DEPARTMENT OF FINANCE

University Of Dar Es Salaam

Business School
FN 100: Principles of Microeconomics
Genuine Martin
B.Com, M.A. (Economics)
Lecture 1:
The Meaning and Scope
of Microeconomics
University of Dar es
Salaam Business School “Knowledge for Management Excellence”
 Defining Economics
 Economics is the social science concerned
with the efficient use of scarce resources
to achieve maximum satisfaction of human
material wants.
 It is a study of choices made by consumers,

business firms, workers and governments.

 Scarcity is therefore the basic economic
problem.
 Wants are unlimited, but resources are
limited.
 Defining Economics
 We must therefore make choices, and with
choices, come opportunity costs.
 Economics is mainly concerned with scarce
resources and goods.
 It is the presence of scarcity that motivates

the study of how society allocates resources

and goods.
 Opportunity cost is what you give up when

you make a choice.

 Defining Economics
 For example, the cost of joining the
University for BBA is what you can buy with
tuition & other fees, what you could earn by
working and what you could do with the free
time.
 Specialization
• Because of scarcity, we specialize in what
we do best and trade that for what we
need in order to get the most out of our
resources.
• E.g. I teach; I get paid for it; I use the
money to buy food and clothes and pay
rental fees for my apartment.
• One must specialize in producing goods in
which he/she has a comparative
advantage i.e. produces a good at a lower
opportunity cost.
 Branches of Economics
 The study of Economics is divided into two
main branches; the macroeconomics and
microeconomics.
 Macroeconomics is the branch of
economics that deals with aggregate
economic variables, such as the level and
growth rate of national output, interest rates,
unemployment, and inflation.
 It considers the aggregate performance of all
markets in the economy.
 Branches of Economics
 Microeconomics is concerned with the
decisions made by individual economic
units – consumers, workers, investors and
business firms.
 It explains how:

 Consumers can best allocate their limited

incomes to the various goods and services.
 Workers can best allocate their time to
labor instead of leisure, or to one job
instead of another, etc.
 Branches of Economics
 Firms can best allocate limited financial
resources to hiring additional workers
versus buying new machinery, and to
producing one set of products versus
another.
 Microeconomics relies heavily on the use of

theory, which can (by simplification) help

to explain how economic units behave and
to predict what behavior will occur in the
future.
 Branches of Economics
 Questions of interest to micro-economists
include:
 What determines the price of particular goods
and services?
 What determines the output of particular
firms?
 What determines the wages workers
receive?
 The interest rates lenders receive?

 Typical macroeconomic questions include:

 Branches of Economics
 What determines the general price level?
 The rate of inflation?

 What determines national income and

production levels?
 Economic Analysis
 The analysis of economic issues is normally
divided into two perspectives; Positive
Economics and Normative Economics.
 Positive Economics attempts to describe
how the economy and economic policies
work without resorting to value judgments
about which results are best.
 The distinguishing feature of positive
economic hypotheses is that they can be
tested and either confirmed or rejected.
 Economic Analysis
 E.g., the hypothesis that “an increase in the
supply of money leads to an increase in
prices” belongs to the realm of positive
economics because it can be tested by
examining the data on the supply of money
and the level of prices.
 Normative Economics involves the use of
value judgments to assess the performance
of the economy and economic policies.
 Normative economic hypotheses cannot be
 Economic Analysis
 E.g., the hypothesis that “corporate tax is
bad for the economy” belongs to the realm of
normative economics because it is based on
a value judgment and therefore cannot be
tested, confirmed, or refuted.
 Most of the disagreements among

economists concern normative economic

hypotheses.
 Factors of Production
❑ Goods and services are produced by using
productive resources that economists call
factors of production which are grouped in
four categories land, labour, capital and
entrepreneurship.
❑ Land includes all natural resources (the
gift of nature) such as soil, minerals, water,
wildlife, etc.
❑ Labour is the work time and work effort
that people devote to producing goods and
 Factors of Production
 The quality of labor depends on the
knowledge and skills that people obtain from
education, on-the-job training, and work
experience.
 The tools, instruments, machines, buildings,
and other constructions that businesses use
to produce goods and services are capital.
 The human resource that organizes land,
labor, and capital is entrepreneurship.
 Factors of Production
 The rewards for use of these resources
in productive activities are rent for land;
wages for labor, interest for capital and
profit for entrepreneurship.
 Circular Flows Through Markets
 Microeconomics is concerned with the
interaction of households (individual) and
business firms to form markets and
industries.
 The figure below illustrates how households
and firms interact in the market economy.
 A firm is an economic unit that hires factors

of production and organizes those factors to

produce and sell goods and services.
 Circular Flows Through Markets
 Factors of production and goods and
services flow in one direction and money
flows in the opposite direction.
 In market economies markets coordinate
individual decisions through price
adjustments.
 A market is any arrangement that enables

buyers and sellers to get information and do

business with each other.
 The Circular Flow

International
participants
Goods and services Product
demanded markets
Goods and services
supplied

Business
Consumers Governments
Firms

Factors of
production supplied
Factors of
Factor production demanded
International markets
participants

20
 Government Involvement in the
Economy
 The circular flow of resources illustrates one
important economic agent.
 This economic agent is the government.
 There are situations in the economy where
the market may fail to efficiently allocate
resources and thus government intervention
becomes imperative.
 These situations include:
 Public Goods – some goods cannot be
provided by the market because of their non-
excludable and non-rival characteristics.
 Government Involvement in the
Economy
 While non-excludability means people
cannot be prevented from using the good,
non-rival means one person’s use of the good
does not diminish another’s use.
 A private producer has no incentive to supply
the good.
 Common Resources - the market for a
common resource, such as the environment,
ocean fishing, and certain water supplies
cannot be efficient.
 Government Involvement in the
Economy
 Common resources are non-excludable
because they cannot be assigned property
rights.
 As a result, government control is necessary
for an efficient and sustainable use of the
resources.
 Monopoly Power – the imaging of monopoly
producers due to barriers to entry and
economies of scale may result into inefficiency.
 Government Involvement in the
Economy
 Externalities - the production and
consumption of some goods create
externalities (i.e. costs and benefits that are
borne by people other than the buyer and
seller).
 Government intervention is required to correct
negative externalities (social costs).
 Asymmetric Information - competitive
markets only work efficiently when both buyer
and seller are well-informed.
 Government Involvement in the
Economy
 When the buyer is more informed than the
seller, or vice versa the market outcome is
inefficient.
 For example, in insurance markets, buyers
know more about their riskiness than sellers.
 How Does the Government
Intervene in the Economy?
 The government produces goods and
services, including roads and national defense.
 The government transfers income through
both the tax system and expenditure.
 The government collects taxes, and that alters
economic behavior. For instance, taxes on
labor change the incentives to work.
 The government regulates economic activity
through environmental protection, workplace
safety, and consumer protection.
 The Economic Problem

❑ Because of scarcity of resources every

economy always seek answers to the following
three questions
❑ 1. What to produce
❑ 2. How to produce?
❑ 3. For whom to produce?
❑ The three questions are answered differently
in different economies.
❑ Under pure capitalism the questions are
answered by the interaction between buyers
and sellers.
 The Economic Problem

❑ Markets unrestricted, private property and

prices coordinate the market.
❑ In the command economic system the
government answers all the questions.
❑ Under mixed market economies, the
government has a role to play.
❑ Enforces property rights, regulates markets
and levies taxes to provide goods & services
 The Production Possibilities Frontier
(PPF)
 The economy uses its resources and
technology to produce the maximum
number of goods possible.
 The Production Possibilities Frontier
(PPF) is an economic model used for
economic analysis of production decisions.
 The PPF is the boundary between those
combinations of goods and services that can
be produced and those that cannot.
 The Production Possibilities Frontier
(PPF)
 The PPF shows the goods that an economy
is capable of producing with its currently
available resources and technology
 The PPF is also used to explain the concepts
of scarcity, choice, & opportunity cost.
 To illustrate the PPF, we focus on two goods
at a time and hold the quantities of all other
goods and services constant.
 The Production Possibilities Frontier
(PPF)
 Everything remains the same (ceteris
paribus) except the two goods we’re
considering.
 The PPF

Unattainable point,
10 given available technology,
resources and labor force
8
Efficient C D
Colla

6
points
B
4
A
Inefficient
2 point
0
2 4 6 8 10
Pizza
32
 Production Possibilities Frontier (PPF)
 The figure above shows the PPF for two
goods: cola and pizza.
 Any point on the frontier such as E and any
point inside the PPF such as Z are
attainable.
 Points outside the PPF are unattainable.

 We achieve production efficiency if we

cannot produce more of one good without

producing less of some other good.
 Production Possibilities Frontier (PPF)
 Points on the frontier are efficient.
 Any point inside the frontier, such as Z, is
inefficient.
 At such a point, it is possible to produce
more of one good without producing less of
the other good.
 At Z, resources are either unemployed or
misallocated.
 Production Possibilities Frontier (PPF)
 Every choice along the PPF involves a
tradeoff i.e. we must give up some cola to
get more pizzas and vise versa.
 The outward bow (concave) of the PPF
means that as the quantity produced of
each good increases, so does its
opportunity cost.
 As we move down along the PPF, we
produce more pizzas, but the quantity of
cola we can produce decreases.
 Production Possibilities Frontier (PPF)
 The opportunity cost of a pizza is the cola
forgone.
 In moving from E to F the opportunity cost
of the fifth 1 million pizzas is 5 million cans
of cola.
 Note that the opportunity cost of a can of

cola is the inverse of the opportunity cost

of a pizza i.e. one can of cola costs 1/5 of a
pizza.
 Production Possibilities Frontier (PPF)
 Since all the points along the PPF are
efficient to determine which of the
alternative efficient quantities to produce,
we compare marginal costs and benefits.
 The marginal cost of a good or service is

the opportunity cost of producing one more

unit of it.
 Production Possibilities Frontier (PPF)

 In the above figure, as we move along

the PPF in part (a), the opportunity cost
of producing one more pizza is the
marginal cost of a pizza.
 Economic Growth: Shifts in the
PPF
❑ The expansion of production possibilities—
and increase in the standard of living—is
called economic growth.
❑ Two key factors influence economic
growth:
❑ * Technological change is the development
of new goods and of better ways of
producing goods and services.
❑ * Capital accumulation is the growth of
capital resources, which includes human
capital.
 Economic Growth: Shifts in the
PPF
 When resources increases and/or the
technology advances the PPF shifts
outward from its origin.
 More cola and/or pizzas will be produced.

 The unattainable becomes attainable.

 The economy will grow.

 Shifts in the PPF

Neutral Technological Change

Colla

C
A

0 B D Pizza
42
 Shifts in the PPF

Biased Technological Change

Colla
C
B

0
A Pizza
43