Importance or Use, Characteristics and Scope of Microeconomics

What are the Scope of Microeconomics?

Microeconomics studies small, individual units. This is obvious from aforementioned definitions. As opined by H. Craig Peterson and W. Cris Lewis “Micro-economics focuses on the behavior of the individual actors on the economic stage: firms and individuals and their interactions in markets.”

Likewise, in the words of E.K. Browning and J.M. Browning microeconomics is the branch of economics based on the economic behavior of  ‘small’ economic units: Consumers, workers, savers business managers, firms, individual industries and markets, and so on.

It is, thus, obvious that the study of individual units or individual consumers, individual firms or their small group form the scope of micro-economics. Broadly speaking,

The scope of microeconomics covers the following topics:

  1. Theory of demand
  2. Theory of production and costs
  3. Theory of product pricing
  4. Theory of factor pricing
  5. Theory of economic welfare

1. Theory of demand

The goods are produced due to the consumers demand. Hence, in micro-economics, at first, the theory of demand or the theory of consumer behavior is studied.

This includes the meaning, types, law, and determinants of demand, elasticity of demand, law of diminishing utility, law of equip-marginal utility, indifference curve, revealed preference theory and so on. Besides, the practical importance of these theories is also included in micro-economics.

2. Theory of production and costs

One of the important branches of economics is production and cost theory. The theory of production consists of the factors of production, concepts of different types of product and the theories like law of variable proportions, laws of returns to scale, least-cost combinations of inputs and so on.

Similarly, the theory of costs consists of the different concepts of cost, nature of short-run and long-run costs etc. It also includes linear programming, a mathematical technique of cost-minimization or output maximization.

3. Theory of product pricing

Since micro-economics studies the determination of prices of goods and services, it is also known as price theory. The relative price of different goods is determined under different market situations.

The market situations may be perfect competition, monopoly monopolistic competition, oligopoly and so on. Micro-economics studies the process of pricing of goods in these markets.

The theory of factor pricing includes the study of the costs, revenue, profit, position of loss and the behavior regarding profit maximization or cost minimization.

Hence, the theory of product pricing is also known as the theory of the firm.

4. Theory of factor pricing

The theory of factor pricing is another important branch of micro-economics. The theory of factor pricing is also called the theory of distribution. The goods are produced with the joint efforts of land, labour, capital and entrepreneur.

These are called factors of production. The rewards of these factors are called rent, wages, interest and profit respectively. In factor pricing the determination of rents wages, interest and profit is studied. There are different traditional and modern theories regarding the determination of the rewards of factors of production.

5. Theory of economic welfare

The theory of economic welfare is also known as welfare economics. Welfare economics is an important branch of micro- economics. The normative price theory is called welfare economics.

The subject matter of welfare economics includes the potential measures of maintaining economic prosperity of men as consumers and producers and to improve those prosperity or welfare.

One of the important functions of welfare economics is to define and analyse the law of economic efficiency. The economy is said to be efficient when the quantity of goods and services are produced so as to yield maximum satisfaction to the consumers.

The economic efficiency is the subject matter of welfare economics. Welfare economics is the important branch of micro- economics.

Hence, micro-economics is intimately related to economic efficiency or welfare. A.P. Lerner has rightly remarked, “In micro- economics we are more concerned with the avoidance or elimination of waste.” Micro-economics identifies the conditions of efficiency and suggests measures to avoid inefficiency. This helps to improve the economic condition of people.

What are the Use or Importance of Microeconomics?

Microeconomics has many theoretical and practical importance. Due to this even the neo-classical economists had concentrated on micro-economics. Although Keynes popularized macroeconomics, the importance of microeconomics has not declined.

The importance of microeconomics can be analyses on the basis of following headings:

  1. Understand the working of the economy
  2. Efficient allocation of resources
  3. Useful in business decision-making
  4. Study of human behavior
  5. Examine conditions of economic welfare
  6. Formulation of public policies
  7. Solution of contemporary micro-economic problems

1. Understand the working of the economy

The knowledge of micro-economics is indispensable to know the working of the economy. The economy consists of public and private sector.

The analysis of individual industries, wages and salary determination, individual taxes, international trade all rests on micro-economic foundations.

Similarly, most of the government activities can be analyzed with same concepts applied to private sector.

As for example, price determination by post office, cost of national defense etc are analyzed by using micro-economics.

2. Efficient allocation of resources

Micro-economics assumes that consumers and producers act rationally. The producer surveys possible course of action, measures the expected benefits and costs of each course of action.

He then selects those courses of action, which promise greatest benefits over costs. The rational behaviour leads to best use of resources.

Micro- economics teaches to make best use of resources. It suggests how to achieve a given objective with fewest resources or at least cost.

Micro- economics says how resources are allocated in the production of goods and services. It says which commodity is to produce, how much to produce and why to produce.

3. Useful in business decision-making

Micro-economics is applied to analyses problems faced b business executives. The price theory in the service of business executives is known as managerial economics.

It contributes improved decision-making in the area of demand analysis, optimal production decision, pricing decisions to maximize profit.

It guides businessmen to determine the price of different goods and factors of production.

The use of micro-economics in business decision-making can be further elaborated as follows:

(a) Optimal resource allocation

Micro-economics is useful in optimal allocation of resources The resources or factors of production are always scarce and limited with the business firm. Hence they will have to make the optimal allocation of resources. Micro-economics tells how the productive resources are allocated in the production of numerous goods and services. It. informs – which goods to be produced, how much to produce and why to produce. Likewise, it informs how to distribute the produced goods and services among people for consumption.

(b) Optimal production decision

The business firm can produce goods with different alternative techniques. They have to continuously face the problem of the technique to be chosen. Because, the resources like labour and capital are limited.

On the contrary, their objective is to earn maximum profit. Micro-economics helps to solve these problems.

“Micro-economics works as a powerful modern tool of managerial decision making in the solutions of such problems”.

(c) Pricing policy

The firms will have to face the problem of pricing their products. The firm should be able to fix appropriate price to achieve its objectives. Micro-economics provides the basis for analysis solving the pricing problems.

It provides knowledge a price of products is determined. The theory of demand demand and other theories of consumer behavior guide a firm in making in the solutions of such problems”.

4. Study of human behavior

Micro-economics studies many forms of human behavior. The law of diminishing utility, equip-marginal utility, indifference curve theory all study human behavior.

Economic theory can be used simply to describe the economic phenomenon. Such descriptive theory is called positive economics.

As for example, when orange becomes scarce, price rises. Positive theory says one causes another.

The scarcity of orange is the cause and price rise is the effect. Economic theory can also be used to say what should happen.

When the theory prescribes policy action, it is called normative theory.

As for example, when orange becomes scarce, price should increase, so that consumer will use less orange and switch on to other fruits. (Otherwise they will have to wait in queue.)

Micro economics is both positive and normative science.

5. Examine conditions of economic welfare

The normative price theory is called welfare economics.

Welfare economics studies welfare of the people as producers and consumers. It suggests possible ways of improving welfare of people. It helps to avoid waste and bring more social welfare.

It defines and analyses the rules of economic efficiency .

6. Formulation of public policies

Micro-economics helps government to formulate different economic policies for the welfare of the people. It gives tools and foundations for analysis of economic policy.

The economic policy influences the economy. It causes changes in allocation of resources. The public policy relates to tax, loans, subsidy, price etc.

The price theory provides analytical tools for economic policies affecting price and production. An important tool is benefit cost analysis, which is used widely in public policy decisions.

Micro-economics assists government to make best use of scarce resources.

7. Solution of contemporary micro-economic problems

Price theory is also used in practical aspects of economics such as public finance, international trade. It helps to analyses the effect different taxes, benefits from international trade, correct balance trade and payments.

Micro-economics can be used in contemporary micro-economic problems such as issues facing consumers, effect of government policy, control of pollution, programs to alleviate poverty, fair trade pricing etc.

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