Microeconomics is the study of economics related to individuals, firms, companies, etc. The scarcity of resources makes its allocation very important. Demand and Supply are two major factors in microeconomics. Welfare economics and Labour economics are also part of microeconomics. In microeconomics, any two factors are studied keeping everything else constant.
According to the law of demand, as the price increases, the demand decreases. According to the law of supply, as price increases the supply increases. Market equilibrium is reached when the quantity produced of a good or service become equal to the quantity supplied. The price at which this occurs is the equilibrium price.
Elasticity is another concept. It shows the responsiveness of demand and supply to the price. When the magnitude of price elasticity of demand |Ed| <1, the demand is relatively inelastic.
Example – Quantity of Medicine demanded doesn’t change much with the price. If |Ed|>1, the demand is elastic.
Example – the change in flight price of an airline changes the number of people opting for that particular airline.
The price of another product changes the quantity demanded of a product. This is termed as Cross Elasticity of Demand (XED). When the price of a substitute product changes, XED becomes positive. When the price of a complementary product changes, XED becomes negative.
When Price Elasticity of Supply |Es|<1, supply is relatively less elastic to price change. Example – Supply of rare painting.
When |Es | >1, supply is more elastic to price change.
Example – When the price changes, the quantity of a particular crop produced can change significantly.
Over the long run, demand and supply become more elastic.
The concept of elasticity can be applied not only to price but also to income, labor, etc.
Opportunity cost is the cost of choosing one alternative over the other. Production Possibilities Frontier (PPF) is a graph plotted between the quantities produced of 2 goods with the available resources. It shows different combinations that can be produced by fully utilizing the resources. To produce more of one good, some quantity of others should be sacrificed. All the points on the PPF are feasible, above that are impossible and below that are not profitable.
The utility is the benefit or satisfaction obtained from a good or product. According to the law of diminishing utilities, as the supply increases, the Marginal Utility (MU) of each subsequent unit decreases.
A consumer always has a budget. B <= p|x|x+p y|y is the budget constraint. He purchases x units of X at the rate of p x and y units of Y at the rate of p y . The entire thing should cost less than B. The line plotted for various values of x and y, according to the equation B = p|x|x+p y|y is called a budget line.
A customer may have the same preference for different combinations of two goods say X and Y. The plot made by connecting all these indifferent points is called the indifference curve. There can be many indifference curves for 2 products.
The consumer always wants to maximize the utility. The maximization problem U(x,y) is very important in microeconomics. The utility is maximized subject to the budget constraint. The solution to the maximization problem can be obtained graphically. The indifference curve for which the budget line is a tangent at one point is chosen. The quantities of X and Y at that point (x1, y1) give maximum utilization.
The terms like Marginal Cost (MC), Marginal Revenue (MR) are used frequently in microeconomics. To produce any good or service, fixed costs (FC) and variable costs (VC) are involved. Total Cost (TC) is the sum of both. MC is the ratio of change in cost to the change in quantity produced. MR is the change in revenue for a unit increase in selling of the product. Profit maximization occurs when MC = MR. As production increases, the average total cost (ATC) decreases.
Microeconomic studies are based on a perfectly competitive market. In such a market there will be a number of sellers of identical products. There will be a huge number of rational buyers also. Rational buyers try to maximize utility and have accurate price information. Anyone can enter the competitive market. The established firms don’t have any additional advantage. The players are price takers and they can’t change the price. Ideally, there should be no external intervention.
Example – Products like the washing machine, microwave, etc. are examples.
In a monopoly, there will be only one big player. Some become natural monopolies due to the cost involved. Example –Electricity distribution in some countries. In many countries, railway transportation is a government monopoly. Oligopoly is a situation when very few players are involved in a sector.
Example – Microsoft and Linux dominate the PC operating systems.
To predict the behavior of multiple players in an oligopolistic market, Game Theory and Nash equilibrium are used often.
Would you like to read more about this topic? This book might interest you: Basic Microeconomics.