Economics as a branch of knowledge is concerned with studying human behaviour based on the allotment of scarce resources such that the producers can maximise their profits, consumers can maximise their satisfaction and society can achieve the maximum amount of social welfare. In short, economics is about creating and making choices on the face of scarcity.
The subject matter of this discipline is studied under two branches. Microeconomics is one of those two broad branches.
- Microeconomics is a branch of economics that studies the behavior of individuals, households, and firms in making decisions about resource allocation.
- Microeconomics analyzes how markets work, how prices are determined, and how individuals respond to changes in prices and income.
- Microeconomics is significant because it helps understand the choices people make and how they affect the economy.
Definition of Microeconomics
The English term ‘Micro’ traces its origin in the Greek word ‘mikros,’ meaning small. In the context of microeconomics, this term is used to refer to small individual units. To be more specific, microeconomics is the study of economic problems at the individual level.
It observes and investigates the economic activities of individual units of an economy—for example, a firm, a market, a household, individual industry and many more.
Characteristics of Microeconomics
In the context of its primary goal to balance scarcity with choice, microeconomics exhibit the following characteristic features:
- It observes, investigates and predicts the behaviour of individual units of an economy.
- As the ambit of its study is limited to individual units, the degree of aggregation tends to be limited. For example, a collection of firms signify an industry.
- It primarily deals with problems like distribution of resources and related policies and principles.
- The main tools or instruments it uses to study economic problems include supply and demand.
- The principal determinant that solves the problems in microeconomics is the price.
- The method of study that this branch of economics uses is namely, partial equilibrium analysis. Under this method, the impact of one variable over all other variables is considered as equal.
- As the determination of the output and price of an individual economic unit forms one of the primary concerns of microeconomics, the branch is also referred to as ‘Price Theory.’
Significant Theories in Microeconomics
The following are some of the significant theories employed in Microeconomics.
- Theory of Production Input Value
This theory argues that a product or service’s cost is determined by the number of inputs used in its production. For example, land, labour, capital, taxation and so on.
2. Theory of Consumer Demand
It is concerned with the correlation between products and services consumption preference and consumption expenditure.
3. Theory of Opportunity Cost
According to this theory, the value or cost of the next best existing alternative is the opportunity cost. Opportunity cost depends on the quality or value of the next best option and not on the number of choices.
4. Production Theory
It is concerned with the process of conversion of inputs into outputs. The goal is to select the right combination of commodities and combining techniques to reduce cost yet maximise profit.
Advantages of Microeconomics
The following are some principal advantages of Microeconomics:
- It helps in predicting the potential rise in prices based on the study of demand and supply.
- Observing and analysing the behaviour of small economic units and the demand-supply chain allows the decision-makers to make the authoritative allocation of resources.
- The concepts of microeconomics allow business associations to chalk out their future course of action.
- With its simple models of analysing economic problems, understanding the overall economic phenomena becomes more straightforward.
- Microeconomics provides the basis for studying Macroeconomics.
Disadvantages of Microeconomics
Even though Microeconomics is vital for studying the individual units of an economy, it suffers from inherent limitations.
- Microeconomics assumes that the impact of one production variable is equal over all other production variables. Such an assumption is unrealistic.
- It strives for laissez-faire policy or pure capitalism, which is not practicable.
- It depends on macroeconomics, specifically for the rate of interest and profit determination.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.