Microeconomics Definition, Uses, and Concepts

What Is Microeconomics?

Microeconomics is the social science that studies the implications of incentives and decisions and how they affect the utilization and distribution of resources on an individual level. Microeconomics shows how and why different goods have different values. It addresses how individuals and businesses conduct and benefit from efficient production and exchange and how individuals can best coordinate and cooperate with each other.

Microeconomics provides a more detailed understanding of individuals, firms, and markets. Macroeconomics provides a more aggregate view of economies.

Understanding Microeconomics

Microeconomics is the study of what's likely to happen when individuals make choices in response to changes in incentives, prices, resources, or methods of production. These scenarios are also known as tendencies. Individuals are often grouped into microeconomic subgroups such as buyers, sellers, and business owners. These groups create the supply and demand for resources, using money and interest rates as pricing mechanisms for coordination.

The Uses of Microeconomics

Microeconomics can be applied in a positive or normative sense. Positive microeconomics describes economic behavior and explains what to expect if certain conditions change. It theorizes that consumers will tend to buy fewer cars than before if a manufacturer raises the prices of cars.

The price of copper will tend to increase if a major copper mine collapses in South America because supply is restricted. Positive microeconomics could help an investor see why Apple Inc. (AAPL) stock prices might fall if consumers buy fewer iPhones. It could also explain why a higher minimum wage might force The Wendy's Company (WEN) to hire fewer workers.

These explanations, conclusions, and predictions of positive microeconomics can then be applied normatively to prescribe what people, businesses, and governments should do to attain the most valuable or beneficial patterns of production, exchange, and consumption among market participants.

Method of Microeconomics

Microeconomic study has historically been performed according to general equilibrium theory, developed by Léon Walras in "Elements of Pure Economics," and partial equilibrium theory, introduced by Alfred Marshall in "Principles of Economics."

The Marshallian and Walrasian methods fall under the larger umbrella of neoclassical microeconomics. Neoclassical economics focuses on how consumers and producers make rational choices to maximize their economic well-being, subject to the constraints of how much income and resources they have available.

Neoclassical economists make simplifying assumptions about markets such as perfect knowledge, infinite numbers of buyers and sellers, homogeneous goods, or static variable relationships to construct mathematical models of economic behavior.

These methods attempt to represent human behavior in functional mathematical language. This allows economists to develop mathematically testable models of individual markets. Neoclassicals believe in constructing measurable hypotheses about economic events and then using empirical evidence to determine which hypotheses work best.

They follow the “logical positivism” or “logical empiricism” branch of philosophy in this way. Microeconomics applies a range of research methods depending on the question being studied and the behaviors involved.

Basic Concepts of Microeconomics

The study of microeconomics involves several key concepts, including but not limited to:

• Incentives and behaviors: This addresses how people as individuals or in firms react to the situations with which they're confronted.
• Utility theory: Consumers will choose to purchase and consume a combination of goods that will maximize their happiness or “utility” subject to the constraint of how much income they have available to spend.
• Production theory: This is the study of production or the process of converting inputs into outputs. Producers seek to choose a combination of inputs and methods of combining them that will minimize costs to maximize their profits.
• Price theory: Utility and production theory interact to produce the theory of supply and demand which determines prices in a competitive market. Price theory concludes that the price demanded by consumers is the same as that supplied by producers in a perfectly competitive market. This results in economic equilibrium.

The Bottom Line

Microeconomics is a field of study focused on the decision-making of individuals and firms within economies. It's in contrast with macroeconomics, a field that examines economies on a broader level.

Microeconomics may look at the incentives that influence individuals to make certain purchases, how they seek to maximize utility, and how they react to restraints.

Microeconomics for firms may look at how producers decide what to produce, in what quantities, and what inputs to use based on minimizing costs and maximizing profits. Microeconomists formulate various types of models based on logic and observed human behavior. They test the models against real-world observations.