Microeconomics facts for kids

Microeconomics helps us understand how markets work, like this busy marketplace in Delhi.

Microeconomics is a part of economics that looks at how individuals and businesses make choices. It studies how they decide to use their limited resources. It also examines how these choices affect each other. Think of it as studying the small parts of the economy.

Microeconomics helps us understand how markets work. It shows how buyers and sellers agree on prices for goods and services. It also explains how resources are shared among different uses. Sometimes, markets don't work perfectly. Microeconomics also studies these "market failures."

While microeconomics focuses on individual choices, macroeconomics looks at the economy as a whole. Macroeconomics deals with big topics like economic growth, inflation (when prices go up), and unemployment. Microeconomics helps us understand how government policies, like changing taxes, affect individual choices and the larger economy.

Understanding Microeconomics

Microeconomics is all about understanding how people and businesses make decisions. It explores how they choose what to buy, what to sell, and how to use their money and time. These choices are important because resources like money, time, and materials are limited.

How People and Businesses Make Choices

Economists often imagine that people try to get the most satisfaction or "utility" from their choices. Businesses, on the other hand, usually try to make the most profit. These goals guide their decisions in the market.

Resources and Choices

Everyone, from a single person to a large company, has limited resources. This means they cannot have everything they want. Microeconomics studies how these limited resources are used. For example, a company must decide if it should spend money on new machines or hire more workers. A person decides whether to buy a new video game or save for a bike.

Governments also make choices about resources. They decide how to spend tax money on things like schools or roads. Sometimes, governments even decide what goods companies should produce. For instance, in the past, some governments told car factories what types of cars to build.

The History of Microeconomics

Economists often specialize in either microeconomics or macroeconomics. The idea of looking at economics in these two ways started a long time ago.

A Norwegian economist named Ragnar Frisch first talked about these different views in 1933. He used terms like "micro-dynamic" and "macro-dynamic." Later, in 1941, another economist, Pieter de Wolff, used the actual word "microeconomics" in a published article.

Key Ideas in Microeconomics

Microeconomics has several important ideas that help us understand how markets and economies work.

Consumer Choices

This part of microeconomics looks at why people buy what they do. It connects what people like (their preferences) to what they spend their money on. This helps us understand how much of a product people will want at different prices. Consumers try to get the most satisfaction from their purchases, given their budget.

How Goods Are Made (Production)

Production theory studies how things are made. It's about taking different inputs, like raw materials and labor, and turning them into useful goods or services. This can include everything from manufacturing a car to delivering a package.

The Cost of Making Things

The price of something is often linked to how much it costs to make. This includes the cost of labor (workers), capital (machines and buildings), land, and even taxation. Technology also plays a big role in how efficiently things are produced.

In the short term, a company's total costs are made up of two types: fixed costs and variable costs.

Fixed costs are expenses that do not change, no matter how much a company produces. Examples include rent for a factory, salaries for managers, and utility bills.
Variable costs are expenses that change with the amount of goods produced. These include the cost of raw materials, delivery fees, and supplies for production.

Over a short period, like a few months, most costs are fixed. But over a longer time, like two or three years, many costs can become variable. Companies can then decide to produce less, buy fewer materials, or even sell some equipment.

Sunk Costs

A sunk cost is money that has already been spent and cannot be recovered. For example, a pharmaceutical company might spend millions of dollars researching a new medicine. If the research fails, that money is a sunk cost. It's gone and cannot be used for something else.

The Value of What You Give Up (Opportunity Cost)

Because our resources are limited, every choice we make means giving up something else. The opportunity cost of an activity is the value of the next best thing you could have done instead.

Imagine you love waffles, but you love chocolate even more. If someone offers you only waffles, you'd take them. But if you're offered waffles or chocolate, you'd choose the chocolate. The opportunity cost of eating waffles is missing out on the chocolate. You choose the chocolate because its benefit is greater than the benefit of the waffles you gave up. Opportunity costs are a part of every decision we make.

How Prices Work (Price Theory)

Microeconomics is sometimes called price theory. This is because prices are very important in how buyers and sellers interact. Prices are set by the actions of individuals and businesses.

Price theory uses the idea of supply and demand to explain and predict how people behave in markets. It helps us understand how prices lead to a balance in markets. This field is often linked to the Chicago school of economics.

Price theory looks at how people react to prices. It can also be used to understand many social issues. For example, it can help explain choices related to education or even marriage.

Important Microeconomic Models

Supply and Demand: How Prices Are Set

The supply and demand model shows how prices change based on how much of a product is available (supply) and how much people want it (demand). This graph shows what happens when demand increases.

Supply and demand is a key model in economics. It explains how prices are set in markets where there are many buyers and sellers. In such a market, the price of a product settles at a point where the amount buyers want to buy equals the amount sellers want to sell. This point is called economic equilibrium.

Prices and quantities are the most visible parts of goods bought and sold in a market. The idea of supply and demand helps us understand how prices guide what is produced and what is consumed.

What is Demand?

Demand is how much of a good or service all buyers are willing to purchase at different prices. We can show demand with a table or a graph. The law of demand says that usually, as the price of a product goes up, people want to buy less of it. If the price goes down, people want to buy more. Other things, like a person's income, can also change demand.

What is Supply?

Supply is how much of a good or service sellers are willing to offer at different prices. Businesses usually want to make the most profit. So, if the price they can sell a good for goes up, they will want to supply more of it. This is called the Law of Supply. If the price goes down, they will supply less. Factors like the cost of making the product or new technology can also change supply.

Market Balance (Equilibrium)

Market equilibrium is the point where the amount supplied by sellers exactly matches the amount demanded by buyers. On a graph, this is where the supply and demand lines cross.

If the price is too low, there will be more demand than supply. This shortage will push the price up.
If the price is too high, there will be more supply than demand. This surplus will push the price down.

The supply and demand model predicts that prices and quantities will naturally move towards this balance point. In a perfectly competitive market, this balance means that the cost to make the last item is equal to the value buyers get from it.

In the short term, some production costs are easy to change (variable), like electricity or raw materials. Other costs are harder to change (fixed), like factory buildings. Over a longer time, almost all costs can be changed. This affects how quickly supply can react to changes in demand or price.

Supply and demand analysis helps us understand many things. It explains how wages are set in labor markets, based on how many jobs are available and how many people are looking for work. It also helps us understand the overall economy, like total production and general price levels.

Different Kinds of Markets

Market structure describes the features of a market. This includes how many companies are in it, how big they are, if their products are similar, and how easy it is for new companies to join or leave.

Governments sometimes create rules to make sure markets work fairly. These rules can help prevent problems when markets don't regulate themselves. For example, building codes ensure that buildings are safe, even if it costs companies more money. Without these rules, companies might not prioritize safety if consumers aren't pushing for it.

Perfect Competition

In a perfectly competitive market, there are many small companies selling identical products. No single company can influence the price. Buyers also know everything about the products. An example might be many sellers on an online marketplace like eBay selling very similar items.

Imperfect Competition

Imperfect competition describes markets that have some, but not all, features of perfect competition. In these markets, companies have some power to influence prices. For example, companies like Pepsi and Coke, or Sony, Nintendo, and Microsoft in the video game industry, are in imperfect competition. They are not monopolies, but they are not perfectly competitive either.

Monopolistic Competition

In monopolistic competition, many companies sell products that are slightly different from each other. Think of restaurants, clothing brands, or shoe companies. Even though there are many choices, each company tries to make its product unique. This gives consumers more variety, even if it means products might cost a bit more than in perfect competition.

Monopoly: One Seller

A monopoly is a market where only one company sells a particular good or service. Because there's no competition, monopolies can often charge higher prices and produce less than what society might ideally want. However, some monopolies, called natural monopolies, can be good. This happens when one producer can provide a service, like water or electricity, at a lower cost than many smaller producers could.

Oligopoly: A Few Sellers

An oligopoly is a market dominated by a small number of large companies. These companies might sometimes work together to keep prices high, forming a cartel. Or, they might compete fiercely with each other, using lots of advertising. A duopoly is a special type of oligopoly with only two main companies.

Other Market Types

Monopsony: A market with only one buyer and many sellers.
Bilateral monopoly: A market with one seller and one buyer.
Oligopsony: A market with a few buyers and many sellers.

Thinking Strategically: Game Theory

Game theory is a tool used in economics and business to understand how people or companies make decisions when their outcomes depend on what others do. It's like studying a game where players make strategic moves.

Game theory helps explain many situations, such as how companies compete in an auction, how they bargain, or how they form social networks. It's used in many areas, from understanding how people behave to how industries are organized.

The Role of Information in Economics

Information economics looks at how information affects the economy and people's decisions. Information has unique qualities: it's easy to create but sometimes hard to trust. It spreads easily but can be hard to control.

Understanding how information works is very important today, especially with the rise of technology companies. This field helps us see how people make choices when they don't have all the information, or when they try to get more information.

Microeconomics in Real Life

The United States Capitol Building is where many laws, including tax laws, are made. These laws directly affect how people and businesses make economic choices, a topic studied in public economics.

Microeconomics is used in many specialized areas of study:

Economic history looks at how economies and economic systems have changed over time.
Education economics studies how education is provided and its effects on people's skills.
Financial economics explores topics like investments and how companies are financed.
Health economics examines how healthcare systems are organized.
Industrial organization studies how companies compete and innovate in markets.
Law and economics applies economic ideas to understand how different laws work.
Political economy looks at how political systems influence economic decisions.
Public economics studies government policies related to taxes and spending.
Urban economics examines challenges in cities, such as pollution and traffic.
Labor economics focuses on job markets, including wages and employment.