Micro Economics, Definition, Uses, and Concepts
Assumptions and definitions
The word microeconomics is derived from the Greek words μικρό (small, minor) and οικονομία (economics).
Microeconomic theory usually begins with the study of a single logical and useful individual. For economists, rationality means that an individual possesses multiple, complete and stable preferences.
The technical assumption that preference relationships are continuous is necessary to ensure the existence of a utility function. Although microeconomic theory can proceed without this assumption, it will make comparative statistics impossible since there is no guarantee that the resulting utility function will be differentiable.
Microeconomic theory advances by defining a competitive budget group which is a subset of the consumption group. At this point, economists assume that preferences are not saturated locally. Without the assumption of LNS (Local Non Saturation) there is no 100% guarantee but there will be a logical rise in the individual benefit. With the necessary tools and assumptions in place, the utility maximization problem (UMP) is developed.
The utility maximization problem is the core of consumer theory. The utility maximization problem attempts to explain the axiom of action by imposing the axioms of rationality on consumer preferences and then mathematical modeling and analysis of the results. The utility maximization problem serves not only as a mathematical basis for consumer theory but also as a metaphysical explanation for it. That is, the utility maximization problem is used by economists not only to explain what or how people make choices but why people make choices as well.
The utility maximization problem is a constrained optimization problem in which an individual seeks utility maximization subject to budget constraints. Economists use the maximum value theory to ensure that there is a solution to the utility maximization problem. That is, since budget constraints are both finite and closed, there is a solution to the utility maximization problem. Economists call the solution to the utility maximization problem the Walrasian demand or correspondence function.
The problem of utility maximization has so far been developed by taking consumer tastes (i.e. consumer utility) as primitive tastes. However, an alternative way of developing microeconomic theory is to take consumer choice as the primitive choice. This form of microeconomic theory is referred to as the revealed preference theory.
The supply and demand model describes how prices vary as a result of a balance between the availability of a product at each price (supply) and the desires of those with purchasing power at each price (demand). The graph shows a rightward shift in demand from D1 to D2 along with the subsequent increase in price and quantity required to reach a new equilibrium point to clear the market on the supply curve (S).
Supply and demand theory usually assumes that markets are perfectly competitive. This means that there are many buyers and sellers in the market and none of them has the ability to significantly influence the prices of goods and services. In many real-world transactions, the assumption fails because some individual buyers or sellers have the power to influence prices. Often times, sophisticated analysis is required to understand the supply and demand equation of a good model. However, the theory works well in situations that satisfy these assumptions.
History
Economists usually consider themselves microeconomics or macroeconomists. The difference between microeconomics and macroeconomics was probably introduced in 1933 by the Norwegian economist Ragnar Frisch, winner of the first Nobel Memorial Prize in economic sciences in 1969. However, Frisch did not actually use the word microeconomics, Instead he draws the differences between “microdynamic” and “macrodynamic” analysis in a manner similar to how the words “microeconomics” and “macroeconomics” are used today. The first known use of the term “microeconomics” was in an article published by Peter de Wolf in 1941, who expanded the term “microdynamics” to “microeconomics”
Microeconomic Theory
consumer demand theory
Consumer demand theory relates consumption preferences of both goods and services to consumption expenditures; Ultimately, this relationship between preferences and consumption expenditures is used to relate preferences to consumer demand curves. The relationship between personal preferences, consumption and the demand curve is one of the most closely studied in economics. It is a method of analyzing how consumers can balance preferences and expenditures through utility maximization according to consumer budget constraints.
production theory
Production theory is the study of production, or the economic process of turning inputs into output. Production uses resources to create a good or service suitable for use or gift giving in a gift economy or exchange in a market economy. This can include manufacturing, warehousing, shipping, and packaging. Some economists broadly define production as all economic activities other than consumption. They see every business other than final purchasing as a form of production.
production cost theory of value
The value-cost theory of production states that the price of a thing or condition is determined by the total cost of the resources used to make it. Cost can include any of the factors of production (including labour, capital, or land) and taxes. Technology can be viewed as a form of fixed capital (eg an industrial factory) or working capital (eg intermediate goods).
In the mathematical model of production cost, the short-run total cost is equal to the fixed cost plus the total variable cost. Fixed cost refers to the cost that is incurred regardless of how much the firm produces. Variable cost is a function of the quantity of an object being produced. The cost function can be used to characterize production through dualism theory in economics, primarily developed by Ronald Sheppard (1953, 1970) and other scholars (Sickles & Zelenyuk, 2019, chapter 2).
opportunity cost
Opportunity cost is closely related to the idea of time constraints. One can only do one thing at a time, which means that inevitably, one always gives up on other things. The opportunity cost of an activity is the value of the next best alternative that one might do instead. The opportunity cost depends only on the value of the next best alternative. It doesn’t matter if one has five alternatives or 5000.
Opportunity costs can determine when to do something as well as when to do something. For example, one may like pancakes, but loves chocolate more. If someone offered only pancakes, one would take it. But if pancakes or chocolates are served, one will take chocolate. The opportunity cost of eating pancakes is sacrificing the opportunity to eat chocolate. Since the cost of not eating chocolate is higher than the benefits of eating pancakes, it makes no sense to opt for pancakes. Of course, if one opts for chocolate, one still faces the opportunity cost of giving up eating pancakes. But one is willing to do so because the chance cost of a waffle is less than the benefits of chocolate. Opportunity costs are an inevitable limitation of behavior because one has to decide what is best and forgo the next best alternative.
What is microeconomics?
Microeconomics is the social science that studies the implications of incentives and decisions, specifically about how those incentives affect the use and distribution of resources. Microeconomics explains how and why different commodities have different values, how individuals and firms run and benefit from efficient production and exchange, and how individuals better coordinate and cooperate with each other. In general, microeconomics provides a more complete and detailed understanding than macroeconomics.
Main Points
>>Microeconomics studies the decisions of individuals and firms to allocate resources for production, exchange, and consumption.
>>Microeconomics deals with prices and production in individual markets and the interaction between different markets but leaves the study of aggregates at the economic level to the overall economy.>
>Microeconomists formulate different types of models based on observed human reasoning and behavior and test the models against real-world observations.
Understanding Microeconomics
Microeconomics is the study of what can happen (inclinations) when individuals make choices in response to changes in incentives, prices, resources, and/or methods of production. Individual actors are often grouped into microeconomic subgroups, such as buyers, sellers, and business owners. These combinations create supply and demand for resources, using money and interest rates as a pricing mechanism for coordination.
Uses of Microeconomics
Microeconomics can be applied in the positive or normative sense. Positive microeconomics describes economic behavior and explains what to expect if certain conditions change. If a manufacturer raises car prices, positive microeconomics says consumers will tend to buy less than before. If a major copper mine in South America collapses, the price of copper will tend to increase, because supply is restricted. Positive microeconomics can help an investor see why Apple Inc stock prices are down. If consumers buy fewer iPhones. Microeconomics can also explain why a higher minimum wage might force Wendy’s to hire fewer workers.
These interpretations, conclusions, and predictions of positive microeconomics can then also be applied normatively to describe what individuals, firms, and governments must do for the most valuable or beneficial patterns of production, exchange, and consumption among market participants. This extension of microeconomic ramifications of what ought to be or what people ought to do also requires at least the implicit application of some kind of moral or ethical theory or principles, which usually implies some form of utilitarianism.
Microeconomics method
The study of microeconomics has historically been conducted according to the general equilibrium theory, developed by Leon Walras in The Elements of Pure Economics (1874) and the partial equilibrium theory, introduced by Alfred Marshall in Principles of Economics (1890). The Great Canopy of Neoclassical Microeconomics. Neoclassical economics focuses on how consumers and producers make rational choices to maximize their economic well-being, given the constraints of how much income and resources they have. Neoclassical economists make simplistic assumptions about markets—such as perfect knowledge, infinite numbers of buyers and sellers, homogeneous goods, or constant variable relationships—in order to build mathematical models of economic behavior.
These methods attempt to represent human behavior in functional mathematical language, allowing economists to develop mathematically testable models for individual markets. Neoclassicals believe in building measurable hypotheses about economic events, and then using empirical evidence to see which hypotheses work best. In this way they follow the branch of philosophy “logical positivism” or “logical empiricism”. Microeconomics applies a range of research methods, depending on the question being studied and the behaviors involved.
Basic Concepts of Microeconomics
The study of microeconomics includes several key concepts, including (but not limited to):
Motivations and Behaviors: How people, as individuals or in companies, react to situations they encounter.
Utility theory: Consumers will choose to buy and consume a set of goods that will increase their happiness or ‘utility’, given the constraints of how much income they have available to spend.
Production theory: is the study of production – or the process of turning inputs into output. Producers seek to select the combination of inputs and methods of their combination that minimize cost in order to maximize their profits.
Price Theory: Utility and production theory interact to produce the theory of supply and demand that determines prices in a competitive market. In a perfectly competitive market, you conclude that the price demanded by consumers is the same as that offered by producers. This results in an economic equilibrium.
Price Theory
Price theory is a field of economics that uses the supply and demand framework to explain and predict human behavior. It is associated with the Chicago School of Economics. Price theory studies competitive equilibrium in markets to yield testable hypotheses that can be rejected.
Price theory is not the same as microeconomics. Strategic behavior, such as the interactions among sellers in a market where they are few, is a significant part of microeconomics but is not emphasized in price theory. Price theorists focus on competition believing it to be a reasonable description of most markets that leaves room to study additional aspects of tastes and technology. As a result, price theory tends to use less game theory than microeconomics does.
Price theory focuses on how agents respond to prices, but its framework can be applied to a wide variety of socioeconomic issues that might not seem to involve prices at first glance. Price theorists have influenced several other fields including developing public choice theory and law and economics. Price theory has been applied to issues previously thought of as outside the purview of economics such as criminal justice, marriage, and addiction.
Microeconomic models
Supply and demand
Supply and demand is an economic model of price determination in a perfectly competitive market. It concludes that in a perfectly competitive market with no externalities, per unit taxes, or price controls, the unit price for a particular good is the price at which the quantity demanded by consumers equals the quantity supplied by producers. This price results in a stable economic equilibrium.
A graph depicting Quantity on the X-axis and Price on the Y-axis
The supply and demand model describes how prices vary as a result of a balance between product availability and demand. The graph depicts an increase (that is, right-shift) in demand from D1 to D2 along with the consequent increase in price and quantity required to reach a new equilibrium point on the supply curve (S).
Prices and quantities have been described as the most directly observable attributes of goods produced and exchanged in a market economy. The theory of supply and demand is an organizing principle for explaining how prices coordinate the amounts produced and consumed. In microeconomics, it applies to price and output determination for a market with perfect competition, which includes the condition of no buyers or sellers large enough to have price-setting power.