Microeconomics, Supply, Demand, and Economic Models

Introduction to Economics and the Market System

Economics is defined as the study of how society allocates limited resources and goods (Encyclopedia Britannica, 2009). Resources include inputs such as labor, capital, and land, which are used to produce goods. Goods include products such as food and clothing, as well as services such as those provided by barbers, doctors, and firefighters. Goods and resources are often deemed scarce because of society's demand for them relative to their availability (Stapleford, 2012). Economics, then, becomes the study of how goods and resources are allocated when scarce. It also allows us to anticipate the outcomes of changes in governmental policies, company practices, population shifts, and similar developments.

The market system is one avenue economists use to allocate scarce resources. A market is defined as any system or arrangement where trade takes place (Encyclopedia Britannica, 2009). In the United States, several markets are trading at all times. The study of the market system falls into two branches: macroeconomics and microeconomics.

Defining Microeconomics and Its Historical Development

Microeconomics is the study of the economic behavior of individual firms, consumers, and industries, and the distribution of total production and income among them (Encyclopedia Britannica, 2009). Microeconomics allows economists to analyze the market in order to establish the average price point for goods and services. This analysis also aids in the allocation of society's resources among all potential uses (Funderburk, 2012).

This branch of economics first emerged when economists began analyzing consumer decision-making processes and outcomes in the early 18th century (Stapleford, 2012). The first in-depth explanation of the discipline came from a Swiss mathematician named Nicholas Bernoulli, who laid the groundwork for microeconomic theory by suggesting that consumer choices are always rational. In the late 19th century, London economist Alfred Marshall proposed examining individual markets and firms as a way to understand the broader economy. It was then that microeconomics became formally established as a field of study.

In the mid-20th century, the concept of market failure led to the modern definition of microeconomics (Funderburk, 2012). Market failure refers to situations in which market operations prevent the efficient allocation of resources. Today, microeconomists are primarily concerned with analyzing market failure and suggesting ways to prevent or mitigate it (Stapleford, 2012). This is typically accomplished through public policy and/or government intervention.

Market Failure, Utility, and the Law of Supply

One example of market failure is the monopoly. Monopolies occur when businesses lower the cost of products and/or services to such an extent that it forces competitors out of business (Encyclopedia Britannica, 2009). Similarly, businesses that enjoy a strong market share can monopolize industry resources and deny access to competitors in an attempt to control the means of production. In certain industries, government intervenes to prevent such market conditions.

Microeconomists view monopolies and other market failures as an inefficient allocation of resources (Funderburk, 2012). For instance, monopolies may also occur when there is a lack of market competition and one company charges higher-than-market-value prices for products. Unfair pricing directly impacts consumers — the product may become unaffordable, and if it is a necessity such as gasoline, consumer spending may become strained, thereby negatively affecting broader economic conditions. Furthermore, a business that holds a monopoly on a limited resource may misuse or deplete it, damaging the economy or even the environment. Other types of market failure include information asymmetry, missing markets, and externalities (Encyclopedia Britannica, 2009). Microeconomists argue that supply and demand are best balanced through perfect competition, and that no single organization should possess enough power to influence the overall pricing of a particular good or service.

In microeconomics, consumer behavior is typically analyzed through the concept of utility (Stapleford, 2012). In short, consumers purchase products to increase their satisfaction, and businesses produce to maximize their profits. Utility ultimately drives demand and keeps prices reasonable through market competition. The theory is straightforward and applicable to most industries, making microeconomics a foundation for nearly all economic theory (Funderburk, 2012).

Supply characteristics relate to the behavior of firms in producing and selling a product or service. The law of supply states that, all things being equal (often expressed in its Latin form, ceteris paribus), as the price of a good or service increases, the quantity supplied of that good or service also increases, and vice versa (Funderburk, 2012). At higher prices, producers are willing to offer more products than when prices are low. Producers of goods and services will make every attempt to increase production as a means of increasing profits. The incentive of profit must be greater than the total cost of producing the good, which includes the resources and the value of other goods that could have been produced instead (Encyclopedia Britannica, 2009). Suppliers' profits are dependent on consumer demands and valuations. When suppliers do not earn enough revenue to cover the cost of production, they incur a loss. Losses occur whenever consumers value a good less than the other goods that could have been produced with the same resources (Stapleford, 2012).