Microeconomics is a ‘bottom-up’ approach where patterns from everyday life are pieced together to correlate demand and supply. The study examines how the behaviors of individuals, households, and firms have an impact on the market.
Microeconomics is entirely contradictory to macroeconomics. It is a narrower concept that focuses only on a single market or segment. This study only interprets the tiny components of the economy. The study states that the market attains equilibrium when the supply of goods controls the demand.
Table of contents
- Microeconomics Definition
- Understanding Microeconomics
- Microeconomics Principles
- Microeconomics Examples
- Frequently Asked Questions (FAQs)
- Recommended Articles –
- Microeconomics is an economic stream that correlates the behaviors of people, companies, and households with the changes in demand and supply. Additionally, it also studies production and resource distribution within a particular segment, sector, or market.
- According to the neoclassical approach of microeconomics, the producers and consumers ensure maximum economic welfare through rational decision-making.
- The various concepts studied under the macroeconomics discipline include production theory, consumer behavior theory, pricing theory, marginal utility theory, and income theory.
- Unlike macroeconomics, it is a study of human behavior and overlooks aggregate factors like GFP, employment, inflation, and recession.
Microeconomics studies the behavior of consumers and firms and correlates it with demand and supply. The neo-classical approach states that consumers and producers derive optimum economic benefit by making rational decisions. As a result, this analysis helps businesses, individuals, and the government prepare for future possibilities. Companies use the study to ensure resource utilization, competitive pricing, optimized production, and an uninterrupted supply of goods. Based on this theory, governments change taxes, subsidiesSubsidiesA subsidy in economics refers to direct or indirect financial assistance from the government to an individual, household, business, or institution to promote social and economic policies., grants, and advances.
Microeconomics primarily comprises the pricing theory, income theory, consumer behavior theory, production theory, and marginal utility theoryMarginal Utility TheoryA customer's marginal utility is the satisfaction or benefit derived from one additional unit of product consumed. It could be calculated by dividing the additional utility by the amount of additional units.. This analysis predicts a future possibility based on the buying decisions of businesses, individuals, and governments. It is entirely contradictory to macroeconomicsContradictory To MacroeconomicsMacroeconomics examines the elements that influence the local, regional, national, or global economy, as well as the overall economy's averages and aggregates. Microeconomics, on the other hand, is a narrower concept concerned with the decision-making of single economic variables and only interprets the economy's tiniest components., which studies the change in the gross domestic productGross Domestic ProductGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period. resulting from the shift in aggregate demand and supply of goods. In microeconomics, the economists focus only on a single market or segment. Also, microeconomics believes that the markets attain equilibrium when the supply of goods controls the demand. In 1936, economists noticed a macroeconomic dis-equilibrium as there was a sustained depression, and this stream was separated from the former.
Microeconomics does have its drawbacks. It is limited to a specific industry or market. It ignores crucial economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others. like aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices., aggregate supplyAggregate SupplyAggregate Supply is the projected supply that a business calculates based on the existing market conditions. Various factors such as changing economic trend are considered before calculating the aggregate supply., and national domestic product (NDP). Further, it falsely assumes that the economy operates at a full-employment.
Microeconomics follows the general principles of economics. Some of these are discussed below:
#1 – Demand and Supply
When demand exceeds supply over a period, suppliers either increase the supply or increase the prices. As prices go up, demand would ideally reduce since the number of people who can afford goes down. This way, suppliers buy time to get back in action coping with the demand.
Conversely, when supply surpasses demand, suppliers would either have to cut down on their supply or decrease the prices of the products being sold. Remember, at this point, manufacturers have a surplus of stock. So, when prices go down, demand would pick up and equal the supply.
Finally, when both supply and demand are optimal, a state of equilibrium is achieved. The correlation between demand and supply and the state of equilibrium assumes that all other factors except price and demand remain constant.
#2 – Opportunity Cost
A consumer who is also a decision-maker has limited resources (money) and unlimited options (opportunities) to use their resources. The cost a consumer suffers by not choosing the best alternative is the opportunity costOpportunity CostThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. It's essentially the cost of the next best alternative that has been forgiven.. This is with the assumption that the choices are mutually exclusiveMutually ExclusiveMutually exclusive refers to those statistical events which cannot take place at the same time. Thus, these events are entirely independent of one another, i.e., one event's outcome has no impact on the other event's result..
It is an opportunity which a decision-maker lets go of. Say Sandra plans to buy a car and selects an SUV over a hatchback, then Sandra bears the opportunity cost of not choosing a hatchback.
#3 – Law of Diminishing Marginal Utility
This microeconomics concept is widely used for maximizing consumers’ utility. The law of diminishing marginal utility plays a crucial role in consumers’ decisions when purchasing. This law emphasizes that the demand for a particular product decreases with each consecutive unit consumed by a customer. For instance, an individual buys ice cream, consumes it, and then buys another one. Finally, after having three ice-creams, he doesn’t want them anymore and stops purchasing them.
#4 – Giffen Goods
Giffen goodsGiffen GoodsGiffen goods are the goods whose demand curve doesn't conform to the 'first rule of demand', i.e., price and quantity demanded of Giffen goods are inversely related to each other, unlike other goods, where price and quantity demanded are positively related. Therefore, they are inferior goods without a substitute. It is named after the Scottish statistician, Sir Robert Giffen. are the necessary items whose price rise doesn’t affect the demand. What makes Giffen goods unique is the price and demand equation. These are probably rational decisions, where the buyers are willing to pay a higher price despite the price hype. These types of exceptional goods are called ‘Giffen goods,’ where the demand curveDemand CurveDemand Curve is a graphical representation of the relationship between the prices of goods and demand quantity and is usually inversely proportionate. That means higher the price, lower the demand. It determines the law of demand i.e. as the price increases, demand decreases keeping all other things equal. is positively sloped.
For instance, the price rise of petrol doesn’t reduce its demand. In order to be considered Giffen Goods, products must fulfill some of the following criteria:
- A lack of substitute productsSubstitute ProductsAny alternative, replacement, or backup of a primary product in the market is referred to as a substitute product. It refers to any commodity or combination of goods that might be used in place of a more popular item in normal circumstances without affecting the composition, appearance, or utility..
- The substitute should be inferior.
- Amount spent on the product should be a major portion of the customer’s budget.
#5 – Veblen Goods
Veblen GoodsVeblen GoodsVeblen Goods is a category of luxury goods whose demand increases with the increase in price. It behaves the opposite to the demand and supply theory. are similar to Giffen goods. These are the goods that are considered a symbol of status, esteem, or luxury. These are goods for which consumers do not mind paying a higher price. Typical examples include Rolls Royce, jewelry, and gems. The higher the prices higher the intensity to purchase these goods. Customers do this to exhibit their status.
#6 – Income and Elasticity
As income increases, the demand for superior goods also increases. Also, when the income falls, the demand also slopes down. Alternatively, as the price drops, consumers can buy more goods. In both cases, the customer’s purchasing power goes up. On the contrary, Giffen and Veblen’s goods are examples of inelastic price demand.
#7 – Substitution and Elasticity
Substitution effect: when the prices are higher than one can afford, people may prefer a cheaper substitute. This behavior of change in demand due to price is called the price elasticity of demandPrice Elasticity Of DemandPrice elasticity of demand, which is calculated by dividing the percentage change in quantity (Q/Q) by the percentage change in price (P/P), determines the elasticity of demand based on price. Price Elasticity of Demand = % Change in Quantity (q/q)/% Change in Price (p/p).
For example, if the price of leather jackets rises, consumers will prefer to buy woolen overcoats to shield themselves in winters.
Let us now understand the concept with the help of an example. Online shopping is on the rise as it is convenient for buyers. As a result, the offline clothes market has experienced a gradual downfall. This shows that the change in consumer behavior impacted the demand for clothes in the brick-and-mortar market.
Similarly, the Covid pandemic affected the travel industry; individuals are now seen avoiding vacations. Apparently, the change in the people’s mindset resulted in less demand for hotel rooms, flights, and tourism. Simultaneously, the demand for pharmaceutical goods soared. Suppliers could not keep up with the demand. Again, this resulted in a shortage and price rise.
Frequently Asked Questions (FAQs)
Microeconomics refers to the economics discipline that relates how the individual, household, and corporate behaviors mold consumer decisions, resource distribution, and economic output. Adam Smith is a Scottish political economist, author, and philosopher. He is credited for this economic concept. He is also known as the father of modern economics.
Microeconomics is a more defined stream that focuses on the demand and supply of a specific segment or market influenced by the behavior of people and business entities. In contrast, macroeconomics studies a nation’s overall economy and the effect of factors like inflation, recession, aggregate demand, employment, and national output.
The three primary microeconomics concepts include demand supply, incentives, and costs and benefits. Additionally, production, resource allocation, price, consumption, and scarcity are taken into consideration.
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