Microeconomics is composed of two words – micro and economics. Micro is derived from the Greek word ‘mikros’ which means ‘small’ and economics is the branch of knowledge which studies about the production, consumption, and transfer of wealth incurred during the trade.
The term microeconomics was first coined by Ragner Frich in the year 1993. He was a Norwegian economist and the co-recipient of first ever Nobel Memorial Prize in Economic Science (1969).
“Microeconomics is the study of particular firms, particular households, individual prices, wages, income, individual industries, particular commodities.” -K. E. Boulding
Microeconomics is the branch of Economics which is concerned with the single factors and effects of the individual decision. It studies about the economic actions of the individual unit and small group of the individual unit such as industry and market, in an attempt to understand their decision-making process.
Microeconomics focuses on basic theories of demand and supply. It explains how factor pricing (rent, wage, interest and profit) is affected by the interaction of demand and supply in the market and how the price of a product is determined in accordance.
Assumptions of Microeconomics
There are few assumptions, on the basis of which, theories and principles of microeconomics have been proposed. These assumptions are
- Every individual behaves in a logical or sensible manner.
- Valid information about supply, demand, price, and other market conditions are freely available.
- Efforts of goods and labor are divisible.
- There is always full employment in the market.
- The economic activities between private parties are free from government intervention.
- Microeconomics is based on the assumption ‘ceteris paribus’. It is a Lain phrase which means ‘with other things being equal or held constant.’
Features of Microeconomics
Studies individual unit
Microeconomics is defined as the study of the market behavior of individual consumers and producers. For this purpose, the whole economy is divided into small individual units such as household, firm, commodity, market, etc. To study microeconomics, an economist selects a small unit and conducts a detailed observation of micro variables.
Microeconomics is not concerned with the whole or aggregate. It works by slicing a single economy into smaller units. It views economy microscopically by studying the behavior of individual consumer, producer, market, and so on.
Microeconomics includes the study of basic theories of demand and supply, including the process of achievement of equilibrium state in the market through the interaction of demand and supply. During the study, microeconomics deals with various forces which explain how prices of factors of production (rent, wage, interest and profit) are determined and how prices of commodities are affected.
Analyzes economic efficiency
Economic efficiency is attained when goods and services are as effectively consumed as it is produced. Every individual tries to attain maximum satisfaction from the goods consumed while every producer works on maximizing their profit. Microeconomics studies in-depth about ways of allocating available or existing resources of the economy to meet the desires of both producers and consumers.
Microeconomics is based on partial equilibrium. It is a condition in which equilibrium is attained by considering only a part of the market. In economy, this phenomenon is commonly known as ‘ceteris paribus’ which means ‘with other things being equal or held constant’.
It is by nature that all consumers desire unlimited satisfaction and all producers desire unlimited profit. Microeconomics studies about these economic wants of producers and consumers, analyze individual production and consumption units and define how maximum satisfaction and profit can be achieved by efficient utilization of scarce resources.
Construction of models
Microeconomics comprises various complex phenomena. Such phenomena are expressed in terms of an economic model for understandability. An economic model may be chart, schedule, diagram or economic law, all of which explains the relationship between two or more economic variables.
Limitations of Microeconomics
Not true in case of aggregates
What is true for an individual is not always true at the aggregate level. In other words, any outcome at personal level may be different at societal and national level. For example, saving is good for the individual but if all individuals of an economy begin to save, the entire economy would collapse. This is because, with the rise in aggregate saving starts to fall aggregate demand, investment, employment and income of the nation.
Assumption of full employment
Microeconomics analysis is based on the assumption of full employment. The phenomenon of full employment does not exist in the real market or it is a rare phenomenon in a capitalist economy. Thus, assumptions of microeconomics are unrealistic.
Microeconomics does not explain the function of the whole economy. It only deals with individual factors of the market. It might not be possible for an economist to get correct information of individual consumers and producers. Thus, results drawn from microeconomic analysis might often be inaccurate.
Unrealistic assumption of ‘ceteris paribus’
Most of the theories and principles of microeconomics are based on the assumption of ceteris paribus. Economic variables might remain constant in the economy which is static in nature but the real economy is always dynamic in nature.