MICROECONOMICS

2006-08-08T22:24:00.000-05:00

Acces Course in Microeconomics --->
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What is Microeconomics?

In general terms Microeconomics is the study of the shaping of prices. This field of the economic theory, analyze the behavior of consumers, and producers such as persons, households, enterprises, governors, etc. Considering their economic choices as individual units, interacting in markets with different levels of competitiveness, and under the laws of supply and demand.

Microeconomic theory, concerns to the theoretical foundations of the distribution of total production and income among agents, considered as consumers and producers. It considers individuals both agents as suppliers of land, labour, and capital and as the ultimate consumers of the final product and services, also examines firms both as suppliers of products and services, and as consumers inputs of labour and capital.

Microeconomics seeks to analyze the market mechanisms that establish relative prices among goods and services and allocate society's resources among their many possible uses.

Scopes of Microeconomics

The field of economics is broken down into two distinct areas of study: microeconomics and macroeconomics. Microeconomics looks at the smaller picture and focuses more on basic theories of supply and demand and how individual businesses decide how much of something to produce and how much to charge for it. People who have any desire to start their own business or who want to learn the rationale behind the pricing of particular products and services would be more interested in this area.

One important scope of microeconomics is to analyze market competitiveness mechanisms that establish relative prices amongst goods and services and allocate society's resources amongst their many alternative uses. The last concept is known as “Opportunity cost”.

Also microeconomics analyses market failures, where markets fail to maximize welfare, as well as describing the theoretical conditions needed for perfect competition.

Significant fields of study in microeconomics include :

- Theory of the firm; monopoly, oligopoly, monopsony.
- Markets under asymmetric information, and moral hazard.
- Choices taken under uncertainty.
- Economic applications of game theory, and.
- General equilibrium and society welfare.

Macroeconomics, on the other hand, looks at the big picture (hence "macro"). It focuses on the national economy as a whole and provides a basic knowledge of how things work in the business world. For example, people who study this branch of economics would be able to interpret the latest Gross Domestic Product figures or explain why an spot rate of unemployment is not necessarily a bad thing. Thus, for an overall perspective of how the entire economy works, you need to have an understanding of economics at both the micro and macro levels, regarding the necessity of understand the logic of microeconomic theory to make easy deep comprehension of macroeconomic theory, and the debate between these two fundamental fields; concerning to the microeconomic foundations of macroeconomics, about the theory of aggregation, and the use of a representative and standard agent in order to be used with the forecasting models of macroeconomics.

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Fundamental Entries and Terms in Microeconomics
Aggregation of individual demand to total, or market, demand
Elasticity
Consumer Surplus
Opportunity Cost
Producer Surplus

Consumer Theory
Preference
Indifference Curve
Utility
Marginal Utility
Income

Production and Pricing Theory
Production theory basics
X-Efficiency
Factors of Production
Production Possibility Frontier
Production Function
Economies of Scale
Economies of Scope
Profit Maximization
Price Discrimination
Transfer Pricing
Joint Product Pricing

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The Supply and Demand Model

The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand).

The graph -1 depicts an increase in demand from D1 to D2 along with the consequent increase in price and quantity required to reach a new market-clearing equilibrium point on the supply curve (S).
Displacements in demand are caused for any of the following causes, all operating at the same time, with different force, for any combinations of them, or for any single of the variables listed below:

- Changes in Income or Income’s allocation among people.
- Changes in the quantity of population.
- Changes in prices of complementary or substitutes goods (services).
- Changes in fashions or preferences (pushed by advertisement).

The graph -2 depicts an increase in supply from S1 to S2 along with the consequent decrease in price and increase in quantity required to reach a new market-clearing equilibrium pointed on the demand curve (D).
Displacements in supply curve are caused for any of the next causes, all operating at the same time with different force, for any combinations of them, or for any single of the variables listed below:

- Changes in cost structure.
- Changes in productive efficiency
- Changes in scales economies.The last above variables can be summarized as Changes in Technology

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Optimization as Rationality

It is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output. Given this assumption, there are four categories in which a firm's profit may be considered.
The Graph – 3 depicts the situations that could be faced by entrepreneurs:

- Situation one: Between the Price 1 and Price 2 lines; a firm is said to be making an economic profit when its average total cost is less than the market price (price 2) of the product, at the profit-maximizing output.
These abnormal economic profits are equals to the quantity output multiplied by the difference between the average total cost and the market price, this is known as extra-profit or surplus, and depict the power of the firm to determine price in such industry.

- Situation two: Over the Price 2 line; a firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total cost equals price at the profit-maximizing output.

In economics a “normal profit rate” is understood as the general rate of profits earned in the whole industry for any single enterprise.
In addition Graph – 3, depicts the profit-maximizing output, as the equilibrium point, where Marginal cost equals Total average cost, and equals the price level (price 2). Over this point the single enterprise tend to gain monopolistic surplus. The microeconomic model assume this situation as a temporal disturbance, which, is adjusted under competitiveness conditions when more entrepreneurs are enticed for the big profits, arising more enterprises in that industry, increasing the supply of goods and pressing down the price to the normal profit point.
Despite the last consideration, in real life there exist natural and/or artificial barriers to entry in the market, in consequence the monopolistic or oligopolistic trend in the market tend to remain for ever, unless the government and the policy makers interfere the market conditions until the structure of this market back to the desired conditions. At this point the governor and policy makers act as an special agent, maximizing the social-welfare.
If monopoly or oligopoly are convenient structures for the society is an “opened debate”, but in general this two structures are inefficient for customers because as can be seen in graph – 3; the price is bigger than the competitiveness price, therefore the consumer surplus decrease.

- Situation three: Between price 1 and price 3 lines, this gap is depicted by the average total cost and by average variable cost at the profit-maximizing output, then the firm is said to be in a loss-minimizing condition. The firm should still continue to produce, however, since its loss would be larger if it was to stop producing.
By continuing production, the firm can offset its variable cost and at least part of its fixed cost, but by stopping completely it would lose equivalent of its entire fixed cost.

- Situation four: If the price is below average variable cost at the profit-maximizing output, depicted under de price – 3 line, in the correspondent graph: The firm is said to be in shutdown. Losses are minimized by not producing at all, since any production would not generate returns significant enough to offset any fixed cost and part of the variable cost. By not producing, the firm losses only its fixed cost.
The depicted dynamic enterpriser’s movements shape the business cycle as en evolutionary structure in which the market competence rules, push up the innovative and technological dexterities for managers, researchers, and share holders, in order to survive in the market; a place where only the most adapted survive for the long wave in the same manner as the natural evolution in which all species fight among them to survive over the time in places restricted by the resource’s scarcity and under changing environmental conditions.

Coming back to the idea about the market imperfections is possible to set up that in economics, a market failure is a situation in which markets do not efficiently organize production or allocate goods and services to consumers (for example, a failure to allocate goods in a way some see as socially or morally preferable). To economists, the term would normally be applied to situations where the inefficiency is particularly dramatic, or when it is suggested that non-market institutions would provide a more desirable result.

On the other hand, to many, market failures are situations where market forces do not serve the perceived "public interest". Here, the focus is on the economists' theories of market failure.
Economists use model-like theorems to explain or understand such cases. The two main reasons that markets fail are:

- The inadequate expression of costs or benefits in prices and thus into microeconomic decision-making in markets.
- Sub-optimal market structures: In economics, information asymmetry
occurs when one party (seller or customer) to a transaction has more or better information than the other party. (It has also been called asymmetrical information and markets with asymmetrical information). Typically it is the seller that knows more about the product than the buyer, however, it is possible for the reverse to be true: for the buyer to know more than the seller.

Examples of situations where the seller usually has better information than the buyer are numerous but include used-car salespeople, stockbrokers, real estate agents, and life insurance transactions.
Examples of situations where the buyer usually has better information than the seller include estate sales as specified in a last will and testament, and the labour market.

This situation was first described by Kenneth J. Arrow in a seminal article on health care in 1963 entitled "Uncertainty and the Welfare Economics of Medical Care," in the American Economic Review.

George Akerlof later used the term asymmetric information in his 1970 work The Market for Lemons. He also noticed that, in such a market, the average value of the commodity tends to go down, even for those of perfectly good quality. It is even possible for the market to decay to the point of nonexistence.
Because of information asymmetry, unscrupulous sellers can "spoof" items (like software, second-hand cars, or computer games) and defraud the buyer. As a result, many people not willing to risk getting ripped off, will avoid certain types of purchases, or will not spend as much for a given item.

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Opportunity Cost in Microeconomics

The simplest way to estimate the opportunity cost of any single economic decision is to consider, "What is the next best alternative choice that could be made?" (This is even though most economic decisions involve multiple alternatives.) The opportunity cost of paying for college this semester could be the ability to make car payments. The opportunity cost of a vacation in the Bahamas could be the down payment money for a house.

Note that opportunity cost is not the sum of the available alternatives, but rather of benefit of the best alternative of them. The opportunity cost of the city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money that could have been made from selling the land, or the loss of any of the various other possible uses -- but not all of these in aggregate.
Although opportunity cost can be hard to quantify, its effect is universal and very real on the individual level. The principle behind the economic concept of opportunity cost applies to all decisions, not just economic ones.
Since the work of the Austrian economist Friedrich von Wieser, opportunity cost has been seen as the foundation of the marginal theory of value.

Throughout microeconomic theory, it is assumed that:
- The real cost that measure economic decisions is the “Opportunity cost”, rather than “Monetary cost.”
- All the time the agents behave as rationales, so they minimize the opportunity cost, as hence: All economic resources are and located in their best possible alternative of use.
- The last issue operates only if the markets are released to evolve under the free forces of supply and demand, so individual agents must let that in the long wave all temporal disturbances in prices, become endogenously adjusted to the initial equilibrium point.

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General Assumptions of Microeconomics

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 (At least an enough number) that guarantee that none of them have the capacity to determine prices of goods and services. In many real-life transactions, the assumption fails because some individual buyers or sellers or groups of buyers or sellers do have the ability to influence prices. Quite often a sophisticated analysis is required to understand the demand-supply equation of a good. However, the theory works well in simple situations. 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 so-called market failures lead to resource allocation that is sub optimal by some standard. In such cases, economists may attempt to find policies that will avoid waste; 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. The demand for various commodities by individuals is generally thought of as the outcome of a utility-maximizing process. The interpretation of this relationship between price and quantity demanded of a given good is that, given all the other goods and constraints, this set of choices is that one which makes the consumer happiest.

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