Microeconomics is the branch of economics that pertains to decisions made at the individual

level, such as the choices individual consumers and companies make after evaluating resources,
costs, and tradeoffs.

History Microeconomics is the study of the behaviour of individuals and small impacting
organisations in making decisions on the allocation of limited resources. The modern field
ofmicroeconomics arose as an effort of neoclassical economics school of thought to put
economic ideas into mathematical mode.

A Brief History of Microeconomic Theory

Introduction

Contemporary microeconomics uses mathematical models to represent the ideal behavior of

individual consumers and producers in a theoretical market. While these models rely upon the
perfectly logical causal implications of mathematics, they are based upon and incorporate ideas
that came before the use of modern mathematical modeling. Contemporary microeconomics has
its roots in Adam Smith’s theory of the free market (c. mid 1770s) and in the Utilitarians’ theory
of human behavior (c. mid 1800s).

Adam Smith and the Theory of the Free Market (c. mid 1700s)

In his book, An Inquiry into the Nature and Cause of the Wealth of Nations, Adam Smith
constructed the theory of the free market. In this theory Smith attempts to explain how an
unregulated (i.e. “free”) market can generate new wealth and benefits to society that outstrip any
previous economic system (i.e. feudalism) or any conceivable new economic system.

He theorized that in an unregulated (i.e. “free) market individuals are able to pursue their own
self-interest.

The pursuit of self-interest generates economic competition. According to Smith's view,

competition is generated in all markets throughout the economy. It is generated among
consumers for access to employment and goods, among producers for access to resources and to
markets, and between consumers and producers over the distribution of the benefits from
transactions.

Competition in turn generates the independent adjustment of prices. If the quantity

demanded of a good is greater the quantity supplied of the good the current market price, then
market price will independently rise. If the quantity supplied of a good is greater the quantity
demanded of the good the current market price, then market price will independently fall. The
independent adjustment of prices is the most important process in the market mechanism, i.e. in
the demand and supply process.

These independent price adjustments continue until an equilibrium is generated where the
quantity demand of the good exactly equals the quantity supplied of the good at a single market
price.

Smith concludes that when equlibrium occurs the market has achieved a series of beneficial
results:
(i) Efficiency.

There are three different but inter-related concepts of efficiency all of which occur at
equilibrium:
• Economic Efficiency: producing the maximum economic (or financial) return from a given
set of economic (or financial) resources), for example from a given amount of investment.

• Productive Efficiency: producing the maximum output from a given set of productive
resources (i.e. inputs). This means there is no waste or pollution occurring. Any residual
(leftover) resources have no productive use and do no harm.

• Allocative Efficiency: producing the optimal mix of outputs from society’s resources. All of
society’s resources are being used to produce the most desired goods consistent with consumer’s
preferences. There is no under-production or over-production of any good in the economy and
every production process is efficient. So every resource is allocated to its best possible use.

(ii) Social Optimality

Adam Smith theorized that since individuals pursuing their self-interest in the unregulated
market could freely enter into fair and balanced transactions (i.e. no one in the market had any
power to manipulate prices or output, or force specific conditions on anyone else in the market)
then each person was assured to gain the maximum benefit for themselves in every transaction
that they entered. Otherwise they would not agree to the terms of the transaction. They would
simply go on to a more beneficial transaction. Since everyone was engaged in such transactions
the unregulated market would generate the maximum benefits for everyone partaking in the
market. Society based upon an unregulated market would produce the maximum benefits.

Pareto Optimality. While this is a very reassuring theory (people everywhere have
always wanted to believe that their society is the best even in the face of contrary evidence)
economists have only been able to establish that the market is able to generate a Pareto
Optimality. This occurs when no one can gain any additional benefits unless someone else in the
economy loses some benefits. In other words, all of the benefits have been distributed. Every
piece of the pie has been distributed to someone. The only way for a Pareto optimal situation to
be improved upon is for the pie to grow larger and more becomes available to distribute.

The problem with Pareto Optimality is that it is an extremely weak concept of what is social best.
In fact, it does not meet the basic concepts of democratic fairness, since it cannot distinguish a
democracy as being better than a brutal dictatorship.

Imagine a country that produces $100,000 and has population of 100 people. The dictator
receives $90,000 and hires and arms a military of 9 people to force the rest of the population to
work. The military receives $1000 each. The remaining 90 people have $1000 to share between
them. Note that not one worker can earn even $1 more unless someone else loses $1. Even taking
a dollar from the dictator to give to a worker would not be considered a Pareto improvement
since the dictator has to lose $1.

This an important point in understanding how Neoclassical microeconomic theory functions and
how it has been misused. The laissez-faire doctrine which argues that an unregulated market
always produces a better result than a regulated market is, perhaps. the most common
misapplication of Neoclassical microeconomic theory. The laissez-faire doctrine can only be
shown to produce Pareto optimality not the broader concepts social optimality or democratic
fairness.
(iii) Consumer Sovereignty

Smith concludes that at market equilibrium producers have produced only those goods most
desired by demanders. The point is that producers do not choose what to produce leaving
consumers only the choice of what to pick out of range of possibly less desired goods, for
example production under the former Soviet system. Rather, producers respond to what
consumers are willing and able to spend money on. Therefore, consumers determine what is
most needed and desired for the society, and producers respond with the most efficient way to
produce it.
(iv) Uniqueness

Smith’s theory of the free market concludes that there is only a single equilibrium – single most
efficient, socially best, solution to any economic problem.

Market Imperfections and Market Failures

Smith was aware of a couple of potential problems in the Free Market Theory. One area he was
concerned about was the tendency for producers to try to collude to set prices to avoid
competition.
"People of the same trade seldom meet together, even for merriment and diversion, but the
conversation ends in a conspiracy against the public, or in some contrivance to raise prices."

Another area was what he called "public works", goods that were beneficial to be provided to the
society as a whole but which no individual producer would have an incentive or ability to
provide. For Smith these included roads, bridges, and public education.

Since Smith's time economists have come to analyze both of these areas and to identify a few
others that Smith could not have known about. These characteristics of markets are now common
and well understood. When they occur in actual markets then the free market will fail to generate
the beneficial outcomes. Additionally, when we alter the free market models to include these
imperfect market conditions then the models generate results that more accurately reflect actual
markets rather than ideal markets. That is the under these imperfect conditions the market will
fail to acheive the efficient, optimal, unique equilibrium theorized by Smith. We classify these
market conditions as market imperfections and market failures.
Market imperfections occur when there is some inherent problem with the pricing function of
the market. In this case the free market will produce the good at an equilibrioum price and
quantity, however, that price and quantity will not be the efficient, optimal price and quantity.
Categories of market imperfections are market power (i.e. monopoly, oligopoly, et
cetera); externalities; and imperfect information. Smith's concern about price collusion in the
comment above is an example of a market imperfection.

Market failures occur when the market is unable to produce a good or service at all under
competitive conditions. With market failures the market is entirely unable to generate a price, or
cannot generate a competitive price and ensure that they are paid by every consumer. When these
conditions exist either the government must provide the goods directly, or the government must
allow a private monopoly to produce the goods under heavy regulation and with guarantees of
profit rates that approximate a competitive market. The primary category of market failures is
called public goods. Smith's "public works" - roads, bridges, public education - are examples of
public goods.

Another area that our textbook (The Economy Today, Schiller) includes as a market failure is the
issue of equity. The free market will not provide any goods for anyone who cannot pay the
market price for the good. Additionally, the free market will not employ and provide an income
to anyone who is not actively employed. Thus, the free market is guaranteed to starve to death all
those who are unable to work and provide for their own care - orphans, disabled, mentally ill,
seniors, et cetera. These conditions violate all modern standards of fairness (i.e. equity),
especially in democracies. Thus, the free market cannot produce economic equity.

The Utilitarianian Theory of Human Behavior (c. mid 1800s)

The Utilitarians were a leading group of philiosphers of the mid 1800s who argued that there was
a fundamental theory that exlained all human behavior. According to the Utilitarians all human
behavior conformed to the "pleasure-pain principle". All human behavior was said to be
motivated by the pursuit of pleasure and avoidance of pain. This became important to economic
theory because it was a specific interpretation of Smith's claim that in an unregulated market
people pursue their self-interest. Under the Utilitarians' interpretation "pursuing self-interest"
meant seeking the maximum pleasure and minimum pain in all endeavors, or in economic terms,
in all transactions.

The Marginalists, aka Neoclassicals, and Utility Maximization (c. late 1800s to present)

The Marginalists (now-a-days caled Neoclassicals) made the final step in translating Smith's
Theory of the Free Market into a set of mathematical models. By recognizing that "seeking
maximum pleasure and minimum pain" could be easily formulated as a calculus constrained
maximization problem they began writing mathematical models (systems of equations) to
represent the essence of Smith's Free Market Theory. They developed the mathematical methods
and structure that are now used in most microeconomic theory.
(i) Utility Maximization
Specifically, they modelled all economic actors as making choices based upon seeking to
maximize the utility (i.e. benefit) gained from their choices within the limits of their resources
(budget, income, endowment).

Consumers are modelled as seeking to maximize the utility of their purchases limited by their
budget (or income).

Producers are modelled as seeking to maximize profit limited by their technology.

Government is modelled as seeking to maximize total public benefit limited by its budget (or
available resources).

Note that for producers we use slightly different terminology, the words "profit" and
"technology". We do this only to be more specific. In the case of consumers we assume some
theoretical benefit called "utility" since we cannot state precisely what consumers maybe trying
to achieve with any specific choice or purchase. In the case of producers we can be more specific
since producers must seek a profit in order to be successful. Similarly we use the term
"technology" instead of "budget" to emphasize that a producer is making a decision based upon a
specific production process or enterprise. A budget, or investment, or set of costs fund a
production process but do not in themselves produce anything. They must first be spent on or
invested in a productive process, which we call "technology".
(ii) Economic Rationality

When we model human decision-making behavior with mathematics we represent human

behavior as being just as logical as the mathematics. We have little choice in this since
mathematics is perfectly logical and internally consistent. Thus if we use mathematics to
represent human choices we are necessarily limiting the choices to only the mathematically
logical results. For example, while Sara might always prefer apple pie over cherry pie, she may
occasionally choose a piece of cherry instead of the apple pie for random, emotional,
unconscious, or other inconsistent reasons. This is not an option in mathematics. If 6 is greater
than 5, then 6 must always be greater than 5 in all calculations. For this reason we model all of
our economic decisionmakers in microeconomic models as being perfectly consistent (i.e.
economically rational) in all their choices.

An "economically rational" person:

 is a utility maximizer;
 and can rank or prioritize all of their preferences over all alternative goods or
options.
So note that we have now translated Smith's idea of "individuals pursuing self-interest" into a
mathematical model of "utility maximizers who prioritize all of the preferences".

“The theory of rational behavior is usually presented as a study of the principals upon which a
rational man would act. This rational man...makes no errors in arithmetic, or logic, in attempting
to achieve his clearly defined objectives...Every action is perfectly thought out; every risk is
perfectly calculated.”

Harry Markowitz (the father of modern investment portfolio theory)

(iii) The Utility Maximization Model and Actual Behavior

It is important to remember that a model is not a description of actual phenomena, but a tool to
help us think about the actual phenomena. Thus, a model can be unrealistic in many ways but
still valuable in helping us to identify fundamental relationships, forces, tendencies, or possible
outcomes of actual phenomena.

Given what we know about cognitive psychology, utility maximization is a ludicrous concept;
equilibrium pretty foolish outside of financial markets; perfect competition a howler for most
industries. The reason for making these assumptions is not that they are reasonable but that they
seem to help us produce models that are helpful metaphors for things that we think happen in the
real world.
How I Work
Paul Krugman, PhD
Prof. of Economics & Int'l Affairs,
Princeton University

(iv) Irrationality and Behavioral Economics

Just as market imperfections and market failures are common economic conditions that show
free market theory to be an overally narrow model, contemporary psychology provides
considerable evidence that humans do not behave nor make decisions like the free market theory
assumes. In other words, the assumption of a a rational, perfectly logical, self-interested,
maximizing decisionmaker is inaccurate. Economists who are attempting to analyze how people
actually make decisions and to include this process in economic models and theory are called
Behavioral Economists. One of the leading Behavioral Economists is Dan Ariely, author
of Predictably Irrational (which I highly recommend for students interested in delving into
current cutting edge economics). Below I've placed several video links to YouTube videos of Dr.
Ariely explaining how humans actually make decisions and why the free market models of
traditional free market theory are such poor tools.

Before you check out Dan's videos let me provide two explanatory points. First, as a young man
Dan was an Israeli soldier and survived a bomb blast, which burned 70% of his body. This
experience is relevant because it started him on this path of economic research, as he explains in
one of the videos.

Secondly, when he states in the videos that "there are free lunches" he is criticising the
Neoclassical assumption that the market always generates the efficient, optimal outcome. In
Neoclassical economics we often state that "there are no free lunches", as short hand for saying
all goods are properly priced, all costs are properly accounted for, and the free market produces
at maximum efficiency. By claiming there are free lunches he is saying that by acknowledging
that we are not rational, and changing our behavior to be more rational or implementing rules to
make us behave rationally, we can actually increase efficiency without sacrificing any additional
resources. More rational behavior results in less waste and error, so we get more output and more
efficiency for the same resources used. There are free lunches.

Decisions Involve Tradeoffs

This refers to the concept of making compromises. A person may have to give something up to
get something else they want more. For example, say you are offered a chocolate bar or a
lollipop. You have to choose to give up one to get the other.

Opportunity Cost of Resource

The second economic principle emphasizes the cost of whatever it is you gave up. For
example, you took the lollipop, which has an economic profit, what you gain from the choice,
of $.85. But you had to give up the chocolate, which had an economic profit of $.45. So you
actually only gained $.40 for your choice. But if you didn’t have a choice and were only
offered the lollipop, you wouldn’t have given anything up and would have gained an economic
profit of $.85.

Cost-Benefit Analysis

This principle can be a little difficult to grasp. Marginal thinking is to make small adjustments.
For example, a movie theater offers matinee prices. The theater knows fewer people see
movies in the afternoon. The standard ticket price of the movie is $10 and at that price the
theater will sell two tickets for a matinee show. But by offering a $6 matinee price, the theater
ended up selling five tickets. By selling the tickets at a 40 percent discount, the theater actually
made $10 more.

Response to Incentives

People respond to different incentives in good or bad ways, but the point is that we respond. A
bar might offer a buy one, get one free drink. The good side of the incentive is free drinks, the
bad side might be a college student who forgoes studying to drink. Either way, the response to
the incentive was there.

Trading Services for Money

It is important to clarify that trades include using money to pay for something. Say someone is
skilled at giving massages. You get the massage, relying on this person, and then trade your
money as a payment.
Markets Organize Economic Activity

Markets are defined simply as a place where people make an agreement, settle on a price and
then communicate that to the world at large. The food market, for example, has farmers
making an agreement to sell at a set price and then supermarkets communicate that by selling
the food to the public.

Government and Market Efficiency

The government may get involved if the market efficiency isn’t working or if the market is
failing to distribute. This failure is often caused by externality, which means that the product
impacts more than just the direct buyers and sellers. For example, cars benefit drivers, but
emissions are also a health concern for people.

Principal of Productivity

Simply put, this principle is productivity. The richer the country, the higher the level of
productivity.

Too Much Money Causes Inflation

This principle refers to inflation. Prices go up to reflect the amount of money being printed.
While the more money makes people think they’re wealthier, inflation causes prices to go up
and that money loses some of its value.

Inflation and Unemployment Tradeoff

Also referred to as the Phillips Curve, this principle says that you can’t keep unemployment
low and inflation under control at the same time and, therefore, create a tradeoff.
Economic Resources: types and definitions

Economic resource 1: Land

Land is an economic resource that includes all natural physical resources like gold, iron, silver,
oil etc. Some countries have very rich natural resources and by utilizing these resources they
enrich their economy to the peak.

Such as the oil and gas development of North Sea in Norway and Britain or the very high
productivity of vast area of farm lands in the United States and Canada. Some other developed
countries like Japan have smaller economic resources. Japan is the second largest economy of
the world but reliant on imported oil.

Economic resource 2: Labor

The human input in the production or manufacturing process is known as labor. Workers have
different work capacity. The work capacity of each worker is based on his own training,
education and work experience.

This work capacity is matters in the size and quality of work force. To achieve the economic
growth the raise in the quality and size of workforce is very essential.

Economic resource 3: Capital

In economics, Capital is a term that means investment in the capital goods. So, that can be used
to manufacture other goods and services in future.
Following are the factors of capital:

Fixed Capital
It includes new technologies, factories, buildings, machinery and other equipments.

Working Capital
It is the stock of finished goods or components or semi-finished goods or components. These
goods or components will be utilized in near future.

Capital productivity
New features of capital building, machinery or technology are commonly used to improve the
productivity of the labor. Such as the new ways of farming helps to enhance the productivity of
the agriculture sector and give more valuable jobs in this sector which motivates people to come
out for work.

Infrastructure
It is a stock of capital that is used to maintain the whole economic system. Such as roads, railway
tracks, airports etc.

Economic resource 4: Entrepreneurship

The Entrepreneur is person or individual who wants to supply the product to the market, in
order to make profit. Entrepreneurs usually invest their own capital in their business. This
financial capital is generally based on their savings and they take risks linked to their
investments. This risk-taking can be rewarded by the profit of the business. Entrepreneurship is,
thus, an important economic resource.
 Entrepreneurial marketing
is less about a single marketingstrategy and more about a marketing spirit that differentiates
itself from traditional marketing practices. It eschews many of the fundamental principles
of marketing because they are typically designed for large, well established firms.

who employ entrepreneurial marketing

Entrepreneurial marketing is best defined by the types of companies that use it. The easiest way to
identify an entrepreneurial marketing effort is to look at the company doing the marketing. Start ups
and emerging companies use entrepreneurial marketing to help establish themselves in emerging
industries.
It is important to distinguish these businesses from small businesses. While they do start small, their
goal is to grow rapidly and to become major players in their industry as quickly as possible. This is
drastically different from a restaurant or machine shop that may be content to stay small forever.
Growth is the primary goal of entrepreneurship, and marketing is the primary means for growth.

In 1984, a college student named Michael Dell decided to found a computer company. Today it is one of the
largest and best known computer companies in the world. Below are some of the steps that Dell took in its
earliest stages to get noticed in the computer market.

 Define your customers – Dell realized early that there was a hole in the market for customized business
computers. Their first products were marketed to large and midsized companies looking to purchase many
computers at once. It was only in the late 90s that they began to focus on personal computers for students
and families.
 Offer something new – In the early 80s, computers were bought and sold primarily through retail stores.
Dell took the then radical step of selling directly to consumers, cutting out the retail middle man. This made
it easy for business customers to place large orders and to customize each computer they purchased.
 Go to where the customers are – Dell marketed at electronics trade shows, in trade magazines, and in
other avenues that corporate technology officers would follow. Advertising messages highlighted the ways
that Dell computers were optimized for business customers.
 Offer exceptional services – Dell offered 24 hour technical support to all of its customers. This was a
valuable service to customers who were only beginning to integrate computers into their businesses.

How to Implement Your Marketing Plan

1. Set the right expectations. ...
2. Build the team and secure resources. ...
3. Communicate the plan. ...
4. Build out timeline and tasks. ...
5. Set up a dashboard for tracking success. ...
6. Monitor and check-in regularly. ...
7. Be willing to adapt. ...
8. Communicate results and celebrate success!