Microeconomics: What It Is
Microeconomics is the branch of economics that analyzes the effects of incentives and decisions on resource allocation and consumption.
In microeconomics, we see how and why prices vary across goods, how businesses and consumers alike can reap the benefits of streamlined production and trade, and how people can work together more effectively. Microeconomics, in comparison to macroeconomics, tends to offer a more comprehensive and nuanced picture.
KEY POINTS
- Individual and corporate choices regarding the allocation of production, exchange, and consumption resources are the focus of microeconomics.
- Macroeconomics is concerned with the aggregates of an economy as a whole, while microeconomics focuses on individual markets and the interaction between them.
- Models are developed by microeconomists based on logic and observed human behavior, and then the models are tested against actual data.
The Basics of Microeconomics
What tends to happen (tendencies) when people make decisions in response to shifts in incentives, prices, resources, and/or production methods is the focus of microeconomics.
Microeconomics classifies individuals into categories like buyers, sellers, and business owners. Money and interest rates serve as a pricing mechanism for these groups to coordinate the supply and demand of resources.
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Applications of Microeconomics
Both positive and normative uses of microeconomics are possible. In positive microeconomics, we learn how economies function and what to anticipate when external factors alter the status quo. When car prices go up, sales typically go down because consumers can’t afford to buy as many vehicles.
If a significant copper mine were to fail in South America, the metal’s price would likely rise due to supply concerns. An investor could benefit from a better understanding of positive microeconomics to understand why Apple Inc.
stock prices could decline if consumers buy fewer iPhones. A higher minimum wage may cause The Wendy’s Company to reduce its workforce, which can be understood through the lens of microeconomics.
After explaining and predicting the most valuable or beneficial production, exchange, and consumption patterns among market participants, normative microeconomics can then prescribe what individuals, firms, and governments should do to bring about these outcomes.
The application of microeconomics beyond the realm of “what is” to “what ought to be” or “what people ought to do” necessitates the application of at least some ethical or moral theory or principles, typically a form of utilitarianism.
Microeconomic Theory and Practice
General equilibrium theory, developed by Léon Walras in Elements of Pure Economics (1874), and partial equilibrium theory, introduced by Alfred Marshall in Principles of Economics (1921), have historically been used in the study of microeconomics (1890).
Neoclassical microeconomics is a broad school of thought that includes the Marshallian and Walrasian approaches. In neoclassical economics, consumers and producers are assumed to act rationally in order to maximize their economic well-being given their income and resource constraints.
To create mathematical models of economic behaviour, neoclassical economists make simplifying assumptions about markets, such as perfect knowledge, infinite numbers of buyers and sellers, homogeneous goods, or static variable relationships.
Economists are able to create mathematically testable models of individual markets by employing these techniques, which attempt to represent human behaviour in functional mathematical language.
Neoclassical economists believe that the best way to predict economic outcomes is to come up with testable hypotheses and then test those hypotheses with data.
They are adherents of the philosophical school known as “logical positivism” or “logical empiricism” because of this. Depending on the topic at hand and the participants’ actions, microeconomics employs a variety of research techniques.
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Microeconomics: The Fundamentals
Among the many central ideas central to the study of microeconomics are:
- Individual and organizational responses to various situations are influenced by incentives and behaviours.
- According to the theory of consumer utility, consumers will spend their money on the set of goods and services that brings them the greatest amount of satisfaction, or utility.
- The study of production, or the transformation of raw materials into finished goods, is known as production theory. In order to maximize profits, producers always look for the most cost-effective inputs and ways to combine them.
- Price theory: In a free market, prices are set according to the theory of supply and demand, which is derived from the interaction of the utility theory and the theory of production. It concludes that in a perfectly competitive market, the price paid by consumers and the price paid by producers are identical. That leads to a state of economic stability.
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