Microeconomics (from Greek prefix mikro- meaning
"small" + economics) is a branch of economics
that studies the behaviour of individuals
and firms in making decisions regarding the
allocation of scarce resources and the interactions
among these individuals and firms.One goal
of microeconomics is to analyze the market
mechanisms that establish relative prices
among goods and services and allocate limited
resources among alternative uses.
Microeconomics shows conditions under which
free markets lead to desirable allocations.
It also analyzes market failure, where markets
fail to produce efficient results.
Microeconomics stands in contrast to macroeconomics,
which involves "the sum total of economic
activity, dealing with the issues of growth,
inflation, and unemployment and with national
policies relating to these issues".
Microeconomics also deals with the effects
of economic policies (such as changing taxation
levels) on the aforementioned aspects of the
economy.
Particularly in the wake of the Lucas critique,
much of modern macroeconomic theory has been
built upon microfoundations—i.e. based upon
basic assumptions about micro-level behavior.
== Assumptions and definitions ==
Microeconomic theory typically begins with
the study of a single rational and utility
maximizing individual.
To economists, rationality means an individual
possesses stable preferences that are both
complete and transitive.
The technical assumption that preference relations
are continuous is needed to ensure the existence
of a utility function.
Although microeconomic theory can continue
without this assumption, it would make comparative
statics impossible since there is no guarantee
that the resulting utility function would
be differentiable.
Microeconomic theory progresses by defining
a competitive budget set which is a subset
of the consumption set.
It is at this point that economists make The
technical assumption that preferences are
locally non-satiated.
Without the assumption of LNS (local non-satiation)
there is no guarantee that a rational individual
would maximize utility.
With the necessary tools and assumptions in
place the utility maximization problem (UMP)
is developed.
The utility maximization problem is the heart
of consumer theory.
The utility maximization problem attempts
to explain the action axiom by imposing rationality
axioms on consumer preferences and then mathematically
modeling and analyzing the consequences.
The utility maximization problem serves not
only as the mathematical foundation of consumer
theory but as a metaphysical explanation of
it as well.
That is, the utility maximization problem
is used by economists to not only explain
what or how individuals make choices but why
individuals make choices as well.
The utility maximization problem is a constrained
optimization problem in which an individual
seeks to maximize utility subject to a budget
constraint.
Economists use the extreme value theorem to
guarantee that a solution to the utility maximization
problem exists.
That is, since the budget constraint is both
bounded and closed, a solution to the utility
maximization problem exists.
Economists call the solution to the utility
maximization problem a Walrasian demand function
or correspondence.
The utility maximization problem has so far
been developed by taking consumer tastes (i.e.
consumer utility) as the primitive.
However, an alternative way to develop microeconomic
theory is by taking consumer choice as the
primitive.
This model of microeconomic theory is referred
to as revealed preference theory.
The theory of supply and demand usually assumes
that markets are perfectly competitive.
This implies that there are many buyers and
sellers in the market and none of them have
the capacity to significantly influence prices
of goods and services.
In many real-life transactions, the assumption
fails because some individual buyers or sellers
have the ability to influence prices.
Quite often, a sophisticated analysis is required
to understand the demand-supply equation of
a good model.
However, the theory works well in situations
meeting these assumptions.
Mainstream economics does not assume a priori
that markets are preferable to other forms
of social organization.
In fact, much analysis is devoted to cases
where market failures lead to resource allocation
that is suboptimal and creates deadweight
loss.
A classic example of suboptimal resource allocation
is that of a public good.
In such cases, economists may attempt to find
policies that avoid waste, either directly
by government control, indirectly by regulation
that induces market participants to act in
a manner consistent with optimal welfare,
or by creating "missing markets" to enable
efficient trading where none had previously
existed.
This is studied in the field of collective
action and public choice theory.
"Optimal welfare" usually takes on a Paretian
norm, which is a mathematical application
of the Kaldor–Hicks method.
This can diverge from the Utilitarian goal
of maximizing utility because it does not
consider the distribution of goods between
people.
Market failure in positive economics (microeconomics)
is limited in implications without mixing
the belief of the economist and their theory.
The demand for various commodities by individuals
is generally thought of as the outcome of
a utility-maximizing process, with each individual
trying to maximize their own utility under
a budget constraint and a given consumption
set.
== Basic microeconomic concepts ==
The study of microeconomics involves several
"key" areas:
=== Demand, supply, and equilibrium ===
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.
=== Measurement of elasticities ===
Elasticity is the measurement of how responsive
an economic variable is to a change in another
variable.
Elasticity can be quantified as the ratio
of the change in one variable to the change
in another variable, when the later variable
has a causal influence on the former.
It is a tool for measuring the responsiveness
of a variable, or of the function that determines
it, to changes in causative variables in unitless
ways.
Frequently used elasticities include price
elasticity of demand, price elasticity of
supply, income elasticity of demand, elasticity
of substitution or constant elasticity of
substitution between factors of production
and elasticity of intertemporal substitution.
=== Consumer demand theory ===
Consumer demand theory relates preferences
for the consumption of both goods and services
to the consumption expenditures; ultimately,
this relationship between preferences and
consumption expenditures is used to relate
preferences to consumer demand curves.
The link between personal preferences, consumption
and the demand curve is one of the most closely
studied relations in economics.
It is a way of analyzing how consumers may
achieve equilibrium between preferences and
expenditures by maximizing utility subject
to consumer budget constraints.
=== Theory of production ===
Production theory is the study of production,
or the economic process of converting inputs
into outputs.
Production uses resources to create a good
or service that is suitable for use, gift-giving
in a gift economy, or exchange in a market
economy.
This can include manufacturing, storing, shipping,
and packaging.
Some economists define production broadly
as all economic activity other than consumption.
They see every commercial activity other than
the final purchase as some form of production.
=== Costs of production ===
The cost-of-production theory of value states
that the price of an object or condition is
determined by the sum of the cost of the resources
that went into making it.
The cost can comprise any of the factors of
production: labour, capital, land,entrepreneur.
Technology can be viewed either as a form
of fixed capital (e.g.
plant) or circulating capital (e.g.
intermediate goods).
=== Opportunity cost ===
The economic idea of opportunity cost is closely
related to the idea of time constraints.
You can do only one thing at a time, which
means that, inevitably, you’re always giving
up other things.
The opportunity cost of any activity is the
value of the next-best alternative thing you
may have done instead.
Opportunity cost depends only on the value
of the next-best alternative.
It doesn’t matter whether you have 5 alternatives
or 5,000.
Opportunity costs can tell you when not to
do something as well as when to do something.
For example, you may like waffles, but you
like chocolate even more.
If someone offers you only waffles, you’re
going to take it.
But if you’re offered waffles or chocolate,
you’re going to take the chocolate.
The opportunity cost of eating waffles is
sacrificing the chance to eat chocolate.
Because the cost of not eating the chocolate
is higher than the benefits of eating the
waffles, it makes no sense to choose waffles.
Of course, if you choose chocolate, you’re
still faced with the opportunity cost of giving
up having waffles.
But you’re willing to do that because the
waffle's opportunity cost is lower than the
benefits of the chocolate.
Opportunity costs are unavoidable constraints
on behaviour because you have to decide what’s
best and give up the next-best alternative.
=== Market structure ===
The market structure can have several types
of interacting market systems.
Different forms of markets are a feature of
capitalism and market socialism, with advocates
of state socialism often criticizing markets
and aiming to substitute or replace markets
with varying degrees of government-directed
economic planning.
Competition acts as a regulatory mechanism
for market systems, with government providing
regulations where the market cannot be expected
to regulate itself.
One example of this is with regards to building
codes, which if absent in a purely competition
regulated market system, might result in several
horrific injuries or deaths to be required
before companies would begin improving structural
safety, as consumers may at first not be as
concerned or aware of safety issues to begin
putting pressure on companies to provide them,
and companies would be motivated not to provide
proper safety features due to how it would
cut into their profits.
Some examples of markets:
commodity markets
insurance markets
bond markets
energy markets
flea markets
debt markets
stock markets
online auctions
media exchange markets
real-estate market.
=== Perfect competition ===
Perfect competition is a situation in which
numerous small firms producing identical products
compete against each other in a given industry.
Perfect competition leads to firms producing
the socially optimal output level at the minimum
possible cost per unit.
Firms in perfect competition are "price takers"
(they do not have enough market power to profitably
increase the price of their goods or services).
A good example would be that of digital marketplaces,
such as eBay, on which many different sellers
sell similar products to many different buyers.
=== Imperfect competition ===
In economic theory, imperfect competition
is a type of market structure showing some
but not all features of competitive markets.
==== Monopolistic competition ====
Monopolistic competition is a situation in
which many firms with slightly different products
compete.
Production costs are above what may be achieved
by perfectly competitive firms, but society
benefits from the product differentiation.
Examples of industries with market structures
similar to monopolistic competition include
restaurants, cereal, clothing, shoes, and
service industries in large cities.
==== Monopoly ====
A monopoly is a market structure in which
a market or industry is dominated by a single
supplier of a particular good or service.
Because monopolies have no competition they
tend to sell goods and services at a higher
price and produce below the socially optimal
output level.
Although not all monopolies are a bad thing,
especially in industries where multiple firms
would result in more problems than benefits
(i.e. natural monopolies).
Natural monopoly: A monopoly in an industry
where one producer can produce output at a
lower cost than many small producers.
==== Oligopoly ====
An oligopoly is a market structure in which
a market or industry is dominated by a small
number of firms (oligopolists).
Oligopolies can create the incentive for firms
to engage in collusion and form cartels that
reduce competition leading to higher prices
for consumers and less overall market output.
Alternatively, oligopolies can be fiercely
competitive and engage in flamboyant advertising
campaigns.
Duopoly: A special case of an oligopoly, with
only two firms.
Game theory can elucidate behavior in duopolies
and oligopolies.
==== Monopsony ====
A monopsony is a market where there is only
one buyer and many sellers.
==== Oligopsony ====
An oligopsony is a market where there are
a few buyers and many sellers.
=== Game theory ===
Game theory is a major method used in mathematical
economics and business for modeling competing
behaviors of interacting agents.
The term "game" here implies the study of
any strategic interaction between people.
Applications include a wide array of economic
phenomena and approaches, such as auctions,
bargaining, mergers & acquisitions pricing,
fair division, duopolies, oligopolies, social
network formation, agent-based computational
economics, general equilibrium, mechanism
design, and voting systems, and across such
broad areas as experimental economics, behavioral
economics, information economics, industrial
organization, and political economy.
=== Labor economics ===
Labor economics seeks to understand the functioning
and dynamics of the markets for wage labor.
Labor markets function through the interaction
of workers and employers.
Labor economics looks at the suppliers of
labor services (workers), the demands of labor
services (employers), and attempts to understand
the resulting pattern of wages, employment,
and income.
In economics, labor is a measure of the work
done by human beings.
It is conventionally contrasted with such
other factors of production as land and capital.
There are theories which have developed a
concept called human capital (referring to
the skills that workers possess, not necessarily
their actual work), although there are also
counter posing macro-economic system theories
that think human capital is a contradiction
in terms.
=== Welfare economics ===
Welfare economics is a branch of economics
that uses microeconomics techniques to evaluate
well-being from allocation of productive factors
as to desirability and economic efficiency
within an economy, often relative to competitive
general equilibrium.
It analyzes social welfare, however measured,
in terms of economic activities of the individuals
that compose the theoretical society considered.
Accordingly, individuals, with associated
economic activities, are the basic units for
aggregating to social welfare, whether of
a group, a community, or a society, and there
is no "social welfare" apart from the "welfare"
associated with its individual units.
=== Economics of information ===
Information economics or the economics of
information is a branch of microeconomic theory
that studies how information and information
systems affect an economy and economic decisions.
Information has special characteristics.
It is easy to create but hard to trust.
It is easy to spread but hard to control.
It influences many decisions.
These special characteristics (as compared
with other types of goods) complicate many
standard economic theories.
== Applied ==
Applied microeconomics includes a range of
specialized areas of study, many of which
draw on methods from other fields.
Industrial organization examines topics such
as the entry and exit of firms, innovation,
and the role of trademarks.
Labor economics examines wages, employment,
and labor market dynamics.
Financial economics examines topics such as
the structure of optimal portfolios, the rate
of return to capital, econometric analysis
of security returns, and corporate financial
behavior.
Public economics examines the design of government
tax and expenditure policies and economic
effects of these policies (e.g., social insurance
programs).
Political economy examines the role of political
institutions in determining policy outcomes.
Health economics examines the organization
of health care systems, including the role
of the health care workforce and health insurance
programs.
Education economics examines the organization
of education provision and its implication
for efficiency and equity, including the effects
of education on productivity.
Urban economics, which examines the challenges
faced by cities, such as sprawl, air and water
pollution, traffic congestion, and poverty,
draws on the fields of urban geography and
sociology.
Law and economics applies microeconomic principles
to the selection and enforcement of competing
legal regimes and their relative efficiencies.
Economic history examines the evolution of
the economy and economic institutions, using
methods and techniques from the fields of
economics, history, geography, sociology,
psychology, and political science.
== History ==
The difference between microeconomics and
macroeconomics was introduced in 1933 by the
Norwegian economist Ragnar Frisch (Nobel Prize
1969).
== See also ==
Economics
Macroeconomics
