CHARACTERISTICS OF MICROECONOMICS

- Is concerned with the process of resource allocation by individual decision units or

markets. It is also concerned with efficiency with which these resources are
allocated.
1. Microeconomics looks at the decisions of individual units. It focuses on the choices
made by individual decision units such as households, producers, and firms.
Resource allocation decisions are made by these individual entities in a market
economy. It is necessary to understand their decisions in order to understand the
economic system.
2. Microeconomics, often call price theory, looks at how prices are determined in
various types of market structures such as pure competition, monopoly,
monopolistic competition, and oligopoly.
3. Microeconomics is concerned with social welfare. It examines the efficiency,
relative desirability, and choice of alternative methods by which resources are
utilized to alleviate scarcity. This branch of microeconomics is termed “welfare
economics”
4. Microeconomics has a limited focus, Microeconomics is just a part of the economics
decipline. It does not examine the processes or efficiency of allocation in
alternative types of economic systems, such as a socialistic planned economy,
Neither does microeconomics focus on other economics issues, such as aggregate
level of employment of resources or the rate of inflation. Problems dealing with
the aggregate economy are within the domain of macroeconomics
5. Microeconomics develops skills, The study of microeconomics helps develop a set of
useful and marketable skills as follows:
a. Microeconomics helps develop logical reasoning
b. Microeconomics helps develop skill in the construction and use of models. This
one of the major skills economist teach to the business community.
c. Microeconomics employs optimizing techniques that are useful for making
decision in a variety of situations.
d. The concepts studied in microeconomics are applicable to personal resource
allocation decisions, such as career choices or financial investments.

Economic Model

Microeconomics makes extensive use of modeling, comparatives statics, and

mathematics. Economic models are composed of a series of statements of assumptions or
given and statements of implications or deductions. The statement describes the essential
features of an item op process and the inter relationships between factors or variable
models.
Among the best-known economic models is the competitive market or “supply and Demand”.
The Supply and Demand situations developed and explained in economics books are actually
examples of economic models.

The Market Model is an example of comparative statistics analysis. The supply and
demand relations can be expressed in three different forms: 1) verbal ( or logical),
Mathematical, and graphical.

Law of Supply can be expressed in the following words: Supply is a schedule of prices and
quantities that a supplier or supplier are willing to offer for sale at each price per period
of time. These supplier would be encouraged to sell more at higher prices and would sell
less at lower prices. This is because higher prices, other things being constant, mean
higher profits, and lower prices mean lower profits. Thus, prices and quanmtity offered
for sale are directly related, that is, the higher the price, the more supply; the lower the
price, the less supply.

The verbal explanation of the Law of Supply can be expressed in mathematical notations
too. Mathematical notations are shortcut representation of verbal explanations. The Law
of Supply can be expressed succinctly in an equation:

Qs= 500PhP

The equation Qs = 500PhP means that if the price is say PhP1, quantity supplied (qs)
PhP3 quantity supplied would be (Qs) would be PhP500 ( 500 x 1 = 500 ); if the price is
PhP3, quantity supplied would be PhP1,500 ( 500 x 3 = 1,500 ) ; if the price is Php6,
quantity supplied would be PhP3,000 ( 500 x 6 = 3000 ). Thus, we can see that there is a
direct relationship between the price and the quantity supplied.

The Law of Supply can also be expressed graphically. If we use the given raw data and
compute the supply schedule as expressed in the equation, Qs = 500P, we will derive the
following data.

Table

Supply Schedule

Price Quantity Supplied

1 500
2 1000
3 1500
4 2000
5 2500
6 3000
Models are Abstractions

Common feature of all models is that they focus only on the essential elements of an
object or process. In our example, we analyzed the behavior of supply only from the point
of view of varying prices. We mentioned if prices are high, quantity supplied is also be
high. Clearly, we know that supply of commodities is affected by other factors.

Models that consistently predict a broad range of real world phenomena are classified
as theories. Not all models are theories. Most of the models encountered in our text are
regarded as theories. Whn there is a correspondence between the consitions described in
the assumptions of a model and the conditions in the economy, Model may be applied to
predict or forecast events in the economy. The test of a theory is the consistency of its
predictions.

We can say that microeconomics is concerned with three type of models.

1. Models to explain the resource allocation or “choice” decisions of individual

household, producers , and firms
2. Models to explain how prices and quantities exchanged are determined in various
types of market structures.
3. Modles to examine the market economy as an interrelated system ( general
equilibrium model )

An Example of Model

- Intervention in the energy industry has been practiced by government in at least

four forms’ price and tax administration, licensing, rationing, and corpoirate
participation in the industry. One can attempt a theoretical construct to defend
government presence in an oligopoly industry like oil refining and marketing. It has
been demonstrated in earlier works in oligopoly theory that a government purchase
entry into an oligopoly industry can improve short-run market performance by
inducing an increase in total industry output.
- Assume a [etrp;ei, [rpdict de,am fimctopm tjat cam be ex[ressed as:
Qt = a-bP

Where: Qt is total industry sales;

P represents the selling price of the private firms acting jointly; and a and b
are positive coefficients.

Start with three firms of equal sizes acting initially as a joint monopoly with identical unit
variable cost of k. Profit will be maximized when:
 P = (a + bk)
2
And the resultant sales would be:

Qt = ( a + bk)
2
Then, allo9w government entry through a buy out of existing capacity ( perhaps one of the
three firm). Presume that the government firm has been mandated to engineer the
highest possible industry output without the inflicting losses on the private firms and that
prices are set so that there is never unsatisfied demand at those price levels.

One can conceive of two sales policy options that government can take. We can call one a
sales neutral strategy in the sense that regardless of the price it sets, it leave the
elasticity of demand facing the privater firms the same as before the entry of
government.

The other is a discriminatory sales policy in the sense that it electys to sell the product to
buyers who are prepared to pay higher prices for the commodity. This can happen only if
it is the low price seller in the market is so tolerated by the private firms.

Strategy A Select a price level that will maximize joint monopoly profits after allowing the
government firm to sell all it can at the price that it selects. Private firms will end up
pricing above the government’s price level.

Strategy B. Price within the government entry can be derived from any combination of
strategies pursued by government and private industry, respectively. Corresponding
industry output at profit-maximizing price strategies by the private firms can then be
estimated for any price level the government sets. Likewise, private profit resulting from
a joint monopoly decision mode can then be expressed as a function of the government
price strategy.
If we analyze this example, we can see that this model satisfies the three type of
microeconomics that concerned with: resource allocation decisions, pricing decisions, and
market economy as an interrelated system dound in a market model called “oligopoly”

COMPARATIVE STATICS VS DYNAMIC ANALYSIS

Comparative statics focuses on the shift in equilibrium positions ( statics ) for an
individual decision unit, a market, or an economic system. Microeconomics extensively uses
comparative statics analysis.

EQUILIBRIUM – refers to a state in which there is a balance of internal forces and no

tendency for the situation to change unless outside forces intervene. A system in such
equilibrium may also be termed “static”
Let us say in a competitive market supply and demand for a commodity reach equilibrium at
the price of PhP20 per unit. If demand exceeds supply because of an increase in
population and an effective advertising program, it is possible that price would go up to PhP
22 per unit. Comparative statics is applicable here because ther is a shift in equilibrium
brought about by an increase or shift in demand. Thus, price would go up from Php 20 to
Php 22 per unit.

DYNAMIC ANALYSIS – focuses on the pattern and rate of change for some variable
between points in time. In the static model the initial price of Php20 was predicted to go
up to Php 22 without informing the consumers when or how much time it would take for the
price to increase. If the model tells us that the price of the commodity would go up in a
week’s time, then the dynamic analysis is used.

PARTIAL VS. GENERAL EQUILIBRIUM – compares equilibrium changes for one decision
unit or one market independent of related changes in the economic system. It assumes for
the purpose of analysis that other factors will remain the same.

For example, we know that the demand for a commodity depends on its price ( other things
being constant ). Demand of the commodity can thus be expressed as: Qd = f(P)

GENERAL EQUILIBRIUM ANALYSIS recognizes the interdependence of all decision units

and all markets in the economic system. It examines changes within the context of the
entire system. All variable are allowed to adjust in response to the initial change. The
changes are then incorporated into the calculations.
Example: we know that the demand for a commodity depends not only on its
Price (P), but also on income (Y), population (Po), price expectation (Pe), advertising and
promotion (Ad), among others things. This attempts to include all possible variable that
would affect demand all under the general equilibrium analysis. A more realistic demand
equation can now be expressed as: Qd = f(P,Y,Po,Pe,Ad )

The Circular flow of Economic Activity

Within the economy, the basic activities of production, consumption, employment, and
income generation take place though the interrelationship existing between the basic
consuming unit, which is the household, and the basic producing unit, which is the firm.
 Good and Services
Payments

HOUSEHOLD BUSINESS FIRM

Rents, Interest, Wages & Profits

Land, Labor, Capital & Entreprenneurs

The top lop in the diagram shows the business firm supplying the household with
gods and services in exchange for payments representing consumption expenditures. On
the other hand, the business firm has to use economic resources consisting of land, labor,
capital and entrepreneur to produce these goods and service. The household provides the
firms these resources in exchange for payments in the forms of rent, interest, wages,
salaries, and profit.

BASIC ECONOMIC PROBLEM

1. What to produce? – types of goods society desires

2. How much to produce? – refers to the quantity of each good that the economy
will have to produce to make up the total output.
3. How to produce?- is a question on the technique of production and the manner
of combining resources to come up with the desire output.
4. For Whom to produce- refers to the market to which the producers will sell
their products.

TYPES OF ECONOMIC SYSTEM

1. TRADITIONAL ECONOMOMIC SYSTEM – production decisions are made

according to customs and traditions.
2. COMMAND ECONOMY – the answers to the basic economic problems are
dictated by the government through the head of the nation or a group of men
designated by the head to make decisions.
3. MARKET SYSTEM – deals with the economic problems by considering
consumer’s choices. Indicator is the consumer demand in the market as
reflected in the prices of goods and services. This is best describe as the free
enterprise where individual enjoy the right of private property. The economy,
operates of voluntary exchange and cooperation among private individuals and
organization.

Under the free enterprise system individual is free to do the following:

1. Purchase goods and services of his choice within the limits of his income;
2. Offer his economic resources for sale in exchange for a financial remuneration.
3. Establish a business enterprise of his choice for the production and sale of
desired product.

MIXED ECONOMY – it is a system exists in its pure form.