Microeconomics: Introduction to Supply and Demand

Microeconomics (from Greek prefix mikro- meaning “small” + economics) is a branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. One goal of microeconomics is to analyze the market mechanisms that establish relative prices among goods and services and allocate limited resources among alternative uses. Microeconomics shows conditions under which free markets lead to desirable allocations. It also analyzes market failure, where markets fail to produce efficient results.

While microeconomics focuses on firms and individuals, macroeconomics focuses on the sum total of economic activity, dealing with the issues of growth, inflation, and unemployment and with national policies relating to these issues. Microeconomics also deals with the effects of economic policies (such as changing taxation levels) on microeconomic behavior and thus on the aforementioned aspects of the economy. Particularly in the wake of the Lucas critique, much of modern macroeconomic theories has been built upon microfoundations—i.e. based upon basic assumptions about micro-level behavior.

Microeconomic theory typically begins with the study of a single rational and utility maximizing individual. To economists, rationality means an individual possesses stable preferences that are both complete and transitive. The technical assumption that preference relations are continuous is needed to ensure the existence of a utility function. Although microeconomic theory can continue without this assumption, it would make comparative statics impossible since there is no guarantee that the resulting utility function would be differentiable.

Real versus Nominal Prices

We often want to compare the price of a good today with what it was in the past or is likely to be in the

What Is a Market?

Business people, journalists, politicians, and ordinary consumers talk about markets all the time—for example, oil markets, housing markets, bond markets, labor markets, and markets for

Introduction to Microeconomics

The Rolling Stones once said: “You can’t always get what you want.” This is true. For most people (even Mick Jagger), that there are limits

The Market Mechanism

The next step is to put the supply curve and the demand curve together. We have done this in Figure 2.3. The vertical axis shows

Supply and Demand

The basic model of supply and demand is the workhorse of microeconomics. It helps us understand why and how prices change, and what happens when

Why Study Microeconomics?

We think that after reading this book you will have no doubt about the impor- tance and broad applicability of microeconomics. In fact, one of

Consumer Behavior

Some time ago, General Mills introduced a new breakfast cereal. The new brand, Apple-Cinnamon Cheerios, was a sweetened and more flavorful variant on General Mills’

Effects of Government Intervention—Price Controls

In the United States and most other industrial countries, markets are rarely free of government intervention. Besides imposing taxes and granting subsidies, governments often regulate

Understanding and Predicting the Effects of Changing Market Conditions

So far, our discussion of supply and demand has been largely qualitative. To use supply and demand curves to analyze and predict the effects of

Short-Run versus Long-Run Elasticities

When analyzing demand and supply, we must distinguish between the short run and the long run. In other words, if we ask how much demand

Elasticities of Supply and Demand

We have seen that the demand for a good depends not only on its price, but also on consumer income and on the prices of

Changes in Market Equilibrium

We have seen how supply and demand curves shift in response to changes in such variables as wage rates, capital costs, and income. We have

Cost-of-Living Indexes

The Social Security system has been the subject of heated debate for some time now. Under the present system, a retired person receives an annual

Marginal Utility and Consumer Choice

In Section 3.3, we showed graphically how a consumer can maximize his or her satisfaction, given a budget constraint. We do this by finding the

Revealed Preference

In Section 3.1, we saw how an individual’s preferences could be represented by a series of indifference curves. Then in Section 3.3, we saw how

Consumer Choice

Given preferences and budget constraints, we can now determine how individual consumers choose how much of each good to buy. We assume that consumers make

Budget Constraints

So far, we have focused only on the first element of consumer theory—consumer preferences. We have seen how indifference curves (or, alternatively, utility func- tions)

Consumer Preferences

Given both the vast number of goods and services that our industrial economy provides for purchase and the diversity of personal tastes, how can we

Empirical Estimation of Demand

Later in this book, we will explain how demand information is used as input into a firm’s economic decision-making process. General Motors, for example, must

Network Externalities

So far, we have assumed that people’s demands for a good are independent of one another. In other words, Tom’s demand for coffee depends on

Consumer Surplus

Consumers buy goods because the purchase makes them better off. Consumer sur- plus measures how much better off individuals are, in the aggregate, because they

Market Demand

So far, we have discussed the demand curve for an individual consumer. Now we turn to the market demand curve. Recall from Chapter 2 that

Income and Substitution Effects

A fall in the price of a good has two effects: Consumers will tend to buy more of the good that has become cheaper and

Individual Demand

This section shows how the demand curve of an individual consumer follows from the consumption choices that a person makes when faced with a budget

Bubbles of consumer behavior

During 1995 to 2000, the stock prices of many Internet companies rose sharply. What was behind these sharp price increases? One could argue—as many stock

The Demand for Risky Assets

Most people are risk averse. Given a choice, they prefer fixed monthly incomes to those which, though equally large on average, fluctuate randomly from month

Reducing Risk concerning consumer behavior

As the recent growth in state lotteries shows, people sometimes choose risky alternatives that suggest risk-loving rather than risk-averse behavior. Most people, however, spend relatively

Preferences of consumer Toward Risk

We used a job example to show how people might evaluate risky outcomes, but the principles apply equally well to other choices. In this section,

Describing Risks concerning consumer behavior

To describe risk quantitatively, we begin by listing all the possible outcomes of a particular action or event, as well as the likelihood that each

Demand Theory – A Mathematical Treatment

This appendix presents a mathematical treatment of the basics of demand theory. Our goal is to provide a short overview of the theory of demand

Measuring Cost of Production: Which Costs Matter?

Before we can analyze how firms minimize costs, we must clarify what we mean by cost in the first place and how we should measure

Returns to Production Scale

Our analysis of input substitution in the production process has shown us what happens when a firm substitutes one input for another while keeping output

Production with Two Variable Inputs

We have completed our analysis of the short-run production function in which one input, labor, is variable, and the other, capital, is fixed. Now we

Production with One Variable Input (Labor)

When deciding how much of a particular input to buy, a firm has to compare the benefit that will result with the cost of that

Firms and Their Production Decisions

Firms as we know them today are a relatively new invention. Prior to the mid-1800s, almost all production was done by farmers, craftsmen, individuals who

Behavioral Economics 189

Recall that the basic theory of consumer demand is based on three assumptions: (1) consumers have clear preferences for some goods over others; (2) consumers

Estimating and Predicting Cost of Production

A business that is expanding or contracting its operation must predict how costs will change as output changes. Estimates of future costs can be obtained

Dynamic Changes in Costs—The Learning Curve

Our discussion thus far has suggested one reason why a large firm may have a lower long-run average cost than a small firm: increasing returns

Production with Two Outputs—Economies of Scope

Many firms produce more than one product. Sometimes a firm’s products are closely linked to one another: A chicken farm, for instance, produces poultry and

Long-Run versus Short-Run Cost Curves

We saw earlier (see Figure 7.1— page 239) that short-run average cost curves are U-shaped. We will see that long-run average cost curves can also

Cost in the Long Run

In the long run, a firm has much more flexibility. It can expand its capacity by expanding existing factories or building new ones; it can

Cost in the Short Run

In this section we focus our attention on short-run costs. We turn to long-run costs in Section 7.3. 1. The Determinants of Short-Run Cost The

Introduction to Monopoly

As the sole producer of a product, a monopolist is in a unique position. If the monopolist decides to raise the price of the product,

The Impact of a Tax or Subsidy

What would happen to the price of widgets if the government imposed a $1 tax on every widget sold? Many people would answer that the

Import Quotas and Tariffs

Many countries use import quotas and tariffs to keep the domestic price of a product above world levels and thereby enable the domestic industry to

Price Supports and Production Quotas

Besides imposing a minimum price, the government can increase the price of a good in other ways. Much of American agricultural policy is based on

Minimum Prices

As we have seen, government policy sometimes seeks to raise prices above market-clearing levels, rather than lower them. Examples include the former regulation of the

The Efficiency of a Competitive Market

To evaluate a market outcome, we often ask whether it achieves economic efficiency—the maximization of aggregate consumer and producer surplus. We just saw how price