1. Micro Economics
PGDM TRIMESTER- I
Dr. Poonam Kain
Apeejay Institute of Technology
Greater Noida

2. Why to study economics
 To introduce key economic concepts like scarcity,
rationality, equilibrium, time perspective and
opportunity cost.
 To explain the basic difference between microeconomics
and macroeconomics.
 To help the reader analyze how decisions are made about
what, how and for whom to produce.
 To define managerial economics and demonstrate its
importance in managerial decision making.

3. Economics
 How a society tries to solve the human problems of
unlimited wants and scarce resources.
 Deals with the society as a whole and human
behaviour in particular
 Studies the production, distribution, and
consumption of goods and services.
 A science in its methodology, and art in its
application.

4. Economics
 Scientific study of the choices made by
individuals and societies with regard to the
alternative uses of scarce resources employed
to satisfy wants.

5.  Application of economic theory and the tools of analysis of decision
science to examine how an organisation can achieve its objectives most
effectively
 Study of allocation of the limited resources available to a firm or other
unit of management among the various possible activities of that unit
 Applies economic theory and methods to business and administrative
decision-making
 Application of economic principles and methodologies to the decision-
making process within the firm or organization

6. Fundamental Concepts of economics
 Ceteris Paribus
 Latin phrase
 “With other things (being) the same” or “all other things being
equal”.
 Rationality
 Consumers maximize utility subject to given money income.
 Producers maximize profit subject to given resources or minimize
cost subject to target return.

7. Fundamental Concepts of economics
 Positive and Normative
 Positive economics: “what is” in economic matters
 Establishes a cause and effect relationship between variables.
 Analyzes problems on the basis of facts.
 Normative economics: “what ought to be” in economic matters.
 Concerned with questions involving value judgments.
 Incorporates value judgments about what the economy should be like.

8. Fundamental Concepts of economics
 Short Run and Long Run
 Short run: Time period not enough for consumers and producers to
adjust completely to any new situation.
 Some inputs are fixed and others are variable
 Long run: Time period long enough for consumers and producers to
adjust to any new situation.
 All inputs are variable
 Decisions to adjust capacity, to introduce a larger plant or continue with
the existing one, to change product lines.

9. Fundamental Concepts of economics
 Concept of scarcity
 Unlimited human wants
 Limited resources available to satisfy such wants
 Best possible use of resources to get:
 maximum satisfaction (from the point of view of consumers) or
 maximum output (from the point of view of producers or firms)
 Concept of opportunity cost
 Opportunity cost is the benefit forgone from the alternative that is not
selected.
 Highlights the capacity of one resource to satisfy multitude of wants
 Helps in making rational choices in all aspects of business, since
resources are scarce and wants are unlimited

10. Fundamental Concepts of economics
 Concept of margin or increment
 Marginality: a unit increase in cost or revenue or utility.
 Marginal cost: change in Total Cost due to a unit change in output.
 Marginal revenue: change in Total Revenue due to a unit change in
sales.
 Marginal utility: change in Total Utility due to a unit change in
consumption.
 Incremental: applied when the changes are in bulk, say 10% increase
in sales.

11. Summary
 Economics studies the choices made by individuals and
societies in regard to the alternative uses of scarce resources
which are employed to satisfy unlimited wants.
 Microeconomics is the study of the behaviour of individual
economic units, such as an individual consumer, a seller, a
producer, a firm, or a product.
 Macroeconomics deals with the study of aggregates, the
economy as a whole.


12. Summary
• Production Possibilities Curve (PPC) is a graph that shows the
different combinations of the quantities of two goods that can
be produced (or consumed) in an economy, subject to the
limited availability of resources.
• The knowledge of managerial economics helps to understand
the interrelationships among the various functional units of
any firm (namely production, marketing, HR, finance, IT and
legal)
• Decision sciences provide the tools and techniques of analysis
used in managerial economics, in particular numerical and
algebraic analysis, optimization, statistical estimation and
forecasting.

13. Consumer Choice
 Given the prices of different commodities, consumers decide
on the quantities of these commodities according to their
paying capacity, and tastes and preferences.
 Consumers’ choices, tastes and preferences rests on the
following assumptions:
 Completeness: A consumer would be able to state own
preference or indifference between two distinct baskets of
goods.
 Transitivity: An individual consumer’s preferences are
always consistent.
 Non-satiation: A consumer is never satiated permanently.
More is always wanted; if “some” is good, “more” of the
good is better.

14. Consumer Choice
 Commodities are desired because of their utility
 Utility is the attribute of a commodity to satisfy or satiate a consumer’s
wants
 Utility is the satisfaction a consumer derives from consumption of a
commodity
 Mathematically: utility is the function of the quantities of different
commodities consumed:
U= f(m1, n1, r1)

15.  Utility is the measure of satisfaction a
consumer derives from consumption of a
commodity; it is an attribute of a commodity
to satisfy a consumer’s needs. According to
cardinal school, utility is measurable like any
other physical commodity.

16. Cardinal Utility Analysis
 Marshall and Jevons opined that Utility is a cardinal concept and
is measurable (in utils) like any other physical commodity
 Total Utility (TU)
 Sum total of utility levels out of each unit of a commodity
consumed within a given period of time
 Marginal Utility (MU)
 Change in total utility due to a unit change in the commodity
consumed within a given period of time.
 MU=TUn -TUn-1 or MU=

17. Cardinal Utility Analysis
 Law of Equimarginal Utility
 Marginal utilities of all commodities should
be equal
 The consumer has to distribute his/her income on
different commodities so that utility derived from
last unit of each commodity is equal for all other
commodities in the consumption basket.
MU M MU N
= = ... = MU I
PM PN
 Mathematically:

18.  As per law of equimarginal utility, a
consumer will maximize utility when the
marginal utility of the last unit of money
spent on each commodity is equal to the
marginal utility of the last unit of money
spent on any other commodity.

19. Cardinal Utility Analysis
 Law of Diminishing Marginal Utility
 Marginal utility for successive units consumed goes on decreasing.
 When the good is consumed in standard quantity, continuously and in
multiple units and the good is not addictive in nature.
 The following diagrams show Total Utility (TU) and Marginal Utility
TU of X
(MU) curves MU of X
MU
TU
O O
Quantity of X Quantity of X

20.  As per law of diminishing marginal utility, as
you one consumes more and more units of a
commodity, total utility would goes on
increasing, but at a diminishing rate.

21. Marginal Utility and Demand Curve
MU curve is downward sloping.
For any given amount of income when price of the MU, P
commodity is PC, the consumer would consume QC
quantity of the commodity (point C on the MU curve,
where MU= PC) PA A
B
PB
When price increases to PB, the consumer has to PC
C
readjust consumption to restoring level of utility.
the new equilibrium is at point B on the MU curve MU=D
where MU= PB
O QA QB QC Quantity
As price goes on increasing, the desired consumption
of the commodity for the consumer goes on
diminishing and vice versa. Points A, B, C, and so on,
would thus lie on the demand curve of the consumer
for the commodity.

22. Ordinal Utility Analysis
 Edgeworth, Fisher and others negate the physical measurement of utility.
 A consumer is able to rank different combinations of the commodities in
order of preference or indifference.
 Utility is not additive but comparative.
 Indifference Curve Analysis (J.R. Hicks and R.G.D. Allen )
 Indifference curve: Locus of points which show the different
combinations of two commodities among which the consumer is
indifferent, i.e. derives same utility.
 Since all these points render equal utility to the consumer, an
indifference curve is also known as an isoutility (“iso” meaning
equal) curve.
 Indifference map: group of indifference curves

23. Properties of Indifference Curves
 Indifference curves are downward sloping. Y
 This is because of the assumption of non- A
satiation
B
Good Y
 Higher indifference curve represents higher
utility C
D
 Indifference curves can never intersect IC2
IC1
 Indifference curves are convex to the origin.
O
Good X X
 This is because two goods cannot be
perfect substitutes of each other

24. Exceptional Shapes of Indifference Curves
QY Perfect
QY Perfect
Complements
Substitutes
O O
QX QX
QY
Irrational QY Social Bads
Behaviour
O O
QX QX

25. Diminishing Marginal Rate of Substitution
 MRS is the proportion of one good (M) that the consumer would be willing to
give up for more of another (N)
 MRS is the ratio between rates of change in M and N, down the indifference
∆N
curve : MRS MN = −
 ∆M …..(1)
 To increase consumption of M, the consumer has to reduce consumption of N
and hence the negative sign. MRSMN goes on diminishing as we move down the
indifference curve.
 Gain in utility due to consumption of more units of one commodity must be
equal to the loss in utility due to consumption of less units of the other
commodity
MU M
= − ∆N
MU N ∆M …..(2)
MU M
= MRS MN
MU N …..(3)

26. Consumer’s Equilibrium
 Budget line of a consumer, consists of all possible combinations of the two
commodities that the consumer can purchase with a limited budget:
 Budget constraint depends upon income of the consumer and prices of the
commodities in the consumption basket.
 Consumer would reach equilibrium point, i.e. highest level of satisfaction
given all constraints at the highest indifference curve he/she can reach.
Mathematically
PM.QM+PN.QN=I
(Where PM is price of commodity M, QM quantity of M, PN price of N, QN
quantity of M and I is income of the consumer.

27.  Budget constraint to the consumer includes income of the consumer and
prices of the commodities in the consumption basket. A change in any of
these constraints would lead to a shift in the budget line. Such a shift can
be of three types: upwards, downwards and swivelling.
 The consumer will be at equilibrium at a point where the budget line is
tangent to the highest attainable indifference curve.
 According to the theory of revealed preferences, demand for a
commodity by a consumer can be ascertained by observing the buying
pattern of the consumer.
 Consumer surplus is equal to the difference between the price a
consumer is willing to pay and the price he/she actually pays for a
commodity.

28. Consumer’s Equilibrium
 Conditions for consumer’s equilibrium:
 Consumer spends all income in buying the two commodities; hence point of
equilibrium will always lie on the budget line.
 Point of equilibrium will always be on the highest possible indifference curve the
consumer can reach with the given budget line.
 Consumer is able to maximize utility at a point where the budget line is tangent to an
indifference curve
 This is the highest possible curve attainable by the consumer, subject to budget
constraint.
 Budget line may
 shift either upwards or downwards due to any change in income of the consumer while
price of the commodities remaining same

29. Consumer’s Equilibrium
 Feasible set is the area
OAB, and area beyond
Quantity of N
budget line AB is
A
infeasible area;
therefore IC4 is beyond C
reach of the consumer.
QN E
 Equilibrium is attained
IC4
at point E where the D
IC3
AB is tangent to curve IC2
IC1
IC3 (highest attainable O
QM B Quantity of M
indifference curve).
 Point C and B are
attainable but on lower

30. Revealed Preference Theory
 Indifference curves analysis had limitations in terms of its highly theoretical
structure and simplifying assumptions.
 Samuelson came up with an approach to assessing consumer behaviour and
introduced the term ‘revealed preference’. The basic hypothesis of the
theory is ‘choice reveals preference’.
 Demand for a commodity by a consumer can be ascertained by observing
the actual behaviour of the consumer in the market in various price and
income situations.
 This gives us a demand curve for an individual consumer on the basis of
observed behaviour.
 Demand for any good (or basket of goods) is known to always increase
when money income alone rises hence it must shrink when price alone
rises.

31. Revealed Preference Theory
 AB is the budget line. OAB is the feasible set, given the price and income constraints.
 If out of all the possible combinations of two goods M and N, the consumers chooses
C, it may be deduced that the consumer has revealed his/her preference for C over all
other possible combinations (say D, L, R)
Quantity of N
A
A1 D
C
N
L
R
O B’
M B B1
Quantity of M

32. Consumer Surplus
 The difference between the price consumers are willing to pay and what
they actually pay is called consumer surplus.
 Individual consumer surplus measures the gain that a consumer makes by
purchasing a product at a price lower than what he/she had expected to pay.
 In a market the total consumer surplus measures the gain to the society due
to the existence of a market transaction.

33. Consumer Surplus
 Equilibrium market price and quantity Price
are at (P*, Q*) D
 If there is a customer who is willing to
A Consumer
pay as high as P1 but actually pays only P1 Surplus
P*, the difference between the two prices P2 B
S
(P1 – P*) represents the surplus of the
first consumer. E
P*
 If a second consumer is willing to pay P2 S
D
and actually pays P* gains a surplus of
(P2 – P*).
O
 Total consumer surplus in the economy Q1 Q2 Q* Quantity
is given by the triangular area P*DE

34. Summary
According to ordinal school, utility cannot be measured in physical units;
it is possible to rank utility derived from various commodities.
 Indifference curves are downward sloping and convex to the origin; a
higher indifference curve would represent higher utility and two
indifference curves do not intersect each other.
Marginal Rate of Substitution (MRS) shows the amount of a good that a
consumer would be willing to give up for an additional unit of another
commodity.