Microeconomic Thought and Theory

Microeconomics is the branch of economics that deals with individual consumers and firms decision making where the former maximizes utility while the latter has to maximize profits. Microeconomics has two broad divisions, the consumer side, and the firm side. Some of the factors that are considered in consumer decision-making are consumer satisfaction and the impact of price on demand. The firms have to contend on how much product to produce (supply) and how to set the most efficient prices to compete effectively in the market. All the decision made by individual consumers and a group of firms have to be about alternative options and scarce resources. Therefore, Microeconomics is a study of all the dynamics in individual consumer and firms’ decision-making in the production and consumption of goods and services.  

How people make decisions is an important area of Microeconomics. The first approach in individual decision making is people facing trade-offs. The trade-off is based on the concept that there is nothing like free lunch; therefore, people have to give up something to obtain something they desire. A good example is a trade-off between efficiency and equity. Due to scarce resources, the society may decide to distribute the economic output in the community fairly at the expense of efficiency where the society obtains maximum benefits from its resources. In making the best decision, the decision-maker should strike a balance or equilibrium between the two or more competing factors. A goal has to be traded off for another in decision-making.

The second factor on how people make decisions is “the cost of something is what you give up to get it” (Mankiw, 2012). Making decisions or trade-offs require conduction a cost-benefits analysis. In a decision, the individual has to ascertain what they will benefit from selecting an option and what will be given up in choosing the option (opportunity cost). The best choice is the one that provides the maximum benefit at the minimum cost. The best decision is also the one has the least opportunity cost i.e. the option that one will have to give up the least. For example, a student may choose not to go to a party so that they can study. In this case, the opportunity cost is the time he would enjoy at the party.  The perspectives of looking at the opportunity cost are different. One may argue that choosing to study is a worthwhile investment over partying while another may argue that partying is part of life-work balance, therefore it is necessary. 

The third factor in individual decision making is rational people think at the margin. Thinking at the margin is all about thinking ahead or for the future. Intelligent people will think in a way to achieve their goals in the best possible way. For consumers, it is about making the best decisions by balancing the prices, their income and utility of a product. For firms, they have to make decisions that reduce costs and increase the revenue for the purpose of maximizing profit.  For instance, parking at a certain location is 15$ while parking an area that is a kilometer away is free; therefore, an individual is faced with the question of going to a distant location to park or having to pay to park at a near location. 

The last factor in individual decision making is people respond to incentives. Incentives are implemented to encourage desired outcomes. One of the most significant incentives in economics is the price. A low-priced commodity would act as an incentive for the consumers to purchase more while a high-priced product will serve as an incentive for suppliers to produce more. Incentives can be grouped into four categories remunerative e.g. money, moral e.g. right or wrong action, coercive e.g. punishment and natural e.g. anger or fear. Just like the other factors, in when people respond to incentives, they have to balance between benefits and costs. For instance, increasing the retirement age people will likely continue to work because it will improve life satisfaction but will have to balance with productivity and cost of benefits (Southwood, 2014).

People interact with each other in different ways. Through trade, people are better off because they gain from each other. For example, a country can export agriculture produce to a country and import technological devices from the same country; this fosters specialization. People can interact in the markets that are driven by the dynamics of supply and demand. Firms and households interact in the market through the dynamics of the markets that include the market prices. In such market economies, there are decentralized decisions through the allocation of resources (Mankiw, 2012). The government can be called upon to improve the market outcomes through the promotion of equity and efficiency; this is done through policy enactment and enforcement. 

The economy works as a whole through the interplay of different mechanisms. A country’s production determines its standards of living. Productivity is the quantity of goods and services produced by a worker per hour. Productivity is affected by education, technology, policies, resources, and costs. A country with high productivity has high standards of living (Broadberry & Burhop, 2010). The printing more money in an economy increases the money supply in the economy without increased production. The general prices of products will increase due to increase in purchasing power, and therefore the value of money will fall. This injection of money into the economy can lead to increase in demand and supply in the short run, therefore leading to increased employment, this is referred to as the short-run trade-off between inflation and unemployment.

The demand curve is a plot of quantity demanded on the x-axis and price on the y-axis. The demand curve slopes downwards from left to right because the decrease in prices will lead to increase in quantity demanded. The supply curve is a plot of quantity supplied on the x-axis and price on the y-axis. The supply curve slopes upwards from left to right because an increase in price will result in an increase in quantity supplied. Where the demand and supply curve intersect is known as market equilibrium and the market will operate at this price. The intersection also determines the quantity that will be purchased and sold in a market. 

In an attempt to manage the economy, the government can use price controls; this can either be price ceilings (maximum prices) or price floors (minimum prices). If the legal price is above the market equilibrium price, the price floor creates an excess supply, and when the legal price is below the market price, price ceiling creates a shortage. Tax is another factor that affects equilibrium price. An increase in tax on consumers’ e.g. sales tax will reduce the consumer demand thus decreasing the equilibrium price keeping the supply constant. On the other hand, increasing the tax on producers’ e.g. VAT will reduce supply, therefore, reducing the equilibrium price keeping the demand constant. The equilibrium price depends on the interplay between the degree of tax on consumers and tax on producers. Elasticity is the extent of responsiveness of quantity of good demanded to changes in factors of demand. Price elasticity is responsiveness of quantity demanded to changes in price. In a given supply curve, a flatter or less steep demand curve (elastic) has a more elastic equilibrium price or point.

 

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