Microeconomics Module 1: The Science of Economics

Module Title: Module I - The Science of Economics

Course Title: Microeconomics
Course Number: Social Studies 109

Course Description:
The course provides an introduction to a core area of economics known as
microeconomics. It considers the operation of a market economy and the problem of
how best to allocate society's scarce resources. The course considers the way in which
various decision making units in the economy (individuals and firms) make their
consumption and production decisions and how these decisions are coordinated. It
considers the laws of supply and demand, and introduces the theory of the firm, and its
components, production and cost theories and models of market structure. The various
causes of market failure are assessed, and consideration is given to public policies
designed to correct this market failure.

Total Learning Time: 12 hrs.

Pre-requisites: None

Overview:
In this module, the student will focus on basic terms of economics. Distinguish
the difference between macroeconomics and microeconomics. Explain the different
types of economic system.

Most Essential Learning Outcomes:

At the end of the lesson, the students must have:

1. Defined the basic terms in Economics.
2. Differentiated and explained the types of economic system.
3. Discussed the Schools of Economic Theory.
4. Compared and Contrast Microeconomics and Macroeconomics.

Indicative Content:
Understanding Economics
Types of Economics
Economic Resources
Types of Economic Systems
Microeconomics and Macroeconomics

Discussion

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The Science of Economics

Most people have a general idea of what Economics is. They live with it; they
practice it. Some will even be able to define it. Economics is concerned with the
production, and use of materials goods and services. Adam Smith, the recognized father
of Economics, stated that Economics is “an inquiry into the nature and causes of the
wealth of the nations.”

What is Economics?
Economics is a social science concerned with the production, distribution, and
consumption of goods and services. It studies how individuals, businesses,
governments, and nations make choices on allocating resources to satisfy their wants
and needs, trying to determine how these groups should organize and coordinate efforts
to achieve maximum output.

Economics can generally be broken down into macroeconomics, which

concentrates on the behavior of the aggregate economy, and microeconomics, which
focuses on individual consumers and businesses.

KEY TAKEAWAYS
Economics is the study of how people allocate scarce resources for production,
distribution, and consumption, both individually and collectively.

Two major types of economics are microeconomics, which focuses on the

behavior of individual consumers and producers, and macroeconomics, which
examine overall economies on a regional, national, or international scale.

Economics is especially concerned with efficiency in production and exchange

and uses models and assumptions to understand how to create incentives and
policies that will maximize efficiency.

Economists formulate and publish numerous economic indicators, such as gross

domestic product (GDP) and the Consumer Price Index (CPI).

Capitalism, socialism, and communism are types of economic systems.

Understanding Economics
One of the earliest recorded economic thinkers was the 8th-century B.C. Greek
farmer/poet Hesiod, who wrote that labor, materials, and time needed to be allocated
efficiently to overcome scarcity. But the founding of modern Western economics
occurred much later, generally credited to the publication of Scottish philosopher Adam
Smith's 1776 book, An Inquiry Into the Nature and Causes of the Wealth of Nations.

The principle (and problem) of economics is that human beings have unlimited
wants and occupy a world of limited means. For this reason, the concepts
of efficiency and productivity are held paramount by economists. Increased
productivity and a more efficient use of resources, they argue, could lead to a higher
standard of living.

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Despite this view, economics has been pejoratively known as the "dismal
science," a term coined by Scottish historian Thomas Carlyle in 1849. 2 He used it to
criticize the liberal views on race and social equality of contemporary economists
like John Stuart Mill, though some sources suggest Carlyle was actually describing the
gloomy predictions by Thomas Robert Malthus that population growth would always
outstrip the food supply.

Types of Economics
The study of economics is generally broken down into two disciplines.

Microeconomics focuses on how individual consumers and firm make

decisions; these individuals can be a single person, a household, a
business/organization or a government agency. Analyzing certain aspects of
human behavior, microeconomics tries to explain they respond to changes in
price and why they demand what they do at particular price levels.
Microeconomics tries to explain how and why different goods are valued
differently, how individuals make financial decisions, and how individuals best
trade, coordinate and cooperate with one another. Microeconomics' topics range
from the dynamics of supply and demand to the efficiency and costs associated
with producing goods and services; they also include how labor is divided and
allocated, uncertainty, risk, and strategic game theory.

Macroeconomics studies an overall economy on both a national and

international level. Its focus can include a distinct geographical region, a
country, a continent, or even the whole world. Topics studied include foreign
trade, government fiscal and monetary policy, unemployment rates, the level of
inflation and interest rates, the growth of total production output as reflected by
changes in the Gross Domestic Product (GDP), and business cycles that result
in expansions, booms, recessions, and depressions.

Micro- and macroeconomics are intertwined; as economists gain an

understanding of certain phenomena, they can help us make more informed decisions
when allocating resources. Many believe that microeconomics' foundations of
individuals and firms acting in aggregate constitute macroeconomic phenomena.

Schools of Economic Theory

There are also schools of economic thought. Two of the most common
are monetarist and Keynesian. Monetarists have generally favorable views on free
markets as the best way to allocate resources and argue that stable monetary policy is
the best course for managing the economy. In contrast, the Keynesian approach
believes that markets often don’t work well at allocating resources on their own and
favors fiscal policy by an activist government in order to manage irrational market
swings and recessions.

Economic analysis often progresses through deductive processes, including

mathematical logic, where the implications of specific human activities are considered
in a "means-ends" framework. Some branches of economic thought emphasize
empiricism, rather than formal logic—specifically, macroeconomics
or Marshallian microeconomics, which attempt to use the procedural observations
and falsifiable tests associated with the natural sciences.

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Since true experiments cannot be created in economics, empirical economists

rely on simplifying assumptions and retroactive data analysis. However, some
economists argue economics is not well suited to empirical testing, and that such
methods often generate incorrect or inconsistent answers.

Economic Resources: Types and Definitions

There are four fundamental types of economic resources: Land, Labor,
Capital, and Entrepreneurship

Economic resource 1: Land

Land is an economic resource that includes all natural physical resources like
gold, iron, silver, oil etc. Some countries have very rich natural resources and by
utilizing these resources they enrich their economy to the peak.

Such as the oil and gas development of North Sea in Norway and Britain or the
very high productivity of vast area of farm lands in the United States and Canada. Some
other developed countries like Japan have smaller economic resources. Japan is the
second largest economy of the world but reliant on imported oil.

Economic resource 2: Labor

The human input in the production or manufacturing is known as labor. Workers
have different work capacity. The work capacity of each worker is based on his own
training, education and work experience.

This work capacity is matters in the size and quality of work force. To achieve
the economic growth the raise in the quality and size of workforce is very essential.

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Economic resource 3: Capital

In economics, Capital is a term that means investment in the capital goods. So,
that can be used to manufacture other goods and services in future. The following are
the factors of capital:

Fixed Capital
It includes new technologies, factories, buildings, machinery and other
equipment.

Working Capital
It is the stock of finished goods or components or semi-finished goods
or components. These goods or components will be utilized in near future.

Capital Productivity
New features of capital building, machinery or technology are
commonly used to improve the productivity of the labor. Such as the new ways
of farming helps to enhance the productivity of the agriculture sector and give
more valuable jobs in this sector which motivates people to come out for work.

Infrastructure
It is a stock capital that is used to maintain the whole economic system.
Such as roads, railway tracks, airports etc.

Economic resource 4: Entrepreneurship

The Entrepreneur is person or individual who wants to supply the product to
the market, in order to make profit. Entrepreneurs usually invest their own capital in
their business. This financial capital is generally based on their savings and they take
risks linked to their investments. This risk-taking can be rewarded by the profit of the
business. Entrepreneurship is, thus, an important economic resource.

Types of Economic Systems

The way scarce resources get distributed within an economy determines the type
of economic system. There are four different types of Economic Systems; a traditional
economy, a market economy, a command economy, and a mixed economy. Each type
of economy has its own strengths and weaknesses.

Traditional Economic System

The traditional economic system is the most traditional and ancient
types of economies in the world. Vast portions of the world still function under
a traditional economic system. These areas tend to be rural, second- or third-
world, and closely tied to the land, usually through farming.

In general, in a traditional economic system, a surplus would be rare.

Each member of a traditional economy has a more specific and pronounced role,
and these societies tend to be very close-knit and socially satisfied. However,
they do lack access to technology and advanced medicine.

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Command Economic System

In a command economic system, a large part of the economic system
is controlled by a centralized power. For example, in the USSR most decisions
were made by the central government. This type of economy was the core of
the communist philosophy.

Since the government is such a central feature of the economy, it is often

involved in everything from planning to redistributing resources. A command
economy is capable of creating a healthy supply of its resources, and it rewards
its people with affordable prices. This capability also means that the
government usually owns all the critical industries like utilities, aviation, and
railroad.

In a command economy, it is theoretically possible for the government

to create enough jobs and provide goods and services at an affordable rate.
However, in reality, most command economies tend to focus on the most
valuable resources like oil.

China or D.P.R.K. (North Korea) are examples of command economies.

Advantages of Command Economic Systems

 If executed correctly, the government can mobilize resources on a
massive scale. This mobility can provide jobs for almost all of the
citizens.

 The government can focus on the good of society rather than an

individual. This focus could lead to more efficient use of resources.

Disadvantages of Command Economic Systems

 It is hard for central planners to provide for everyone’s needs. This

challenge forces the government to ration because it cannot calculate
demand since it sets prices.

 There is a lack of innovation since there is no need to take any risk.

Workers are also forced to pursue jobs the government deems fit.

Market Economic System

In a free-market economy, firms and households act in self-interest to
determine how resources get allocated, what goods get produced and who buys
the goods. This is opposite to how a command economy works, where the
central government gets to keep the profits.

There is no government intervention in a pure market economy

(“laissez-faire“). However, no truly free market economy exists in the world.
For example, while America is a capitalist nation, our government still regulates
(or attempts to control) fair trade, government programs, honest
business, monopolies, etc.

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In this type of economy, there is a separation between the government

and the market. This separation prevents the government from becoming too
powerful and keeps their interests aligned with that of the markets.

Historically, Hong Kong is considered an example of a free market

society.

Advantages of a Free Market Economy

 Consumers pay the highest price they want to, and businesses only
produce profitable goods and services. There is a lot of incentive for
entrepreneurship.

 This competition for resources leads to the most efficient use of

the factors of production since businesses are very competitive.

 Businesses invest heavily in research and development. There is an

incentive for constant innovation as companies compete to provide
better products for consumers.

Disadvantages of a Free Market Economy

 Due to the fiercely competitive nature of a free market, businesses
will not care for the disadvantaged like the elderly or disabled. This
lack of focus on societal benefit leads to higher income inequality.

 Since the market is driven solely by self-interest, economic needs

have a priority over social and human needs like providing
healthcare for the poor. Consumers can also be exploited by
monopolies.

Mixed Economic System

A mixed economy is a combination of different types of economic
systems. This economic system is a cross between a market economy and
command economy. In the most common types of mixed economies, the market
is more or less free of government ownership except for a few key areas like
transportation or sensitive industries like defense and railroad.

However, the government is also usually involved in the regulation of

private businesses. The idea behind a mixed economy was to use the best of
both worlds – incorporate policies that are socialist and capitalist.

To a certain extent, most countries have a mixed economic system. For

example, India and France are mixed economies.

Advantages of Mixed Economies

 There is less government intervention than a command economy.
This results in private businesses that can run more efficiently and
cut costs down than a government entity might.

 The government can intervene to correct market failures. For

example, most governments will come in and break up large

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companies if they abuse monopoly power. Another example could

be the taxation of harmful products like cigarettes to reduce
a negative externality of consumption.

 Governments can create safety net programs like healthcare or social

security.

 In a mixed economy, governments can use taxation policies

to redistribute income and reduce inequality.

Disadvantages of Mixed Economies

 There are criticisms from both sides arguing that sometimes there is
too much government intervention, and sometimes there isn’t
enough.

 A common problem is that the state run industries are

often subsidized by the government and run into large debts because
they are uncompetitive.

Microeconomics and Macroeconomics

Economics is divided into two different categories: microeconomics and
macroeconomics. Microeconomics is the study of individuals and business decisions,
while macroeconomics looks at the decisions of countries and governments.

While these two branches of economics appear to be different, they are actually
interdependent and complement one another. Many overlapping issues exist between
the two fields.

KEY TAKEAWAYS
Microeconomics studies individuals and business decisions,
while macroeconomics analyzes the decisions made by countries and
governments.

Microeconomics focuses on supply and demand, and other forces that

determine price levels, making it a bottom-up approach.

Macroeconomics takes a top-down approach and looks at the economy as a

whole, trying to determine its course and nature.

Investors can use microeconomics in their investment decisions, while

macroeconomics is an analytical tool mainly used to craft economic and fiscal
policy.

Microeconomics
Microeconomics is the study of decisions made by people and businesses
regarding the allocation of resources and prices of goods and services. It also takes into
account taxes, regulations, and government legislation.

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Microeconomics focuses on supply and demand and other forces that determine
the price levels in the economy. It takes what is referred to as a bottom-up approach to
analyzing the economy. In other words, microeconomics tries to understand human
choices, decisions, and the allocation of resources.

Having said that, microeconomics does not try to answer or explain what forces
should take place in a market. Rather, it tries to explain what happens when there are
changes in certain conditions.

For example, microeconomics examines how a company could maximize its

production and capacity so that it could lower prices and better compete in its industry.
A lot of microeconomic information can be gleaned from the financial statements.

Macroeconomics
Macroeconomics, on the other hand, studies the behavior of a country and how
its policies affect the economy as a whole. It analyzes entire industries and economies,
rather than individuals or specific companies, which is why it's a top-down approach.
It tries to answer questions like "What should the rate of inflation be?" or "What
stimulates economic growth?"

Macroeconomics examines economy-wide phenomena such as gross domestic

product (GDP) and how it is affected by changes in unemployment, national income,
rate of growth, and price levels.

Macroeconomics analyzes how an increase or decrease in net exports affects a

nation's capital account, or how GDP would be affected by the unemployment rate.

Macroeconomics focuses on aggregates and econometric correlations, which is

why it is used by governments and their agencies to construct economic and fiscal
policy. Investors of mutual funds or interest-rate-sensitive securities should keep an eye
on monetary and fiscal policy. Outside of a few meaningful and measurable impacts,
macroeconomics doesn't offer much for specific investments.

John Maynard Keynes is often credited as the founder of macroeconomics, as

he initiated the use of monetary aggregates to study broad phenomena. Some
economists dispute his theory, while many of those who use it disagree on how to
interpret it.

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Review Questions and Exercises

Exercise 1
Name:______________________________________ Course and Year:__________

Multiple Choice. Write only the letter of the best answer on the blank.

_______ 1. Production decisions are made according to customs and traditions.

a. Traditional system c. Command system

b. Market system d. Mixed system

______ 2. The system works under the principle that the interest of society
should prevail over that of the individual.

a. Traditional system c. Command system

b. Market system d. Mixed system

______ 3. Market prices serve as signals to the producers about what goods to
produce and how much of these goods should be produced.

a. Traditional system c. Command system

b. Market system d. Mixed system

______ 4. The economic problems are answered predominantly through the

price mechanism and modified through government intervention.

a. Traditional system c. Command system

b. Market system d. Mixed system

______ 5. An economy where individuals exercise free enterprise.

a. Traditional system c. Command system

b. Market system d. Mixed system

Exercise 2

Essay. Make a persuasive arguments about your best economic system.

(Provide your own answer sheets)

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