Microeconomics is a branch of economics that studies the behaviour of individual units such as

households, individuals and enterprises within the economy. Microeconomics is distinct with the study
of Macroeconomics, which studies the economy as a whole entity. Microeconomics uses demand and
supply as tools of analysis to study the decisions of individual entities in the economy.

What does microeconomics study

Microeconomics studies how prices are determined in the marketplace. Manufacturers and customers
initiate forces that we term them as supply and demand accordingly and it is their interaction within the
marketplace that devises the price mechanism. It is also known as Price Theory as it deals with the
determination of price of commodities and factors.

Importance of microeconomics

Microeconomics has both theoretical and practical importance. It helps in formulating economic policies
which enhance productive 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 equilibrium position. It also helps the
government in formulating correct price policies. It helps in 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.

Limitations of microeconomics

The major limitation of microeconomics is it fails to explain the functioning of an economy as a whole. It
cannot explain unemployment, poverty, illiteracy and other problems prevailing in the country.

Microeconomic concepts

Microeconomic concepts are involved with decisions made by firms and households. The specific
concepts being focused on are:

marginal utility and demand

diminishing returns and supply

elasticity of demand
elasticity of supply

market structures (excluding perfect competition and monopoly)

role of prices and profits in determining resource allocation.

Teaching and learning for a topic involving microeconomic concepts from the list above would typically
require a minimum of three different microeconomic concepts to be studied.

Key concept indicators

For each microeconomic concept:

Defines or describes the microeconomic concept.

Processes and/or presents sufficient data or information related to the microeconomic concept to
support:

a detailed explanation of the microeconomic concept

a justification about the implications of microeconomic concept.

Illustrates the microeconomic concept on an appropriate economic model.

Provides a detailed explanation the microeconomic concept that is supported by reference to both:

specific processed and/or presented data or information

information on the economic model used to illustrate the concept.

Provides a detailed explanation to justify the implication of the micro economic concept for one of:

a consumer

a producer

government.

Note: The justification will need to be supported with references to evidence from both an economic
model and processed and/or presented data or information.

An in-class consumption experiment is a possible context for the marginal utility and demand
microeconomic concept
To introduce students to the benefit of thinking at the margin, get them to reflect on decisions they
have made in a real life scenario.

For example, you and a couple of friends go to a movie (that is highly rated by critic) but you all realise
after 20 minutes you aren’t going to enjoy it. One friend suggests leaving and going to his house to play
pool but the other argues that it would be silly to waste the $12 you’ve each spent on a movie ticket.

What would an economist do?

Answer: Play pool – because once you’ve started watching the movie the ticket is a sunk cost (that is,
can't be recovered), so the real problem you face is: do you spend an hour and a half watching a boring
movie, or do you go to a friend’s house to play pool? Since no extra cost is associated with these choices
and the benefit received from playing pool is higher than watching a boring movie, the rational choice is
to play pool.

Once students have an understanding of thinking at the margin, you could conduct an in-class
experiment. For example, get students in groups to continuously drink cups of coke. Before each cup is
drunk, students should record how much they would be prepared to pay for it (which represents the
marginal utility of that cup). This data could be recorded in a table (see below).

What is Microeconomics?

Microeconomics is the study of how individuals and companies make choices regarding the allocation
and utilization of resources. It also studies how individuals and businesses coordinate and cooperate,
and the subsequent effect on the price, demand, and supply. Microeconomics refers to the goods and
services market and addresses economic and consumer concerns.

Microeconomics

Why are seniors receiving discounts on public transportation systems? Why do flight tickets cost so
much during the holiday season? Such questions are considered to be microeconomic, as they are
focused on markets or individuals in an economy. Microeconomics also analyzes market failures where
productive results are not achieved.
Summary

Microeconomics deals with the study of how individuals and businesses determine how to distribute
resources and how they interact.

The supply and demand theory in microeconomics assumes that the market is perfect.

Microeconomics uses various principles, such as the Law of Supply and Demand and the Theory of
Consumer Demand, to predict the behavior of individuals and companies in situations involving financial
or economic transactions.

Assumptions in Microeconomic Theory

Microeconomic theory begins with a single objective analysis and individual utility maximization. To
economists, rationality means an individual’s preferences are stable, total, and transitive.

It assumes continuous preference relations to ensure that the utility function is differentiable when you
compare two different economic outcomes.

The microeconomic model of supply and demand assumes that the markets are perfect. It means that
there are a large number of buyers and sellers in the market, and none of them can influence the price
of products and services significantly. Nonetheless, in real-life cases, the principle fails when any buyer
or seller controls prices.

Theories in Microeconomics

1. Theory of Consumer Demand

The theory of consumer demand relates goods and services consumption preference to consumption
expenditure. Such a correlation provides a way for consumers, subject to budget constraints, to achieve
a balance between expenses and preferences by optimizing utility.
2. Theory of Production Input Value

According to the production input value theory, the price of any item or product is determined by the
number of resources spent to create it. Cost may include several of the production factors (including
land, capital, or labor) and taxation. Technology may be regarded as either circulating capital (e.g.,
intermediate goods) or fixed capital (e.g., an industrial plant).

3. Production Theory

The production theory in microeconomics explains how businesses decide on the quantity of raw
material to be used and the quantity of items to be produced and sold. It defines a relationship between
the quantity of the commodities and production factors on the one hand, and the price of the
commodities and production factors on the other.

4. Theory of Opportunity Cost

According to the opportunity cost theory, the value of the next best alternative available is the
opportunity cost. It depends entirely on the valuation of the next best option and not on the number of
options.

The Demand and Supply Model of Microeconomics

The demand and supply model of microeconomics explains the relationship between the quantity of a
good or service that the producers are willing to produce and sell at different prices and the quantity
that consumers are willing to buy at such prices. In a market economy, price and quantity are
considered basic measures to gauge the goods produced and exchanged.

Basic definitions

Demand: In microeconomics, demand is referred to as the quantity of product or service that the
consumers are willing to purchase at a particular price level. The quantity demanded by the consumers
also depends on their ability to pay.

Supply: In microeconomics, supply refers to the amount of product or service that the producers are
willing to provide at a particular price level. Moreover, companies seek to maximize their profit; hence,
they would manufacture and supply a larger quantity of products if they can be sold at higher prices.

Law of Demand and Supply

In microeconomics, the law of demand states that the quantity of commodities demanded by
consumers varies inversely with prices of the commodities, all other factors being constant. This implies
that if the price of any commodity increases, the demand for that commodity will decrease.

The law of supply states that an increase in the price of any commodity will lead to an increase in supply
and vice versa, all other factors being constant. The producers attempt to maximize their profit by
increasing the quantity when the price rises.

Microeconomics - Law of Demand and Supply

The point of intersection of the demand curve and supply curve is called the equilibrium point. At the
equilibrium point, the price and quantity are respectively known as the equilibrium price (P*) and
equilibrium quantity (Q*). Due to a change in any of the economic or consumer factors, the market
shifts away from the equilibrium point. However, the economy behaves accordingly to bring the market
back to the equilibrium point.

Now, assume that the price of a certain commodity falls below P*. In such a case, the demand for that
commodity will surge. The quantity supplied will not be enough to cater to the quantity demanded,
resulting in excess demand or shortage. The producers will realize that they have an opportunity to sell
whatever quantity they have at a higher price and make profits.

Consequently, the price will rise toward the equilibrium. Similarly, if the price of a commodity increases
above P*, there will be a drop in quantity demanded. At the new price, the quantity supplied is more
than the quantity demanded, which results in excess supply or surplus. The producers will eventually
start selling at lower prices, causing an increase in demand, and the market will move towards the
equilibrium point.

Structure of the Market

Market structure is determined by various aspects, such as the number of buyers and sellers in the
market, the distribution of market shares between them, and how convenient it is for the companies to
enter and leave the market.

1. Pure competition
Pure competition is a market structure in which numerous small firms compete against each other. The
demand and supply determine the quantity of the commodities produced and the market prices. The
firms cannot influence the prices, and the commodities produced by all the firms are identical.

2. Monopoly

In such a monopolistic market structure, there is a single company controlling the supply in the entire
market. As there are no substitutes, the company reduces the quantity supplied, increases the price, and
earns considerable profits.

3. Oligopoly

In an oligopoly, a few companies control the entire market. The companies can either compete or
collaborate to raise prices and earn more profits.

4. Monopsony

A monopsony exists when only one buyer is controlling the demand for commodities, whereas there are
many sellers in the market.

5. Oligopsony

An oligopsony exists when there are only a small number of buyers but many sellers. In such a market,
the buyers exert more power than sellers, unlike oligopoly, where sellers control the market.
More Resources

CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to
take their careers to the next level. To keep learning and developing your knowledge base, please
explore the additional relevant resources below:

Keynesian Economic Theory

Market Dynamics

Political Economy

Aggregate Supply and Demand