Microeconomics: Meaning, Scope, Importance and Limitations

Microeconomics / Micro Economic Analysis

The word ‘MICRO‘ is derived from the Greek word ‘MIKROS‘, which means “Small”. The meaning of micro is millionth part of a thing. Generally, it means the smallest unit of anything

Microeconomics studies the economic actions and behaviour of individual units and small groups of individual units. It is the study of small components of the economy. It establishes the relationship between facts and results, which are called economic laws. Microeconomics is also called “The Price Theory”, because it deals with the price of goods and services, rewards of the factors of production and interaction of the markets.

Microeconomics is the study of households, firms and industry. It explains the working of market for individual commodities and behaviour of individual buyer and seller in such market. There are two types of markets that are product market and factor market These markets are dependent on each other. The factors of production are earning in factor market but they are spending in product market. The change in one market is reflected in other market. There are differences in the working of these markets.

In product market. demand comes from households and supply comes from firms. A group of similar firms is called an industry. In product pricing the forces behind demand are examined. A household can get maximum satisfaction through allocation of its expenses. A firm can get maximum profit when marginal revenue is more than marginal cost. An industry is in equilibrium when new firm does not enter the market or old firm does not leave the market. It is a matter of resource allocation.

The factor market is examined because of supply of factors and derived demand from product market. In fact, microeconomics deals with individual consumer and a firm or industry. Therefore, it is concerned with behaviour of individual consumers and producers and principles relating to organisation and operations of firms and industries.

Microeconomics is based on full employment in the economy so it examines the equilibrium position of consumer and producer. It is called price theory because it deals mainly with prices of products and prices of productions factors.

Definition:

According to K. E. Boulding

Microeconomics is the study of particular firm, particular household, individual price, wage, income, industry and particular commodity.

According to R. H. Leftwitch

Microeconomics is concerned with the economic activities of such economic units as consumers, resource Owners and business firms.

According to Gardner Ackley

“Microeconomics deals with the division of total output among industrialists, producers and firms and the allocation of resources among competing groups. It considers problems of income distribution. Its interest is in relative prices of particular goods and services.”

According to Prof. Samuelson

“Micro economics studies the behaviour of individual parts and units of any economy, e. g., determination of the price of a product or study and observation of the behaviour of a consumer or a firm”.

Scope of Microeconomics:

In micro economics the following problems and theories are discussed:

1. Price Theory

According to Prof. Robbins, human wants are unlimited but the resources to satisfy them are limited. Therefore, we face the problem of choice in wants and economy in means. This problem is solved by the price mechanism automatically. In other words, prices of all goods are determined by the equilibrium of demand and supply. So, demand and supply are discussed in micro economics.

Each economic system has to make the decisions regarding what is to produced, how it is to be produced and how the resources to be allocated amongst the different competing uses. Such all, under capitalism, is performed with the help “Price Mechanism” i.e., those goods will be produced by the producers which maximize their profits; those techniques will be adopted which minimize their cost of production and the resources will be allocated in those uses where the resource command higher prices etc. Thus, in the micro economics, we deal with the problem of production, consumption, distribution and resource allocation.

2. Theory of Consumer Behaviour and Demand

In this part, consumer’s behaviour is studied. It is examined how he satisfies his multiple ends with his scarce means e.g., why consumers purchase goods and which factors influence their decisions. In other words, theory of utility, concepts of demand and elasticity of demand are studied in it.

As everyone has to face the problem of multiplicity of wants and limited money income. In such state of affairs, it is the desire of each consumer to maximize his satisfaction, when so happens the consumer is said to be in equilibrium. Much the micro economics deals with the problem of equilibrium.

In order to describe consumer equilibrium basically we have two school of thoughts-Classical and Neo-classical. The classical economists presented the “Utility Approach” or “Cardinal Approach”, while the Neo-classical economists presented”. Indifference Curve Approach” or “Ordinal Approach”. In addition to these two approaches Professor Paul. A. Samuelson has also presented a theory of consumer behaviour which is known as “Revealed Preference Theory”.

After having discussed the theories of “Satisfaction Maximization” the demand behaviour of a consumer with respect to a particular commodity is also considered in micro economic theory.

3. Theory of Production Behaviour

In capitalism factories are in private ownership. Therefore, quantity of production of goods is decided by different firms individually. Every firm tries to get equilibrium or maximize its profit. For this purpose, a firm tries to find optimum combination of factors. Each student of Economics is well aware of with the four factors of production like land, labor, capital and entrepreneur.

These factors are responsible for production activities. According to classical economists, in short run, the production depends upon the units of labor only while the capital etc. is kept fixed, In such state of affairs the total production increases at different rates. This phenomenon is known as “Law of Variable Proportions” in micro economic theory.

4. Theory of firm Behaviour:

Like a consumer, the firm also wants to attain equilibrium. While the equilibrium of the firm is attached with “Minimization of Costs” or “Maximization of Output”. Both these situations are also known as “Optimum Factor Combination of a firm”, Thus to describe firm’s equilibrium or “optimum factor combination”, we have two approaches in micro economics (1) Classical’s Marginal Productivity theory (2 Neo-Classical’s “Isoquant – Iso Cot Approach”.

5. Theory of Costs and Revenues:

In micro economics we study different types of costs of production. The analysis of costs of production may be from short run point of view as well as from long run point of view. In this context the traditional and modem approaches are adopted. Moreover, different types of revenues arc also considered in microeconomics.

6. Theory of Market Structure and Behaviour:

The types of market like Perfect Competition, Monopoly, Duopoly and Monopolistic Competition are of greater significance for the readers of micro economics. Accordingly, here it is analyzed that how the firms under different market conditions make decisions regarding the determination of price and output.

7. Theory of Income Distribution:

The national income of a country is the result of joint efforts of land, labor, capital and organization. Accordingly, the national income, has to be distributed amongst these factors. OR it is to be seen that how the factor prices like wages will determined in the competitive and nor competitive markets. Thus, for this purpose we have the classical and neo classical theories in microeconomics.

8. Theory of General Equilibrium:

The Consumer equilibrium and the Producer equilibrium are the representatives of partial equilibria. But the existence of equilibrium of all the consumers of the economy or all the producers of the economy generates General equilibrium of consumption or production. Such all along with different criteria of welfare economics are the important issues of microeconomics.

9. Theory of Welfare Economics:

In the present time, social as well as economic welfare has attained greater importance. Accordingly, the economists have to devise those measures and criteria which are aimed at creating efficiency and optimality in the economic system. Therefore, in microeconomics, we study different techniques which bring welfare to the people.

10. Economics of Uncertainty:

Most of the traditional or classical economics is based upon certainty, i.e., the economic agents do not have to face risk while making decisions. But in the present time the element of risk has attained a lot of importance. Accordingly, economic theories are also being devised on the basis of uncertainty. Therefore, in microeconomics, we also study the economics of uncertainty.

Uses / Importance / Advantages of Microeconomics:

We can realize the importance of the study of micro economics from the following points.

1. Utility Maximization:

It teaches us to purchase the required products in most suitable quantities so that the total utility obtained is maximized. Hence, Micro economic analysis explains us the optimum use of our income and by virtue of it enables us to avoid the wastage of hard-earned income.

2. Resource Allocation:

By the study of micro economics we come to know how millions of consumers and producers allocate their consumption and production resources in an attempt to achieve their optimum level.

3. Income Distribution:

By the distribution theories we learn the determination of rewards to factors of production in the form of rent, interest, wages and profit by which distribution of wealth takes place. Unequal distribution of income will lead to unequal distribution of wealth. It will then consequently provoke reaction to achieve fair and relatively equal distribution of income/wealth in a society.

4. Price Determination:

The study of micro economics is highly helpful in understanding the determination of relative prices for the productive services rendered by different factors of production.

5. Optimization:

It also helps entrepreneurs to achieve optimum production point with their budget constraint. By this, they can maximize their profit or at least they will minimize their losses.

6. Welfare Policies:

It also helps to frame economic policies aimed at achieving public welfare e.g. tax exemption for the poor, determination of rewards according to qualification and productive capabilities, minimum wage laws etc.

7. Guidance for Consumers:

It enables the consumers to allocate their 1ncome on different goods in such a way that total utility is maximized; thus, helping them to avoid the wastage of resources.

8. Guidance for Producers:

It enables entrepreneurs to achieve the optimum combination of factors of production and thereby it enables them to maximize their profit: or at least minimize their losses. When the rewards of factors of production are determined in accordance with their marginal productivity, the chances of their exploitation are minimized. Thus, it enables labourers as well to achieve suitable rewards for their productive services.

9. Coordination Between Small Units of Economy:

It also provides guidance for small segments of an economy to bear them well coordinated with each other. Moreover, the study of micro economics is essential to achieve the best outcome of macro policies.

10. Working of Economy:

Microeconomics provides idea about working of the economy. It tells us about behaviour of consumer or firm. All such consumers and firms are part of the whole economy.

11. Predictions:

Microeconomics is based on certain predictions. There are certain conditions that become basis of predictions. It explains that if some event happens then what. will be the result. If demand goes up the prices will go up.

12. Economic Policies:

Microeconomics is used to formulate policies. it tells us effect of government policies on allocation of resources. The people can oppose new taxes. The government can adjust its policies through reaction of individuals.

13. Basis of Welfare Economics:

Microeconomics is the basis of welfare economics. The individual firms and organisations pay taxes to the government. They can check whether the government has used that money for welfare of the people.

14. Management Decisions:

Business decisions re made with the help of microeconomics. The analysis of demand and cost is essential. The management can use facts and figures to arrive at most suitable decision.

15. Basis of Whole Economy:

Microeconomics is the basis of whole economy. Microeconomics studies small and individual units of the economy which later on becomes a base to study the economy as a whole.

16. Solves Problems of Firms:

Microeconomics is helpful in solving the problems of individual firms. The working of firm is examined to know the real problem. The solution is made to handle such problem.

Disadvantages / Limitations of Microeconomics:

Following are the demerits of micro economic analysis and policies related to it.

1. Free Market Economy:

Microeconomics is based on the idea of free market economy. In fact, there Is no free market economy after great depression of 1930.

2. Study of Parts:

Microeconomics is concerned with study of parts but not the whole. In terms of individual terms, it is impossible to describe large and complex universe of facts like economic system.

3. Misleading for Analysis:

Microeconomics is inadequate and misleading for analysis of economic problems. The principles relating to an individual household cannot be applied to the whole. economic system.

4. Full Employment:

Microeconomics assumes that there is full employment. There is no full employment at all times in this world. Full employment is an exception in practical life.

5. Economic Instability:

When every single firm it allowed to operate freely in an open economy, it would naturally go for self-interest; even at the cost of national interest. Thus, it would disrupt the cohesion between different productive units which will ultimately force the economy to move into depression. A free enterprise economy is therefore an unstable economy i.e. the economy which keep: on fluctuating with boom: and depressions.

6. Exploitation of Consumers:

Inspite of proper guidance for the consumers the real-life situation reveals that they are exploited. This happens with the rising rate of inflation iii an economy. With the pace of inflation, on one hand, wealth keeps on concentrating in a few hands while, on the other hand, consumers are deprived of their purchasing power. The natural inequality of income distribution in a free enterprise economy leads to exploitation of consumers.

7. Exploitation of Labourers:

Entrepreneurs exploit their labourers by keeping their wage rate low or even lower than their marginal productivity. This happens in three ways:

(i) By forcing labourers to work for more hours than required under labour laws.

(ii) By installing automatic and computerized plants to increase the marginal productivity of labour which is not followed by increase in their wage rate.

(iii) By setting up production units in remote areas to employ labour at notoriously low wage rate.

8. Absence of Large-Scale Production:

Micro economic analysis encourages setting up of small units for growth of economy. This could possibly be achieved more efficiently by initiating and encouraging large scale production.

9. Unrealistic Assumptions:

Micro economics is based on unrealistic assumptions, especially in case of full employment assumption which does not exist practically. Even behaviour of one individual cannot be generalised as the behaviour of all.

10. Inadequate Data:

Micro economics is based on the information dealing with individual behaviour, individual customers. Hence, it is difficult to get correct information. So, because of incorrect data Micro Economics may provide inaccurate results.

References:

Munir Ahmed Bhutta. Economics, Azeem Academy Publishers, Lahore.

Abdul Haleem Khawja. Economics, Khawja and Khawja Publishing House, Islamabad.

Manzoor Tahir Ch. Principles of Economics, Azeem Academy Publishers, Lahore.

Muhammad Irshad. Economics, Naveed Publications, Lahore.

K K Dewett & M H Navalur. Modern Economic Theory (Theory and Policy), S. Chand Publishing.