Microeconomics is the study of individuals, households, and firms' behavior in decision-making and allocation of resources. It generally applies to markets of goods and services and deals with individual and economic issues. The word 'firm' is used generically to refer to all types of business.
Microeconomics contrasts with the study of macroeconomics, which considers the economy as a whole.
Microeconomic study deals with what choices people make, what factors influence their choices, and how their decisions affect the goods markets by affecting the price, supply, and demand.
Consumers demand goods and services. Producers sell these goods and services. However, nobody can take everything they want from the economic system. They have to make choices - to buy something and forego something. For example, if you have a certain sum of money, you can use it either to buy a toy or a book. If you decide to buy a toy with that money, you chose to not buy the book. So, in this example, the book is the opportunity cost.
Just as individuals and households make opportunity cost decisions about what they consume, so do firms take these decisions about what to produce, and what not to produce.
1. Microscopic approach - Microeconomics divides the whole economy into small individual units such as household, firm, commodity, market, etc. To study, it selects a small unit and conducts a detailed observation of micro variables.
2. Price Theory - Microeconomics deals with various forces which explain how prices of factors of production (land, labor, capital, and entrepreneur) are determined, and how prices of goods and services are affected. Hence, microeconomics is also known as 'price theory'. Price theory benefits both the consumers and producers. It guides consumers on how to make optimum use of money to attain maximum satisfaction. It guides producers on how to fix the price of a product or service, which would fetch the maximum profit.
3. Partial equilibrium - Microeconomics is based on partial equilibrium. It is a condition that takes into consideration only a part of the market to attain equilibrium. It assumes that 'all other things remaining the same, known as 'ceteris paribus'. It neglects the interdependence between economic variables.
4. Analysis of resource allocation and economic efficiency - Resource allocation means the utilization of resources for the production of various goods and services. Microeconomics explains how relative prices of commodities and factors of production determine the allocation of resources. This helps to answer the questions like
- Who will produce the goods/services?
- What goods/services will be produced?
- In what quantities the goods/services will be produced?
- How to price the goods/services?
- How will they be distributed goods/services?
5. Use marginalism principle - Microeconomics makes use of the marginalism principle as a tool of analysis. According to this theory, individuals make economic decisions "on the margin". That is, value is determined by how much additional utility an extra unit of a good or service provides. The concept of marginalism is important in all the areas of microeconomics. Producers and consumers also take economic decisions using this principle.
6. Economizing - It is by nature that all consumers desire unlimited satisfaction and all producers desire unlimited profit. Microeconomics studies these tendencies of producers and consumers, analyze individual production and consumption units and define how maximum satisfaction and profit can be achieved by efficient utilization of scarce resources.
Microeconomics uses certain basic principles to explain how individuals and businesses make decisions. These are:
Microeconomics has both theoretical and practical importance. It helps in formulating economic policies which enhance production efficiency and results in greater social welfare. Microeconomics explains the working of a capitalist economy where individual units are free to take their own decision. It describes how, in a free enterprise economy, individual units attain an equilibrium position. It also helps the government in formulating correct price policies. It helps in the efficient employment of resources by the entrepreneurs. A business economist can make conditional predictions and business forecasts with microeconomic studies. It is used to explain gains from trade, disequilibrium in the balance of payment position, and determination of international exchange rate.
