Microeconomics studies the behavior of individuals and firms and how decisions are made based on the allocation of limited resources. Micro economic theory does not study the economy as a whole and instead studies individuals and their maximizing behavior gain in any economy.
Scope of Microeconomics:
The micro economic theory addresses four important issues at the individual level.
- What should be produced?
- How much should be produced?
- How can a better use of the given resources be made while producing goods and services to maximize the efficiency of production and consumption or to maximize the yields for an individual (company, industry, household, etc.)?
- How can goods and services be distributed for greater well-being?
Importance of Microeconomics:
- To understand the functioning of an economy:
Microeconomics helps make decisions such as how much to produce, what to produce, for whom to produce. Explains the condition of efficiency in both production and consumption.
- Provide tools for economic policies:
It helps determine government policies on resource allocation and prices. It helps to impose tax rates by analyzing supply and demand factors.
- To examine the condition of economic well-being:
Microeconomics helps formulate economic policies aimed at promoting economic well-being and efficiency in production.
- Efficient use of resources:
Microeconomics is used to explain the benefits of international trade, the imbalance of the balance of payments and the determination of currency exchange rates. It helps make rational decisions for both producers and consumers in an economy.
- Useful in making business decisions:
It also helps companies achieve maximum production with the amount of resources given. Commercial companies can make decisions in demand analysis, cost analysis and pricing methods.
- Help in the optimal allocation of resources:
The limited resources of companies can be used optimally by choosing the best alternative that is possible with the help of microeconomics. It also helps producers to select the most efficient and least expensive production technique.
- Price determination:
Prices are determined based on the forces of supply and demand that are the main part of microeconomics.
- Provides tools to evaluate economic policies:
Microeconomics provides tools to evaluate the economic policies of the state. The microeconomics theory explains the condition of efficiency in consumption and production and highlights the factors that are responsible for the diversion of efficiency.
On this basis, microeconomics suggests adequate economic policies to promote economic efficiency and the well-being of people. A pricing policy is also an important tool for economic policies. Microeconomics helps the state formulate correct pricing policies and evaluate them in the proper perspective.
The limitations of microeconomics:
- Micro economic theory assumes full employment in an economy. This assumption is not realistic in real markets. No economy or economic system in the world has witnessed or experienced the scenario of full employment to date.
- The micro economic theory assumes an economic system of ‘Lassiez Faire’. This means an economic system that has ‘No government intervention’. However, when we look around us, we realize that all economic systems throughout the world, including capitalist economies, experience government intervention in economic systems on a regular basis.
- Most micro economic theories are based on the static assumption of “Ceteris Paribus” which means “All other things are equal”. Again, this assumption of “ceteris paribus” is not realistic in real markets.
- Microeconomic theory sometimes leads to the generalization of individual behavior and this may not always be true or correct.
- Microeconomics is only a partial study of an economy and, therefore, does not help us to understand any economic system as a whole.