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Introduction to Microeconomics

In modern times, the study of economics has been divided into two branches i.e. Micro and Macroeconomics. The terms ‘microeconomics’ and ‘macroeconomics’ were first used in economics by Norwegian economist Ragnar Frisch in 1933. After Prof. Frisch, the terms earned popularity when J.M. Keynes clearly distinguished between the terms through his book entitled General Theory of Employment, Interest and Money’ published in 1936. And now the terms are being used in economics by economists all over the world.

1- Meaning of Microeconomics
The word Microeconomics is formed by the two words, ‘micro’ plus ‘economics’. The word ‘micro’ seems to have been derived from the Greek word ‘mikros’. In the Greek language, ‘mikros’ means small. Therefore, microeconomics refers to the study of small individual units of an economy. In other words, Microeconomics deals with the analysis of small individual units of the economy such as individual consumers, individual firms, and small aggregates or groups of individual units, i.e. output of particular goods and services produced by single firms or industries, particular households, individual prices of goods and services, individual wages, incomes, etc.
In this regard, K.E. Boulding has given a definition as ‘Microeconomics is the study of a particular firm, a particular household, individual price, wage, income industry, and particular commodity.’ Thus, microeconomics is the study that seeks to explain how a consumer uses his limited income in various goods and services, and how he maximizes his satisfaction. Similarly, it also seeks to explain how a firm decides what, how and for whom to produce. This is how microeconomics studies small economic units and their behavior but not the economy as a whole.

Microeconomics is concerned with the issues like;

1.How a firm determines the sales price of its products,

2.What amount of output will maximize its profit,

3.How a firm determines the lowest cost combination of different factors of production,

4.How the individual consumer determines the distribution of his/her spending on various goods and services so as to maximize satisfaction,

5.How the prices of individual factors of production are determined,

6.How a firm or an industry allocates limited resources for the production of different goods and services, etc.

This way microeconomics studies small parts of an economic body but not the economy as a whole.

2- Functions of Microeconomic Theory
The functions of a microeconomic theory are concerned with the study of the economic behavior of consumers, resource owners, and business firms who individually can play a decision-making role in a free market economy.

Microeconomic theory is called price theory due to its functional nature related to individual business activities of households and business firms which studies the circular flow of goods and services from households to business-firm and from business-firm to households. The theory analyses the composition of such a flow and the way of price determination of goods and services as well as price of resources used. The circular flow of activities are as follows:
 

In the above figure, the household activities connected to sell the factors land, labor, and capital to the business firm through the factor market and the business firms buy the inputs. The business firms produce and sell goods and services to the households through the goods market. The firms are the sellers and the households are the buyers. Likewise, firms spend money-income received by selling goods and services to buy factors like raw materials, labor, capital, land, etc. This circular flow continues till the economy exists in the society. This is how the firm and household activities are connected with each other and with an interaction between them, the price of goods and services and quantities are determined. This is the way microeconomic theories function. The functions of microeconomic theory can be explained pointwise as below.

2.1-Analysis of Individual Behaviour
The function of microeconomic theory is to explain the behavior of an individual consumer or household in relation to optimum allocation of limited means for achieving maximum possible satisfaction. Similarly, to explain the behavior of an individual producer or firm on account of the use of limited resources to make maximum possible profits.

2.2-Pricing
Another function of microeconomic theory is to give an idea about the determination of the prices of goods and services in different market structures. Similarly, it also functions to help to understand the determination of factor prices like rent, wages, interest in factor markets.

2.3-Business Decision Making
It is a microeconomic theory that provides a basic idea for the firm to make better business decisions so that maximum possible profits can be achieved.

3.4-Formulating Economic Policies
A microeconomic theory provides basic tools to formulate various economic policies like tax policy, trade policy, Policy of promoting business, import, export, etc.

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