What Is Microeconomics?
Microeconomics is the social science that studies the implications of incentives and decisions, specifically about how those affect the utilization and distribution of resources. Microeconomics describes the pricing of products and money, causes of different prices to different people, how can provide more or less benefit to producers, consumers and others, and how individuals best coordinate and cooperate. Generally speaking, microeconomics provides a more complete and detailed understanding than macroeconomics.
What is Microeconomics?
- Microeconomics studies the decisions of individuals and firms to allocate resources of production, exchange, and consumption.
- Microeconomics deals with prices and production in single markets and the interaction between different markets but leaves the study of economy-wide aggregates to macroeconomics.
- Microeconomists formulate mathematical models based on samples of behavior and test the models against real-world observations.
Microeconomics is the study of what is likely to happen (tendencies) 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 groups create the supply and demand for resources, using money and interest rates as a pricing mechanism for coordination.
The Uses of Microeconomics
As a purely normative science, microeconomics does not try to explain what should happen in a market. Instead, microeconomics only explains what to expect if certain conditions change. If a manufacturer raises the prices of cars, microeconomics says consumers will tend to buy fewer than before. If a major copper mine collapses in South America, the price of copper will tend to increase, because supply is restricted. Microeconomics could help an investor see why Apple Inc. stock prices might fall if consumers buy fewer iPhones. Microeconomics could also explain why a higher minimum wage might force The Wendy's Company to hire fewer workers.
Method of Microeconomics
Microeconomic study historically has been performed according to 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 (1890). The Marshallian and Walrasian methods fall under the larger umbrella of neoclassical microeconomics. Neoclassical economics focuses on how consumers and producers make rational choices to maximize their economic well being, subject to the constraints of how much income and resources they have available. Neoclassical economists make simplifying assumptions about markets—such as perfect knowledge, infinite numbers of buyers and sellers, homogeneous goods, or static variable relationships—in order to construct mathematical models of economic behavior.
These methods attempt to represent human behavior in functional mathematical language, which allows economists to develop mathematically testable models of individual markets. Neoclassicals believe in constructing measurable hypotheses about economic events, then using empirical evidence to see which hypotheses work best. In this way, they follow in the “logical positivism” or “logical empiricism” branch of philosophy. 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 involves several key concepts, including (but not limited to):
- Incentives and behaviors: How people, as individuals or in firms, react to the situations with which they are confronted.
- Utility theory: Consumers will choose to purchase and consume a combination of goods that will maximize their happiness or “utility,” subject to the constraint of how much income they have available to spend.
- Production theory: This is the study of production—or the process of converting inputs into outputs. Producers seek to choose the combination of inputs and methods of combining them that will minimize cost in order to maximize their profits.
- Price theory: Utility and production theory interact to produce the theory of supply and demand, which determine prices in a competitive market. In a perfectly competitive market, it concludes that the price demanded by consumers is the same supplied by producers. That results in economic equilibrium.