Economics is broadly divided into macroeconomics and microeconomics. The big picture, macroeconomics, focuses on the behavior of a national or regional economy as a whole: the sum of goods and services, unemployment and prices.
Then there’s a more detailed picture: the people and businesses that make the economic decisions. Microeconomics analyzes behavior. It looks at how individuals and companies respond to incentives and efficiently allocate scarce resources.
People struggle to get as much as possible while spending as little as possible. Economist Thomas Sowell has said that nothing is enough to completely satisfy those who want it. This ubiquity of deprivation in our lives makes the study of human behavior compelling.
Microeconomics is divided into consumer theory, which focuses on people’s behavior in a market setting, and firm theory, which focuses on how businesses operate, once again in a market setting. .
Consumers pursue their own selfishness
In the 19th century, economists referred to consumers as “economic men” or homo economicus. Today they may call consumers economic people. All these terms refer to the idea that individuals make decisions based on their rational pursuit of self-interest.
The meaning of selfishness is very clear, but it is important to understand what economists mean by rationally pursuing it.
To an economist, behavior is rational if it helps to achieve goals. Economists do not make moral judgments on a person’s goals. A behavior that may seem irrational to a non-economist is not necessarily true to an economist.
Ask it to see that a man named Raj wants to rob a bank. Given that goal, economists would say that if Raj monitors the bank to look for security cameras, it’s logical behavior — for Raj.
Or if a woman named Asha hates credit cards, the economists don’t judge her mind and say it’s logical for her to burn credit cards.
Consumers want the most they can afford
To buy anything, a consumer must negotiate with a manufacturer — a seller — whether that seller is a mom and pop store or Amazon. Consumer theory states that they check prices because they are interested in obtaining goods and services that maximize their satisfaction as much as possible at the lowest possible price.
Microeconomists study that interaction mathematically in two ways. First, they attempt to measure a consumer’s level of satisfaction by assigning a number based on how much this consumer values the goods and services he wants to buy in the market. They call this number utility.
Second, they interpret the task of achieving maximum satisfaction as solving a maximization problem. In the maximization problem, a consumer wants to get the biggest bang for his money.
Therefore, the central problem in consumer theory is the study of how consumers go about maximizing their utility in a market setting – buying as much as they like with the money available to them.
What attracts microeconomists studying utility maximization is that it illustrates well the central tension in economics: how to satisfy unlimited needs with limited means. “Unlimited desires” are captured by the notion of utility, and “limited means” refers to the consumer’s limited income or budget. Economists call this the constrained maximization problem.
As an example, consider Sheela, who has a budget of $1,000 per month (her obligation) to rent an apartment. Monthly rents for apartments A, B and C are $900, $1,000 and $1,500. Sheela moves out of apartment C – it’s too expensive. Apartment A will save him money, but apartment B, within his budget, may be good.
Companies also fulfill their selfishness
An integral part of microeconomics is the theory of the firm, the term economists use for companies. Economists believe that businesses exist because team production is efficient and it reduces the cost of the contract.
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Economists study how businesses can maximize profits. Companies, like individual ones, try to solve the maximization problem: how to maximize their profits. Maker theory tries to explain how businesses do things.
The study of profit maximization is fascinating to a microeconomist like me because no company can produce whatever it wants and in unlimited quantities. Businesses are constrained by their technical capabilities and the cost of paying for inputs such as capital and labor. Microeconomists describe these technological capabilities through the production function. This mathematical relationship describes how businesses use capital and labor to produce their goods or services.
Microeconomics looks at how consumers and companies behave in order to understand why society needs economic policies to regulate and shape their behavior.