Principles of Microeconomics
Economics is a subject that provides guidance on how to reconcile unlimited wants and limited resources. In general, it involves applying the concept of tradeoffs within a context where decisions occur through marginal analysis. As they engage themselves in this framework, students will encounter questions regarding the content, purposes, and processes of production in a market-based economy. Some will find answers to those questions as they ponder models of demand and supply. Those models are merely tools with which we can simplify reality and attain a better understanding of the nature of demand and supply. Readers will find discussions on how their purchases are sensitive to income, satisfaction, and prices. They will also learn how their employments generate revenue and profits while their employers respond to consumer wants and needs, seize or miss opportunities, and deal with market constraints. In addition, readers will gain additional insights into the relevance of microeconomics to areas such as labor markets, government regulations, market failures, public goods, and international trade.
Keywords Consumer Equilibrium; Demand; Demand Schedule; Elasticity; Equilibrium; Income; Law of Demand; Law of Supply; Marginal analysis; Marginal Revenue; Marginal Utility; Market Failure; Market; Price Controls; Producers; Profits; Public Goods; Quantity Demanded; Quantity Supplied; Resource Market; Revenue; Satisfaction; Supply; Supply Schedule; Tradeoffs
Economics: Principles of Microeconomics
We can think of economics as a study of reconciliations between unlimited wants and limited resources. Reconciliation is an attempt to find some middle ground in problem solving. The economic problem arises due to resource scarcity and it prompts individuals to make rational choices from amongst all the alternative solutions. Each and every choice involves a sacrifice because it is very difficult, if not impossible, to avoid tradeoffs.
The value of the foregone alternative is, by definition, an opportunity cost. In essence, finding solutions to the economic problem of scarcity involves minimizing opportunity costs. Tradeoffs sometimes take the form of sacrifices that are linear in their relationship, which translate into the correspondence of a benefit with some given or constant amount of cost. However, economists tend to view the equation as one that involves increasing amounts of cost taking the form of a curvilinear relationship.
Whether opportunity costs are constant or increasing their illustration is most effective when one attempts to consider all the possible choice combinations. A study of economics introduces students to many models, some of which focus on consumers and others on producers. It is best to think of graphs and models as tools that simplify reality. With a view toward a nation's ability to produce two items, say goods X and Y, there are numerous combinations of X and Y possible but the production of more X essentially translates into the production of less Y and vice versa.
Economics, in general, involves applying the opportunity cost concept to decisions made at the margin. In other words, how a change in one variable results in a change in another variable. As an introduction to the orientation of economics toward marginal analysis, the production possibilities frontier is a model that portrays all those combinations that a country's entire economy can produce. It is a macroeconomic concept, which effectively conveys the interdependencies among scarcity, choices, and tradeoffs. Nonetheless, this essay is on microeconomics. The difference between those economic divisions resides in their scope. Macroeconomics is a study of economics using models of the whole economy whereas microeconomics is a study of the behaviors of consumers and producers as they interact in models we can refer to as a market.
Foundations of Microeconomics
Students in economics courses may find these three questions in their textbooks and possibly their exams: What will be produced? For whom will it produced? How will it be produced? Furthermore, studies in microeconomics usually begin by acknowledging a set of assumptions.
- First and foremost is the ceteris paribus (translation means all else is held constant) assumption.
- The second assumption is that consumers and producers behave as rational agents who have access to full, perfect information relevant to their decisions.
- Another assumption is that those agents engage in transactions through which no individual or group brings an inordinate amount of influence to an exchange decision.
- The fourth and last assumption is that an exchange between a buyer and a seller yields benefits and/or costs for them only thereby omitting or ignoring the private exchange's relevance to larger society. A theme in economics is that individuals pursuing their own self interests promote societal betterment.
Problems unrelated to scarcity arise in the marketplace when any of the last three assumptions become unrealistic or fail to hold true. Policy analysts and economists refer to that situation as a market failure. Its occurrence may establish a rationale for governmental intervention including the formation and the implementation of public policies; market failure will be revisited towards the end of this essay.
A call for governmental policies or interventions suggests that something should occur in order to alleviate a problem. That call would fit the classification of normative economics, which is one of two types of economic analysis. The other type is positive economics which occurs when analysts deal strictly with data or facts centering their attention on whether that information is accurate. For example, individuals are more likely to agree on matters regarding the accuracy of data than they are on matters regarding what ought to occur in response to their interpretations of the data. In sum, differences exist in the content of a statement containing the word "is" versus others containing the word "ought" or "should." Macroeconomics is more normative than microeconomics due primarily to its orientation toward policies promoting economic growth, employment, and price stability.
Students will receive information on a variety of distinctions, some more subtle than other, and concepts in an economics course. The fallacy of composition concept is one. It occurs when an analyst is errant in forming the conclusion that what is true for an individual is also true for a group. In addition, there is a distinction between correlation and causation. Economic theory and models utilize causation in the sense that a change in an independent variable causes a change in a dependent variable; for example, many economists agree that consumer's demand for an item causes firms to supply it. Analysts define correlation as the presence of a statistical association between variables in the absence of a theoretical basis that specifies a change in one variable causes a change in another; for example, studies show that the number of babies born under a full moon is statistically and significantly higher than a new moon. Yet we are confident that one does not cause the other because the moon is always present regardless of its illumination phase.
The aforementioned set of clarifications, distinctions, and assumptions provide a foundation with which readers can form a better, yet terse, understanding of the way economists view the world. In the exposition ahead, readers will also gain a better sense of microeconomic theory and they will receive suggestions that purport to reinforce their learning. This condensed essay of microeconomics may require readers to consult textbooks and other sources for additional details, examples, and cases due to their deliberate omission for the sake of brevity. The remainder of this essay represents an attempt to apply the world view as introduced above.
The foundation of economics emphasizes consumers and demand as integral components. With regard to the consumer or demand side, students learn very early in their coursework that an inverse relationship exists between price and quantity demanded in accordance with the Law of Demand. Relatively speaking, smaller amounts are in demand at higher prices and vice versa. On the producer or supply side, they learn that a positive relationship exists between price and quantity supplied according to the Law of Supply.
Models contain a set of relationships and those relationships use lines and curves for illustrative purposes. However, graphs are a known stumbling block for many students so their omission from this essay serves to expedite learning. Though this author attempts to describe what an economics student might see on a graph, there are points within this essay when students will benefit by referring to graphs in an economics textbook; those by Arnold (2011), McConnell & Brue (2012), Guell (2007) and other economists will suffice. When the need arises, readers are encouraged to consult those sources as they read through the pages of this essay. All said, when viewing a two-dimensional graph showing the demand and supply curves in the market for any given item, viewers would notice that its price appears on the vertical axis and its quantity is appears on the horizontal axis.
Equilibrium price and quantity occur where quantity demanded equals quantity supplied or where the downward-sloping demand curve intersects the upward sloping supply curve. Furthermore, on the one hand, a surplus occurs at a price above equilibrium. It is the result of the quantity supplied being greater than the quantity demanded. On the other hand, a shortage occurs at a price below equilibrium. It results from the quantity demanded exceeding the quantity supplied. In order to move price and the situation toward equilibrium, two forms of movement may occur on the graph: A movement along the curve and a shift in the curve. Students frequently confuse those two forms. In order to keep them clear, students need to remember that a change in price initiates movement along the curve whereas a change in a determinant initiates a shift in the curve. In addition, the curve illustrates the relationship between the axis variables thus any change in them will result in movement along the curve.
An equilibrium point is static at one instance, but it is also dynamic in nature by virtue of a curve shift that results in a different intersection of the demand and supply curve. New intersections and new equilibrium prices and quantities often result from any inward or outward curve shift. The demand curve will shift in accordance with a change in a determinant and so will the supply curve. In the pages ahead, readers will gain valuable insights into studying microeconomic concepts and learning how to apply them successfully.
Five determinants exist each for demand and for supply and any change in them will prompt the curve to shift. Increases or decreases in demand or supply occur in accordance with a change in a determinant. A rightward, outward, or upward shift in the demand curve is an increase in demand whereas an opposite shift is a decrease in demand. By extension, an increase (decrease) in demand means consumers will purchase a larger (smaller) quantity of an item at any given price. A rightward, downward, or outward shift in the supply curve is as an increase in supply whereas an opposite shift is a decrease in supply. Likewise, an increase (decrease) in supply means producers will supply a larger (smaller) quantity of an item at any given price. In contrast to curve shifts, any movement along a demand curve or a supply curve is respectively a change in quantity demanded or quantity supplied to which there is a corresponding change in price. The list of five determinants for demand and those for supply is as follows:
Correspondence between prices and quantities is revealed through demand and supply schedules. Construction of these schedules occurs at two levels of aggregation. Compilations of a market-level demand schedule and supply schedule originate with individual-level schedules. All individuals that buy or sell an item constitute the market for that item. Individual demand schedules represent the quantities each consumer is willing and able to purchase at each price. The summation of quantities from those individual demand schedules across each price becomes the market demand schedule. In comparison, market supply schedules represent the sum of quantities that individual producers are willing and able to sell at each price as long as the market price makes it is feasible for them to do so.
In terms of those individual-level demand schedules, the ability to purchase an item is a function of a consumer's income and the willingness to purchase is a function of the satisfaction that originates from the item's consumption. In other words, consumers maximize their utility subject to their budget constraints. Utility is another word for the satisfaction an individual receives when consuming the item. Marginal utility then, by definition, is the additional unit of satisfaction from consuming an additional amount of the item. However, marginal utility increases but it becomes smaller with additional amounts until a point is reached at which it is zero. Afterwards, marginal utility then becomes negative and it decreases at an increasing rate as a consumer begins to regret overindulgence. This pattern illustrates the diminishing marginal utility concept. One example of this concept is how the feeding frenzy that accompanies a buffet-style meal often results in regrets as the diner attempts to get the most out of each dollar spent.
Income constraints, marginal utility, and item prices jointly influence a consumer's purchase plans. Income and item price are primary factors in determining how much the consumer will purchase. With a simplifying assumption that only two items are available for purchase, it is useful to ponder for a moment what combination of them is attainable for a given amount of income and is desirable for achieving an equal amount of utility. Consumer equilibrium is, by definition, a point at which the marginal utility per dollar spent is equal across all...
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