What is Microeconomics?

Microeconomics is the social science that studies the implications of 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.

Key Takeaways

  • 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 use mathematics as a language to formulate theories and observational studies to test their theories against the real world performance of markets.

What is Microeconomics?

Understanding 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 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. Microeconomics can address questions like these that might have very broad implications for the economy; 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). 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. 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 their empirical research depends on the collection and observation of economic data from real world markets. The economic efficiency of markets is then determined by how well real markets adhere to the rules of the model.

Basic Concepts of Microeconomics

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

  • 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 method of combining them that will minimize cost in order to maximize their profits.
  • Utility theory: Analogous to production 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.
  • Price theory: Production theory and utility 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.
  • Industrial organization and market structure: Microeconomists study the many ways that markets can be structured, from perfect competition to monopolies, and the ways that production and prices will develop in these different types of markets.