How does the company decide how much to charge for its fashionable new products? Why are some people willing to pay more for the product than others? How does your decision affect how companies price their products? The answer to all these and more questions is microeconomics. Read on to understand what microeconomics is and how it works.
What is it?
Microeconomics pays attention to the role of consumers and businesses in the economy, and pays particular attention to how these two groups make decisions. These decisions include when consumers buy goods and how many goods they buy, or how companies determine the price of their products. Microeconomics examines smaller units of the overall economy; it is different from macroeconomics, which focuses on the impact of interest rates, employment, output, and exchange rates on the government and the entire economy. Both microeconomics and macroeconomics study the impact of actions from the perspective of supply and demand.
Microeconomics is broken down into the following principles:
- Individuals make decisions based on the concept of utility. In other words, the decision made by the individual should increase personal happiness or satisfaction. This concept is called rational behavior or rational decision-making.
- Companies make decisions based on the competition they face in the market. The more competition a company faces, the less room it has for pricing.
- Both individuals and consumers consider the opportunity cost of their actions when making decisions.
Total utility and marginal utility
The core of how consumers make decisions is the concept of personal benefit, also known as utility. The more benefits consumers feel that the product provides, the more consumers are willing to pay for the product. Consumers usually assign different levels of utility to different commodities, thereby generating different levels of demand. Consumers can choose to buy any number of goods, so utility analysis usually focuses on marginal utility, which represents the satisfaction brought about by adding a unit of goods. Total utility is the total satisfaction that consuming a product brings to consumers.
Utility can be difficult to measure, and even more difficult to aggregate to explain how all consumers behave. After all, every consumer feels different about a particular product. Take the following example as an example:
Think about how much you like to eat certain foods, such as pizza. Although you may be really satisfied after eating one slice, the seventh slice of pizza will make your stomach ache. As far as you and pizza are concerned, you might say that the benefit (utility) you get from eating the seventh slice of pizza is hardly as great as the first slice. Imagine that the value of eating the first slice of pizza is set to 14 (any number chosen for illustration).
Figure 1 below shows that every time you eat an extra slice of pizza, the total utility will increase, because the more you eat, the less you feel hungry. At the same time, because every time you eat an extra slice, the hunger you feel decreases, and the marginal utility—the utility of every extra slice—will also decrease.
|Pizza slices||Marginal utility||Total utility|
In chart form, Figure 2 and Figure 3 are as follows:
Note the difference between total utility and marginal utility creation.
The decrease in satisfaction experienced by consumers from increased units is called the law of diminishing marginal utility. Although the law of diminishing marginal utility is not a true law in the strict sense (there are exceptions), it does help explain the resources consumers spend. For example, the extra dollars needed to buy the seventh piece of pizza is better elsewhere. use.
For example, if you are given the option of buying more pizza or buying soda, you may decide to give up another slice for a drink. Just as you can point out what each slice of pizza means to you in a chart, you might also be able to show how you feel about different amounts of soda and pizza combinations. If you were to draw this chart on a chart, you would get an indifference curve that depicts the level of equivalence (satisfaction) of consumers facing various product combinations.
Figure 4 shows the combination of soda and pizza, you will be equally satisfied.
When consumers or companies decide to buy or produce specific goods, they do so at the price of buying or producing other things. This is called opportunity cost. If a person decides to spend a month’s salary on vacation instead of saving, then the direct benefit is to vacation on the beach, but the opportunity cost is the interest that may be generated in the account and the interest that may be generated in the future will be completed with this money.
To illustrate how opportunity costs affect decision-making, economists use a chart called the Production Possibility Frontier (PPF). Figure 5 shows the combination of two commodities that a company or economy can produce. The points inside the curve (point A) are considered inefficient because the maximum combination of the two commodities is not reached, and the points outside the curve (point B) do not exist because they require a higher efficiency level than is currently possible . The points outside the curve can only be reached by increasing resources or improving technology. The curve represents the maximum efficiency.
The graph shows the quantity of two different goods that a company can produce, but it does not always seek to produce Along Curve, companies may choose to produce inside The boundary of the curve. The company’s decision to produce less efficient products is determined by the demand for these two commodities. If the demand for the goods is lower than the demand that can be efficiently produced, then the company is more likely to restrict production. This decision was also affected by the competition faced by the company.
A well-known example of PPF in practice is the “guns and butter” model, which shows the combination of defense spending and civilian spending that the government can support. Although the model itself oversimplifies the complex relationship between politics and economy, the general idea is that the more the government spends on defense, the less it spends on non-defense projects.
Market failure and competition
Although the term market failure may be associated with unemployment or large-scale economic depression, the meaning of the term is different. When the economy is unable to allocate resources effectively, market failures will occur. This can lead to scarcity, surplus or general mismatch between supply and demand. Market failure is usually related to the role of competition in the production of goods and services, but it can also be caused by information asymmetry or misjudgment of the impact of specific behaviors (called externalities).
The level of competition a company faces in the market, and how this determines consumer prices, may be a more widely cited concept. There are four main types of competitions:
- Perfect competition: A large number of companies produce a commodity, and a large number of buyers are in the market. Because there are too many companies producing, there is little room for differentiation between products, and individual companies cannot influence prices because their market share is very low. There are almost no barriers to entry for the production of this commodity.
- Monopolistic competition: A large number of companies produce a product, but these companies can distinguish their products. The barrier to entry is also very low.
- Oligopoly: Relatively few companies produce a product, and each company can distinguish its product from its competitors. The barriers to entry are relatively high.
- Monopoly: A company controls the market. The barriers to entry are very high because the company controls the entire market share.
The price set by a company is determined by the competitiveness of its industry, and the company’s profit is judged by the balance between its costs and income. The fiercer the competition in the industry, the fewer options a single company has when it comes to pricing.
We can analyze the economy by examining how the decisions of individuals and companies change the types of goods produced. In the end, the smallest part of the market—the consumer—decides the course of the economy by making the choices that best match consumers’ perceptions of costs and benefits.