MICROECONOMIC

CHAPTER 1  INTRODUCTION

1.1 DISCIPLINE OF ECONOMICS THEORY

There are two different categories concerning economic behavior, the micro economics and macro economics.

Micro economics
The study of economic behavior of individual making units such as producer, consumer, household, and firms.

Macro economics
The study of economic system as a whole or on the basis of aggregate such as consumer price index, inflation rate, national income and unemployment level.

1.2 DEFINITION OF ECONOMICS

Conventional perspective

Definition
A study of how societies make use of scarce resources to fulfill their unlimited wants.

Scarce resources refer to the limited factors of production, which are; Land Labor Capital Entrepreneur Unlimited wants refer to the behavior of man to maximize satisfaction/utility.

Main focus
Maximization of society’s material welfare.

Consumers maximize satisfaction/utility Producers maximize profits Owners of resources maximize returns

Conclusion Attainment of maximum worldly satisfaction
Discusses the economic problems as they are (normative) not what they ought to be (positive)
Not concerned with value judgment and spiritual well being
Disregard the influence of religion values on economic activities

Islamic perspective

Definition
Islamic economics is a social science which studies the economic problems of people imbued with Islamic values

Objective of all economic activities
Achievement of Al Falah (prosperity in the world and in the Hereafter) and the blessings of Allah

The philosophic foundations of Islamic Economics

TAUHID
It is the belief and understanding that Allah is the Creator, the Lord, the Sustainer and the Giver. It encompasses 3 aspects; Hablumminaan Allah - the relationship between man and Allah
Habluminnaannas - the relationship between man and man - the relationship between man and nature

1. Rububiyyah
The belief that Allah alone nurtures, nourishes, sustains, develops, and leads us toward success/perfection

2. Khalifah
The role of man as the vicegerent of Allah, entrusted with all the economic resources. Has the responsibility of illustrating a role model for other men to follow. 3. Tazkiyyah
The concept of purification and growth. Responsible to enrich the world and purify his asset/wealth through zakat, sadaqah, waqaf, and charity.

4. Ukhuwah
The concept of brotherhood, showing the right attitude towards other human being.

5. Al-Falah The concept of success/happiness/prosperity in this world and the Hereafter.

1.3 ECONOMIC CONCEPTS

I. Scarcity
The excess of human wants over what can actually be produced from the limited resources.

Conventional perspective

Land –Inputs into production that are provided by nature such as raw materials from the surface of earth, mineral and oil deposits. The reward is rent.
Labor – All forms of human input, both physical and mental, into current production. The reward is wage.
Capital – All inputs into production that have themselves been produced such as factories, machineries, equipments and tools. The reward is interest.
Entrepreneur – The person who has the capability to combine all resources into the production of goods and services. The reward is profit.

Islamic perspective

In Islam, resources provided by Allah are plentiful but human have to explore other alternatives to replace the depleting resources. Also, human unlimited wants in Islam is due to ‘wasatiah‘ concept. The wants may be based on ‘nafs’

Land – Nature is a gift from Allah, therefore man should take care of the environment without damaging it.
Labor – Responsible to find ‘halal’ income and practice good work ethics. Aware of his social obligation to the society such as paying ‘zakat’ and contribute to ‘amal jariah’
Capital – Should come from ‘halal’ sources. Returns in the form of ‘riba’ are prohibited.
Entrepreneur – Production of goods and services should follow the Islamic rules. Practice good corporate governance and responsible for his workers’ welfare.

II. Choice
Since resources are limited, choices must be made. Therefore one must choose the best alternative with the most benefit.

III. Opportunity Cost
When one chose the best alternative, the second best alternative must be forgone. Therefore opportunity cost is measured in terms of the second best alternative forgone.

The Production Possibility Curve can further illustrate these three basic economic concepts.

1.4 PRODUCTION POSSIBILITY CURVE (PPC)

Definition
A graph that shows various combinations of goods and services that can be produced using all the resources available.

Assumptions
1. The economy is producing two goods only
2. Resources are fixed
3. State of technology is constant
4. The economy is operating at full employment.

Schedule of PPC

Combination
Motorcycles
CD players
A
0
18
B
1
17
C
2
15
D
3
12
E
4
8
F
5
0

Graph of PPC

CD players


Shape of PPC is concave

Motorcycles

Points along the curve are considered efficient combinations
Points outside the curve are unattainable due to the problem of scarcity (point Y)
Points inside the curve are attainable but reflect inefficient allocation of resources, waste and unemployment of resources (point Z)

The shape of PPC and the types of opportunity cost

1. A concave PPC shows that the opportunity cost is increasing y
Combination
Good x
Good y
A
0
10
B
1
9
C
2
7
D
3
4
E
4
0

2. A linear PPC shows that the opportunity cost is constant

Combination
Good x
Good y
A
0
10
B
1
8
C
2
6
D
3
4
E
4
2
F
5
0

Factors that influence the shift of PPC

Given the four assumptions of PPC earlier, the amount of output of the two goods will be fixed. However, the PPC may shift outward (change in the amount of output) based on these factors;

1. The discovery of new technology (i.e. advanced technology in the production of motorcycles)

CD players

Motorcycles

2. The increase in factors of production (i.e. more productive labor in the production of CD players)

CD players

Motorcycles

3. Economic growth Investment in the stock of capital will cause the economy to grow and expand and thus, increase in overall output.

CD players

Motorcycles

1.5 TYPES OF ECONOMIC SYSTEMS

The classifications of four types of economic system are;
1. Capitalism/Free market economy
2. Socialism/Command economy
3. Mixed economy
4. Islamic economy

Basic economic problems

Due to the problem of scarcity, choice must be made;

1. What and how much to produce?
2. How to produce?
3. For whom to produce?

R Firm

Allocation of resources Distribution of output

Each economic system will solve the three basic economic problems differently.

1. Capitalism

A market economy that provides for the ownership of the factors of production and encourages entrepreneurship by offering profit and incentive.

Main features
“Laissez-faire” or hands-off policy private ownership of resources freedom of enterprise price mechanism/invisible hand profit motive competition Strengths functions automatically higher efficiency and incentive to work hard optimum utilization of resources economic development and prosperity

Weaknesses misallocation of resources wasteful competition human welfare ignored inequitable distribution of income

2. Socialism

The central directing authority resolves basic economic problems. Government owns and operates only major industries.

Main features public ownership of resources no private enterprise classless society central economic planning

Strengths better allocation of resources high growth rate and low unemployment rate social justice

Weaknesses high administration cost absence of price mechanism may cause inefficient use of resources no incentive to be more productive and produce quality goods

3. Mixed economy

Mixture of the two systems, market and command. Many planned economies have adopted market mechanism through privatization (the process of converting government enterprise into privately owned companies)

Main features co-existence of public and private sectors role of price system and government directives government regulation and control of private sectors control on monopoly Totally China France Totally planned free-market economy N.Korea Poland M’sia UK USA HK economy S’pore

4. Islamic economy

Based on the five philosophic foundations. A balance between economic freedom and regulated economic system.

Main features the prime objective is to achieve Al Falah all decisions should earn the approval of Allah private ownership is allowed such that it is allocated and utilized accordingly the role of government is to achieve the goals of Islamic society
‘riba’ is prohibited forbidden goods are not produced

ESSAY QUESTIONS

a) Explain the four philosophical foundation of Islamic economics. [10 m] b) Write short notes on the following terms from Islamic perspective ; i) Classification of goods ii) Scarcity iii) Factors of production. [10 m]

c) Using PPC , explain the 3 basic economic concepts of scarcity, choice and opportunity cost. [10 m]

d) Discuss 3 advantages of socialism and 3 disadvantages of market economy. [10 m]

e) Explain how capitalism and socialism solve the basic economic problems. [10 m]

f) Explain the difference between scarcity from conventional perspective and scarcity from Islamic perspective. [10 m]

STRUCTURE QUESTIONS

PRODUCTION POSSIBILITY CURVE

1. The diagram below shows the combination of two products, VCD and computer, that can be produced by Fantasyland.

VCD

25 22

15

Computer 12 17 20

a) i. The opportunity cost to produce from 12 to 17 units of computer is __________

ii. The opportunity cost to produce 25 units of VCD is _______________

iii. The opportunity cost to produce 17 units of computer is _______________

b) Fantasyland’s PPC shows that the type of opportunity cost is ____________

c) List any TWO assumptions that are made when a PPC is constructed.

d) Give TWO reasons why Fantasyland should NOT produce 12 computers and 15 VCDs.

e) It is ________________ for Fantasyland to produce 17 computers and 22 VCDs

because ____________________________

f) Suggest TWO factors that may enable Fantasyland to produce the combination in (e)