Microeconomics Basics: Scarcity, Choice, Profit & Decision-Making

TAKEAWAYS:

• Scarcity forces trade-offs: every choice means sacrificing alternatives (opportunity cost).
• Economic profit ≠ accounting profit: the former subtracts all costs (including implicit costs), while the latter ignores them.
• Fundamental principles (e.g., marginal analysis, incentives) explain how individuals and firms behave.
• Microeconomics applies to business decisions like pricing, production, and resource allocation.
• Real-world examples (e.g., eSewa’s transaction fees, Daraz’s inventory management) use these principles daily.
• Exam questions test definitions, comparisons (e.g., profit types), and applications to business scenarios.

1. What is Microeconomics?

Microeconomics studies individual decision-making by households, firms, and governments in allocating limited resources to satisfy unlimited wants. It focuses on:

• Price determination (e.g., why Daraz raises prices during Dashain).
• Consumer behavior (e.g., why Pathao riders choose routes).
• Firm behavior (e.g., why Ncell sets data plans).
• Market structures (e.g., why NTC is a monopoly).

Why is it called "business economics"? Business economics applies microeconomic principles to real-world business problems, such as:

• Cost minimization (e.g., Khalti reducing transaction fees).
• Profit maximization (e.g., banks setting loan interest rates).
• Resource allocation (e.g., NEPSE deciding stock listings).

Caption: Microeconomics focuses on individual units (firms, households), while macroeconomics studies aggregates (GDP, inflation).

2. The Core Problem: Scarcity and Choice

Scarcity exists because resources (land, labor, capital) are limited, but human wants are unlimited. This forces trade-offs:

• Example: If you spend ₹100 on a smartphone, you cannot buy a book or save for travel. The opportunity cost of the smartphone is the next best alternative (book or savings).

Key Terms:

Caption: A household’s budget allocation: 40% rent, 30% food, 20% transport, 10% savings. The opportunity cost of increasing savings is reducing transport spending.

3. Economic Profit vs. Accounting Profit

Why does this matter?

• Businesses: Economic profit shows true profitability (e.g., eSewa’s profit after accounting for the time its founders could have spent elsewhere).
• Investors: Helps decide if a venture is worthwhile (e.g., starting a Daraz competitor vs. working at a bank).

flowchart TD
    A["Revenue"] --> B["Subtract Explicit Costs<br/>(Rent, Salaries, etc.)"]
    B --> C{"Accounting Profit?"}
    C -->|"Yes"| D["Accounting Profit = Revenue - Explicit Costs"]
    C -->|"No"| E["Subtract Implicit Costs<br/>(Owner's Time, Forgone Salary)"]
    E --> F["Economic Profit = Revenue - (Explicit + Implicit Costs)"]

4. Fundamental Economic Principles

Microeconomics rests on 10 key principles (from Principles of Economics by Mankiw). Two are critical for exams:

(i) How People Make Decisions (Cost-Benefit Analysis)

People make rational choices by comparing marginal benefits (MB) and marginal costs (MC).

• Rule: If MB > MC, do it. If MB < MC, stop.
• Example: Pathao’s driver route choice
  • MB: Earnings per km (₹50/km in Thapathali vs. ₹30/km in Bhaktapur).
  • MC: Time lost in traffic (30 mins vs. 10 mins).
  • Decision: Drive in Thapathali if ₹50 – (₹20 traffic cost) > ₹30.

Graph: Marginal Decision-Making

Marginal Benefit (MB) and Marginal Cost (MC) curves intersect at the optimal quantity.

Caption: A Pathao driver’s decision: Stop picking up passengers when MC (traffic delay) exceeds MB (earnings).

(ii) How People Interact (Incentives Matter)

People respond to incentives (rewards/punishments) to change behavior.

• Example 1: NTC’s internet pricing
  • Incentive: Lower prices for off-peak hours (10 PM–6 AM) → More users at night.
• Example 2: Khalti’s cashback
  • Incentive: 5% cashback on food orders → More people use Khalti instead of cash.

Real-World Impact:

Caption: How businesses use incentives to shape consumer behavior.

5. The Scope of Business Economics

Business economics applies microeconomic theory to real-world problems:

1. Pricing Strategies
   • Example: NEPSE stocks fluctuate based on supply and demand (e.g., Nepal Bank’s share price rises if investors expect higher dividends).
2. Cost Control
   • Example: A café in Kathmandu reduces waste by tracking marginal costs of milk vs. tea.
3. Resource Allocation
   • Example: NTC decides whether to expand fiber in Pokhara (high demand) or Dhangadhi (low demand).
4. Risk Management
   • Example: Banks like NMB calculate economic profit before approving loans to farmers.

mindmap
  root((Business Economics))
    Pricing["Pricing Strategies\n(e.g., NEPSE stocks)"]
    Cost["Cost Control\n(e.g., Daraz inventory)"]
    Allocation["Resource Allocation\n(e.g., NTC fiber expansion)"]
    Risk["Risk Management\n(e.g., bank loans)"]

In the Real World

1. eSewa’s Transaction Fees

   • Concept: Marginal Cost vs. Revenue
   • How it works: eSewa charges a 1.5% fee on transactions. If the marginal cost of processing a ₹1,000 payment is ₹5, but the fee is ₹15, eSewa earns economic profit (after accounting for its opportunity cost, e.g., building an app vs. working at a bank).

2. Daraz’s "Free Shipping" Promotion

   • Concept: Incentives and Elasticity
   • How it works: Daraz offers free shipping on orders above ₹1,000. This increases the quantity demanded because consumers perceive lower marginal cost (no shipping fee). The promotion works because Daraz knows marginal revenue from higher-order values exceeds the cost of free shipping.

3. NTC’s Internet Pricing During Exams

   • Concept: Price Discrimination
   • How it works: NTC often reduces data prices during TU exams. Why? Because students have inelastic demand (they must use data for online exams) and are willing to pay more. NTC captures consumer surplus by charging higher prices to this captive group.

Caption: NTC’s data prices (in ₹/GB) during TU exams vs. normal days. Exam prices are 30% higher due to inelastic demand.

Exam Tip

1. Definitions are key:

   • Memorize economic profit = Revenue – (Explicit + Implicit Costs).
   • Know opportunity cost is the next best alternative, not just money spent.

2. Compare accounting vs. economic profit in examples:

   • Question: "A shopkeeper earns ₹200,000/year. Explicit costs = ₹150,000. If she could earn ₹50,000/year as a teacher, what is her economic profit?"
   • Answer:
     • Accounting profit = ₹200,000 – ₹150,000 = ₹50,000.
     • Economic profit = ₹50,000 – ₹50,000 (forgone teaching salary) = ₹0.

3. Apply principles to real businesses:

   • Question: "How does Pathao use marginal analysis?"
   • Answer:
     • Pathao drivers pick up rides until MB (earnings per km) ≤ MC (traffic delay cost).
     • Example: If a ride in Lalitpur gives ₹100 but takes 20 mins in traffic (MC = ₹20), the net MB = ₹80. If the next ride gives only ₹50, the driver stops.

4. Watch for "fundamental principles" questions:

   • Question: "Explain how incentives affect consumer behavior using a Nepalese example."
   • Answer:
     • Khalti’s cashback increases usage because it lowers the marginal cost of paying digitally.
     • NTC’s off-peak pricing encourages night-time usage by reducing price sensitivity.

5. Draw graphs when asked:

   • For marginal analysis, always show MB and MC curves intersecting at equilibrium.
   • For scarcity, use a pie chart (like the one above) to show trade-offs.

Final Note: This unit is foundational—every other topic (demand, supply, firm behavior) builds on scarcity, choice, and profit. Master these concepts, and the rest will follow. Practice with real-world examples (eSewa, Daraz, NTC) to score full marks!