Introduction to Microeconomics

Economics studies how a society uses its scarce resources to satisfy unlimited wants. The subject is divided into two broad branches depending on what is being studied:

• Microeconomics — studies the economic behaviour of individual units: a single consumer, a single firm, a single market, the price of one good. The word "micro" means small. It deals with topics like demand, supply, price of a product, and consumer and producer behaviour. (It is sometimes called price theory.)
• Macroeconomics — studies the economy as a whole: total (aggregate) output, national income, total employment, the general price level and inflation. The word "macro" means large. (It is sometimes called income theory.) This Class-11 course focuses mainly on microeconomics.

Economics can also be divided by the type of statement it makes:

• Positive economics — deals with facts and "what is"; its statements can be tested as true or false (e.g. "a rise in price reduces demand").
• Normative economics — deals with opinions and "what ought to be"; it involves value judgements that cannot simply be proved true or false (e.g. "the government should give free education").

So microeconomics looks at the small parts, macroeconomics at the whole; positive economics describes, while normative economics prescribes.

The whole of economics springs from one basic fact: scarcity. Human wants are unlimited, but the resources (land, labour, capital) to satisfy them are limited, and those resources have alternative uses. Because we cannot have everything, we must choose — and every choice means giving something up. So economics is often called the science of choice.

The cost of a choice is measured by its opportunity cost — the value of the next-best alternative that is given up. For example, if a farmer uses his land to grow wheat, the opportunity cost is the rice he could have grown instead. Opportunity cost is one of the most important ideas in economics: the "real" cost of anything is what you sacrifice to get it.

Because of scarcity, every economy — rich or poor — must answer three central problems (the basic economic problems of allocation):

• What to produce — which goods and services, and in what quantities (e.g. more food or more weapons)?
• How to produce — by which method/technique (labour-intensive or machine-intensive)?
• For whom to produce — how should the output be distributed among people (who gets how much)?

These problems exist because resources are scarce relative to wants. Solving them well means using resources efficiently so that society gets the most satisfaction from its limited means.

The ideas of scarcity, choice and opportunity cost can be shown in one neat diagram: the Production Possibility Curve (PPC), also called the production possibility frontier. It shows the different combinations of two goods that an economy can produce using all its resources fully and efficiently, with a given technology.

Suppose an economy produces only two goods — say guns and butter. If it puts all resources into butter it makes a lot of butter and no guns; if all into guns, the reverse. In between, it can produce various combinations. Joining these combinations gives the PPC, shown below: