Microeconomics: Definition, Meaning and Scope

1 year ago
Atiqur Rahman
14 minutes

Introduction

To understand what Microeconomics is, one must know what Economics is.

Etymological and General Meaning of Economics

Etymologically, the term Economics comes from the Greek words oikos (house) and nomos (management).

In the present-day sense, Economics is a subject whose study helps individuals, groups, nations, and even international organizations make important choices for material welfare, both short-term and long-term, under limitations or constraints of resources.

Under its widespread umbrella comes the individual or the household going to the market, the firm trying to make profits, the village growing into an industrial town, the less developed country striving for development, multinational organizations and the world economy in general.

Evolution

Even though the term Economics had not come into usage then, there was thinking on economic issues in Western Europe in the 16th to late 17th centuries that went by the name Mercantilism or merchant-like thoughts. It emphasized the role of the government in following policies leading to a positive Balance of Trade, which was thought to be the index of the country’s prosperity.

In the second half of the 18th century, there emerged economic thoughts that go by the name Physiocracy. It emphasized the role of land and agriculture in ensuring a country’s prosperity. The Mercantilists focused on trade and commerce and the accumulation of gold and silver. The Physiocrats focused on productive work, leading to the generation of agricultural surplus.

In the third quarter of the 18th century, with the publication in 1776 of An Inquiry into the Nature and Causes of the Wealth of Nations by Adam Smith, Classical Economics was born. Britain was beginning to experience the Industrial Revolution. Smith emphasized the Division of Labour or Specialization as the source of productivity or efficiency in factories contributing aggregately to the nation’s wealth or prosperity.

J.B. Say, T.R. Malthus, David Ricardo and J.S. Mill enhanced his ideas and added their contributions to this new body of thought. They came from different professions, but all of them had an aggregative approach, took a long-run perspective and made sweeping generalizations. Together with Adam Smith, they constitute the Classical economists.

Towards the end of the 19th century, there developed a new approach, which has come to be called Neo-Classical. Economists began to study economic issues on a more individual level, asking how the price and quantity of specific goods (and services) were determined in the market and how firms set their wages, maximizing their profits and minimizing their costs. The canvas became smaller, the conclusions less sweeping. Instead of the aggregates, the units became marginal or incremental. Instead of the entire nation, the individual consumer or producer became the focus of interest.

Decisions depended on a rational weighing of costs and benefits, leading to a balance or equilibrium. It is this equilibrium that became the most important objective rather than the wealth of nations, that is, growth. Menger, William Stanley Jevons and Alfred Marshall are foremost among these new thinkers who came to be called `marginalists’ or Neo-Classicals.

Marshall’s Definition of Economics

Marshall’s Principles of Economics (1890), the pioneering work of the Neo-Classical tradition, provided the following definition of Economics: “a study of mankind in the ordinary business of life; it (Economics) examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing. Thus it is on one side a study of wealth; and on the other, and more important side, a part of the study of man.”

This definition established the character of the subject for a long time to come. Economics studies human beings as they go about their everyday life.

Robbins’s Definition

In 1932, in Lionel Robbins’ Essay on the Nature and Significance of Economic Science, Lionel Robbins highlighted another aspect of the subject, choice under conditions of scarcity. “Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”

First, resources or means of production (land, labour, capital goods such as machinery, technical knowledge) are scarce or limited. Secondly, what is applied to the production of a certain commodity or service is unavailable for the production of another, alternative one. But human wants for the consumption or use of goods and services (food, clothing, housing, education, entertainment) are countless and unlimited. So people or organizations must choose among them. Economics is the study of how people (or organizations) can choose to use scarce or limited resources to produce various goods and services and distribute them to various members of society for them to consume.

Contemporary Economics is largely built upon this Robbinsian understanding of Economics.

Is Economics a Science or an Art?

If we look at the above two equally famous definitions, we see that while Marshall regards it as a `study of mankind’, which is what the Humanities is, Robbins sees it as a Science.

Most universities award Bachelor of Arts and Master of Arts degrees for the study of Economics. In contrast, the London School of Economics offers BSc and MSc degrees to its students of Economics.

Indeed the scope of Economics is so wide that it is difficult to label it as either science or art. It is perhaps a mixture of both.

As Nobel Prize winner Paul Samuelson put it, “Not only is Economics at once art and a science, economics as a subject can combine the attractive features of both the humanities and the sciences” (Economics, 7th ed., Chapter 1,p 4).

But even if the epithet `science’ is given to Economics, it remains a Social Science. It is, to use Marshall’s words, `the study of mankind’, of people as members of a society or nation or economy, acting and interacting among themselves in the complex process of production and exchange, consumption and distribution.

There is, of course, the concept of a Robinson Crusoe Economy where the country has just a single person performing all the economic activities by himself. The name is borrowed from the title of a book by Daniel Defoe about a man shipwrecked on an island. But this is merely an analytical tool to facilitate the understanding of the complex reality of an actual economy. Essentially, the subject of Economics is social in character.

Is Economics Positive or Normative?

In 1953 Milton Friedman, in his Essays in Positive Economics, said that economists should not be Normative, that is, pass moral strictures or make `value judgments’.

They should be Positive, that is, make propositions or statements such as: ‘If the price of a commodity goes up, its quantity consumed falls, other things remaining the same’ rather than: ‘You stupid consumer! Don’t go on buying more and more of this commodity when the price of it was going up.’

Even policy prescriptions or recommendations should be expressed in a calm, categorical way, such as: ‘If there is inflation and the government prints more notes, the inflation is likely to get aggravated’, instead of: ‘The government should not do a mad thing like printing more notes when there is inflation in the country.’

What subjects does Economics relate to?

Mathematics and Statistics are tools of Economics used for theoretical as well as empirical study. Pioneers like Alfred Marshall used verbal exposition as well as graphs to make their points, say, about the Demand Curve or the various Cost Curves.

But in contemporary times, it is impossible to study Economic Theory without knowledge of Mathematical Techniques such as geometry, algebra, calculus, set theory, and matrices.

However, Samuelson assures that it is only for “the higher reaches of economic theory” that mathematics is needed. For a general understanding, it is enough to be alert and informed. “.. Logical reasoning is the key to success in the mastery of basic economic principles, and shrewd weighing of empirical evidence is the key to success in mastery of economic applications.”(Economics, 7th ed., Ch 1. p 5)

Economics is both theoretical and empirical. For empirical analysis, the application of Statistics to Economics has led to the emergence of Econometrics. Most contemporary research in Economics is done with the help of Econometrics.

Political Science too helps in the study of Economics, which originally was called `Political Economy’. Knowledge of history and geography too, is essential for a grasp of Economics. Sociology and History too are related areas.

Economic History and Economic Geography have developed as subjects in their own right. Other subjects or courses that have emerged from Economics are: Commerce, Business Economics, Business Administration, and Business Management. Undergraduate courses in Commerce and Business Economics compulsorily include courses/papers in Economics.

Micro-Economics

The Term Micro-Economics

In Greek, the words `micro’ and `macro’ mean small and huge, respectively. Micro-Economics is the branch of Economics that studies economic issues in small, individual details, as if under a microscope. In contrast, Macro-Economic studies economic issues in aggregative and overall forms, looking at the broad picture.

Classical economists like Adam Smith, J.B.Say, and David Ricardo were concerned with the nation or the country as a whole and drew their conclusions on an aggregative basis. Their analysis was more macro than micro in nature.

Neo-Classical economists like Alfred Marshall, Menger, and W. S. Jevons were concerned with households and firms as individuals rather than aggregative entities and used `marginal’ (small additional or incremental) units in their methodology. The `margin’ was the concept they used in their technique of study. The old-fashioned Neo-Classical theory of Marginal Utility, for example, says that the price of a commodity is decided by the additional `utility’ that a small additional unit of it yields. Micro-economics is Economics using the perspective of small, micro units.

The Term Macro-Economics

So far as modern Macro-economic (as distinct from Classical Economics, which was macro in character), started with John Maynard Keynes after the Great Depression of the 1930s.

During this Depression, both Europe and America suffered along with their colonies in various parts of the world. There was an accumulation of unsold stock, closure of production units and widespread unemployment; both employers and employees were affected.

Keynes analyzed the phenomenon in terms of Aggregate Demand falling short of Aggregate Supply and argued that under such circumstances, if the Government of a country played an active role and stepped up its own expenditure, Aggregate Demand would be boosted and the Depression corrected.

This was the beginning of modern Macro-Economics. Later John Hicks, Milton Friedman, Lucas and others developed Macro-Economics into a very-well developed body of thoughts with many policy implications.

Micro-Economics vs Macro-Economics

Is there any issue of Microeconomics versus Macroeconomics? Is either of the two more fundamental or important? Most universities make the students first take a course in Micro-Economics and then go on to Macro-Economics. However, some universities are now offering both courses in the same semester or academic year.

So far as undergraduate and even post-graduate studies are concerned, it is essential for students first to grasp the concepts of Microeconomics and then go over to those of Macroeconomics. For example, the concept of the `margin’ is first learnt through Marginal Utility, Marginal Rate of Substitution, Marginal Productivity etc. and only subsequently used through Marginal Propensities to Consume and Save. The concept of Consumer Equilibrium has to be learnt prior to its application in the box diagrams used, say, in the Heckscher-Ohlin Theorem of International Trade Theory.

So far as public policy-making (governmental or even corporate) is concerned, macroeconomics is more relevant.

However, as Paul Samuelson has emphasized, that there is no essential opposition between Macro-Economics and Micro-Economics. “Macroeconomics deals with the big picture – with the macro aggregates of income, employment, and price levels. But do not think that microeconomics deals with unimportant details. After all, the big picture is made up of its parts.” (Economics, 7th ed., p 362). He has also pointed out that both subjects are “vital” to the understanding of the subject (Economics, 7th ed., p 362).

Basic Areas or Scope of Micro-Economics

Micro-economics falls into several broad areas.

Consumer Choice and Demand

This deals with how an individual consumer( person or household) chooses what quantities he/she should buy at certain market prices so as to maximize satisfaction, i.e., how a Demand Curve or function is arrived at for the individual and for the Market.

Production- Cost, Revenue & Profit

This relates to how a productive unit, say, the firm, chooses, on the basis of cost considerations and revenue prospects, what quantity to produce and sell so as to maximize profits, i.e., how a Supply Curve or function arrives at both individual and Market levels.

Market- Structure and Strategy

Markets can be of various forms or structures, beginning with Perfect Competition, Monopolistic Competition, Oligopoly, Duopoly, Monopoly and, Monopsony). In addition to standard tools of Geometry and Calculus, Game Theory is often used to analyze the various strategies suitable for the various markets. So after the analysis of Consumption and Production comes the analysis of Markets.

Factor Payments, Risk, Uncertainty

This relates to the determination of payments for the various factors of production, such as rent, wages and profits, in terms of marginal productivity, reward for risk-taking etc.

Welfare Economics

This relates to the maximization of satisfaction or welfare for society rather than the individual. It encompasses situations of Market Failure, caused often by Externalities, as well as problems caused by information that is Asymmetric.

International Trade

Like two or more individuals, countries too can come together in relations of production and exchange. This international trade too is analyzed in Microeconomics, beginning with the theories of the Mercantilists and Adam Smith to more modern ones. The treatment, however, is different from that of Open Economies in macroeconomics, say, by Mundell-Fleming.

Read More- Microeconomics

  1. Microeconomics: Definition, Meaning and Scope
  2. Methods of Analysis in Economics
  3. Problem of Choice & Production Possibility Curve
  4. Concept of Market & Market Mechanism in Economics
  5. Concept of Demand and Supply in Economics
  6. Concept of Equilibrium & Dis-equilibrium in Economics
  7. Cardinal Utility Theory: Concept, Assumptions, Equilibrium & Drawbacks
  8. Ordinal Utility Theory: Meaning & Assumptions
  9. Indifference Curve: Concept, Properties & Shapes
  10. Budget Line: Concept & Explanation
  11. Consumer Equilibrium: Ordinal Approach, Income & Price Consumption Curve
  12. Applications of Indifference Curve
  13. Measuring Effects of Income & Excise Taxes and Income & Excise Subsidies
  14. Normal Goods: Income & Substitution Effects
  15. Inferior Goods: Income & Substitution Effects
  16. Giffen Paradox or Giffen Goods: Income & Substitution Effects
  17. Concept of Elasticity: Demand & Supply
  18. Demand Elasticity: Price Elasticity, Income Elasticity & Cross Elasticity
  19. Determinants of Price Elasticity of Demand
  20. Measuring Price Elasticity of Demand
  21. Price Elasticity of Supply and Its Determinants
  22. Revealed Preference Theory of Samuelson: Concept, Assumptions & Explanation
  23. Hicks’s Revision of Demand Theory
  24. Choice Involving Risk and Uncertainty
  25. Inter Temporal Choice: Budget Constraint & Consumer Preferences
  26. Theories in Demand Analysis
  27. Elementary Theory of Price Determination: Demand, Supply & Equilibrium Price
  28. Cobweb Model: Concept, Theorem and Lagged Adjustments in Interrelated Markets
  29. Production Function: Concept, Assumptions & Law of Diminishing Return
  30. Isoquant: Assumptions and Properties
  31. Isoquant Map and Economic Region of Production
  32. Elasticity of Technical Substitution
  33. Law of Returns to Scale
  34. Production Function and Returns to Scale
  35. Euler’s Theorem and Product Exhaustion Theorem
  36. Technical Progress (Production Function)
  37. Multi-Product Firm and Production Possibility Curve
  38. Concept of Production Function
  39. Cobb Douglas Production Function
  40. CES Production Function
  41. VES Production Function
  42. Translog Production Function
  43. Concepts of Costs: Private, Social, Explicit, Implicit and Opportunity
  44. Traditional Theory of Costs: Short Run
  45. Traditional Theory of Costs: Long Run
  46. Modern Theory Of Cost: Short-run and Long-run
  47. Modern Theory Of Cost: Short Run
  48. Modern Theory Of Cost: Long Run
  49. Empirical Evidences on the Shape of Cost Curves
  50. Derivation of Short-Run Average and Marginal Cost Curves From Total Cost Curves
  51. Cost Curves In The Long-Run: LRAC and LRMC
  52. Economies of Scope
  53. The Learning Curve
  54. Perfect Competition: Meaning and Assumptions
  55. Perfect Competition: Pricing and Output Decisions
  56. Perfect Competition: Demand Curve
  57. Perfect Competition Equilibrium: Short Run and Long Run
  58. Monopoly: Meaning, Characteristics and Equilibrium (Short-run & Long-run)
  59. Multi-Plant Monopoly
  60. Deadweight Loss in Monopoly
  61. Welfare Aspects of Monopoly
  62. Price Discrimination under Monopoly: Types, Degree and Equilibrium
  63. Monopolistic Competition: Concept, Characteristics and Criticism
  64. Excess Capacity: Concept and Explanation
  65. Difference Between Perfect Competition and Monopolistic Competition
  66. Oligopoly Market: Concept, Types and Characteristics
  67. Difference Between Oligopoly Market and Monopolistic Market
  68. Oligopoly: Collusive Models- Cartel & Price Leadership
  69. Oligopoly: Non-Collusive Models- Cournot, Stackelberg, Bertrand, Sweezy or Kinked Demand Curve
  70. Monopsony Market Structure
  71. Bilateral Monopoly Market Structure
  72. Workable Competition in Market: Meaning and Explanation
  73. Baumol’s Sales Revenue Maximization Model
  74. Williamson’s Model of Managerial Discretion
  75. Robin Marris Model of Managerial Enterprise
  76. Hall and Hitch Full Cost Pricing Theory
  77. Andrew’s Full Cost Pricing Theory
  78. Bain’s Model of Limit Pricing
  79. Sylos Labini’s Model of Limit Pricing
  80. Behavioural Theory of Cyert and March
  81. Game Theory: Concept, Application, and Example
  82. Prisoner’s Dilemma: Concept and Example

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