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Basics of Micro Economics

Updated on May 31, 2014

Introduction

Alfred Marshall made his distinguished contribution to microeconomics and constructed an impressive platform for microeconomic research in his book ‘Principles of Economics’. ‘Micro’ denotes a tiny component. Hence, microeconomics is the investigation of the economic behavior of individuals or small set of individuals. The small set of individuals could be families, companies or industries comprising of various organizations. Microeconomics clarifies how and why these economic units make decision on costing and pricing.

Microeconomics, which happens to be the heir to the conventional “principles of economics,” deals largely with determinations of relative prices and distribution of scarce resources among competing human wants under full employment assumptions.

Microeconomics researches how organizations perform under various competitive circumstances and how joined economic behaviors of customers and merchants establish selling prices in particular market segments. Because microeconomics divides the whole economy into smaller areas to achieve extensive exploration, it is additionally identified as “slicing method.”

Significance of Microeconomics

In a typical economic life, products are purchased and produced; individuals determine the place and the amount of time to work; business executives determine what to produce and the way of carrying out production. Such pursuits generate trading activities that generally occur in markets in which buyers and sellers work together. Persons participating in trading deals are encouraged to accomplish the greatest they could for themselves with small amount of available resources. Decision makers in economics make use of marginal analysis to establish their finest plan of action. Microeconomics is the kingpin of such economic evaluations. It possesses both theoretical and practical credibility. The following are some of them:

Equilibrium Price Determination

Microeconomics is effective in the price fixing and distribution of scarce means among competing unlimited ends. A demand and supply mechanism or price mechanism is normally employed in economic studies. The price mechanism says that price is decided by the joined forces of demand and supply. In other words, demand and supply ascertain the position of equilibrium. At the equilibrium price, the quantity demanded is equivalent to the quantity supplied. If price goes down then the quantity supplied is likely to be less than the quantity demanded.

Function of an Economy

Crucial worthiness of microeconomics is that it aids you in mastering the procedures of an economy. It indicates whether or not the specified economic unit performs optimally. Microeconomics continues to be helpful to work on environmental challenges. The subject is adapted to enlighten wedding, separation, fertility, criminal offense and even suicide habits of people. Microeconomic concepts of voluntary agreements are utilized in legal judgments as well as to define damages for personal injuries. The extension of microeconomics into various social sciences has induced economics to be known as the “imperialist” social science.

Economic Policy

Economic policies are outlined by making use of microeconomics. Pricing methods of microeconomics presents a supporting attitude in this regard. The consequence of direct and indirect taxes on numerous segments of an economy could be conveniently discovered by a study of microeconomics. Microeconomic research is able to point out whether or not the subsidy provided to farmers in the country is justified.

Profit Maximization

Linear programming as an instrument in microeconomics is beneficial to a manufacturer in several strategies. It assists him or her to understand which factor of production is in great quantities and which factor of production is low in volume. This helps a manufacturer to blend the factors of production in a better way and push up his revenues. Linear programming additionally examines the most effective manufacturing method among the various production techniques to realize the highest possible profits.

Microeconomics enables the customers to attain an optimum amount of satisfaction. To realize optimum satisfaction, a rational consumer pursues the theory of substitution. He substitutes one product for another until the ratio of marginal utilities is equal to the ratio of prices of the products under consideration. Similarly, a manufacturer can maximize his earnings while the ratio of marginal productivity of the factors of production is equal to the ratio of their prices.

Microeconomics guides the business professional when making organizational decisions. By making use of the methods of microeconomic principles, the organization can predict the demand and cost of its products.

Basis for other Branches of Economics

Microeconomics is the foundation for welfare economics. The discipline of welfare economics studies the well-being of individuals as customers and manufacturers. The purpose of welfare economics is to enhance social well-being. This maximization of social well-being is achievable solely under perfect competition because under monopoly, oligopoly, or monopolistic competition, you can find a surplus of capacity and misallocation of scarce resources.

In the area of international trade as well, microeconomic tools are extremely advantageous. The most important segments in international trade, which demand the support of microeconomics, are gains from international trade, devaluation, determination of the foreign exchange rate and balance of payments disequilibrium. The relative elasticity of demand for each other’s product decides the benefits from international trade. In the event of devaluation, if the demand for the commodities of the exporting country is elastic, then it will benefit from devaluation. The disequilibrium in the balance of payments takes place because of the discrepancy between the demand for and the supply of foreign currency. The demand for and supply of foreign currency ascertains the rate of exchange in an open market economy.

Predictions

Economic laws are the basis for predictions. This definitely does not imply that price theory empowers us to forecast the future. Rather it can help the proprietor to generate conditional estimations. It implies that if something happens, then a set of outcomes will certainly occur. For instance, the law of demand claims if price drops down, demand increases and vice versa.

Drawbacks of Microeconomics

The significant flaw of microeconomic research is the fact that it is related to the practices of individual components of the economic system and not related to the economy altogether. The most important economic policies of the government like monetary policy and fiscal policy create substantial impact on the challenging financial state. However, these policies never come under the purview of microeconomics, but are analyzed under macroeconomics.

According to Prof R.A. Bilas, microeconomics is just a device of investigation for the economist to complement other disciplines, namely history, statistical methods and mathematics. Further, he cautions while price theory is beneficial, you should not be shattered by the theory.

Validity of Assumptions

Microeconomics is primarily based upon the supposition of full employment in the economy. However, in actuality, full employment is an exceptional case and cannot be prevalent. Therefore, the validity of microeconomic theories based on such assumptions is questionable.

Furthermore, microeconomic models are influenced by the assumption of market economy in which the market mechanism performs an important role. Moreover, it considers the rule of laissez faire on the part of the government. However, after the Great Depression of the 1930s laissez faire policy has got rid of its worth. This clearly informs that the microeconomic study can possibly be unrealistic.

Fallacy of Composition

Microeconomics is not merely insufficient but additionally deceptive. It is not wise to claim that concepts that are relevant in the matter of a specific family, company or industry, can similarly be appropriate to the overall economy. You can find circumstances when plain microeconomic aggregation takes you to differing conclusion compared to what is unveiled by macroeconomics. This may not be a phenomenon but somewhat puzzlement or fallacy called by logicians the “fallacy of composition.”

A fallacy of compositions is the belief that what holds true for every single element considered independently can also be valid for the overall or, in reverse, that what is valid for the total is also valid for every single component regarded independently.

A typical illustration of the fallacy of composition is to claim that the best solution to get out of a fire in a crowed cinema theater is to hurry to the exit. If an individual hurries from his or her chair to the exit, that person might escape safely. However, it would be unwise to claim that if all people hurry to the exit, everybody will escape unharmed.

© 2012 Sundaram Ponnusamy

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