The main goal of the current study is to speak about Microeconomics as a part of Economic Theory and as a separate science. The paper will concentrate on some of the most critical categories of Microeconomics, including the theory of supply and demand, the theory of consumer choice, the method of production and costs, the structure of market and firms’ behavior and others.
Principles of Microeconomics
Microeconomics is a science which studies peculiarities of development and functioning of individual parts of the economy: individuals, households, and enterprises. It focuses its attention on prices, production volume, distribution, and consumption of various goods and services, on condition of various markets and allocation of resources. Microeconomics is also known as price theory since it concentrates on the formation of prices for some of the goods. One of the essential goals of microeconomics is to analyze market mechanisms and reasons of market failure. Two central concepts of market mechanism are supply and demand. Supply is the number of goods and services a producer is offering for sale in the market for certain prices. In its turn, demand is a number of products and services consumers are ready to buy for certain prices according to their preferences and budget. Supply is determined by costs of production and prices in the market. It is obvious that producers will receive higher profits if the prices for the goods go up; they also can gain more money if they increase the production. However, there’s a very important factor in demand, which also determines the number of goods that should be produced. Consumers influence producers more than the producers do. But they are also very much influenced by the prices of the goods. Despite the fact that prices for the goods are not the only factor affecting the consumer, other factors include consumer’s preferences and income; it is considered by the majority of economists that exactly prices are what makes us buy more or less. Demand is characterized by such a feature as elasticity.
The elasticity of application depends on the presence of substitutes of goods in the market. Demand is more elastic when there are more substitutes and vice versa. The relation between supply and demand determines whether the market is functioning properly or not. In a situation when the market is unable to produce efficient results when supply and demand are unbalanced, the market comes to a failure. The structure of the market is also very important as it reflects the possibility of the existence of perfect competition. Perfect competition is a kind of market structure when there is a great number of producers and consumers operating in the market. Unfortunately such structure exists only in theory; however, every market is aiming to reach it. Otherwise, the market can be occupied by monopolistic companies, who are wishing to get as much profit as possible, may artificially increase the prices for goods and services, which may negatively affect the economy in a whole.
The following concept of Microeconomics to speak about will be the theory of consumer choice. The central idea of this theory is that consumer’s actions are guided by the purpose of maximization consumer’s satisfaction or utility while buying and using the goods in different combinations. Thus, consumer choice is a decision-making process based on consumer’s preferences, prices for the goods and consumer’s income with the main goal of maximizing consumer’s satisfaction of needs (utility). Theory of consumer choice is based on three main principles, known as axioms of consumer choice. They are axiom completeness, the axiom of transitivity, and the axiom of non-satiation.
Possessing a certain amount of money (budget constraint) the consumer is trying to reach consumers equilibrium, which is a rational consumer choice, which allows maximizing consumer’s benefits given certain budget constraint. Graphically consumer’s preferences can be shown using indifference curves map, where the consumer is aiming at purchasing a bundle of the goods situated on the furthest from the origin indifference curve because it has the highest utility. Budget constraint of a consumer is shown by budget line, while consumer’s equilibrium is shown by the crossing of budget line and indifference curve.
The theory of production and costs links several basic concepts of economics, such as production, production function, cost of production and prices for the goods. Production is a process of manufacturing goods to gain profit and satisfy consumers’ needs. Before starting the means of production, a producer needs to decide what products to produce, to find the technology of production and find out what are costs that are necessary to produce these goods. This theory concentrates on regularities of the relationship between factors of production and output. For this reason, the production function is used, which shows the number of production factors that are necessary to produce certain goods. It studies the methods of how to choose the right quantity of employees and equipment to produce goods that will bring profit. Theory of production and costs also speaks about such a notion as total costs of a firm, which include fixed costs and variable costs.
Fixed costs are fixed at the same level regardless of output, which means that if output changes they do not. In their turn, variable costs change together with the changes in output. For example, to increase production, a firm may hire more employees or use more raw materials to produce more goods. It will result in the necessity to raise wages fund as new employees also need to get paid and in the increase of expenses on raw materials.
Structure of market and firms’ behavior is another aspect of Microeconomics, which is necessary to speak about. Market structure is a combination of producers and buyers operating in the market. Such interaction determines the price for the goods and their quantity. There are several types of market structure, including perfect competition, monopoly, oligopoly and monopolistic competition.
Perfect competition is an idealized type of market structure, which does not exist and is used only theoretically. However, it has certain features, such as all firms in such market sell an identical product. All firms possess rather a small market share. Thus, they cannot control the market. Buyers in such market have a great number of advantages, including the awareness of nature and the quality of the goods that are being sold. This kind of market is easy to enter and exist due to the lack of any burdens. The following type of market is a monopoly, which is a market structure represented by a single company possessing a very large market share (close to the whole market). Ideally, it is only one firm. Monopoly is characterized by the lack of competition, high prices and low quality of the goods. There is a special kind of monopoly known as a natural monopoly, which is represented by public utilities provided by the government. Such a concept as buyer’s monopoly also exists, and it is known as a monopsony (a situation, when only one buyer controls the market). The following market structure is an oligopoly, where a small number of firms are operating. Participants of such a type of market interact with one another and make common decisions. The last type of market structure is monopolistic competition, which is represented by a large number of firms operating in the market and producing differentiated products. Such market structure possesses features of both perfect competition and monopoly. It is the most common market structure nowadays, where companies can set their prices and produce as many products as they want without affecting the whole market.
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