Microeconomics is primarily concerned with explaining individual behaviors and their interactions. Its preferred level of observation is that of the firm and the market for a particular good or service. Modern microeconomic analysis began its true development at the end of the 19th century with the neoclassical (or marginalist) economists.
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Definition of Microeconomics
From the Greek « micro » meaning small. Microeconomics is the part of economics that analyzes the behavior of individuals or firms and their choices in the areas of consumption, production, and price or income setting.
It conceives of society as a set of individuals having exchange relationships, and it further assumes that they act rationally, i.e., that they make the best use of the resources at their disposal, given the constraints they face:
Households organize their purchases in order to maximize their level of satisfaction (utility in economic terms);
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Firms set their production level in order to maximize their profit.
Subject of Microeconomics
The main object of microeconomic theory is the analysis of the simultaneous determination of prices and quantities produced, exchanged, and consumed. It claims to respect in its abstract formulations the individuality of each good and each agent. In contrast, the rest of the theory is most often macroeconomic, reasoning directly on aggregates of goods (GDP) and agents (households and firms).
For the neoclassical school, this approach must satisfy the requirements of methodological individualism. This position is strongly contested by other economists for whom primacy must be given to collective institutions and social norms as explanatory factors of social interaction.
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Microeconomic theory is somewhat improperly called the theory of prices and resource allocation.
The Objectives of Microeconomics
The objectives of microeconomics are:
- To analyze and predict the behavior of agents in a given economic, technical, and social environment;
- To analyze and predict the social interactions between agents resulting from these behaviors;
- To analyze the product of these interactions, whether they are institutions responsible for organizing them or the result of the interplay of less formalized interaction mechanisms such as exchanges.
The Goal of Microeconomics
The goal of microeconomics is to find the market equilibrium, in other words, the prices and incomes that balance supply and demand in the market. To do this, microeconomics relies on mathematical models: the consumer thus has a utility function, and the producer a production function.
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Thus, the consumer’s program is to maximize his utility under the constraint of his income.
The producer’s program is to maximize his profit under the constraint of the prices of the factors of production.
There is a confrontation in the market between consumers (demand) and producers (supply). The meeting between the two gives rise to the exchange of a quantity of goods and services at a certain price, i.e., the realization of an equilibrium.
The approach is microeconomic, since it is about the behavior of the consumer and the producer, each considered individually. If the rule is valid for one consumer, it is assumed to be valid for all other consumers as well, and if it is valid for one producer, it is valid for all producers.
Fundamental Concepts: The Tools of Analysis
Microeconomics relies on a series of key concepts to analyze individual behaviors and markets:
- Goods: bread, milk, electrical energy, etc… are considered as goods. The quantity of each of them being measured in an appropriate unit;
- Agents: are individuals, groups of individuals, or organizations that constitute elementary acting units. Each agent corresponds to an autonomous decision center.
Microeconomic theory distinguishes two main types of agents:
Producing agents: who transform certain goods into other goods (companies or firms);
Consuming agents: who use certain goods for their own needs (direct satisfaction of their needs): these are households.
Economy: it is defined by a list of goods, a list of consumers, a list of producers, and a vector W of initial resources.
- Supply and demand: The fundamental forces that determine prices and quantities exchanged.
- Elasticity: The sensitivity of the quantity demanded or supplied to a change in price.
- Utility: The satisfaction an individual derives from consuming a good or service.
- Production costs: The set of expenses incurred to produce a good or service.
- Market structures: The different market configurations, such as perfect competition, monopoly, oligopoly, etc., which influence the behavior of firms.
Microeconomics in Action: Concrete Applications
Microeconomics finds applications in many areas, such as:
- Public policy analysis: Evaluating the impact of taxes, subsidies, and regulations on markets and individual well-being.
- Business strategies: Making informed decisions regarding pricing, production, and investment.
- Consumer behavior: Understanding consumer choices and the factors that influence them.
Conclusion
In summary, microeconomics offers a powerful analytical framework for understanding the workings of markets and the individual decisions that shape them.
