Definition: Microeconomics is the branch of economics that study the dynamics of individual entities interacting between each other. To sum up, it theorizes the forces and behaviors that rule the participants of an economic system.
What Does Microeconomics Mean?
Microeconomics, as opposed to macroeconomics, is focused on explaining the decision making processes of market participants individually. These participants are sometimes considered individuals even if they are a group, e.g. a household or a company. By studying the way economic decisions are made an economist can understand how scarce resources are allocated throughout the economic system. These interactions are normally explained in an under-normal-circumstances scenario, this means that there might be variations and departures from theorized behaviors proposed by microeconomics if the environment acts differently than what is expected.
The most widely known theories and concepts of microeconomics are the laws of supply and demand, the economic factors of production and the labor market economic dynamics. For example, the law of supply and demand says that the interaction between each of these forces will reach an equilibrium price at which supplied goods will match demanded goods. On the other hand, it also says that if the price of a given good increases, the quantity of goods demanded will decrease, under normal circumstances.
Here’s an illustration of how this works in practice.
Fast Tires Co. is a company that manufactures different set of tires for regular automobiles. The company is currently restructuring its finances and as part of this effort they identified a weakness in the current price setting procedure. By analyzing the net margin of each product they concluded that in order to increase profitability they must increase prices by 30%. How could a study of the microeconomics involved in this operation help the company?
As we conceptualized previously, microeconomics is concerned with the dynamics of individual entities interacting between each other. By analyzing the behavior of the company’s clients an economist can evaluate the impact of this increase in the overall sales volume of the company. A microeconomics’ concept called elasticity of demand and the laws of supply and demand can be used to study the degree in which the current quantity demanded will be reduced by this increase and how this will affect the company’s financial structure.