Principleof Microeconomics
Principleof Microeconomics
Microeconomics
Microeconomicsis a branch of economics that largely concerns itself with decisionmaking that happens at individual level of every other economicagent. Such economic agent may include firms or even consumers. Inmicroeconomics, the main concern is the economic problem, which isalso known as the scarcity problem(Gans, King & Mankiw, 2011).The study of this branch of economics implies that there is a gapbetween the limited resources and the many unlimited needs and wantsof the society. Any individual or a firm that faces the scarcityproblem is then left at a position where they have to make a choice.Making a choice in this case implies that individuals or firms havedifferent alternatives from which they have to be discriminative.Notably, every choice that an individual makes entails an opportunitythat is forgone. The forgone opportunity is referred to as theopportunity cost. Opportunity cost refers to the gain that anindividual or a firm would have got in case they did not make theparticular decision they have. It refers to the value of the nextbest alternative (Frank, 2014). A case in point would be allocationof an extra hour to either studying or dancing salsa. If anindividual chooses to study economics then the opportunity costinclude the gains that are forgone from dancing salsa.
Onthe other hand, if an individual chooses to dance salsa, theopportunity costs of his or her choice are the gains forgone fromstudying. Microeconomics has its scope, which covers theory ofdemand, theory of production, theory of product pricing, theory offactor pricing, theory of welfare economics and the different typesof microeconomic analysis. Through microeconomics, individuals cananalyze behavior or particular entities, provide different tools forbusiness, give a basis for pricing and come up with tools and modelsfor economic policies. Even though microeconomics is critical as partof economics, it has a couple of limitations. First, microeconomicsis static in nature. Additionally, it is known to have a very limitedscope, and the conclusion that is drawn from microeconomics may bewrong from society point of view. Additionally, microeconomics isknown to ignore the role of government largely.
Demand,Supply and Equilibrium
Demand
Demandrefers to the total amount of goods or services that consumers arewilling and in a position to buy at a set price(Hildenbrand, 2014).Demand mainly is dictated by the needs and wants. Additionally,demand is also dependent on the ability to pay. This means thatanybody who cannot pay has no sufficient demand. The amount that abuyer pays to get a given good or service is known as the price andthe total number of units that are bought at the set price isreferred to as the quantity demanded. There is the law of demand thatreflects the behavior of consumers against their goods. The law ofdemand states that a higher price will lead to a lower quantity ofgood demanded and the lower the price of item or service the higherthe quantity of services or goods demanded. The law of demandoperates while assuming that all the other variables affecting thedemand are held constant.
Tounderstand and exemplify the relationship between demand and price,there are demand curves and schedules put in place. The demandschedule is just a table that displays the specific quantity of goodsdemanded at a given price. On the other hand, a demand curve is justa graphical representation of the quantity that is demanded at agiven price.
Figure1: Graph showing Demand Curve for Gasoline
Fromthe graph, it is evident that as the price rises, the quantity ofgoods and services that are demanded decreases and vice versa. Thevalues of the demand schedule are graphed to give the demand curve.The downward slope of the demand curve is an illustration of the lawof demand.
Thereare different factors that affect demand at ceteris paribus. Thefactors include income, change in taste and preferences, change inpopulation proportion and related goods. The change in the price of agood or service is notably not among the factors that are known tolead to a shift in the demand curve. When the price of good orservice changes, movement occurs along certain demand curve and this,in essence, leads to given changes in the quantity demanded though itdoes not shift the demand curve.
Figure2: Factors that lead to a shift in Demand Curves
Inthe first graph (a), the factors that can lead to increased demandfrom D0 to D1. The second graph (b) illustrates the factors that cancause a decline in demand from Do to D1 when their direction isreversed.
Supply
Supplyrefers to the total amount of goods or services that a producer iswilling to supply at a given price(Mandel, 2012).Often the rise in price ends up increases the amount of quantitybeing supplied of a given good or service while the reduction inprice leads to decrease in the quantity of goods that is supplied.The positive relationship between the price and the quantity suppliedis the law of supply. The higher the price, the higher the quantityof goods supplied and the lower the price, the lower amount of goodsor services supplied at ceteris paribus (Mandel,2012).
Belowis a case example of supply curve that has been derived from supplyschedule. The graph illustrates and exemplifies the supply curve ofgasoline (Figure 3).
Justas the demand, there are factors that exist which lead to a shift inthe supply curve (Mandel,2012).Notably, changes in production cost and the related factors can makean entire supply curve to shift to either right or left. This impliesthat higher or lower quantity can then be supplied at a certainprice.
Oneof the factors that affect supply is the production costs. The othercritical factors that affect supply include natural conditions suchas drought that may lead to a low quantity of goods and good weatherthat may result in a the supply curve shifting to the right. Theother vital factors include technology and government policies. Someof the policies that are considered include taxes, regulations oreven subsidies. Taxes are often the costs of doing business andhigher costs reduce the supply. Regulations such as environmentalconservation when producing can lead to higher costs as firms spendas much as possible to comply with the regulations. Normally, thesubsidy by the government occurs in instances where they reduce thefee of the firm or even pay them directly. The behavior of taxes andsubsidies are shown in the figures below.
Figure4: Graphical Representation of Factors that Shift Supply Curves
Equilibrium
Equilibriumpoint refers to the place of intersection between market demand andsupply. Usually the demand and supply in a free economy determinesthe price at which a good or service is purchased. The point ofintersection of supply and demand curves gives the equilibrium price,which is the price that the market will operate.
Figure5: Graphical Representation of Equilibrium
Theequilibrium price is the price at which the needs of consumers andthe supply of the producers are in synch. At this price, the quantitydemanded is equal to the quantity supplied.
Measurementof Elasticities
Differentmeasures exist for elasticities and they include the price elasticityand cross elasticity.
PriceElasticity of Demand and Supply
Inboth the demand and supply curves, there is an indication of therelationship between price and the number of units that are eitherdemanded or supplied. Price elasticity refers to the ratio betweenthe percentage change in the quantity that is demanded or suppliedand the equivalent change in price. The price elasticity of demandrefers to the change in the percentage of quantity demanded of a goodor service as a proportion of the percentage change in the prices. Onthe other hand, the price elasticity of supply refers to theproportional change in the quantity supplied as divided by the pricechanges percentage.
Categoriesof Elasticity
Elasticitiesare categorized into three including elastic, inelastic and unitary.For the elastic one, the elasticity is known to be greater than one,and it is an indication of the high degree of changes in the price.On the other hand, for the inelastic demand or supply, the elasticityis less than one, and this is a low indication rate of responsivenessto changes in prices. For the unitary elasticity, the responsivenessof demand or supply is proportional in nature.
Whencalculating the elasticity, the average percent change in thequantity, price is captured, and this is known as the midpoint methodfor elasticity.
%change in quantity = Q2–Q1/(Q2+ Q1)/2 × 100
%change in price =P2– P1/(P2+ P1)/2 × 100 
Giventhat the midpoint method uses the same base for both cases, one canget similar elasticity between any two-price points regardless of theexistence of increase or decrease in price.
Apartfrom the mentioned types of elasticities, there are other types ofelasticities, which include perfect, zero and constant. For theperfect elasticity, either the quantity demanded or the quantitysupplied changes by just an infinite amount in response to the pricechanges. On the other hand, there is zero elasticity or perfectinelasticity where despite the percentage change in price the resultis zero change in the quantity. The other is constant unitaryelasticity, which implies that when price in supply or demand curvechange by 1% the result in quantity change of 1%.
ConsumerDemand Theory
Thislaw is mainly anchored on observing the manner in which individualsact to allocate their scarce resources in the different commoditiesthat give them utmost satisfaction (Baumol & Blinder, 2015).Often, human beings are presented with the opportunity to makedecisions regarding the things that they will consume and often thesethings are pegged on the resources available. In this area, there isthe utility theory that recommends that rational individuals will becareful when evaluating and consuming certain bundle of goods thatwill result in utmost satisfaction.
Inthis theory, several basic concepts exist that create the fundamentalprinciples of consumer demand behavior. The two most importantprinciples include the Marginal Utility and the Law of DiminishingMarginal Utility (Baumol & Blinder, 2015). These two conceptsadmit that persons or consumers in most cases get less additionalvalue for every identical item that they get. The theory discussedimmensely contributes to the broader concept of general supply anddemand theory. One of the assumptions under which the theory operatesis that all the consumers are rational and work hard to get maximumutility out of their consumption (Baumol & Blinder, 2015).
Applicationof Consumer Demand Theory
Themain principle that dictates the behavior if most consumer economistis the pursuit of equal marginal utility. Family financial plannersapply the theory when they educate their clients and craft a planthat can allocate the financial resources existing in an efficientmanner. The theory is used when the consumers quickly comprehendsupply and demand and its composition (Baumol & Blinder, 2015).This implies that an individual can plan their satisfaction andconsumption maximization in regards to the things that they consideras great demand or even in scenarios when a given object isoversupplied. Another application is eating seasonally whichexemplifies enjoying satisfaction of items when their supply isutmost (Baumol & Blinder, 2015).
Theoryof Production
Accordingto this theory, the objective of a firm is to maximize profits(Shepherd, 2015). According to this theory, if in the short run, thetotal output remains fixed and if it is a price-taker, then the totalrevenue will eventually remain fixed. The theory then affirms thatthe only way to maximizing the profits is through cost minimization.Additionally, supply largely depends on the cost of production. Theperception to supply an extra unit depends on the marginal cost ofproducing that unit. Therefore, the significant determining factor inthe price-output decision in a firm in any given market is the costof production.
Thecost of the firm is dependent on two critical factors. First, is therelation between inputs and output technically (Shepherd, 2015). Thisimplies the variation of output as the inputs vary. The secondrelation is the prices of factors. In this case, the price of laboror wages, the price of capital or interest rate are considered. Oneof the main theory of production is the production function. Theproduction function exemplifies the relation that occurs betweeninput changes and the output changes. The function also gives themaximum amount of output that can be got by any firm from certainfixed quantity of resources. The production function is donated as Q= f (K, L). In this case, Q is the output (which is thedependent variable) and K and L are capital and labor inputs,respectively (Shepherd, 2015).
Costof Production
Productioncost implies the cost that is spent by a firm when offering servicesor manufacturing a product. Production costs are made up of manyexpenses that include, but are not limited to, general overhead, rawmaterials, and labour. Moreover, the taxes that are levied by theadministration or royalties owed due to the extraction of naturalresources can also be regarded as production costs. For a cost to beregarded as a cost of production, it must have a direct impact thatleads to the generation of revenue for the firm. Manufacturing firmsencounter product costs that are related to both the goods needed forthe creation of an item in addition to the labour required for thecreation. On the other hand, firms offering services experience costof production related to the workforce needed to offer the service inaddition to the material cost incorporated in the provision of theaforementioned service (Hochbaum& Wagner, 2015).In production, the costs can be divided into both indirect costs anddirect costs. In this regard, direct costs can be the costs used inthe manufacturing of vehicles, which are metal materials and theworkforce needed to produce the final good. On the other hand,indirect costs comprises of overhead costs like utility expenses,management salaried, and payment or rent for the premise. Inproduction cost, unit cost can be defined as the expense incurred bya firm for the production, storage, and selling of a single unit of acertain good. Unit costs can be categorised as variable costs, fixedcosts, and overhead costs as shown in the graph below (Figure 6):
PerfectCompetition
Amarket in perfect competition is a theoretical one in which themarket is highly competitive or the competition is at the highestlevel. According to neo-classical economists, consumers stand tobenefit most when they are located in a market that is experiencingperfect competition. A perfect competition market has a number ofcharacteristics as the ones shown below:
The market or consumers have perfect information regarding the market since there are no lags in the conveyance of information nor information failure. The knowledge of the market can be accessed freely since it is available to everyone, thus the risk that the consumers face is very low
Considering that the consumers and the producers in the market have adequate information, it is clear that the decisions they make are rational to increase their own interest.
Such a perfect competitive market does not have any barrier to enter or to leave the market. In that, business people incur low expenses when joining the market in addition to low risk, which is similar to the instance when one leaves the market.
Ina perfect competitive market, the companies only make enough profitto stay in the business and no excess since if they we to cash inprecedes in excess, other firms would gain entrance into the marketand push profits down to the minimum (McDERMOTT,2015).The diagram of a perfect competition is similar to the one depictedbelow (Figure 7):
Accordingto the graph above, the price of the market is established by thesupply and demand of the industry that in turn establishes theequilibrium price of Pe. For a firm to maximise it profits, it has todo so when it attains Q1 where the marginal costs is equal to themarginal revenue.
MarketStructure
Eventhough many individuals tend to think that markets for differentcommodities as being either competitive or monopolistic, the truth isthat the economy is more complex than what many people think.Individual product markets seem to be classified in four extensivecategories, which are perfect competitions, monopoly, monopolisticcompetitions, and oligopolies(Celebi & Fuller, 2012).These market structures are further explained below.
MonopolisticMarket Structure
Inthis market structure, there exists a single producer of a particularproduct. Therefore, there is no competition from others because thecontrol of the product regarding supply and pricing depends on theproducer. Monopolies mainly end up making supernormal profits,especially when controlled by the private sector. An example ofmonopoly is the local electric utilities.
MonopolisticCompetition
Unlikethe monopolistic structure, this market structure has a freedom ofentry and exiting the market. However, businesses have differentiatedcommodities although serving the same purpose. There is a possibilityof making average proceeds in the long term. For example, there arevarious fast food restaurants, which serve hamburgers however, thereexist distinctive differences between each restaurant and hencemaking each a monopolist in its commodities(Celebi & Fuller, 2012).
OligopolisticMarket Structure
Itis a market structure where just a few firms dominate and hence itcan be said to be highly concentrated. Even though only a few firmscontrol the market, it is probable that various small companiesoperate in the same market. For example, chief airlines such as AirFrance and British Airways (BA) operate their routes within minimalcompetition from other small firms. They are usually realized inindustries where there are high barriers to entry.
PerfectCompetition
Inthis market structure, there are many producers of the similar itemwithout obstacles to entry in the market. Moreover, all firms areprice takers and hence no business can control the price. The buyersare many and aware of the prices of commodities in the market.Furthermore, the prices of the goods are determined by demand andsupply, and there are no barriers to entry
WelfareEconomics
Welfareeconomics majors on the best distribution of goods and the otherresources and how their distribution will have impacts on the socialwelfare. This can be as well compared to income allocations and howit significantly affects the surrounding (Cordato, 2013). It beingable to judge markets achievements in the distribution of resources,it is known to have a powerful tool that is known as the utilitypossibility frontier. Utility possibility frontier defines how goodsallocation can be affected by a set of constraints and technology insociety.
Welfareeconomics aim is to find a state that will be the best and have thehighest social satisfaction feeling to its members (Cordato, 2013).The tools that are majorly used by welfare economics are in themicroeconomics. These can be as well used to make macroeconomicsdecisions later. Some economists suggestions are that acquisition ofoverall goodness in social satisfaction is through relocation of aneconomy’s income. This model reflects back to several allocativeand efficiency economic theories.
Welfareeconomics is important in the establishment of public policy. It willmeasure and ensure there is affordable living in an area, easy accessto services, houses that are affordable and availability of jobs thatgenerates income. Welfare economics differs a lot to the capitalistprinciples. There is a rejection of government involvement about purecapitalism matters (Cordato, 2013). However, attention is fully paidto individuals in their choice development, success and seeking ofwealth. Capitalism support is to individuals claiming that societywill get an appraisal through the acquisition of personal wealth.Welfare economics works in correlation with utility. The utility isthe alleged value that is associated with goods or services. It isthe right of a buyer to feel or inquire that the good or service heor she has acquired rhymes with the amount of money that has beenused to buy it.
References
Baumol,W. J., & Blinder, A. S. (2015). Microeconomics:Principles and policy.Cengage Learning.
Celebi,E., & Fuller, J. D. (2012). Time-of-use pricing in electricitymarkets under different market structures. IEEETransactions on Power Systems, 27(3),1170-1181.
Cordato,R. (2013). Welfareeconomics and externalities in an open ended universe: A modernAustrian perspective.Springer Science & Business Media.
Frank,R. (2014). Microeconomicsand behavior.McGraw-Hill Higher Education.
Gans,J., King, S., & Mankiw, N. G. (2011). Principlesof microeconomics.Cengage Learning.
Hildenbrand,W. (2014). Marketdemand: Theory and empirical evidence.Princeton University Press.
Hochbaum,D. S., & Wagner, M. R. (2015). Production cost functions anddemand uncertainty effects in price-only contracts. IIETransactions, 47(2),190-202. doi:10.1080/0740817X.2014.938843
Mandel,M. (2012). Economics:The Basics.McGraw-Hill Higher Education.
McDERMOTT,J. M. (2015). Perfect competition, methodologicallycontemplated. Journalof Post Keynesian Economics, 37(4),687-703. doi:10.1080/01603477.2015.1050335
Shepherd,R. W. (2015). Theoryof cost and production functions.Princeton University Press.
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