Introduction to Microeconomics
Economics is one of the most debated subjects in the world. And that is why it is an umbrella covering different subjects. In the article, we look at microeconomics. It seeks to offer an essential understanding of microeconomics to those who have not studied and a revision opportunity to those who have.
What is Microeconomics?
Many people wonder why economics and why they should study the subject. There are many other subjects one would invest their time in more than this. Well, consider this:
In the information age, specifically media times, people are often faced with decisions. You are online and have written a long post, but should you post or should not. What should you have for breakfast? Which route should you follow in your next class? Should you postpone the semester or take extra classes to finish earlier?
Decisions, decisions, and decisions! We must make a decision. The way we respond to these choices depends on the information we have at any given moment. Economists call this information ‘imperfect’ because we never have enough data to make the right decisions. And even though we don’t have the perfect information, making a decision is a must.
Today, technology has made it easier to gather information. Social media outlets like Facebook, Twitter, and many others are affecting the way people make decisions. It determines how we spend our time, which activities to get involved, which movies to watch, what to buy, and many others. When you want to join a University, you will probably check out their page on Facebook first.
This course emphasizes the fact that everything that happens in economics is affected by how efficient information is disseminated. It is all about how information travels through different media. And it is often the joy of economists when perfect information influences deep and liquid markets.
Hence, microeconomics introduces us to the world of making decisions at an individual level. Economics, as a whole, determines how the world of making decisions, processing information, and understanding behavior in markets operates. Making decisions is the nature of every economics. So if you are still wondering why you should the subject, then you have a reason already.
It is important to understand the difference between microeconomics and macroeconomics. Macro means an overall approach to markets. It studies how the aggregate economy behaves, referring to inflation, price levels, rate of growth, national growth, and more general aspects. Micro focuses on individuals.
Many people think economics is all about money and finance. It is vital to understand economics as more than primarily business or mathematics. It is a general way of viewing the world.
Based on this, we can define microeconomic as a branch of economics that observes the behavior of individual decision-makers. Such parties include individuals, households, and firms (all types of businesses). It is the complete opposite of macroeconomics, which looks at economics as a wide subject.
In other words, micro is all about what motivates households to consider buying a new car instead of going on a fancy vacation. It describes why you should watch a certain movie, go for a specific class, or follow a chosen route. Microeconomics affects everyone daily.
Scarcity is a problem that faces humanity at all levels. The world has resources, but human wants often exceed the available resources. Hence, microeconomics is built on the foundation of economic thinking. Consumers demand goods and services, which are offered by producers. In the economic system, nobody can take anything they want when they want it. There must be a choice. And in order to make this choice, you have to give up something else. There is nothing like a ‘free lunch.’
A good example is when one chooses to buy a new car at the expense of going on a vacation. Individuals in households must make decisions, and so do firms about what they want to produce. Hence, firms can preclude themselves from manufacturing alternative products.
Again a producer must decide the number of goods and services they want to give out and for which market. It would be simple to say a company will just produce as much as possible. But that is never the case in economics. Classical economics teaches than you have to look at all the factors of production. The law of diminishing returns states that “ if we keep on adding variable factors of production (like labor) to the fixed elements (like land), the output becomes proportionally less from each additional unit of the factor added, until, eventually, the entire out will begin diminishing with every addition of a unit factor.
How do markets determine prices for their products? This is often the foundational question for the study of microeconomics. A market system brings together producers and consumers. In traditional settings, a market was a physical location where people with different needs would meet to trade. Today technology has made things much simpler in that humans no longer have to meet.
Producers and consumers create a system called supply and demand. And their interaction based on these specific roles creates a price mechanism. It was once known as the ‘invisible hand’ because it guided the actions of producers and consumers from the background. Markets are essential determinants of everyday life. In other words, human beings interact with demands at all levels. If, for instance, an individual would produce all the food in the world, the same would still need clothes, shelter, and other basic needs. This is why communities have learned to benefit from exchanges. It was first through barter trade before the evolution of money too charges.
It is critical for people to know what they could charge, or pay for goods and services. There was initially no formal thought on this, but the trader discovered that they would run out of inventory if they kept a fixed price on their goods. It was easier to know what others were charging in a physical market. However, things have changed with remote markets whereby there is less perfect knowledge of prices. Based on the thought of Alfred Marshall, “Principles of Economics,” everything you read today on supply and demand, elasticity, revenues, and costs come from this thought. In other words, Marshall established the foundation for an analysis of supply and demand, hence, determining prices in the markets.
All human beings have needs. And these needs create demand, which is often founded on the perceived worth in the given good or service. Necessities such as good food, clothes, and other products are all necessary. But there are several factors that fuel the demand for a specific product, including:
- Its price
- Prices of substitutes and compliment goods and service
- Individual’s income
- Personal preferences and
The economic analysis employs the testing of the quantity demanded against these variables, where all others are constant. In most cases, economists use the relationship between quantity demands and prices to analyze demand. In this case, demand quantity is inversely proportional to price, assuming people are rational consumers, and other demands determining factors are constant. This means where the quantity of demand falls, price surges, and vise versa.
When there is an increase in price, expect a certain decrease in demand. This case is true for most goods. But for “Giffen goods” demand rises with an increase in price. For instance, a high price tag on a piece of designer cloth will increase its demand because it is perceived as a high-quality product.
What about when other variables change. Consider this, when there is an increase in income, and a decrease in tax rates, the demand for goods and services will surge. And the opposite is also true. All these show that human decisions influence economic behavior.
Whereas consumers purchase goods, it is the job of manufacturers to supply the said goods and services. Similar to the case above, where demand has a proportional relationship to quantity demanded and price, supply goes through the same rough. In general, higher prices lead to the production of more goods and services. On a graph, the supply curve, when other factors remain constant, slopes upwards from left to right. The other factors influencing supply include:
- Price of alternative goods and services
- Relative revenues and production cost
- Objective and expectations of the producer
- Involved technology
A company gets maximum profits when its marginal revenue is on a straight line with margin cost. But, as long as the marginal revenue keeps about the variable costs, a firm may continue with productions.
Elasticity is based on the responsiveness of demand or supply to price changes. We say demand price elasticity is high, where a small change in price massively affects the quantity of demand. But if there is little or no effect on demand quantity, then demand is termed as highly inelastic. This is a very vital factor for producers. They have to consider the effects of their pricing strategies over time and adjust appropriately. Also, the government needs to impose fiscal and monetary policies that impose sales taxes so that they can predict tax revenues.
Firms find price elasticity by dividing the change in demand quantity with the price change, or alteration in supply but the price difference. There is price elasticity in demand when price increment reduces the total revenue, and price inelasticity is when price leads to more revenue generated.
While studying price elasticity, it is also vital to look at income elasticity in relation to demand quantity or supply to income changes. Also, you may come across cross elasticity – the responsiveness of demand or supply quantity to the changes in cost.
A state of equilibrium is where the quantity supplied is equal to the quantity of supply. If the set price gets above the equilibrium, it will cause supply to exceed demand. In this case, the company will have to reduce the price to clear the inventory. On the other hand, where the price set is below the equilibrium, demand increases; consequently, the price.
Markets operate freely in a capitalist system. Such is considered desirable. However, market forces are not allowed to operate for all goods and services society needs. There must be such goods and services considered as ‘public,’ – an intervention can adequately supply them. Such services include law and order, and military. And this is why governments may choose to introduce and sustain a process that keeps such goods and services produced and priced either above or below the equilibrium.
A government, for instance, may order minimum prices to protect the producers; hence, supply quantity will be above the demand quantity as long as the minimum price is above the equilibrium price. For instance, the EU has been there to protect the agricultural sector through agricultural policy on minimum prices.
Price intervention is desirable. However, according to microeconomic analysis, such interventions come with consequences, and society must be ready to face them.
The concept of a firm
The theory of the firm, in microeconomics, seeks to understand the structure of a firm in a specific industry. It also seeks to discover lesions from these alternative structures.
The first thing one must understand in this subject is a perfect competition. This means:
- There is a substantial number of producers for homogeneous goods or services.
- Market entry and exit face no barriers.
- There is perfect knowledge among producers and consumers in a specific market.
Under perfect competition, prices tend to lean towards equilibrium. A producer will not sell anything if they price anything above this.
When there is only one producer in the market, they form a monopoly. Note that most countries define a monopoly in terms of a firm that has more than a specified number of capitalizations in the market.
In a case where few producers influence a market, it is called an oligopoly. Here, the producers are likely to have a higher level of knowledge about their competitors. And when there are many producers, the market creates a monopolistic competition. They may have similar products but with the ability to differentiate. A consumer must be aware of these differences.
Those studying this subject will discover it is a broad subject. It is important to look at a broad range of issues, even if they don’t dig deeper. As such, this article was intended to offer more general and basic information on the most vital topics of microeconomics. Understanding the principle discussed above is vital for students, not only of objective tests in the exam but for general life application.
Author: James Hamilton