The word ‘micro‘ is derived from the Greek word ‘mickros’ meaning small. It is that branch of economics theory which deals with the behavior of individual economic units in the economy such as individual households, individual firms, industries, etc. Microeconomics deals with small segments of society.
It deals with how individual businesses decide how much to produce and at what price to sell it and how individual consumers decide on how much of something to buy.
In other words, microeconomics analyses individual consumer’s and firms’ market behavior in an attempt to understand their decision-making processes.
Here problems of individual economic units are studied, such as the equilibrium of a consumer, equilibrium of a firm, and industry.
Microeconomics deals with the central problems of an economy ‘what, how, and for whom to produce.’ Thus instead of studying ‘economic forest’ as a whole, microeconomics looks at its individual parts.
Microeconomics studies how the prices of goods and services are determined in the market. Theories that explain market price determination are called Price Theories. These are the vital components of microeconomics.
- Theory of Demand: It analyses how a consumer allocates his income to different uses so that he maximizes his satisfaction.
- Theory of Price: It determines how prices of goods and services are determined in the market through the interaction of market forces.
- Theory of Supply: It analyses how a producer decides what to produce and how much. The producer focuses on the maximization of profit.
Scope of Microeconomics
Under its principles of consumption like the law of diminishing marginal utility, the law of equal marginal utility, the law of demand, the elasticity of demand, consumer surplus, indifference curve and studied.
Under its principles of production like the law of returns to scale, cost of production, and the optimum combination of factors are studied.
Under it returns of factors of production like interest, wages, salary, and determination of profit and study.
- For decision-making: We use economic analysis in our day to day life, for instance, to decide how to spend a specified period of time, what career to pursue, and how much to spend and save the money we earn. Similarly, Managers also use economic analysis to decide how and what goods and services to produce, how much to produce, and what should be the price of them. Decision-making requires studying the choices made by households, firms, and government and how these choices affect the markets for goods and services.
- To understand market and forecast changes: Microeconomics helps in understanding how markets work and forecasting how various events impact the prices and quantities of products in markets.
- To evaluate government policies: Every economy is influenced by government policies. Through economic analysis, we determine how a government performs its roles in the economy. Government policies affect individual firms. The study of microeconomics helps in evaluating the effect of monetary, fiscal, regulatory, and trade policies on individual firms.
Limitations of Micro-economics
- It cannot explain the problems such as unemployment, poverty, illiteracy, and other problems prevailing at the country level.
- Microeconomics fails to explain how the economy functions as a whole.