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The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). The graph depicts a right-shift in demand from D1 to D2 along with the consequent increase in price and quantity required to reach a new market-clearing equilibrium point on the supply curve (S).
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Microeconomics (from Greek prefix micro- meaning "small" + "economics") is a branch of economics that studies how the individual parts of the economy, the household and the firms, make decisions to allocate limited resources,[1] typically in markets where goods or services are being bought and sold. Microeconomics examines how these decisions and behaviours affect the supply and demand for goods and services, which determines prices; and how prices, in turn, determine the supply and demand of goods and services.[2][3]

This is a contrast to macroeconomics, which involves the "sum total of economic activity, dealing with the issues of growth, inflation and unemployment.[2] Microeconomics also deals with the effects of national economic policies (such as changing taxation levels) on the aforementioned aspects of the economy.[4] Particularly in the wake of the Lucas critique, much of modern macroeconomic theory has been built upon 'microfoundations' — i.e. based upon basic assumptions about micro-level behaviour.

One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market failure, where markets fail to produce efficient results, and describes the theoretical conditions needed for perfect competition. Significant fields of study in microeconomics include general equilibrium, markets under asymmetric information, choice under uncertainty and economic applications of game theory. Also considered is the elasticity of products within the market system.

Contents

Assumptions and definitions

The theory of supply and demand usually assumes that markets are perfectly competitive. This implies that there are many buyers and sellers in the market and none of them has the capacity to significantly influence prices of goods and services. In many real-life transactions, the assumption fails because some individual buyers or sellers have the ability to influence prices. Quite often a sophisticated analysis is required to understand the demand-supply equation of a good model. However, the theory works well in simple situations.

Mainstream economics does not assume a priori that markets are preferable to other forms of social organization. In fact, much analysis is devoted to cases where so-called market failures lead to resource allocation that is suboptimal by some standard (highways are the classic example, profitable to all for use but not directly profitable for anyone to finance). In such cases, economists may attempt to find policies that will avoid waste directly by government control, indirectly by regulation that induces market participants to act in a manner consistent with optimal welfare, or by creating "missing markets" to enable efficient trading where none had previously existed. This is studied in the field of collective action. It also must be noted that "optimal welfare" usually takes on a Paretian norm, which in its mathematical application of Kaldor-Hicks Method, does not stay consistent with the Utilitarian norm within the normative side of economics which studies collective action, namely public choice. Market failure in positive economics (microeconomics) is limited in implications without mixing the belief of the economist and his or her theory.

The demand for various commodities by individuals is generally thought of as the outcome of a utility-maximizing process. The interpretation of this relationship between price and quantity demanded of a given good is that, given all the other goods and constraints, this set of choices is that one which makes the consumer happiest.

Modes of operation

It is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output. Given this assumption, there are four categories in which a firm's profit may be considered.

  • A firm is said to be making an economic profit when its average total cost is less than the price of each additional product at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price.
  • A firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total cost equals price at the profit-maximizing output.
  • If the price is between average total cost and average variable cost at the profit-maximizing output, then the firm is said to be in a loss-minimizing condition. The firm should still continue to produce, however, since its loss would be larger if it were to stop producing. By continuing production, the firm can offset its variable cost and at least part of its fixed cost, but by stopping completely it would lose the entirety of its fixed cost.
  • If the price is below average variable cost at the profit-maximizing output, the firm should go into shutdown. Losses are minimized by not producing at all, since any production would not generate returns significant enough to offset any fixed cost and part of the variable cost. By not producing, the firm loses only its fixed cost. By losing this fixed cost the company faces a challenge. It must either exit the market or remain in the market and risk a complete loss.

Market failure

In microeconomics, the term "market failure" does not mean that a given market has ceased functioning. Instead, a market failure is a situation in which a given market does not efficiently organize production or allocate goods and services to consumers. Economists normally apply the term to situations where the assumptions of the First Welfare Theorem fail leading to the market outcome no longer being on the Pareto frontier. On the other hand, in a political context, stakeholders may use the term market failure to refer to situations where market forces do not serve the public interest.

The four main types or causes of market failure are:

  • Monopolies or other cases of abuse of market power where a "single buyer or seller can exert significant influence over prices or output". Abuse of market power can be reduced by using antitrust regulations.[5]
  • Externalities, which occur in cases where the "market does not take into account the impact of an economic activity on outsiders." There are positive externalities and negative externalities.[5] Positive externalities occur in cases such as when a television program on family health improves the public's health. Negative externalities occur in cases such as when a company’s processes pollutes air or waterways. Negative externalities can be reduced by using government regulations, taxes, or subsidies, or by using property rights to incentivize companies and individuals to take the impacts of their economic activity into account.
  • Public goods are goods that have the characteristics that they are non-excludable and non-rivalrous and include national defense[5], public transportation, federal highways, and public health initiatives such as draining mosquito-breeding marshes. For example, if draining mosquito-breeding marshes was left to the private market, far fewer marshes would probably be drained. To provide a good supply of public goods, nations typically use taxes that compel all residents to pay for these public goods (due to scarce knowledge of the positive externalities to third parties/social welfare). This usually results in a government-run or sponsored monopoly to service the public good as a solution - though government monopolies often have the same social costs as private monopolies as mentioned earlier.
  • Cases where there is asymmetric information or uncertainty (information inefficiency).[5] Information asymmetry occurs when one party to a transaction has more or better information than the other party. For example, used-car salespeople may know whether a used car has been used as a delivery vehicle or taxi, information that may not be available to buyers. Typically it is the seller that knows more about the product than the buyer, but this is not always the case. An example of a situation where the buyer may have better information than the seller would be an estate sale of a house, as required by a last will and testament. A real estate broker buying this house may have more knowledge about the house than the family members of the deceased.
This situation was first described by Kenneth J. Arrow in a seminal article on health care in 1963 entitled "Uncertainty and the Welfare Economics of Medical Care," in the American Economic Review. George Akerlof later used the term asymmetric information in his 1970 work The Market for Lemons. Akerlof noticed that, in such a market, the average value of the commodity tends to go down, even for those of perfectly good quality, because the buyer has no way of knowing whether the product they are buying will turn out to be a "lemon" (a defective product).

Opportunity cost

Opportunity cost of an activity (or goods) is equal to the best next alternative foregone. Although opportunity cost can be hard to quantify, the effect of opportunity cost is universal and very real on the individual level. In fact, this principle applies to all decisions, not just economic ones. Since the work of the Austrian economist Friedrich von Wieser, opportunity cost has been seen as the foundation of the marginal theory of value.

Opportunity cost is one way to measure the cost of something. Rather than merely identifying and adding the costs of a project, one may also identify the next best alternative way to spend the same amount of money. The forgone profit of this next best alternative is the opportunity cost of the original choice. A common example is a farmer that chooses to farm her or his land rather than rent it to neighbors, wherein the opportunity cost is the forgone profit from renting. In this case, the farmer may expect to generate more profit alone. Similarly, the opportunity cost of attending university is the lost wages a student could have earned in the workforce, rather than the cost of tuition, books, and other requisite items (whose sum makes up the total cost of attendance). The opportunity cost of a vacation in the Bahamas might be the down payment money for a house.

Note that opportunity cost is not the sum of the available alternatives, but rather the benefit of the single, best alternative. Possible opportunity costs of the city's decision to build the hospital on its vacant land are the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money that could have been made from selling the land, or the loss of any of the various other possible uses—but not all of these in aggregate. The true opportunity cost would be the forgone profit of the most lucrative of those listed.

One question that arises here is how to assess the benefit of disse must determine a dollar value associated with each alternative to facilitate comparison and assess opportunity cost, which may be more or less difficult depending on the things we are trying to compare. For example, many decisions involve environmental impacts whose dollar value is difficult to assess because of scientific uncertainty. Valuing a human life or the economic impact of an Arctic oil spill involves making subjective choices with ethical implications.

It is imperative to understand that nothing is free. No matter what one chooses to do, he or she is always giving something up in return. An example of opportunity cost is deciding between going to a concert and doing homework. If one decides to go the concert, then he or she is giving up valuable time to study, but if he or she chooses to do homework then the cost is giving up the concert. Opportunity Cost is vital in understanding microeconomics and decisions that are made.

Applied microeconomics

Applied microeconomics includes a range of specialized areas of study, many of which draw on methods from other fields. Applied work often uses little more than the basics of price theory, supply and demand. Industrial organization and regulation examines topics such as the entry and exit of firms, innovation, role of trademarks. Law and economics applies microeconomic principles to the selection and enforcement of competing legal regimes and their relative efficiencies. Labor economics examines wages, employment, and labor market dynamics. Public finance (also called public economics) examines the design of government tax and expenditure policies and economic effects of these policies (e.g., social insurance programs). Political economy examines the role of political institutions in determining policy outcomes. Health economics examines the organization of health care systems, including the role of the health care workforce and health insurance programs. Urban economics, which examines the challenges faced by cities, such as sprawl, air and water pollution, traffic congestion, and poverty, draws on the fields of urban geography and sociology. The field of financial economics examines topics such as the structure of optimal portfolios, the rate of return to capital, econometric analysis of security returns, and corporate financial behavior. The field of economic history examines the evolution of the economy and economic institutions, using methods and techniques from the fields of economics, history, geography, sociology, psychology, and political science.

References

Further reading

  • Bade, Robin; Michael Parkin (2001). Foundations of Microeconomics. Addison Wesley Paperback 1st Edition. 
  • Colander, David. Microeconomics. McGraw-Hill Paperback, 7th Edition: 2008.
  • Dunne, Timothy, J. Bradford Jensen, and Mark J. Roberts (2009). Producer Dynamics: New Evidence from Micro Data. University of Chicago Press. ISBN 9780226172569. 
  • Eaton, B. Curtis; Eaton, Diane F.; and Douglas W. Allen. Microeconomics. Prentice Hall, 5th Edition: 2002.
  • Frank, Robert A.; Microeconomics and Behavior. McGraw-Hill/Irwin, 6th Edition: 2006.
  • Friedman, Milton. Price Theory. Aldine Transaction: 1976
  • Jehle, Geoffrey A.; and Philip J. Reny. Advanced Microeconomic Theory. Addison Wesley Paperback, 2nd Edition: 2000.
  • Hagendorf, Klaus: Labour Values and the Theory of the Firm. Part I: The Competitive Firm. Paris: EURODOS; 2009.
  • Hicks, John R. Value and Capital. Clarendon Press. [1939] 1946, 2nd ed.
  • Katz, Michael L.; and Harvey S. Rosen. Microeconomics. McGraw-Hill/Irwin, 3rd Edition: 1997.
  • Kreps, David M. A Course in Microeconomic Theory. Princeton University Press: 1990
  • Landsburg, Steven. Price Theory and Applications. South-Western College Pub, 5th Edition: 2001.
  • Mankiw , N. Gregory. Principles of Microeconomics. South-Western Pub, 2nd Edition: 2000.
  • Mas-Colell, Andreu; Whinston, Michael D.; and Jerry R. Green. Microeconomic Theory. Oxford University Press, US: 1995.
  • McGuigan, James R.; Moyer, R. Charles; and Frederick H. Harris. Managerial Economics: Applications, Strategy and Tactics. South-Western Educational Publishing, 9th Edition: 2001.
  • Nicholson, Walter. Microeconomic Theory: Basic Principles and Extensions. South-Western College Pub, 8th Edition: 2001.
  • Perloff, Jeffrey M. Microeconomics. Pearson - Addison Wesley, 4th Edition: 2007.
  • Perloff, Jeffrey M. Microeconomics: Theory and Applications with Calculus. Pearson - Addison Wesley, 1st Edition: 2007
  • Pindyck, Robert S.; and Daniel L. Rubinfeld. Microeconomics. Prentice Hall, 7th Edition: 2008.
  • Ruffin, Roy J.; and Paul R. Gregory. Principles of Microeconomics. Addison Wesley, 7th Edition: 2000.
  • Varian, Hal R. (1987). "microeconomics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 461-63.
  • Varian, Hal R. Intermediate Microeconomics. W.W. Norton & Company, 7th Edition.
  • Varian, Hal R. Microeconomic Analysis. W. W. Norton & Company, 3rd Edition.

External links


Study guide

Up to date as of January 14, 2010
(Redirected to Introduction to Microeconomics article)

From Wikiversity

Course Descripition

Introduction to microeconomic analysis of the workings of supply and demand in the determination of price, resource allocation, and distribution. In this course markets are analyzed for their affect on economic efficiency and income distribution.

Introduction:.

Good morning, afternoon, and/or evening, and welcome to Introduction to Microeconomics. Wikipedia defines Microeconomics to be "the study of the economic behaviour of individual consumers, firms, and industries and the distribution of production and income among them".

But what does this mean? "The study of economic behavior". One of the key concepts in Economics is the idea of scarcity. Society as a whole has unlimited wants, and scarcity occurs because there are not enough resources to satisfy these wants. Economic behavior comes into play when deciding how to allocate the resources available.

Lectures

  • Lecture I: Introduction to Microeconomics
Key Terms:
Supply, Quantity Supplied, Law of Supply, Demand, Quantity Demanded, Law of Demand, Equilibrium
Practice Problems: Practice Problems#Supply Demand and Equilibrium
Solutions: Ec 1101 Solutions#Supply Demand and Equilibrium
Key Terms:
Supply, Quantity Supplied, Law of Supply, Demand, Quantity Demanded, Law of Demand, Equilibrium
Practice Problems: Practice Problems#Supply Demand and Equilibrium
Solutions: Ec 1101 Solutions#Supply Demand and Equilibrium
Key Terms:
Excise Tax, Sales Tax
Practice Problems: Practice Problems#The Effects of Taxation
Solutions: Ec 1101 Solutions#The Effects of Taxation
Key Terms:
Indifference, Indifference Curve, Budget Line
Key Terms:
Normal, Inferior, Ordinary, Giffen
  • Lecture VI: Types of Markets
Key Terms:
Oligopoly, Perfect Competition, Monopoly

See also

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Wikibooks

Up to date as of January 23, 2010

From Wikibooks, the open-content textbooks collection

Infobox/Microeconomics

Principles of Microeconomics - Preface

The goal of this book is to explain how people interact economically, understanding the relationship between people, supply and demand, markets, and efficiency. We will do this by first understanding the nature of the basics concepts of microeconomics, then proceeding to how these apply to specific types of situations.

Table of Contents

  1. Definition Development stage: 75% (as of Feb 11, 2005)
  2. Goods and Scarcity Development stage: 100% (as of Feb 11, 2005)
  3. Economic Systems Development stage: 100% (as of Jul 20, 2005)
  4. Supply and Demand Development stage: 100% (as of Feb 11, 2005)
  5. Opportunity Cost Development stage: 75% (as of Feb 11, 2005)
  6. Perfect Competition Development stage: 100% (as of Feb 11, 2005)

Simple English

Microeconomics is the science of how people make decisions at the small scale. It is different from macroeconomics which looks at how the economy works as a whole ("on aggregate"). In microeconomics, we might look at how a person chooses what to buy at the store, or how many things a company will make. Some parts of microeconomics include Consumer Theory and Theory of the Firm, which study how people and businesses make decisions. Game Theory looks at how people make decisions when the outcome (how something ends) depends on what decision another person makes; when agents are said to act "strategically".

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