7 + Essays on Microeconomics

Find my unique collection of essays on ‘Microeconomics’ especially written for school and college students.

Essay on Microeconomics

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Essay Contents:

1. Essay on the Introduction to Microeconomics
2. Essay on the Basic Elements of Microeconomics
3. Essay on the Three Principles of Microeconomics
4. Essay on the Types of Microeconomic Analysis
5. Essay on the Microeconomic Theories and Models: Assumptions and Reality
6. Essay on the Economic and Social Framework of Microeconomic Theory
7. Essay on the Importance of Studying Microeconomics
8. Essay on the Goals of Microeconomic Policies

Essay # 1. Introduction to Microeconomics:

Economics is conventionally divided into two main branches microeconomics and macroeconomics. The prefix ‘micro’ is derived from the Greek word meaning ‘small’. Microeconomics is the study of how people choose under conditions of scarcity .Every choice involves important elements of scarcity.

In most situations the relevant scarcity is money, but even time is also scarce. Each has opportunity cost. Coping with scarcity at an individual level is the essence of microeconomics.

Microeconomics deals with behaviour of individual economic units such as consumers, factor suppliers (workers, landowners, investors) and business firms — virtually any individual or entity that plays a role in the functioning of a modern market-based economy.

Microeconomics is essentially concerned with how and why these units make economic decisions. For example, it explains how consumers make purchasing decisions and how their choices are affected by changing prices and incomes. It also explains how firms decide how many workers to hire and how workers decide where to work and how many hours to work.

Microeconomics is a set of theories which seeks to help us gain an understanding of the process by which scarce resource are allocated among alternative (and competing) uses as also the role of prices and markets in solving the economic problems of a modern mixed economy like that of India.

Microeconomics is essentially an inquiry into the process of resource allocation. A study of microeconomic theory also enables us to predict the behaviour of economic agents such as households (who act both as consumers and factor-owners) and business firms (private).

Essay # 2. The Basic Elements of Microeconomics:

The easiest way to provide a simple overview of microeconomics is to introduce its basic elements.

These are goods and services as also prices:

1. Goods and Services (or Commodities):

These are the central objects of any economic activity. The reason is that ‘economic activity’ consists of the production and exchange of commodities. The basis of separating commodities or drawing a distinction among them is that they cannot be treated as perfect substitutes in production or consumption.

2. Prices:

In a modern market-based economy every commodity has a price which may be expressed in one or two ways. First, we may choose one commodity in the economy as a numeraire, or as the common yardstick or the measuring rod in terms of which all other prices are to be expressed.

If we take gold as the common measuring of everything, its own price is taken as 1. A numeraire is not a medium of exchange like money. It is just a unit of account. Prices then express the rate at which the numeraire exchanges for every other commodity.

The second way, and a more convenient one, in which prices might be expressed is to use a currency, such as rupee as a unit of account. There is a simple one-to-one correspon­dence between prices expressed in terms of units of account and prices expressed as commodity rates of exchange. Thus, suppose we have the set of prices expressed in rupees: p₁, p₂, …, p_n.

Then, by taking one such price, say the n-th, we form the ratios:

r₁ = P₁/P_n; r₂ = P₂/P_n; …. r_n = P_n/P_n = 1 ………………….(1)

These ratios are relative prices. Each relative price is a ratio of two absolute prices.

Each r_ij = 1, 2,… n can be interpreted as the number of units of commodity n which will exchange for one unit of commodity j, i.e., as commodity rates of exchange with n as the numeraire. Each r. will be in dimensions (units of good n I units of good j), i.e.,

p_j/p_n = (Rs. / units of good j ÷ Rs. / units of good n) …….. (2)

= (units of good n / units of good j), j = 1, 2,… n.

Thus, each r_j is the number of units of good n one could buy if one sold a unit of good j and spent the proceeds (p_j units of account) on good n. In this case there are n absolute prices for n different commodities. But there are n – 1 relative prices because the price of any commodity divided by itself is always equal to 1.

Real Vs. Nominal Prices:

In macroeconomics we speak of consumer price index (CPI) which is an aggregate measure of all prices. The rate of inflation in the economy is measured by percentage changes in CPI over time. In microeconomics we refer to two types of prices — the nominal price and the real price.

The nominal (current) price of a good is its absolute price. The real (constant) price of a good is the relative to an aggregate measure of prices. This is the inflation-adjusted price.

In microeconomics we are concerned with real rather than nominal prices. The reason is that consumers make rational choices which involve price comparisons. It is possible to make price comparisons if there is a common basis for such comparison, i.e., if all prices are quoted in real terms.

This simply means that we have always to think in terms of the real purchasing power of rupees even though we often measure prices in rupees.

Role of the Price System:

A second important theme of microeconomics is the role of prices. For example, consumer’s trade-off apples for oranges based on their preferences for each one as also their market prices. Likewise workers trade-off labour for leisure based in part on the ‘price’ that they can get for their labour, i.e., the wage rate.

And firms decide whether to hire more workers or purchase more machines based in part on wage rates and prices of machines.

Microeconomics studies the behaviour of two basic units, viz., an individual consumer (household) and a business firm. [A consumer (household) is also a owner of factors of production, called economic resources (inputs)].

It also examines the operations of two types of markets, viz.,

i. The market for commodities (which include both goods and services) and

ii. The market for economic resources (factor inputs).

The study of the interaction of households and business firms in the market for goods and services as also in the market for factor inputs constitutes the core of any microeconomic study. To be more specific, households own the labour, the capital, the land and the natural resources that business firms require to produce the goods and services households want to buy and are ready to pay for.

Business firms, in their turn, pay to household’s wages, salaries, interest, rents and so on for the services and resources that households provide. Households then use the income that they receive from the business firms to purchase the goods and services produced by business firms.

The incomes of households are items of costs of production of business firms. The expenditure incurred by households on consumption purchases are the receipts (revenues) of business firms.

These three types of flows (i.e., of goods, factors and money) between the two basic units or sectors of an economy are illustrated by the circular flow model of the economy presented in Fig. 1.2, which shows the circular flow of economic activities.

The inner part of the diagram shows the flow of resources from households to business firms as also the flow of goods and services from business firms to households. The outer part shows the flow of money in the form of factor payments from business firms to households. Such payments become the income of the households which they spend to buy goods and services from business firms.

So the money again comes back to business firms from where it flew to the household sector. The outer part of the diagram also shows the flow of consumption expenditure from household to business firms. The prices of goods and services are determined in the upper part of the diagram. Similarly the prices of resources are determined in the lower part of the diagram.

Essay # 3. Three Principles of Microeconomics:

There are three fundamental principles of microeconomics, viz.,

i. The optimisation prin­ciple,

ii. The equilibrium principle and

iii. The marginal principle.

The first principle suggests that people try to choose the best pattern of consumption that they can afford. This is almost a tautology.

If people are free to choose their action, it is reasonable to assume that they try to choose things they want rather than things they do not want.

The second principle suggests that prices adjust until the amount people demand of something is equal to the amount that is supplied. It is quite conceivable that at any given time people’s demands and supplies are not compatible, and hence something must be changing. These changes may take a long time to work themselves out and, even worse; they may induce other changes that might ‘destabilize’ the whole system.

This type of thing rarely happens. In case of apartments, we normally see a fairly stable rental price from month to month or even from year to year. We are interested in this equilibrium price and not in how the market reaches this equilibrium and how it might change over long periods of time. Equilibrium requires that the actions of different economic agents are compatible with one another.

Importance of the Concept of Margin:

The concept of ‘margin’ is of crucial importance in all areas of microeconomics. The reason is that all important microeconomic decisions are taken at the ‘margin’. In positive microeconomics the term ‘margin’ refers to anything extra.

We make use of five important marginal concepts, viz.:

(i) Marginal utility,

(ii) Marginal product,

(iii) Marginal cost,

(iv) Marginal revenue and

(v) Marginal profit.

In normative microeconomics we also make use of other marginal concepts such as social benefit, marginal social cost, marginal private benefit and marginal private cost. Due to scarcity, all economic activities (such as production, consumption, exchange, specialisation and distribution) give rise to some benefits but also involve some costs.

The aim of economic decisions is to maximise net benefits. Net benefits continue to increase as long as the marginal or the extra benefit from an economic activity exceeds the marginal (extra) cost resulting from the action. Net benefits are maximised when the marginal benefit is equated to marginal cost.

To be most specific, consumers seek to maximise the net satisfaction (utility) or net benefit that they receive by spending their limited income. The net benefit of a consumer continues to increase so long as the marginal benefit that he (she) receives from consuming one extra unit of a commodity (such as orange) exceeds the marginal (opportunity) cost of sacrificing (giving up) the consumption of another commodity.

A consumer maximises satisfaction (utility) when the marginal benefit that he receives per rupee spent on every commodity is the same. This is the essence of the law of equimarginal utility, developed by Alfred Marshall, who wrote the first book on microeconomics in 1890.

A simple example will make the point clear. Let us suppose the satisfaction or benefit that an individual gets from consuming one apple with a price of Rs. 10 is more than twice as large as the satisfaction of consuming an orange with a price of Rs. 5. In such a situation, the individual would increase net benefits or satisfaction by consuming more apples and fewer oranges.

As the consumer does this, the marginal benefit of consuming each additional apple declines, while the marginal loss in giving up each additional orange goes up. The consumer reaches the point of maximum satisfaction when the marginal benefit per rupee on each becomes equal.

A firm’s short-run marginal cost is minimised when marginal product of labour (the variable factor) is maximised. Similarly a firm maximises profit by equating marginal revenue with marginal cost. When this happens marginal profit is zero and total profit is maximum.

Essay # 4. Types of Microeconomic Analysis:

The answers to diverse problems of microeconomics depend on the type of analysis we conduct.

The convention is to divide the different types of microeconomic analysis into the following categories:

1. Positive and normative analysis;

2. Statics, comparative statics and dynamics analysis;

3. Short-run and long-run analysis; and

4. Partial and general equilibria analysis.

These distinctions are always to be kept in mind if we are to draw the correct conclusion(s).

1. Positive and Normative Analysis:

Microeconomics is concerned with both positive and normative questions. Positive questions deal with explanation and prediction, normative questions with what ought to be. Positive analysis consists of statements that describe relationships of cause and effect.

Positive analysis is central to microeconomics. Theories are developed to explain certain phenomena, tested against observations, and used to construct models from which predictions are made.

Normative analysis involves questions of what ought to be. Normative analysis is often supplemented by value judgements, weighting equity against economic efficiency. When value judgments are involved microeconomics cannot tell us the what are the best policies. Most of the value judgments involved in economic policy boil down to just trade-off—equity versus economic efficiency.

Positive economics deals with the question of what is and normative economics with the question of what ought to be. Positive economics involves description, while normative economics involves prescription or value judgement. For example, the statement that the government should guarantee a minimum wage for agricultural labourers is a prescriptive (normative) statement.

Positive statements start with assumptions and derive some conclusions (which can be checked with data). A statement such as “A profit-maximising firm will set its price equal to its marginal cost” is a statement of positive economics. Positive statements do not involve value judgements or opinions.

In this article we will start with such assumptions as “consumers maximise utility”, “firms maximise profits”, and then derive some implications from these assumptions. We shall discuss the behaviour of economically rational consumers and firms. Furthermore, we derive conclusions about the behaviour of consumers and firms from some simple assumptions, without imposing any value judgements.

2. Statics, Comparative Statics and Dynamics:

Microeconomic analysis is conventionally divided into three distinct areas of analysis: statics, comparative statics and dynamics. To start with we define the term equilibrium because all the three terms are associated with it. Equilibrium is defined as a position from which there is reason to move.

In microeconomics all attention is turns to the study of equilibrium, which is defined as the optimum position for a given economic unit (a household, a business firm, or even an entire economy) an in which the said economic unit will be deliberately striving for attainment of that position.

The attainment of equilibrium is the outcome of the impersonal balance of the forces of demand and supply in the market models and the forces of leakages and injections in the national income models.

The interplay of certain opposing forces in the two models — one micro model and one micro model — dictates an equilibrium state, if any, in which these opposing forces are just balanced against each other, thus obviating any further tendency to change.

As A.C. Chiang and K. Wainwright put it, “True, the consuming households behind the forces of demand and the firms behind the forces of supply are each striving for an optimal position under the given circumstances, but as per as the market itself is concerned, no one is aiming at any particular equilibrium price or equilibrium quantity (unless, of course, the government happens to be trying to peg the price).”

In the context of macroeconomic equilibrium, they write: “Similarly in national-income determi­nation, the impersonal balancing of leakages and injections is what brings about an equilibrium state and no conscious effort at reaching a particular social goal (such as an attempt to alter an undesirable income level by means of monetary and/or fiscal policies) needs to be involved at all.”

Statics is a branch of economics which studies the properties of position of equilibrium in the economic system. Comparative statics is the branch of economics which compares equilibrium positions when external circumstances change.

In both branches of economics we concentrate only on equilibrium positions. We are not concerned with how long it takes to achieve the equilibrium position or by what path the equilibrium is attained. Dynamics is the branch of economics con­cerned with whether an economic system in disequilibrium reaches an equilibrium position, how long it takes and the path it follows to do this.

In this book we shall not be concerned with dynamics except for the ‘Cobweb’ model. Thus, when we analyse the effect of an untimely rain on the price and output of mangoes, all we ask is what effect this has on the new equilibrium price and output of mangoes. We are not con­cerned with how long consumers and producers take to adjust to the new situation.

Nor do we ask whether the increase in price is (1) gradual as shown by arrow (a) in Fig 1.3, (2) overshooting (because of everyone overestimating the damage at first) as shown by arrow (b) or (3) oscillatory as shown by arrow (c).

Comparative statics looks at points E and E’ only but not at the paths of adjustment from E to E’. This does not mean that comparative static analysis has no use. The truth is that the analysis does give us a lot of information on where we will be going, and these information is a prelude to a dynamic analysis.

3. Short-Run and Long-Run Analysis:

A short-run is a time period during which consumers and producers have not had enough time to make all the adjustments to a new situation. A long run is a time period during which consumers and producers have had enough time to make all the adjustments to the new situation.

So time plays an important role in microeconomics. This is more so in the areas of production and cost. The distinction is drawn on the basis of the complete less or incom­pleteness of adjustment of factor supplies, which rules out or generates possibilities of substitution of factor inputs and changes in the physical aspects of production units such as the scale of production or the size of the firm.

All factors are variable and substitutable in the long run (except in situations where technology permits the use of inputs only in fixed proportions.) Moreover a change in the scale of production or in the size of the firm is possible only in the long run.

However, time also plays an important role in an individual’s consumption and saving decisions. An individual can save (lend) and/or dis-save (borrow) and adjust his consumption accordingly over time. When we study the inter-temporal choice problem, i.e., choice overtime, we see that an individual who borrows money prefers to remain a borrower if the rate of interest falls.

Similarly an individual who lends money prefers to remain a lender if the rate of interest rises. The converse is also true in each case.

4. Partial and General Equilibria Analysis:

Partial equilibrium makes use of the ceteris paribus assumption. This approach was popularized by Alfred Marshall. But in reality other conditions do not remain unchanged. This is why the focus is often on general equilibrium analysis. It is concerned with the study of the effects of certain changes and policies after all the interactions in the economy have taken place.

General equilibrium is achieved only when all the markets are in equilibrium simultaneously. General equilibrium is also known as multi-market equilibrium. This analysis is very useful because in economics everything depends on every other thing.

Essay # 5. Microeconomic Theories and Models- Assumptions and Reality:

Economics is concerned with the explanation and prediction of observed phenomena. In economics explanation and prediction are based on theories. Theories are developed to explain observed phenomena in terms of a set of basic rules and assumptions.

Economic theories are also the basis for making predictions. Theories can be used to the construct models from which quantitative predictions can be made. A model is a mathematical representation, based on economic theory, of a firm, a market or some other entity.

Economic analysis begins with models. In order to predict and explain the economic behaviour of individual consumers, resource owners, and business firms as also the operation of individual markets, various models are used in microeconomics.

The most widely used model is the supply-demand model of an individual market. A model is a simple description of the economists’ view of how things work. Economists first construct simple models and then gradually complicate them.

In constructing a model the economist has to make some ‘simplifying’ assumptions such as these:

(i) There is no uncertainty,

(ii) All consumers have the same taste and

(iii) There is only one homogeneous product.

None of these assumptions, however, is realistic. Yet these unrealistic assumptions are justified on the ground that they enable us to concentrate on the essential aspects of the problem while ignoring irrelevant details. A model is a simplified representation of the real world.

Since a model is oversimplified and its assumptions are unrealistic, it is better to start with a simplified model first and then progressively construct more and more complicated models to come closer to reality.

While suggesting that the assumptions of a theory are never descriptively realistic Milton Friedman writes:

To be important, therefore, a hypothesis must be descriptively false in its assumptions … the relevant question to ask about the assumption of a theory is not whether they are descriptively ‘realistic’ for they never are, but whether they are sufficiently good approxi­mations for the purpose at hand.

And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.

In truth, ‘realistic’ assumptions take all the relevant variables into account but are descriptively inaccurate in the sense that they simplify and idealize rather outrageously. Most economic theories do not generate any prediction. This does not mean that these theories are useless.

These theories suggest new avenues of approach and focus attention on problems that were ignored earlier. Some other economic theories are just exercises in pure deductive logic. If assumptions A, B, C, etc. are made, then conclusions X, Y, Z, etc. follow.

A model is an abstraction. It is based on certain assumptions regarding human behaviour. It seeks to explain interrelationships among economic variables in a systematic way and reach a conclusion or make a prediction on the basis of it.

For example, according to the Marshallian approach, the demand for a commodity depends on the price of the commodity, the income of the buyer(s) and the prices of other (related) goods. But in reality the demand for a commodity depends on many other factors, which are not captured by the theory of demand, based on Marshallian or any other approach.

A theory or a model is normally developed on the basis of casual observation of the real word. But it is necessary to go back to the real world in order to test whether the implications or predictions of the model are correct or not. Only when the predictions arc correct do we accept the model.

Rationality:

There are two central elements of microeconomic models regarding the distinction between consumers and producers. The first is the adoption of the individual decision-taker as the basic unit of analysis. The second is the hypothesis that this decision-taker is rational.

Rational decision-making takes the following form:

(a) The decision-taker sets out all the feasible alternatives, rejecting any which are not feasible.

(b) He takes into consideration all available information in order to assess the consequences of choosing each of the alternatives.

(c) In the light of their consequences he ranks the alternatives in order of preference, where this ordering satisfies certain assumptions of completeness and consistency.

(d) He chooses the alternative with the highest ordering, i.e., the alternative with the consequences he prefers over all others available to him.

The Cost-Benefit Approach to Decisions:

Rational people take decisions by comparing costs and benefits of any economic activity they perform.

The decision rule is very simple. If C(x) denotes the costs of doing x and B(x) the benefits, it is:

If B(x) > C(x), do x; otherwise don’t.

Monetary values are a useful common measure of costs and benefits, even in situations where an activity has nothing directly to do with money. We define B(x) as the maximum rupee amount an individual would be willing to pay to do x. C(x), in turn, is the value of all the resources he must give up in order to do x.

Method of Analysis:

The assumption of rationality implies that microeconomic models of the individual decision-takers, a representative consumer or a business firm take the form of optimisation problems. The decision-taker is assumed to seek the best alternative out of the feasible set of alternatives open to him.

Every economic unit seeks to maximise or minimise something. A typical consumer seeks to maximise utility and a representative firm seeks to maximise profit or sales revenue or minimise cost.

In developing theories of market behaviour it is necessary to aggregate the individual behaviour relationships over groups of economic agents — usually the set of buyers in a market on the one hand and the set of sellers in a market on the other, where they can be separately identified.

This latter qualification is necessary because in some market models an individual may be a buyer at some prices and a seller at other prices. If an individual is both a buyer and a seller he behaves differently than if he is only a buyer or a seller.

1. Equilibrium Methodology:

The method of analysis which is used throughout our study of microeconomic theory is equilibrium methodology. Refers to a position of rest or balance, i.e., to a situation in which the forces determining the state of that system are in balance.

This means that there is no tendency for the variables of the system to change in any direction. Since, in this book, we are concerned with static equilibrium analysis we do not study equilibrium time-paths. So we do allow variables and parameters to vary with time.

An equilibrium of a system (which may be a single market or all markets) will exist when two conditions are satisfied:

(a) Individual decision-makers have no desire to change their planned decisions or reactions.

(b) The plans of decision-makers are consistent or compatible and hence can be realised.

The significance of the concept of equilibrium is that it provides us with a solution principle. However, there are three attributes (properties) of equilibrium which have considerable significance if we want to use the equilibrium state as a prediction of the outcome of the workings of the system.

These are the following:

(a) Existence:

If a system does not possess an equilibrium, it is not possible to describe its outcome as an equilibrium state. So an equilibrium has to exist.

(b) Uniqueness:

A system may possess more than one equilibrium state and the different possible equilibria may have different properties and implications. So it is of considerable interest to know whether for a given system there is only one equilibrium state (which has to be described) or several equilibria (all of which are not significant or relevant for our analysis).

(c) Stability:

An equilibrium is said to be stable if a small deviation from it tends to create forces that bring the system back to equilibrium. An unstable equilibrium is not at all significant because it is unlikely ever actually to be attained.

The appropriate methodology of economics (or, to be most specific, microeconomics) is to test theory not only by the accuracy of its predictive power, but also by whether the predictions follow logically from the assumptions and their internal consistency.

An adequate test of the theory requires two things:

(i) Confirming that the predictions are accurate and

(ii) Showing how the outcome is a direct and logical deduction from the assumptions.

Two approaches are normally used for microeconomic analysis, viz:

(i) Partial equilibrium (Marshallian) approach and

(ii) General equilibrium (Walrasian) approach.

In the partial equilibrium approach only one commodity or factor market is studied at a time, ignoring all other markets. If the general equilibrium approach is followed, then all markets are to be studied simultaneously. The reason is that production and consumption are interrelated. The basic objective is to determine a consistent set of commodity and factor prices.

2. Certainty and Uncertainty:

Finally, when we discuss the behaviour of an individual consumer or a firm in the market place we make use of the assumption of ‘complete certainty.’ This means that all relevant facts about the market are fully known to us.

But information is not always equally and freely available to both buyers and sellers at the same time. This is why we have also to study choice and decision making under uncertainty caused by incomplete information about data relating to a commodity such as wheat or a resource such as labour service.

Markets:

Markets are at the centre of economic activity. Prices of goods and factors of production are determined in markets. Microeconomics also describes how prices are determined by the interactions of consumers, workers and firms in markets which are collections of buyers and sellers that together determine the price of a good or a factor of production.

The central role of markets is another important theme of microeconomics.

The Concept of Market:

Individual economic units are divided into two broad groups according to functions — buyers and sellers, who together interact to form markets. A market is the collection of buyers and sellers. Through their actual or potential interaction, they help to determine the price of a product or set of products. A market is much broader term than an industry.

An industry is a collection of firms that sell the same or closely related products. In effect, an industry is just one side of the market— the supply side.

Competitive Vs. Non-Competitive Markets:

In microeconomics we study the behaviour of both competitive and non-competitive markets. A perfectly competitive market has many buyers and sellers, so that no single buyer or seller has a noticeable impact on price.

Most agricultural markets resemble perfectly competitive markets closely. Some markets contain many producers but are non-competitive in nature. This mean that individual firms can jointly affect the price. The world oil market is one example.

Market Price:

Markets make possible transactions between (among) buyers and sellers. Quantities of a good are sold at specific prices. In a perfectly competitive market a single price — the market price — will usually prevail. In markets that are not perfectly competitive, different firms might charge different prices for the same product.

This might happen because one firm is trying to win customers from its competitors, or because customers have brand loyalties that allow some firms to charge higher prices than others.

The market prices of most goods may and often do fluctuate over time, and for many goods the fluctuations can be rapid. This is particularly true for goods sold in competitive markets. The stock market is an example of a highly competitive market because there are many buyers and sellers of any stock.

The Extent of a Market:

The extent of a market refers to its boundaries, both geographically and in terms of the range of products to be included in it. The extent of a market depends on various factors. The most important factor is the demand for the product.

Essay # 6. The Economic and Social Framework of Microeconomic Theory:

A major portion of microeconomic theory implicitly assumes a certain kind of institu­tional framework. Certain major economic forces are found to operate within this framework. Three facts of all economic systems and societies can be identified.

This means that the members of society want to consume more goods and services than can be produced from those resources (possessed by society), however abundant, in absolute terms they may apparently appear to be.

The second is that there are gains from specialisation more output can be produced if individuals specializes in different aspects of the production process and no one tries to produce everything he (she) needs for consumption and accumulation. Specialisation refers to the use of labour and any other resource in doing those jobs in which a resource has maximum efficiency. Output is then maximised.

Specialisation increases the efficiency of labour due to division of labour. Division of labour refers to breaking up of a task into a number of smaller, most specialised sub-tasks and assigning one of these to each worker. Such a division of labour greatly increases workers’ efficiency by allowing each worker to improve his skill through repetitive performance. As the old saying goes: practice makes a man perfect.

Division of labour also increases labour productivity by saving time lost in switching from one task to another. Specialisation and division of labour give rise to exchange. And exchange becomes meaningful only when money is used as a medium of exchange. Specialisation also occurs among nations when each country produces according own area of comparative advantage or relative efficiency.

Thirdly, information is decentralised no single individual possesses all the economi­cally relevant information, information relating to the characteristics of individuals such as their preferences and their resource endowments (their skills, talents, productivity and the quantity and quality of goods they have to sell) and the actions they take (for example, how hard or carefully they work).

Subject to these realities every society is faced with problems of organising exchange and coordinating the separate decisions of diverse individuals and numerous business firms.

The decisions taken by individuals in an economy are constrained both by technology and by the set of property rights. Technological possibilities open to society are conditioned by the fundamental physical laws which determine what outputs of goods and services can be produced from given set of resources.

Property rights specify the rules (whether formal and legal or informal custom) which specify what individuals are allowed to do with resources at their possession and the outputs of those resources. Technology is related to property rights in the sense that such rights define which of the technologically feasible economic decisions individuals are permitted to make.

Essay # 7. Importance of Studying Microeconomics:

Microeconomics is studied for two different reasons. The first is decision making at the firm level. The second is to design appropriate public policy. Companies have two be concerned about production and selling costs. Various factors effect costs of production and marketing. On the basis of its cost structure a company will have to design its pricing strategy and consider the reaction of its rivals.

Government policy-makers will have to consider the issue of air pollution connected with production and consumption activities. Since this problem is not automatically solved in a market-oriented economy, the government has to solve this problem by imposing taxes, fees, or fines on polluting firms and consumers.

In some countries clean air acts have been passed. In other countries like Singapore smoking at public place is prohibited by law.

Theme of Microeconomics:

i. Resource Allocation:

The first important theme of microeconomics is essentially about the allocation of scarce resources. This involves choice. And the choice problem is faced by consumers, factor suppliers (workers) and firms — the three basic micro-units.

ii. Consumers:

Microeconomics explains how consumers can best allocate their limited incomes to the various goods and services available for purchase. Consumers have limited income, which can be spent on a wide variety of goods and services.

The saving decisions is not discussed explicitly in microeconomics. It is the theme of macroeconomics. Consumer theory describes how consumers, based on their preferences, maximise their well-being by trading-off the purchase of more of some goods with the purchase of less of others.

iii. Workers:

Workers also face constraints and make choices. Microeconomics explains how workers can best allocate their time to labour instead of leisure. Workers often have to decide how many hours per week they wish to work, thereby trading-off labour for leisure.

iv. Firms:

Firms also face constraints in terms of products that they can produce and the resources available to produce them. Microeconomics explains how firms can best allocate limited financial resources to hiring additional workers versus buying new technology and to producing one set of products versus another.

Essay # 8. Goals of Microeconomic Policies:

Efficiency is not the only criterion that is used to evaluate resource allocation.

Microeconomics policies have two broad objectives:

i. Efficiency and

ii. Equity.

Equity refers to the perceived fairness of an outcome. There is often a conflict between the two.

The primary goal of microeconomic policy is the efficient allocation of scarce resources, having alternative uses. Resources are said to be efficiently allocated when it is impossible to increase the output of some goods without reducing that of others.

For example, if we currently produce 100 cars and 200 millions tons of wheat, but by reallocating our resources we could produce 102 cars and the same quantity of wheat, then we have not currently attained efficiency. Another aspect of efficiency requires that it is not possible to improve one person’s well-being without making someone else worse off.

Efficiency is of two types:

i. Technological efficiency and

ii. Economic efficiency.

Techno­logical efficiency refers to the use of resources in a technologically desirable way. Its assessment is not pan of economic theory. Economic efficiency refers to the employment of resources so that consumer welfare is maximised.

Another primary goal of microeconomic policy is equity or fairness in the distribution of goods and services among the people of a country. Some interpret equity as elimination of income inequality. If, for instance, a bus driver, college teacher and doctor are paid the same (or almost the same) wage, this would certainly promote income equality. Others feel that equality means equality of opportunities, not equality of rewards.

Efficiency is achieved through the use of appropriate prices. Equity can be achieved by changing the pattern of income distribution, viz., by taxes and subsidies. For example, government policies to break up monopolies are designed to promote efficiency. Personal income tax at progressive rates, unemployment compensation, subsidies, etc. are used to achieve equity by changing income level.

In general, prices are used to solve resource allocation problems. Problems of income distribution are solved solely by income taxes and subsidies not by modifying the operation ‘of the price (market) system. There is often a conflict between efficiency and equity.

This point is illustrated in Fig. 1.4. Point A marks the most efficient outcome with maximum national output. If society could redistribute income with no loss of efficiency, the economy would move toward point E.

Because redistributive programmes generally create distortions and efficiency losses the path of redistribution might move along the line ABD. Society must be decide how much efficiency to sacrifice to as to gain greater equality. But why should everyone want to avoid inefficient re-distributional programmes that will take the economy from point B to point C?

The issue of equity is often related to determinants of the impact of alternative policies on the distribution of well-being among citizens. For example, most people are concerned about the impact of government policies on such groups as the poor, the elderly or children.

No doubt, positive economic analysis of the outcome of the market mechanism and the political process is useful in providing information about the effects of government policies on income distributions. However, almost all of the microeconomic theory is concerned with the efficiency question, and the equity problem is treated only casually.

Equity problem receives very little attention because it is often considered to be outside the subject area (scope) of microeconomic theory. This is because the definition and evaluation of equity involves value judgments, and this rules out any sort of positive analysis.