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What is 'Microeconomics'

Microeconomics is the social science that studies the implications of individual human action, specifically about how those decisions affect the utilization and distribution of scarce resources. Microeconomics shows how and why different goods have different values, how individuals make more efficient or more productive decisions, and how individuals best coordinate and cooperate with one another. Generally speaking, microeconomics is considered a more complete, advanced and settled science than macroeconomics.

BREAKING DOWN 'Microeconomics'

Microeconomics is the study of economic tendencies, or what is likely to happen when individuals make certain choices or when the factors of production change. Individual actors are often broken down into microeconomic subgroups, such as buyers, sellers and business owners. These actors interact with 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. However, questions about aggregate economic numbers remain the purview of macroeconomics, such as what might happen to the gross domestic product (GDP) of China in 2020.

Method of Microeconomics

Most modern microeconomic study is 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). These methods attempt to represent human behavior in functional mathematical language, which allows economists to identify a mathematically testable model of individual markets.

The Marshellian and Walrasian methods fall under the larger umbrella of neoclassical microeconomics. As logical positivists, neoclassicals believe in constructing measurable hypotheses about economic events, then using empirical evidence to see which hypotheses work best.

Unlike physicists or biologists, economists cannot run repeatable tests, so neoclassical economists make simplifying assumptions about markets – such as perfect knowledge, infinite numbers of buyers and sellers, homogeneous goods, or static variable relationships – to identify solutions. Economic efficiency is determined by how well real markets adhere to the rules of the model.

The major competing view, most frequently espoused by the Austrian school, dismisses neoclassical static equilibrium as unrealistic and fatally flawed. Instead, Austrian economics opts for an analysis based on logical deduction, using the twin principles of spontaneous order and subjectivism. Rather than assuming away heterogeneity and imperfection, the Austrian model describes how economic incentives help individuals overcome the real problems of ignorance and uncertainty. In other words, markets arise because people have incomplete knowledge, different preferences and other imperfections.

Basic Concepts of Microeconomics

The study of microeconomics involves several key concepts, including (but not limited to): 

  • Demand, supply and equilibrium: The theory of supply and demand help 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.
  • Production theory: This is the study of production — or the process of converting inputs into outputs. 
  • Costs of production: This theory states that the price of goods or services is determined by the cost of the resources going into making it. 
  • Labor economics: is the need to understand the functioning and dynamics of the wage labor market. It looks at the suppliers of labor services (or workers), the demand for this service (employers), and tries to understand the pattern of wages, employment and income
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