is drawn with price on the vertical axis and quantity on the horizontal axis. The function actually plotted is the inverse demand function. The demand curve usually slopes downwards from left to right; that is, it has a negative association (for two theoretical exceptions, see Veblen good and Giffen good). The negative slope is often referred to as the "law of demand", which means people will buy more of a service, product, or resource as its price falls. The demand curve is related to the marginal utility curve, since the price one is willing to pay depends on the utility. However, the demand directly depends on the income of an individual while the utility does not. Thus it may change indirectly due to change in demand for other commodities.
Supply In economics, supply is the amounts of some product producers are willing and a ble to sell at a given price all other factors being held constant. Usually, supply is plotted as a supply curve showing the relationship of price to the amount of product businesses a re willing to sell.
Factors affecting supply Innumerable factors and circumstances could affect a seller's willingness or ability to produce and sell a good. Some of the more common factors are: Goods own price: The basic supply relationship is between the price of a good and the quantity supplied. Although there is no "Law of Supply", generally, the relationship is positive or direct meaning that an increase in price will induce and increase in the quantity supplied. Price of related goods: For purposes of supply analysis related goods refer to goods from which inputs are derived to be used in the production of the primary good. For example, Spam is made from pork shoulders and ham. Both are derived from Pigs. Therefore pigs would be considered a related good to Spam. In this case the relationship would be negative or inverse. If the price of pigs goes up the supply of Spam would decrease (supply curve shifts up or in) because the cost of production would have increased. A related good may also be a good that can be produced with the firm's existing factors of production. For example, a firm produces leather belts. The firm's managers learn that leather pouches for smart phones are more profitable than belts. The firm might reduce its production of belts and begin production of cell phone pouches based on this information. Finally, a change in the price of a joint product will affect supply Conditions of Production: The most significant factor here is the state of technology. If there is a technological advancement in one's good's production, the supply increases. Other variables may also affect production conditions. For instance, for agricultural goods, weather is crucial for it may affect the production outputs. Expectations: Sellers expectations concerning future market condition can directly affect supply. If the seller believes that the demand for his product will sharply increase in the foreseeable future the firm owner may immediately increase production in anticipation of future price increases. The supply curve would shift out. Note that the outward shift of the supply curve may create the exact condition the seller anticipated, excess demand.
Price of inputs: Inputs include land, labor, energy and raw materials. If the price of inputs increases the supply curve will shift in as sellers are less willing or able to sell goods at existing prices. For example, if the price of electricity increased a seller may reduce his supply because of the increased costs of production. The seller is likely to raise the price the seller charges for each unit of output. Number of suppliers - the market supply curve is the horizontal summation of the individual supply curves. As more firms enter the industry the market supply curve will shift out driving down prices. Government policies and regulations: Government intervention can have a significant effect on supply. Government intervention can take many forms including environmental and health regulations, hour and wage laws, taxes, electrical and natural gas rates and zoning and land use regulations.
Supply Curve: The relationship of price and quantity supplied can be exhibited graphically as the supply curve. The curve is generally positively sloped. The curve depicts the relationship between two variables only; price and quantity supplied. All other factors affecting supply are held constant. However, these factors are part of the supply curve and are present in the intercept or constant term. There is no such thing as a monopoly supply curve. Perfect competition is the only market structure for which a supply function can be derived. A function is a rule which assigns to each value of a variable one and only one value of the function. In a perfectly competitive firm the price is given. A manager of a competitive firm can tell you precisely what quantity of goods will be supplied for any price by simply referring to the firm's marginal cost curve. To generate his supply function the seller could simply initially set price equal to zero and then incrementally increase the price at each price level he could calculate the quantity supplied using the supply equation following this process the manager could trace out the complete supply function. A monopolist cannot replicate this process. A change in demand can result in the "changes in price with no changes in output, changes in output with no changes in price or both". There is simply not a one to one relationship between price and quantity supplied. There is no single function that relates price to quantity supplied.
Elasticity of Demand Elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price (holding constant all the other determinants of demand, such as income). It was devised by Alfred Marshall. Price elasticity is almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods have a positive ED. In general, the demand for a good is said to be inelastic (or relatively inelastic ) when the ED is less than one (in absolute value): that is, changes in price have a relatively small effect on the quantity of the good demanded. The demand for a good is said to be elastic (or relatively elastic ) when its ED is greater than one (in absolute value): that is, changes in price have a relatively large effect on the quantity of a good demanded. Revenue is maximized when price is set so that the ED is exactly one. The ED of a good can also be used to predict the incidence (or "burden") of a tax on that good. Various research methods are used to determine price elasticity, including test markets, analysis of historical sales data and conjoint analysis.
Factors affecting the elasticity of demand
Availability of substitute goods Breadth of definition of a good Percentage of income Necessity Duration Brand loyalty Who pays
Ed = 0: Perfectly inelastic demand
E d = - ∞: Perfectly elastic demand
- 1 < Ed < 0: Inelastic or relatively inelastic demand Ed = - 1: Unit elastic, unit elasticity, unitary elasticity, or unitarily elastic demand - ∞ < Ed < - 1: Elastic or relatively elastic demand
Elasticity of supply In economics, price elasticity of supply is an elasticity defined as a numerical measure of the responsiveness of the supply of a given good to a change in the price of that good. Price elasticity of supply is a measure of the sensitivity of the quantity of a good supplied in a market to changes in the market price for that good, ceteris paribus. Per the law of supply, it is posited that at a given price and corresponding quantity supplied in a market, a price increase will also increase the quantity supplied.PES is a numerical measure (coefficient) of by how much that supply is affected.
In other words, PES is the percentage change in quantity supplied that one would expect to occur after a 1% change in price. For example, if, in response to a 10% rise in the price of a good, the quantity supplied increases by 20%, the price elasticity of supply would be 20%/10% = 2.
Factors affecting elasticity of supply
Availability of raw materials Length and complexity of production Time to respond Excess capacity Inventories
Production Function In microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs. This function is an assumed technological relationship, based on the current state of engineering knowledge; it does not represent the result of economic choices, but rather is an externally given entity that influences economic decision-making. Almost all economic theories presuppose a production function, either on the firm level or the aggregate level. In this sense, the production function is one of the key concepts of mainstream neoclassical theories. Some non-mainstream economists, however, reject the very concept of an aggregate production function. In micro-economics, a production function is a function that specifies the output of a firm for all combinations of inputs. A meta-production function(sometimes met production function) compares the practice of the existing entities converting inputs into output to determine the most efficient practice production function of the existing entities, whether the most efficient feasible practice production or the most efficient actual practice production. In either case, the maximum output of a technologically-determined production process is a mathematical function of one or more inputs. Alternatively, a production function can be defined as the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. It is usually presumed that unique production functions can be constructed for every production technology. The primary purpose of the production function is to address allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors. Under certain assumptions, the production function can be used to derive a marginal product for each factor, which implies an ideal division of the income generated from output into an income due to each input factor of production.
Cost of Production In economics, the cost-of-production theory of value is the theory that the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can compose any of the factors of production (including labor, capital, or land) and taxation. The theory makes the most sense under assumptions of constant returns to scale and the existence of just one non-produced factor of production. These are the assumptions of the so-called non-substitution theorem. Under these assumptions, the long run price of a commodity is equal to the sum of the cost of the inputs into that commodity, including interest charges. Market price is an economic concept with commonplace familiarity; it is the price that a good or service is offered at, or will fetch, in the marketplace; it is of interest mainly in the study of microeconomics. Market value and market price are equal only under conditions of market efficiency, equilibrium, and rational expectations. In economics, returns to scale and economies of scale are related terms that describe what happens as the scale of production increases. They are different terms and are not to be used interchange Cost of production per unit is the costs associated with production divided by the number of units produced. The difficulty in calculating the cost of production is usually thought to be in assembling all the costs associated with production and there are volumes written about the correct procedures. However, the question of the relationship of the cost of production to the price of the product is seldom discussed. One reason for this is the relationship seems very straightforward. In single product enterprises, the cost of production can be compared directly to the price of the product, regardless of the method used to calculate the cost of production. Determining the relationship between cost of production and the product’s price in joint product enterprises is more difficult. A joint product enterprise in one in which two or more products are produced from one production practice and the costs associated with the production of each individual product cannot be measured with existing information.
Competitive Markets In economics, market structure (also known as the number of firms producing identical products). Monopolistic competition, also called competitive market, where there are a large number of firms, each having a small proportion of the market share a nd slightly differentiated products. Monopoly, where there is only one provider of a product or service. Natural monopoly, a monopoly in which economies of scale cause efficiency to increase continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms. Oligopoly, in which a market is dominated by a small number of firms that together control the majority of the market share. Duopoly, a special case of an oligopoly with two firms. Perfect competition is a theoretical market structure that features unlimited contestability (or no barriers to entry), an unlimited number of producers and consumers, and a perfectly elastic demand curve.
Market Structure
Seller Entry Barriers
Seller Number
Buyer Entry Barriers
Buyer Number
Oligopoly
No
Many
No
Many
Monopoly
Yes
One
No
Many
Case study iBall
“Your eyeball view, Our technology new”
In September 2001, iBall introduced its first mouse in India. iBall today has grown into a leading brand with over 275 products spread across 19 categories. iBall is a well accepted brand in the corporate world and is fast becoming a household name throughout the country. iBall today is Rs.3000 million enterprises. But even iBall had competition, when it entered the Indian market. They came up with new products in the IT market. The design and efficient production of iBall’s products involved not only impressive engineering but a lot of economics as well. First, iBall had to think carefully about the public would react to the design and performance of its products. How strong would demand be initially, and how fast would it grow? How would demand depend on the prices that iBall charged? Understanding consumer preferences and trade-offs and predicting demand and its responsiveness to price are essential to iBall and every other manufacturer. Next iBall had to be concerned with the cost of manufacturing these products. How high would production costs be? How would costs depend on the number of products produced each year? How much and how fast would costs decline as managers and workers gained experience with the production process? And to maximize profits, how many of these new products should iBall plan to produce each year? iBall also had to design a pricing strategy and consider how competitors would react to it. For example, if iBall charges a low price for the basic version of the assembled computer but high price for individual options, such as keyboard? Or would it be more profitable to make these options “standard” items and charger higher price for the assembled computer? Whatever strategy iBall used how were the competitors going to react? As launching any new products requires large investment in new capital equipment, iBall had to consider both the risks and possible outcomes of its decisions. Some as due to uncertainty over the wages that ford would have to pay its workers. What would happen if the government increases tax on imports and exports? How should iBall take these uncertainties into account when making investment decisions? iBall also had to worry
about organizational problems. iBall is an integrated firm in which separate divisions produce engines and parts and then assemble finished products. How should manager of different divisions be rewarded? Finally, iBall had to think about its relationship to the government and the effects of regulatory policies. For example, all of iBall’s products must meet safety regulations. How might these regulations and standards change over time? How might t hey affect costs and profits?
equilibrium
demand, supply and elasticity of demand production function
cost of production
competitive markets
To deal with the competitive market iball launched many other products like keyboards, speakers, headsets, LCD monitors, laptops and many more products. It launched seven new models of mobile phones for senior citizens in India in the year 2009-2010 as well as floating and water proof headsets. Golden Rhino Awards - 2007 (360 Magazine Survey) No.1 Mouse Brand No.1 Cabinet Brand No.1 Speaker Brand No.1 Keyboard Brand iball is growing rapidly in the oligopolistic market. The company entered the Tablet market this year with the new iball slide. It runs on the android operating system and is available for Rs.13,995.
Bibliography Google iBall company Pearson
Made by Mahaan Bhosle (10112) Shreya Chande (10132) Raunak Sharma (10082) Nishant Tahilramani (10087) Deep Ramkumar (10094)