PRINCIPLES OF

MICROECONOMICS (ECON104)

LECTURER: MRS E RWAVEYA

Office 212 commerce building
 Learning objectives
TO BE ABLE TO;
- Explain what economics is all about.
- Define economics
- Explain why economics is a social science
- Explain what an economic problem is
- Define the concept of opportunity cost
- Describe the PPC
- Distinguish between positive and normative
economics
- Comment on why economists disagree on certain
issues
WHAT IS ECONOMICS?

Economic Issues And Concepts

 Economic Issues And Concepts
• Economics-is the study of the study of
how individuals and societies use limited
resources to satisfy unlimited wants.
• Lionel Robbins, defined Economics as a
science which studies human behavior as
a relationship between ends and scarce
means which have alternative uses.
• Other definitions:
• Marshall(1824-1924) – study of mankind in
the ordinary business of life.
• Paul Samuelson- Economics is the study of
how societies use scarce resources to produce
valuable commodities and distribute them
among different people.
• Art of living, we encounter problems that
need to be solved.
• Thus, in any decision of life there is an
economic problem: choice under conditions of
scarcity.
Two fundamental facts:
• a) society wants are virtually unlimited or
insatiable
• b) economic resources are limited in supply or
scarce.( scarcity)
• Therefore the central elements are scarcity
and choice it means individuals and societies
must choose among available alternatives.
• Microeconomics - is concerned with
decision-making by individual economic
agents such as firms and consumers.
• Macroeconomics - is concerned with the
aggregate performance of the entire economic
system
 Resources
• Land-natural endowments e.g. arable land,
forests, lakes and minerals
• Labour – human resources both mental and
physical; size of labour force (quantity) and
skills of labour force (quality)
• Capital – all manufactured aids to production
i.e. goods used to produce other goods such
as tools, machinery and buildings NOT
financial capital.
• Entrepreneurship – human resources; ideas
• These are factors of production – used to
produce the things that people desire i.e.
goods and services
• Goods – tangible
• Services – intangible
• People use goods and services to satisfy
many of their wants.
•The act of making goods is called production
•The act of using then is called consumption
•Scarce resources entail constrained choice
•Scarcity implies that choices must be made
•Making choices implies the existence of
costs (opportunity cost)
Decision to have more of something requires
a decision to have less of something else
• How then can the scarce resources be
allocated to satisfy unlimited wants in a
manner that will create the most benefit
to society
• How do people make best decisions?
Think and make decisions like an
economist
 How people make decisions: some lessons of economics
(Mankiw (2017),

Lesson 1: People face trade-offs

• Decision making generally involves trading off

one thing for another

• Good decision making requires an

understanding/evaluation of the available
options
 The lessons of economics.

Lesson 2: The cost of something is what you

give up to get it.
• Decision making requires a comparison of the
costs and benefits of alternative choices.
• Determining the ‘real’ cost of a choice is not
always easy.
• An opportunity cost applies to all choices.
“The opportunity cost [of an item is] whatever
must be given up to obtain some item”
 The lessons of economics.

Lesson 2: The cost of something is what you give up to

get it.
To calculate opportunity cost of a particular choice
consider all of the resources involved /used if that
choice is taken.
Next estimate the value of these resources if they were
to be used in their next best alternative use.
Example: Should I purchase a new laptop computer?
• Consider purchase price of laptop.
• Consider time spent researching most appropriate
brand.
 The lessons of economics.

• Consider time spent researching where you can get

the best price
• Consider the next best alternative use of your time
• Consider the next best alternative use of the
purchase price of the laptop
Now consider the following
a) Enrolling at UZ for Bsc Economics vs Work
b) Going to a lecture or sleeping
 The lessons of economics.
Lesson 3: Rational people think at the margin

“Marginal changes [are] small incremental adjustments to

a plan of action”
• People make decision by comparing costs and benefits
at the option.
Example: What is the cost of undertaking the next
additional action – e.g.. Studying for one more hour for
your econ104 exam (marginal cost) compared to the
benefit from studying for that additional hour (marginal
benefit)?
• A decision is rational if the marginal benefit is equal to
or exceeds the marginal cost
 The lessons of economics.

Lesson 4: People respond to incentives

Marginal changes in costs or benefits motivate people

to respond.
Example:
Financial incentives such as changes to tax rules alter
the savings/spending patterns of individuals
Changes in price alter the spending patterns of
consumers
 The lessons of economics.

Lesson 5: Trade can make everyone better off

• Trade allows individuals/countries to specialise

in what they do best.
• Think about the types of goods/services
exported and imported from your Zimbabwe.
 The lessons of economics.

Lesson 6: Markets are usually a good way to

organise economic activity

Households decide what to buy and

who to work for.
Firms decide who to hire and what to
produce
 The lessons of economics.

Lesson 7: Governments can sometimes improve

market outcomes
• Markets sometimes fail to operate efficiently
“Market failure [is] a situation in which a market
left on its own fails to allocate resources
efficiently”
Two causes of market failure are the existence
of:
• Externalities
• Market power
 The lessons of economics.

Lesson 7: Governments can sometimes improve

market outcomes
An “externality [is] the impact of one person’s
actions on the wellbeing of a bystander”

“Market power [is] the ability of a single

economic actor (or small group of actors) to
have a substantial influence on market prices
 The lessons of economics.

• Lesson 8: A Country’s Standard of Living

Depends on Its Ability to Produce Goods and
Services

• Citizens of high-income countries have more

goods and better services and a longer life
expectancy than citizens of low-income
countries.
 The lessons of economics.

• Lesson 9: Prices Rise When the Government

• Prints Too Much Money
 The lessons of economics.
• Lesson 10: Society Faces a Short-Run Trade-off between
Inflation and Unemployment
• Although a higher level of prices is, in the long run, the
primary effect of increasing the quantity of money, the
short-run story is more complex and controversial.
• Most economists describe the short-run effects of
monetary injections as follows:
- Increasing the amount of money in the economy
stimulates the overall level of spending and thus the
demand for goods and services.
-Higher demand may over time cause firms to raise their
prices, but in the meantime, it also encourages them to
hire more workers and produce a larger quantity of goods
and services.
- More hiring means lower unemployment.
 Four Key Economic Questions

• Resources are scarce, all societies

face the problem of deciding what
to produce and how each person
will consume.
• Societies differ as to who makes
the choices and how they are
made.
• What is produced and how?
- concerns the allocation of scarce resources
among alternative uses i.e. land, labour and
capital
• What is consumed and by whom?
- These two questions fall in the realm of
Microeconomics:
- is the study of the causes and consequences of
the allocation of resources as it is affected by the
workings of the price system and government
policies that seek to influence it.
- It studies choices of consumers, firms and how
government affects these choices.
• Why are some resources sometimes
idle?
• Is productive capacity growing? –shown
by outward shift of PPF.
• These questions fall in the realm of
macroeconomics:
– is the study of the determination of
economic aggregates such as total output,
total employment, the price level, and the
rate of economic growth.
 Who makes the choice and how?
• This is done through the organizational
mechanism called the Economic System.
• Social organisation is an important part of
economic organisation because it can
influence the use of resources
• Three aspects need to be highlighted.
a) Ownership of resources
b) Control of the uses of resources
c) Goals and objective of the controllers of
resources
 Who makes the choice and how?
Types of Economic System:
a) Traditional
b) Command economy
c) Free market economy
d) Mixed economy
 Economic systems
• An economic system describe how a country’s
economy is organised.
– Because resources are scarce, each country needs
a system to determines how to use its productive
resources.
- The way a society’s answers the qusetions ( what
to produce, how to produce and for whom to
produce) determines it’s economic system.
 Types Of Economic Systems
• Traditional Economies
- An economy in which behaviour is
based mostly on tradition, custom
and habit.
- works best in the unchanging
environment because where events
are dynamic, adaptation is
inevitable.
- This resulted in the eroding of this
economic system.
 Types Of Economic Systems

Command Economies
- an economy in which most
economic decisions are made by a
central planning authority usually
the government.
- i.e. what to produce, how to
produce it and who gets it.
- there is centralization of decision
making since the government owns
all the resources.
 Command economy
• based on the notion of “growth with
equity” a socialist ideology.
• Have not fared well in the world.
• Today there is a remarkable decrease
of countries that relied heavily on
central planning. Even the world’s
leading proponents- China, Cuba
where there is increasing amount of
market determination
• Why on decrease?
 Centrally planned economies failed
because:
• Failure of organisation due to large
economic size and population
• Failure of quality control
• Lack of incentives
• Environmental degradation
 Free Market Economy
• Individual households and firms pursue their
own self – interests without any central
regulation.
• The system works through a market:
 institution through which buyers and
sellers interact and engage in exchange of
goods and services.
• Components:-
a) consumer sovereignty – free to choose
b) free enterprise (produce goods that yield the
highest profits)
 Free Market Economy
Price Function
• The price mechanism operate to
allocate resources in such a way as to
answer the 3 basic economic question
of what is to be produced, how and
how it is to be distributed
• price signal to producers which goods
are more profitable to produce
• thus produce goods which give highest
returns.
• Also signals to consumers which
goods give the most value for their
$ and
 they purchase the good based on
this information.
• Proponents argue that it leads to
efficient production and better
response to diverse and changing
consumer preferences.
 Mixed Economy
• No fully traditional, centrally planned,
free market – are pure types useful only
for studying basic principles
• In practice, every economy is a mixed
economy in the sense that it combines
significant elements of all three systems
in determining economic behaviour.
• Within any economy the degree of mix
varies from sector to sector.
• When economists speak of a
particular economy as being
centrally planned, they mean only
that the degree of the mix
weighted heavily toward the
command principle.
• If speak of market economy they
mean only that the degree of mix
is weighted heavily toward
decentralized decision making
• Thus no pure economic system
working alone even in market
economy the command principle is
applied:
a) legislated minimum wages and
prices
b) Restrictions on imports
c) Rules and regulations for
environment protection
 Which economic system is best?
• Market system has proven to be the best
because it promotes the goals of growth,
freedom and efficiency.
 HOW DO ECONOMIST WORK?

• Economics is a social science

• we explore what it means to be

‘scientific’ in terms of economics
 Methodology of economists
• Economist seek to understand the
world by developing theories (economic
principles) and models that explain
some of the things that have been seen
and to predict some of the things that
will be seen.
• Economists observes complex economic
behaviour and generalizes.
• Economic theories: - these are broad
generalizations about complex
economic behaviour. (hypothesis)
• E.g. there is negative relationship
between price and the amount
demanded, ceteris paribus.
 Scientific method
 Observe a phenomenon

 Make simplifying assumptions and

formulate a hypothesis

 Generate predictions and

 Test the hypothesis

 What are these assumptions?
• They use assumptions,
• all other things held constant (ceteris
paribus)
• This helps to simplify reality and focus on
the relationships that interest us.
• Usually study at least two variables of
interest. e.g. money supply and interest
rates, income and quantity demanded of
a product.
 Common fallacies (pitfalls) in
economic reasoning
• The post hoc fallacy
- it is quite tempting to look at two events that
happen in sequence and assume that the first
caused the second to happen. This is not always
the case. Like after this therefore because of
this.” Committed when it is assumed that
because one thing occurred after another, it
must have occurred as a result of it.
• The fallacy of composition
- erroneous belief that what is true for a part is
necessarily true for the whole.
- theories that seem to work well when applied
to individuals, often break down when they are
applied to the whole. Often leads to incorrect
conclusions
• Failure to hold all other things constant (ceteris
paribus)
 Using economic models
• Introduce simple diagrams: the visual style
makes it easier to demonstrate economic
principles.
• Models – an abstraction designed to
illustrate some point but not designed to
generate testable hypotheses.
• Models can be described with – words;
math or pictures (graphs)
• Graphs – plot economic variables: bars,
histograms, line, pie chats, e.t.c.
• Statistical analysis – mathematical
manipulation of economic data
 Production possibility frontier
(PPF)
• Model of scarcity, choice and opportunity
cost
• Choice between 2 goods
• PPF shows maximum combination of 2
goods given current resources.
• A “production possibility frontier [is] a
graph that shows the various
combinations of output that the economy
can possibly produce given the available
factors of production and the available
technology”. It assumes that all resources
are used efficiently.
We need to ask and answer the following
questions.
• How can we use a diagram to illustrate
the concept of an economic problem?
• What does the model of a PPF enable us
to predict about the notions of scarcity,
choice and opportunity cost?
• Assumptions necessary to represent
production possibilities in a simple production
possibilities curve model:
1. efficiency
2. fixed resources
3. fixed technology
4. two products
 Production Possibility Frontier

Two goods produced here

Shoes are shoes and bread.
A

S1 C

D
S2

E
O
B1 B2 Bread
 Production Possibility Frontier

shoes What does point A tell us?

A
What does point E tell us?
What about points C and D?
S1 C

D
S2

E
O
B1 B2 Bread
 Production Possibility Frontier

Point A – all available resources

are being used to produce shoes
Point E– all available resources
shoes are being used to produce bread
A Points C and D- resources allocated
between each product in different
S1 C combinations

D
S2

E
O
B1 B2 bread
 Production Possibility Frontier

How does this model help

shoes us understand the concepts
A
of choice and opportunity cost?
The economy must choose
S1 C Between points along the PPF.

D
S2

E
O
B1 B2 bread
 Production Possibility Frontier

Assume we are initially at point C

Shoes What is the opportunity cost of
A
choosing to move to point D?
S1 C

D
S2

E
O
B1 B2 Bread
 Production Possibility Frontier

Assume we are initially at point C

shoes What is the opportunity cost of
A
choosing to move to point D?
To gain B2 minus B1 of bread,
S1 C we give up
S1 minus S2 of shoes
Loss of
Shoes

D
S2
Gain of
Bread
E
O
B1 B2 Bread
 Production Possibility Frontier

Shoes Add a point to the diagram to

A indicate scarcity.
Any point outside the PPF
S1 C represents an unattainable
Combination – due to scarce
resources

D
S2

E
O
B1 B2 Bread
 Production Possibility Frontier

Shoes Add a point to the diagram to

A indicate an inefficient use of
resources.
S1 C

D
S2

E
O
B1 B2 Bread
 Production Possibility Frontier

Shoes Add a point to the diagram to

A indicate an inefficient use of
resources.
S1 C Any point inside the PPF
represents an inefficient use
of resources.
Point F- inefficient use of resources
F

D
S2

E
O
B1 S2 Bread
 Production Possibility Frontier

Shoes What shocks to the model

A would cause the PPF to
shift
C •Inwards
S1
•Outwards?

D
S2

E
O
B1 B2 Bread
• Inefficiency, unemployment and
underemployment are illustrated by a point
inside the production possibilities curve.
• Economic Growth can also be illustrated with
a production possibilities curve. An outward
shift to the right of the curve.
can happen if
– if there are more resources or better technology.
– Growth will change the potential output of the
economy, hence the shift of the entire curve.
 Summary
 Scarcity – unattainability of combinations
 Choice – selection of attainable combinations
 Opportunity Cost – downward sloping
 Concavity – reveals increasing opportunity costs. The
economic rationale for increasing oc is that economic
resources are not completely adaptable to
alternative uses.
 Economic Analysis: Positive and
Normative Advice
• Economist give two broad types of advice:
a) normative.
b) positive
• positive economics
• normative economics
 Positive economics
• attempt to describe how the economy functions
• Deals with facts and avoids value judgements.
• It attempts to set forth scientific statements about
economic behaviour.
• Positive statement – is a statement about what
actually is as opposed to what ought to be and how
it works.
• Resolved by analysis and empirical evidence -relies
on testable hypotheses
 Normative economics
• It involves value judgements about what the
economy should be like – eg to evaluate or
recommend alternative policies
• No right or wrong answers because they involve
ethics and values rather than facts.
• Normative statement – a statement about what
ought to be done as opposed to what actually is
• Resolved through political debate and decisions,
and not by economic analysis alone
 Example
• Suppose want to advice government about
resource idleness
• Government ought to try harder to reduce
UE. This is normative advice- making a
judgements about the value of various things
that the government could do with its limited
resources and about the costs and benefit of
reducing UE.
• If government want to reduce UE, reducing
UE insurance benefits is an effective way of
doing so. This is positive advice – no value
judgements but giving ;exact’ way of doing it.