Microeconomics

Novosibirsk State Technical University 
 
 
 
 
 
 
 

Microeconomics 
 
 

Students: Maryina Irina,

Otroshchenko Alena 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Novosibirsk 2007

Contents 

1. Introduction……………………………………………………………………………………..3

2. Overview………………………………………………………………………………………..3

3. Assumptions and definitions……………………………………………………………………3

4. Modes of operation……………………………………………………………………………..4

5. Market failure…………………………………………………………………………………..4

6. Opportunity cost…………………………………………………………………………….. ...5

7. Applied microeconomics……………………………………………………………………….6

8. Conclusion……………………………………………………………………………………...7

9. Links……………………………………………………………………………………………7 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1. Introduction

Microeconomics is a branch of economics that studies how individuals, households, and firms make decisions to allocate limited resources, typically in markets where goods or services are being bought and sold.

Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the supply and demand of goods and services.

Macroeconomics, on the other hand, involves the "sum total of economic activity, dealing with the issues of growth, inflation, and unemployment and with national economic policies relating to these issues" and the effects of government actions (e.g., changing taxation levels) on them. Particularly in the wake of the Lucas critique, much of modern macroeconomic theory has been built upon 'microfoundations'—i.e. based upon basic assumptions about micro-level behaviour. 
 

2. Overview

One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market failure, where markets fail to produce efficient results, as well as describing the theoretical conditions needed for perfect competition. Significant fields of study in microeconomics include markets under asymmetric information, choice under uncertainty and economic applications of game theory. Also considered is the elasticity of products within the market system. 
 

3. Assumptions and definitions

The theory of supply and demand usually assumes that markets are perfectly competitive. This implies that there are many buyers and sellers in the market and none of them have the capacity to significantly influence prices of goods and services. In many real-life transactions, the assumption fails because some individual buyers or sellers or groups of buyers or sellers do have the ability to influence prices. Quite often a sophisticated analysis is required to understand the demand-supply equation of a good. However, the theory works well in simple situations.

Mainstream economics does not assume a priori that markets are preferable to other forms of social organization. In fact, much analysis is devoted to cases where so-called market failures lead to resource allocation that is suboptimal by some standard (highways are the classic example, profitable to all for use but not directly profitable for anyone to finance). In such cases, economists may attempt to find policies that will avoid waste directly by government control, indirectly by regulation that induces market participants to act in a manner consistent with optimal welfare, or by creating "missing markets" to enable efficient trading where none had previously existed. This is studied in the field of collective action. It also must be noted that "optimal welfare" usually takes on a Paretian norm, which in its mathematical application of Kaldor-Hicks Method, does not stay consistent with the Utilitarian norm within the normative side of economics which studies collective action, namely public choice. Market failure in positive economics (microeconomics) is limited in implications without mixing the belief of the economist and his or her theory.

The demand for various commodities by individuals is generally thought of as the outcome of a utility-maximizing process. The interpretation of this relationship between price and quantity demanded of a given good is that, given all the other goods and constraints, this set of choices is that one which makes the consumer happiest. 
 
 
 

4. Modes of operation

It is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output. Given this assumption, there are four categories in which a firm's profit may be considered.

A firm is said to be making an economic profit when its average total cost is less than the price of each additional product at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price.

A firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total cost equals price at the profit-maximizing output.

If the price is between average total cost and average variable cost at the profit-maximizing output, then the firm is said to be in a loss-minimizing condition. The firm should still continue to produce, however, since its loss would be larger if it were to stop producing. By continuing production, the firm can offset its variable cost and at least part of its fixed cost, but by stopping completely it would lose the entirety of its fixed cost.

If the price is below average variable cost at the profit-maximizing output, the firm should go into shutdown. Losses are minimized by not producing at all, since any production would not generate returns significant enough to offset any fixed cost and part of the variable cost. By not producing, the firm loses only its fixed cost. By losing this fixed cost the company faces a challenge. It must either exit the market or remain in the market and risk a complete loss.  
 

5. Market failure

In microeconomics, the term "market failure" does not mean that a given market has ceased functioning. Instead, a market failure is a situation in which a given market does not efficiently organize production or allocate goods and services to consumers. Economists normally apply the term to situations where the inefficiency is particularly dramatic, or when it is suggested that non-market institutions would provide a more desirable result. On the other hand, in a political context, stakeholders may use the term market failure to refer to situations where market forces do not serve the "public interest," a subjective assessment that is often made on social or moral grounds.

The four main types or causes of market failure are:

Monopolies or other cases of abuse of market power where a "single buyer or seller can exert significant influence over prices or output"). Abuse of market power can be reduced by using antitrust regulations.

Externalities, which occur in cases where the "market does not take into account the impact of an economic activity on outsiders." There are positive externalities and negative externalities. Positive externalities occur in cases such as when a television program on family health improves the public's health. Negative externalities occur in cases such as when a company’s processes pollutes air or waterways. Negative externalities can be reduced by using government regulations, taxes, or subsidies, or by using property rights to force companies and individuals to take the impacts of their economic activity into account.

Public goods such as national defense and public health initiatives such as draining mosquito-breeding marshes. For example, if draining mosquito-breeding marshes was left to the private market, far fewer marshes would probably be drained. To provide a good supply of public goods, nations typically use taxes that compel all residents to pay for these public goods (due to scarce knowledge of the positive externalities to third parties/social welfare); and

Cases where there is asymmetric information or uncertainty (information inefficiency). Information asymmetry occurs when one party to a transaction has more or better information than the other party. Typically it is the seller that knows more about the product than the buyer, but this is not always the case. buyers in some markets have better information than the Sellers. For example, used-car salespeople may know whether a used car has been used as a delivery vehicle or taxi, information that may not be available to buyers. An example of a situation where the buyer may have better information than the seller would be an estate sale of a house, as required by a last will and testament. A real estate broker purchasing this house may have more information about the house than the family members of the deceased.

This situation was first described by Kenneth J. Arrow in a seminal article on health care in 1963 entitled "Uncertainty and the Welfare Economics of Medical Care," in the American Economic Review. George Akerlof later used the term asymmetric information in his 1970 work The Market for Lemons. Akerlof noticed that, in such a market, the average value of the commodity tends to go down, even for those of perfectly good quality, because the buyer has no way of knowing whether the product they are buying will turn out to be a "lemon" (a defective product).  

6. Opportunity cost

Although opportunity cost can be hard to quantify, the effect of opportunity cost is universal and very real on the individual level. In fact, this principle applies to all decisions, not just economic ones. Since the work of the Austrian economist Friedrich von Wieser, opportunity cost has been seen as the foundation of the marginal theory of value.

Opportunity cost is one way to measure the cost of something. Rather than merely identifying and adding the costs of a project, one may also identify the next best alternative way to spend the same amount of money. The forgone profit of this next best alternative is the opportunity cost of the original choice. A common example is a farmer that chooses to farm his land rather than rent it to neighbors, wherein the opportunity cost is the forgone profit from renting. In this case, the farmer may expect to generate more profit himself.

When economists refer to the "opportunity cost" of a resource, they mean the value of the next-highest-valued alternative use of that resource. If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you can't spend the money on something else. If your next-best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the pleasure you forgo by not reading the book.

The word opportunity in opportunity cost is actually redundant. The cost of using something is already the value of the highest-valued alternative use. But as contract lawyers and airplane pilots know, redundancy can be a virtue. In this case, its virtue is to remind us that the cost of using a resource arises from the value of what it could be used for instead.

This simple concept has powerful implications. It implies, for example, that even when governments subsidize college education, most students still pay more than half of the cost. Take a student who pays $2,000 in tuition at a state college. Assume that the government subsidy to the college amounts to $5,000 per student. It looks as if the cost is $7,000 and the student pays less than half. But looks are deceiving. The true cost is $7,000 plus the income the student forgoes by attending school rather than working. If the student could have earned $15,000 per year, then the true cost of the education is $7,000 plus $15,000. Of this $22,000 total, the student pays $17,000 ($15,000 plus $2,000).

What about the cost of room and board while attending school? This is not a true cost of attending school at all, because whether or not the student attends school, someone must pay room and board.

One question that arises here is how to assess the benefit of dissimilar alternatives. We must determine a dollar value associated with each alternative to facilitate comparison and assess opportunity cost, which may be more or less difficult depending on the things we are trying to compare. For example, many decisions involve environmental impacts whose dollar value is difficult to assess because of scientific uncertainty. Valuing a human life or the economic impact of an Arctic oil spill involves making subjective choices with ethical implications.

 
 

The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). The graph depicts a right-shift in demand from D₁ to D₂ along with the consequent increase in price and quantity required to reach a new market-clearing equilibrium point on the supply curve (S). 
 

7. Applied microeconomics

Applied microeconomics includes a range of specialized areas of study, many of which draw on methods from other fields. Industrial organization and regulation examines topics such as the entry and exit of firms, innovation, role of trademarks. Law and economics applies microeconomic principles to the selection and enforcement of competing legal regimes and their relative efficiencies. Labor economics examines wages, employment, and labor market dynamics. Public finance (also called public economics) examines the design of government tax and expenditure policies and economic effects of these policies (e.g., social insurance programs). Political economy examines the role of political institutions in determining policy outcomes. Health economics examines the organization of health care systems, including the role of the health care workforce and health insurance programs. Urban economics, which examines the challenges faced by cities, such as are sprawl, air and water pollution, traffic congestion, and poverty, draws on the fields of urban geography and sociology. The field of financial economics examines topics such as the structure of optimal portfolios, the rate of return to capital, econometric analysis of security returns, and corporate financial behavior. The field of economic history examines the evolution of the economy and economic institutions, using methods and techniques from the fields of economics, history, geography, sociology, psychology, and political science. 
 
 
 
 
 
 
 
 
 
 

8. Conclusion

Let economics associate not only with a set of material benefits. It is important to understand that this is an investigation not only of the whole material world surrounding us but also of the people behavior around us. The study of economics is a fundamental base of modern life as all countries develop in this field and aim to attain the best results, and not only macroeconomics but also microeconomics plays a specific role in it. More and more people are trying to get knowledge in this field.  And we are no exception of them. There exists an opinion that if man has no talents and abilities he becomes an economist. But this is quite wrong. It is the country development that defines its economic state. So, the development of a country supposes the preparation of experienced specialists.

There are a few specialties in economics, even a separate department, at our university, but it is the energy department that we have chosen as we consider the development of economic aspect of energy relations to play a large role in our country and we suppose to have our future profession in this field.    

9. Links

http://www.wikipedia.org

http://www.econlib.org/library/Enc/OpportunityCost.html  by David R. Henderson

http://economics.about.com/od/opportunitycosts/f/opportunitycost.htm

http://economics.about.com/od/microeconomics/Microeconomics_Resources.htm