Understanding Microeconomics

Microeconomics is one of the widest subjects of economics. It is the part of economics that deals with the individual unit of economic variables and their behavior. The term ‘Microeconomics’ was first used by Norwegian Economist Ragnar Frisch in 1933 AD. It is the study of different parts of the economic system, not the economy as a whole or in aggregate.  Microeconomics shows how and why different goods have different values, how individuals and businesses conduct and benefit from efficient production and exchange and how individuals best coordinate and cooperate.

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).¹ 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—to construct mathematical models of economic behavior.

Key Definitions

Defined By	Definitions
K.E. Boulding	“Microeconomics is the study of a particular firm, a particular household, individual price, wage, income, industry and particular commodity.”

From the above definitions and discussion, microeconomics can be understood as the study of individual and their behavior regarding different economic variables.  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. It formulates various types of models based on logic observed human behavior and tests the models against real-world observations. Importantly, microeconomics is concerned with the following key concepts as well:

• 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 the cost 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.

Scope/Use/Significance of Microeconomics

Microeconomics deals with different subject matters. Thus, it has a wider scope and uses in the context of studying individual units of economics and their behavior. Hence, the scope or use or significance of microeconomics can be discussed as below:

1. Commodity Pricing: The price of an individual commodity is determined by the market forces of demand and supply. Microeconomics is concerned with demand analysis i.e. individual consumer behavior and supply analysis i.e. individual producer behavior.
2. Factor Pricing Theory: Microeconomics helps in determining the factor prices for land, labor, capital and entrepreneurship in the form of rent, wage, interest and profit respectively. Land, labor, capital and entrepreneurship are the factors that contribute to the production process.
3. Demand analysis: With the help of microeconomic analysis, business firms can forecast their level of demand within a certain time interval. The demand for a commodity fluctuates depending upon various factors affecting it. Thus, business firms and decision-makers can determine the level of demand for the commodity.
4. Cost analysis: Microeconomic theories explain various conditions of cost like fixed cost, variable cost, average cost and marginal cost. Along with this, it also provides an analysis of the short-run and long-run costs that help the business decision-makers determine the cost of production and other related costs, so they can implement policies to cut down costs and increase their level of profit.
5. Theory of Economic welfare: Welfare economics in microeconomics is concerned with solving the problems in the improvement and attaining economic efficiency to maximize public welfare. It attempts to gain efficiency in production, consumption/distribution to attain overall efficiency and provides answers for ‘What to produce?’, ‘When to produce?’, ‘How to produce?’ and ‘For whom it is to be produced?’
6. Optimum Utilization of Resources: The study of microeconomics helps the decision-makers to analyze and determine how the productive resources are allocated for various goods and services. It also helps in solving the producers’ dilemma of what to produce, how much to produce and for whom to produce.
7. Free Market Economy: Microeconomics explains the operating of a free market economy where, an individual producer has the freedom to take economic decisions like what to produce, how to produce, or for whom to produce. Allocation of resources is determined by price or market mechanism i.e. interaction between demand and supply
8. Production Decision Optimization: Microeconomics deals with different production techniques that help to find out the optimal production decision which helps the decision-makers to determine the factors needed to produce a certain product or a range of products.
9. Pricing Policy of Business: Microeconomic analysis provides business managers with a thorough knowledge of theories of production and pricing to ensure optimum profit for the firm in the long run.
10. Formulation of Public Economic Policies: Microeconomics tools are useful for introducing policies relating to tax, tariff, debt, subsidy etc. it helps the governmental bodies to fixate on the tax rate, types of tax and the amount of tax to be charged to buyers and sellers.
11. Basis of Managerial Economics: Microeconomics used for the study of a business unit, but not the economy as a whole is known as managerial economics. The various tools used in microeconomics like cost and price determination, at an individual level become the foundation of managerial economics.

Limitations of Microeconomics

Although microeconomics is an essential part of economics, it is not free from limitations. Some key limitations of microeconomics have been mentioned below:

• Microeconomics is based on unrealistic assumptions of full employment, perfect competition and laissez-faire policies
• Based on the assumption of “Ceteris Paribus” meaning ‘Other Things Remaining Constant’ do not apply to different microeconomic theories as such other things remaining constant is not really in the actual economy
• No focus on aggregate as it is limited to individuals
• Microeconomics has limited scope due to the existence of government intervention
• Do not explain the relationship between different variables and sectors of the economy

Difference Between Microeconomics and Macroeconomics

Basis	Microeconomics	Macroeconomics
Focus	It focuses on the study of a particular market segment.	It focuses on the total economy which consists of several market segments.
Economic Variables	It studies individual economic units.	It studies aggregate economic variables.
Applicability	It applies to internal or operational issues.	It applies to external environmental issues.
Subjects Covered	It covers individual products, firms, households, industry, wages and price.	It covers topics like national income, national output, price level etc.
Issues Dealt	It deals with the issues such as the price of a commodity affecting its quantity demanded and quantity supplied.	It deals with major economic issues such as poverty, unemployment, monetary policy, fiscal policy etc.
Price Determination	Microeconomics determines the price of a specific commodity, its substitute and complementary goods.	It is crucial in maintaining the general price level, avoiding the situation of inflation or deflation.
Approach	It is a bottom-up approach to economics	It is a top-down approach to economics.

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