CHAPTER-1

INTRODUCTION TO MICRO ECONOMICS

I. Choose the correct answer (each question carries 1 mark)

1. The scarce resources of an economy have

(a) Competing usages (b) Single usages
(c) Unlimited usages (d) none of the above
Competing usages

2. Which of the following in an example of micro economic study?

(a) National income (b) Consumer Behaviour
(c) Unemployment (d) foreign trade
Consumer behaviour

3. Central problems of an economy includes

(a) What to produce (b) How to produce
(c) For whom to produce (d) All of the above
All of the above

4. Traditionally, the subject matter of economics has been studied under the following broad
branches.
(a) Micro and macro Economics (b) Positive and Normative
(c) Deductive and Inductive (d) None of the above
Micro and Macro Economics.

II. Fill in the blanks (each question carries 1 marks)

1. Scarcity of resources gives raise to..................... Problem of choice

2. In a centrally planned economy, all important decisions are made by …… Government

3. ……….. is a set of arrangements where economic agents can freely exchange their
endowments or products with each other? Market

4. In reality all economies are ……………… Mixed Economies.

III. Match the following (each question carries 1 mark)

1. Market economy a. Government

2. Service of a Teacher b. Private
3. Centrally planned economy c. Skill
4. Positive economics d. Evaluate the Mechanism
5. Normative economics e. Functioning of Mechanism

Ans: 1 - b ; 2- c ; 3- a ; 4- e ; 5- d.
IV Answer the following questions in a sentence/word. (Each question carries 1 mark)

1. Why does the problem of choice arise?

An economic problem arises because of limited resources, unlimited wants, and
alternative uses of resources. To allocate limited resources to satisfy unlimited wants -
the problem of choice arises.

2. What is Market Economy?

A market economy (capitalistic economy) is that economy where the economic
decisions are undertaken based on market mechanism by the private entrepreneurs. It
functions on demand and supply conditions.
Example- USA, UK.

3. What do you mean by Centrally Planned Economy?

A centrally planned economy (socialistic economy) is that economy where the
economic activities are controlled by the central Government.
Example-Russia, China, North Korea etc.

4. Give the meaning of Microeconomics.

Microeconomics is the study of individual economic units like a consumer, a producer, a
firm etc.

5. What do you mean by Positive Economics?

The positive economics is the study of ‘what was’ and ‘what is’ under the given set of
circumstances. It deals with the scientific explanation of the working of the economy
(functioning of mechanism).

6. What is Normative Economics?

The Normative economics studies ‘what ought to be’. It explains about ‘what should
be and should not be done’. It deals with evaluation of mechanism.

V. Answer the following in 4 sentences. (Each question carries 2 marks)

1. Mention the central problems of an economy.

The central problems (basic problems / fundamental problems) of an economy are as
follows:
1.What to produce (Problem of choice) - What goods are to be produced and in what
quantities?
2. How to produce (Problem of technology)- How the goods are to be produced?
3.For whom to produce (Problem of distribution)- For whom the goods are to be
produced?
2. Distinguish between Micro and Macroeconomics.

• Microeconomics deals with individual units (individual income individual

saving, price of a commodity etc) so its scope is narrow.
• Macro Economics delas with aggregates (national income,aggregate
saving,general price level etc ) so its scope is wider.
• Microeconomics follows slicing method
• Macro Economics follows lumping method
• Micro economics studies partial equilibrium in the economy.
• Macro economics studies general equilibrium in the economy.

3. Distinguish between positive and normative economics

The positive economics –

• It is the study of ‘what was’ and ‘what is’ under the given set of circumstances.
• It deals with the scientific explanation of the working of the economy(functioning
of mechanism).
• It explains the cause-and-effect relationship of economic variable.
• Positive statements are capable of empirical verification (it can be tested or
proved).
E.g.: if the tax on tobacco is doubled, then there will be reduction in tobacco consumption.

The Normative economics

• Its studies ‘what ought to be’.

• It explains about ‘what should be and should not be done’.
• It deals with evaluation of mechanism. In normative economics we try to
understand whether the mechanisms are desirable or not.
• Normative statements are subjective, and value based or sometimes called
matters of opinion. (It cannot be tested)
Eg: unemployment is more harmful than inflation/ the government should provide
necessities to all the citizens.

4.What do you mean by production possibility set?

The collection of all possible combinations of the goods and services that can be
produced from a given amount of resources and a given stock of technological
knowledge is called the production possibility set of the economy.
 5. What is opportunity cost?
An opportunity cost is the cost of having a little more of one good in terms of the
amount of the other good that has to be forgone. This is known as the opportunity cost
of an additional unit of the goods. Or
The cost of next best alternative foregone or sacrificed is called as opportunity cost.

6. What is Production Possibility Frontier (Production Possibility Curve / Transformation

Curve)

The production possibility frontier (PPF) is a graphical representation of the

combinations of two commodities that can be produced with the given resources which
are fully utilized and with the given technique of production.

VI. Answer the following question in 12 sentences. (each question carries 4 mark)

1. Briefly explain, how the family farm, weaver, teacher can use their resources to fulfill
their needs in a simple economy.
A family farm may own a plot of land, farming implements, a pair of bullocks and
labour services of the family members.
A weaver may have some yarn, cotton and other instruments required for weaving cloth.
The teacher in a school has the skills required to impart education to the students. Each
of these decision-making units can produce some goods or services by using the resources
that it has and use part of the produce to obtain other goods and services which it needs.
Eg: The family farm can produce corn, use part of the produce for consumption and buy
clothing, housing, and various services in exchange of corn.
Similarly, the weaver can get goods and services she wants in exchange for the cloth she
produces.
The teacher can earn some money by teaching students in the college / school and use
the money for obtaining goods and services that she/he wants.
Each individual can thus use his/her resources to fulfill his/her needs. It goes without
saying that no individual has unlimited resources compared to his/ her needs.

2. Briefly explain the Production Possibility Frontier (PPF/PPC).

The PPF is a graphical representation of the combinations of two commodities
(eg:cotton and wheat) that can be produced when the resources of the economy are fully
utilized and with given technology. It is also called as Production possibility curve (PPC)
or transformation curve.
Assumptions of PPF:
1. Resources are given, and they can be transferred
2. Technology remains constant
3. Given resources are fully and efficiently utilized
4. Only 2 goods are considered (eg: cotton and wheat).
 The following table shows combinations of cotton and wheat that can be produced when
the resources of the economy are fully utilized.

Production possibilities Wheat (in lakh tons) Good Y Cotton (in lakh tons) Good X

A 100 0

B 90 10

C 70 20

D 40 30

E 0 40

This can be graphically represented as follows:

Y A
wheat B .F G – attainable comb
F - unattainable com
D
.G
E
O cotton X

• As per the above graph, the points lying strictly below the production possibility
curve represents a combination of cotton and wheat that will be produced when
all or some of the resources are underemployed (point G).
• The points lying on the PPC (A B C D E) shows that the resources are fully utilized
(full employment and efficient use of resources).
• The point F shows unattainable combination.

The change in PPC:

1. Shift in PPC: When there is change in productive capacity with respect of both the
goods. The PPC can shift due to
a) Change in resources (resources are increased or decreased)
b) Change in technology (improvement in technology or deterioration)

2. Rotation of PPC: When there is change in productive capacity with respect to only one
good, good X or good Y.
 Characteristics of PPF:

1.PPF slopes downward: More of one good can be produced only by taking resources from
the production of another good.

2.PPF is concave to the origin: PPF is concave to the origin because of increasing Marginal

rate of transformation (MRT).

Extra ( MRT is the ratio of number of units of a commodity sacrificed to gain an additional unit
of another commodity. MRT is increased because it is assumed that no resources are equally
efficient in production of all goods.

MRT= No. of units sacrificed

No. of units gained.

In the case of PPF, Marginal Opportunity Cost (MOC) is always increasing. MOC refers to
the number of units of a commodity sacrificed to gain one additional unit of another commodity.
Increasing MOC operates because productivity and efficiency of factors of production decreases
as they are shifted from one use to another.)

3. Briefly explain the central problems of an economy.

The problem of choice arising out of limited resources and unlimited wants are called economic
problem. Every economy whether developed or underdeveloped, Capitalistic or socialistic or
mixed economy, there will be three basic economic problems viz., What to produce, How to
produce and For Whom to produce.

a) What to Produce (problem of choice)

As resources are scarce, economy cannot produce everything in infinite quantities. So,
this problem arises. The problem of what to produce has two dimensions. They are
1.What goods and services are to be produced (Whether to produce more guns or more
food grains should be grown or whether more capital goods like machines, tools, etc.,
should be produced or more consumer goods (electrical goods, daily usable products etc.)
will be produced.
2. In what quantity the goods are to be produced
What goods to be produced and in what quantities depends on the economic system of
the country. In socialistic economy, the Government decides and in Capitalistic economy
market forces decides and in mixed economy both the Government and market forces
provide solutions to this problem.
b) How to Produce (problem of technology):
Since resources are limited, it becomes necessary to choose a technology which uses
resources most economically. There are various alternative techniques of producing a
product.
 There are two types of techniques of production viz.,
(a) Labour intensive technology (greater use of labour)
(b) capital intensive technology (greater use of capital)
The society has to decide whether production should be based on labour intensive or
capital-intensive techniques. The choice of technology would depend on the availability
of different factors of production (land, labour, capital) and their relative prices (rent,
wages, interest).
c) For whom to produce (problem of distribution).
Another important decision which an economy has to take is for whom the goods should
be produced. The economy cannot satisfy all wants of all the people. Therefore, it has to
decide who should get what and how much of the total output of goods and services. The
society has to decide about the shares of different groups of people- poor, middle class
and the rich, in the national output. It has 2 aspects:
1.Factoral distribution of income (income share of different factors of production)
2.Interpersonal distribution of income (income share of individuals in the economy)

4. Write a short note on a Centrally Planned Economy.

A centrally planned economy also called as socialistic economy is that economy
where the economic activities are controlled and governed by the central Government.
Here, the Government takes decisions about the allocation of resources in accordance
with predetermined goals and objectives to attain economic and social welfare. Social
welfare is the main motive of production. Example, Russia, China, North Korea etc.
In a centrally planned economy, Government decides what to produce, how to
produce and what prices are to be fixed.
• Regarding what to produce, the Government may produce those goods and services which
are most useful for its society.
• Regarding how to produce, the most suitable technique of production is adopted -whether
labour intensive or capital intensive in accordance with the situation in the economy.
• Regarding whom to produce, the goods and services are produced to those people who are
suffering from hunger.
• Centrally planned economy gives importance to the quality of life rather than quantity of
production.

5.Write a short on market economy.

• A market economy also known as capitalistic economy, is that economy in which the
economic decisions are undertaken based on market mechanism by the private
entrepreneurs.
• It functions on demand and supply conditions. Eg: USA, Japan, Australia, UK.
 • In market economy, private individuals own the factors of production. Here, the
profit is the main goal of business.
• There is least intervention of Government in the economic activities.
• Price mechanism plays a major role in market economy. Prices are the balancing
wheel of the market mechanism because it coordinates the decisions of the
producers (supply)and consumers(demand). The price is determined by demand and
supply in the market. No individual organization or Government is responsible for
the production and distribution or pricing of goods. All depend on market
mechanism.
Regarding basic problems of an economy,
The problem of what to produce is solved based on demand and profit. The producers
produce those goods which are high in demand and less in supply which in turn bring
more income.
The problem - how the goods are to be produced is determined by the competition
among different entrepreneurs. They select least cost combination of technology so that
they can get more returns with less cost.
The problem of whom to produce is decided based on purchasing power of consumers.
The producers produce commodities to the rich as they can afford to pay more but poorer
sections of the society are neglected.

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