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micro economics
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Topic: microeconomyMicroeconomics is a branch of mainstream economics that studies the behavior of
individuals and firms in making decisions regarding the allocation of scarce resources
and the interactions among these individuals and firms. Microeconomics focuses on the
study of individual markets, sectors, or industries as opposed to the national economy as
whole, which is studied in macroeconomics.
One goal of microeconomics is to analyze the market mechanisms that establish relative
prices among goods and services and allocate limited resources among alternative uses.
Microeconomics shows conditions under which free markets lead to desirable allocations.
It also analyzes market failure, where markets fail to produce efficient results.
While microeconomics focuses on firms and individuals, macroeconomics focuses on the
sum total of economic activity, dealing with the issues of growth, inflation, and
unemployment and with national policies relating to these issues. Microeconomics also
deals with the effects of economic policies (such as changing taxation levels) on
microeconomic behavior and thus on the aforementioned aspects of the economy.
Particularly in the wake of the Lucas critique, much of modern macroeconomic theories
has been built upon microfoundations—i.e. based upon basic assumptions about micro-
level behavior.
Assumptions and definitions
The word microeconomics derives from the Greek words μικρό (small, minor) and
οικονομία (economy). Microeconomic study historically has been performed according to
general equilibrium theory, developed by Léon Walras in Elements of Pure Economics
(1874) and partial equilibrium theory, introduced by Alfred Marshall in Principles of
Economics (1890).
Microeconomic theory typically begins with the study of a single rational and utility
maximizing individual. To economists, rationality means an individual possesses stable
preferences that are both complete and transitive.
The technical assumption that preference relations are continuous is needed to ensure the
existence of a utility function. Although microeconomic theory can continue without this
assumption, it would make comparative statics impossible since there is no guarantee that
the resulting utility function would be differentiable.
Microeconomic theory progresses by defining a competitive budget set which is a subset
of the consumption set. It is at this point that economists make the technical assumption
that preferences are locally non-satiated. Without the assumption of LNS (local non-
satiation) there is no 100% guarantee but there would be a rational rise
, in individual utility. With the necessary tools and assumptions in place the utility
maximization problem (UMP) is developed.
The utility maximization problem is the heart of consumer theory. The utility
maximization problem attempts to explain the action axiom by imposing rationality
axioms on consumer preferences and then mathematically modeling and analyzing the
consequences. The utility maximization problem serves not only as the mathematical
foundation of consumer theory but as a metaphysical explanation of it as well. That is,
the utility maximization problem is used by economists to not only explain what or how
individuals make choices but why individuals make choices as well.
The utility maximization problem is a constrained optimization problem in which an
individual seeks to maximize utility subject to a budget constraint. Economists use the
extreme value theorem to guarantee that a solution to the utility maximization problem
exists. That is, since the budget constraint is both bounded and closed, a solution to the
utility maximization problem exists. Economists call the solution to the utility
maximization problem a Walrasian demand function or correspondence.
The utility maximization problem has so far been developed by taking consumer tastes
(i.e. consumer utility) as the primitive. However, an alternative way to develop
microeconomic theory is by taking consumer choice as the primitive. This model of
microeconomic theory is referred to as revealed preference theory.
The theory of supply and demand usually assumes that markets are perfectly competitive.
This implies that there are many buyers and sellers in the market and none of them have
the capacity to significantly influence prices of goods and services. In many real-life
transactions, the assumption fails because some individual buyers or sellers have the
ability to influence prices. Quite often, a sophisticated analysis is required to understand
the demand-supply equation of a good model. However, the theory works well in
situations meeting these assumptions.
Mainstream economics does not assume a priori that markets are preferable to other
forms of social organization. In fact, much analysis is devoted to cases where market
failures lead to resource allocation that is suboptimal and creates deadweight loss. A
classic example of suboptimal resource allocation is that of a public good. In such cases,
economists may attempt to find policies that avoid waste, either directly by government
control, indirectly by regulation that induces market participants to act in a manner
consistent with optimal welfare, or by creating "missing markets" to enable efficient
trading where none had previously existed.
This is studied in the field of collective action and public choice theory. "Optimal
welfare" usually takes on a Paretian norm, which is a mathematical application of the
Kaldor–Hicks method. This can diverge from the Utilitarian goal of maximizing utility
because it does not consider the distribution of goods between people. Market failure in
positive economics (microeconomics) is limited in implications without mixing the belief
of the economist and their theory.
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