Microeconomics Definition, Uses, and Concepts

What Is Microeconomics?

Microeconomics is the social science that studies the implications of incentives and decisions,
specifically how those affect the utilization and distribution of resources. Microeconomics
shows how and why different goods have different values, how individuals and businesses
conduct and benefit from efficient production and exchange, and how individuals best
coordinate and cooperate with one another. Generally speaking, microeconomics provides a
more complete and detailed understanding than macroeconomics.

KEY TAKEAWAYS

 Microeconomics studies the decisions of individuals and firms to allocate resources of

production, exchange, and consumption.
 Microeconomics deals with prices and production in single markets and the interaction
between different markets but leaves the study of economy-wide aggregates to
macroeconomics.
 Microeconomists formulate various types of models based on logic and observed human
behavior and test the models against real-world observations.

Understanding Microeconomics

Microeconomics is the study of what is likely to happen (tendencies) when individuals make
choices in response to changes in incentives, prices, resources, and/or methods of production.
Individual actors are often grouped into microeconomic subgroups, such as buyers, sellers, and
business owners. These groups create the supply and demand for resources, using money
and interest rates as a pricing mechanism for coordination.

The Uses of Microeconomics

Microeconomics can be applied in a positive or normative sense. Positive microeconomics

describes economic behavior and explains what to expect if certain conditions change. If a
manufacturer raises the prices of cars, positive microeconomics says consumers will tend to buy
fewer than before. If a major copper mine collapses in South America, the price of copper will
tend to increase, because supply is restricted. Positive microeconomics could help an investor
see why Apple Inc. stock prices might fall if consumers buy fewer iPhones. Microeconomics
could also explain why a higher minimum wage might force The Wendy's Company to hire
fewer workers.

These explanations, conclusions, and predictions of positive microeconomics can then also be
applied normatively to prescribe what people, businesses, and governments should do in order
to attain the most valuable or beneficial patterns of production, exchange, and consumption
among market participants. This extension of the implications of microeconomics from
what is to what ought to be or what people ought to do also requires at least the implicit
application of some sort of ethical or moral theory or principles, which usually means some
form of utilitarianism.

Method of Microeconomics

Microeconomic study historically has been performed according to general equilibrium theory,
developed by Léon Walras in Elements of Pure Economics (1874) and partial equilibrium
theory, introduced by Alfred Marshall in Principles of Economics (1890).1 The Marshallian and
Walrasian methods fall under the larger umbrella of neoclassical microeconomics. Neoclassical
economics focuses on how consumers and producers make rational choices to maximize their
economic well being, subject to the constraints of how much income and resources they have
available. Neoclassical economists make simplifying assumptions about markets—such as
perfect knowledge, infinite numbers of buyers and sellers, homogeneous goods, or static
variable relationships—in order to construct mathematical models of economic behavior.

These methods attempt to represent human behavior in functional mathematical language,

which allows economists to develop mathematically testable models of individual markets.
Neoclassicals believe in constructing measurable hypotheses about economic events, then using
empirical evidence to see which hypotheses work best. In this way, they follow in the “logical
positivism” or “logical empiricism” branch of philosophy. Microeconomics applies a range of
research methods, depending on the question being studied and the behaviors involved.
Basic Concepts of Microeconomics

The study of microeconomics involves several key concepts, including (but not limited to):

 Incentives and behaviors: How people, as individuals or in firms, react to the situations
with which they are confronted.
 Utility theory: Consumers will choose to purchase and consume a combination of goods
that will maximize their happiness or “utility,” subject to the constraint of how much
income they have available to spend.
 Production theory: This is the study of production—or the process of converting inputs
into outputs. Producers seek to choose the combination of inputs and methods of
combining them that will minimize cost in order to maximize their profits.
 Price theory: Utility and production theory interact to produce the theory of supply and
demand, which determine prices in a competitive market. In a perfectly competitive
market, it concludes that the price demanded by consumers is the same supplied by
producers. That results in economic equilibrium.
Macroeconomics Definition, History, and Schools of Thought

What Is Macroeconomics?

Macroeconomics is a branch of economics that studies how an overall economy—the markets,

businesses, consumers, and governments—behave. Macroeconomics examines economy-wide
phenomena such as inflation, price levels, rate of economic growth, national income, gross
domestic product (GDP), and changes in unemployment.

Some of the key questions addressed by macroeconomics include: What causes unemployment?
What causes inflation? What creates or stimulates economic growth? Macroeconomics attempts
to measure how well an economy is performing, understand what forces drive it, and project
how performance can improve.

KEY TAKEAWAYS

 Macroeconomics is the branch of economics that deals with the structure, performance,
behavior, and decision-making of the whole, or aggregate, economy.
 The two main areas of macroeconomic research are long-term economic growth and
shorter-term business cycles.
 Macroeconomics in its modern form is often defined as starting with John Maynard
Keynes and his theories about market behavior and governmental policies in the 1930s;
several schools of thought have developed since.
 In contrast to macroeconomics, microeconomics is more focused on the influences on
and choices made by individual actors in the economy (people, companies, industries,
etc.).

Understanding Macroeconomics

As the term implies, macroeconomics is a field of study that analyzes an economy through a
wide lens. This includes looking at variables like unemployment, GDP, and inflation. In
addition, macroeconomists develop models explaining the relationships between these factors.
These models, and the forecasts they produce, are used by government entities to aid in
constructing and evaluating economic, monetary, and fiscal policy. Businesses use the models
to set strategies in domestic and global markets, and investors use them to predict and plan for
movements in various asset classes.

Properly applied, economic theories can illuminate how economies function and the long-term
consequences of particular policies and decisions. Macroeconomic theory can also help
individual businesses and investors make better decisions through a more thorough

The link between goods markets and large-scale financial variables such as price levels and
interest rates was explained through the unique role that money plays in the economy as a
medium of exchange by economists such as Knut Wicksell, Irving Fisher, and Ludwig von
Mises.

Macroeconomics vs. Microeconomics

Macroeconomics differs from microeconomics, which focuses on smaller factors that affect
choices made by individuals and companies. Factors studied in both microeconomics and
macroeconomics typically influence one another.

A key distinction between micro- and macroeconomics is that macroeconomic aggregates can
sometimes behave in very different ways or even the opposite of similar microeconomic
variables. For example, Keynes referenced the so-called Paradox of Thrift, which argues that
individuals save money to build wealth (micro). However, when everyone tries to increase their
savings at once, it can contribute to a slowdown in the economy and less wealth in the aggregate
(macro). This is because there would be a reduction in spending, affecting business revenues
and lowering worker pay.

Meanwhile, microeconomics looks at economic tendencies, or what can happen when

individuals make certain choices. Individuals are typically classified into subgroups, such as
buyers, sellers, and business owners. These actors interact with each other according to the laws
of supply and demand for resources, using money and interest rates as pricing mechanisms for
coordination.
Limits of Macroeconomics

It is also important to understand the limitations of economic theory. Theories are often created
in a vacuum and lack specific real-world details like taxation, regulation, and transaction costs.
The real world is also decidedly complicated and includes matters of social preference and
conscience that do not lend themselves to mathematical analysis.

It is common in economics to find the phrase ceterus paribus, loosely translated as "all else
being equal," in economic theories and discussions. This is because there are so many variables
that economists use this phrase as an assumption to focus on the relationships between the
variables being discussed.

Even with the limits of economic theory, it is important and worthwhile to follow significant
macroeconomic indicators like GDP, inflation, and unemployment. This is because the
performance of companies, and by extension their stocks, is significantly influenced by the
economic conditions in which the companies operate.

Likewise, it can be invaluable to understand which theories are in favor and influencing a
particular government administration. The underlying economic principles of a government will
say much about how that government will approach taxation, regulation, government spending,
and similar policies. By better understanding economics and the ramifications of economic
decisions, investors can get at least a glimpse of the probable future and act accordingly with
confidence.

Macroeconomic Schools of Thought

The field of macroeconomics is organized into many different schools of thought, with differing
views on how the markets and their participants operate.

Classical

Classical economists held that prices, wages, and rates are flexible and markets tend to clear
unless prevented from doing so by government policy, building on Adam Smith's original
theories. The term “classical economists” is not actually a school of macroeconomic thought but
a label applied first by Karl Marx and later by Keynes to denote previous economic thinkers
with whom they respectively disagreed.

Keynesian

Keynesian economics was founded mainly based on the works of John Maynard Keynes and
was the beginning of macroeconomics as a separate area of study from microeconomics.
Keynesians focus on aggregate demand as the principal factor in issues like unemployment and
the business cycle.

Keynesian economists believe that the business cycle can be managed by active government
intervention through fiscal policy, where governments spend more in recessions to stimulate
demand or spend less in expansions to decrease it. They also believe in monetary policy, where
a central bank stimulates lending with lower rates or restricts it with higher ones.

Keynesian economists also believe that certain rigidities in the system, particularly sticky
prices, prevent the proper clearing of supply and demand.

Monetarist

The Monetarist school is a branch of Keynesian economics credited mainly to the works of
Milton Friedman. Working within and extending Keynesian models, Monetarists argue that
monetary policy is generally a more effective and desirable policy tool to manage aggregate
demand than fiscal policy. However, monetarists also acknowledge limits to monetary policy
that make fine-tuning the economy ill-advised and instead tend to prefer adherence to policy
rules that promote stable inflation rates.

New Classical

The New Classical school, along with the New Keynesians, is mainly built on integrating
microeconomic foundations into macroeconomics to resolve the glaring theoretical
contradictions between the two subjects.
The New Classical school emphasizes the importance of microeconomics and models based on
that behavior. New Classical economists assume that all agents try to maximize their utility and
have rational expectations, which they incorporate into macroeconomic models. New Classical
economists believe that unemployment is largely voluntary and that discretionary fiscal policy
destabilizes, while inflation can be controlled with monetary policy.

New Keynesian

The New Keynesian school also attempts to add microeconomic foundations to traditional
Keynesian economic theories. While New Keynesians accept that households and firms operate
based on rational expectations, they still maintain that there are a variety of market failures,
including sticky prices and wages. Because of this "stickiness," the government can improve
macroeconomic conditions through fiscal and monetary policy.

Austrian

The Austrian School is an older school of economics that is seeing some resurgence in
popularity. Austrian economic theories mainly apply to microeconomic phenomena. However,
they, like the so-called classical economists, never strictly separated micro- and
macroeconomics.

Austrian theories also have important implications for what is otherwise considered
macroeconomic subjects. In particular, the Austrian business cycle theory explains broadly
synchronized (macroeconomic) swings in economic activity across markets due to monetary
policy and the role that money and banking play in linking (microeconomic) markets to each
other and across time.

Macroeconomic Indicators

Macroeconomics is a rather broad field, but two specific research areas represent this discipline.
The first area is the factors that determine long-term economic growth, or increases in the
national income. The other involves the causes and consequences of short-term fluctuations in
national income and employment, also known as the business cycle.
Economic Growth

Economic growth refers to an increase in aggregate production in an economy.

Macroeconomists try to understand the factors that either promote or retard economic growth to
support economic policies that will support development, progress, and rising living standards.

Economists can use many indicators to measure economic performance. These indicators fall
into 10 categories:1

 Gross Domestic Product indicators: Measure how much the economy produces
 Consumer Spending indicators: Measure how much capital consumers feed back into
the economy
 Income and Savings indicators: Measures how much consumers make and save
 Industry Performance indicators: Measures GDP by industry
 International Trade and Investment indicators: Indicates the balance of payments
between trade partners, how much is traded, and how much is invested internationally
 Prices and Inflation indicators: Indicate fluctuations in prices paid for goods and
services and changes in currency purchasing power
 Investment in Fixed Assets indicators: Indicate how much capital is tied up in fixed
assets
 Employment indicators: Shows employment by industry, state, county, and other areas
 Government indicators: Shows how much the government spends and receives
 Special indicators: All other economic indicators, such as distribution of personal
income, global value chains, healthcare spending, small business well-being, and more

The Business Cycle

Superimposed over long-term macroeconomic growth trends, the levels and rates of change of
significant macroeconomic variables such as employment and national output go through
fluctuations. These fluctuations are called expansions, peaks, recessions, and troughs—they also
occur in that order. When charted on a graph, these fluctuations show that businesses perform in
cycles; thus, it is called the business cycle.
The National Bureau of Economic Research (NBER) measures the business cycle, which uses
GDP and Gross National Income to date the cycle.2 The NBER is also the agency that declares
the beginning and end of recessions and expansions.

How to Influence Macroeconomics

Because macroeconomics is such a broad area, positively influencing the economy is

challenging and takes much longer than changing the individual behaviors within
microeconomics. Therefore, economies need to have an entity dedicated to researching and
identifying techniques that can influence large-scale changes.

In the U.S., the Federal Reserve is the central bank with a mandate of promoting maximum
employment and price stability. These two factors have been identified as essential to positively
influencing change at the macroeconomic level.

To influence change, the Fed implements monetary policy through tools it has developed over
the years, which work to affect its dual mandates. It has the following tools it can use:3

 Federal Funds Rate Range: A target range set by the Fed that guides interest rates on
overnight lending between depository institutions to boost short-term borrowing
 Open Market Operations: Purchase and sell securities on the open market to change
the supply of reserves
 Discount Window and Rate: Lending to depository institutions to help banks manage
liquidity
 Reserve Requirements: Maintaining a reserve to help banks maintain liquidity—
reduced to 0% in 2020
 Interest on Reserve Balances: Encourages banks to hold reserves for liquidity and pays
them interest for doing so
 Overnight Repurchase Agreement Facility: A supplementary tool used to help control
the federal funds rate by selling securities and repurchasing them the next day at a more
favorable rate
 Term Deposit Facility: Reserve deposits with a term, used to drain reserves from the
banking system
  Central Bank Liquidity Swaps: Established swap lines for central banks from select
countries to improve liquidity conditions in the U.S. and participating countries' central
banks
 Foreign and International Monetary Authorities Repo Facility: A facility for
institutions to enter repurchase agreements with the Fed to act as a backstop for liquidity
 Standing Overnight Repurchase Agreement Facility: A facility to encourage or
discourage borrowing above a set rate, which helps to control the effective federal funds
rate.

The Fed continuously updates the tools it uses to influence the economy, so it has a list of 14
other previously used tools it can implement again if needed.4

What Is Macroeconomics in Economics?

Macroeconomics is the field of study of the way a overall economy behaves.

What are the 3 Major Concerns of Macroeconomics?

Three major macroeconomic concerns are the unemployment level, inflation, and economic
growth.

Why Is Macroeconics Important?

Macroeconomics helps a government evaluate how an economy is performing and decide on

actions it can take to increase or slow growth.

The Bottom Line

Macroeconomics is a field of study used to evaluate performance and develop actions that can
positively affect an economy. Economists work to understand how specific factors and actions
affect output, input, spending, consumption, inflation, and employment.
The study of economics began long ago, but the field didn't start evolving into its current form
until the 1700s. Macroeconomics now plays a large part in government and business decision-
making.

Utilitarianism: What It Is, Founders, and Main Principles

What Is Utilitarianism?

Utilitarianism is a theory of morality that advocates actions that foster happiness or pleasure and
oppose actions that cause unhappiness or harm. When directed toward making social, economic,
or political decisions, a utilitarian philosophy would aim for the betterment of society as a
whole.

Utilitarianism would say that an action is right if it results in the happiness of the greatest
number of people in a society or a group.

KEY TAKEAWAYS

 Utilitarianism is a theory of morality that advocates actions that foster happiness and
oppose actions that cause unhappiness.
 Utilitarianism promotes "the greatest amount of good for the greatest number of people."
 When used in a sociopolitical construct, utilitarian ethics aims for the betterment of
society as a whole.
 Utilitarianism is a reason-based approach to determining right and wrong, but it has
limitations.
 Utilitarianism does not account for things like feelings and emotions, culture, or justice.

Understanding Utilitarianism
Utilitarianism is a tradition of ethical philosophy that is associated with Jeremy Bentham (1747-
1832) and John Stuart Mill (1806-1873), two late 18th- and 19th-century British philosophers,
economists, and political thinkers. Utilitarianism holds that an action is right if it tends to
promote happiness and wrong if it tends to produce sadness, or the reverse of happiness—not
just the happiness of the actor but that of everyone affected by it.

At work, you display utilitarianism when you take actions to ensure that the office is a positive
environment for your co-workers to be in, and then make it so for yourself.

"The greatest good for the greatest number" is a maxim of utilitarianism.

The 3 Generally Accepted Principles of Utilitarianism State That

 Pleasure, or happiness, is the only thing that has intrinsic value. To say that
something has intrinsic value means that it is simply good in itself. Intrinsic value
contrasts with instrumental value. Something has instrumental value when it is a means
to some end.
 Actions are right if they promote happiness, and wrong if they promote
unhappiness.
This principle is quite controversial since it involves that the moral quality of an action
is decided by the size of its consequences. So long as an action produces maximum
benefits for the greatest number of people, utilitarianism does not care whether the
results are driven by immoral motives. However, this principle can be refuted since most
people would agree that the moral quality of an action depends on the motive or
intention behind it.
 Everyone's happiness counts equally. Although this axiom may seem quite obvious,
this principle of equality was radical and progressive in Bentham's time. By then, it was
commonly accepted that some lives and some people's happiness were simply more
important and valuable than others. Betham's principle of equality makes the
government responsible for creating policies that would benefit all equally, not just the
elite.
Utilitarianism's Relevance in a Political Economy

In liberal democracies throughout the centuries, the progenitors of utilitarianism spawned

variants and extensions of its core principles. Some of the questions they wrestled with include:
What constitutes "the greatest amount of good"? How is happiness defined? How is justice
accommodated?

In today's Western democracies, policymakers are generally proponents of free markets and
some base level of government interference in the private lives of citizens so as to assure safety
and security. Although the appropriate amount of regulation and laws will always be a subject
of debate, political and economic policies are geared primarily toward fostering as much well-
being for as many people as possible, or at least they should be. Where there are disadvantaged
groups who suffer income inequality or other negative consequences because of a utilitarian-
based policy or action, most politicians would try to find a remedy.

In Business and Commerce

Utilitarianism holds that the most ethical choice is the one that will produce the greatest good
for the greatest number. As such, it is the only moral framework that can justify military force
or war. Moreover, utilitarianism is the most common approach to business ethics because of the
way that it accounts for costs and benefits.

The theory asserts that there are two types of utilitarian ethics practiced in the business world,
"rule" utilitarianism and "act" utilitarianism.

 Rule utilitarianism helps the largest number of people using the fairest methods possible.
 Act utilitarianism makes the most ethical actions possible for the benefit of the people.

In the Corporate Workplace

Most companies have a formal or informal code of ethics, which is shaped by their corporate
culture, values, and regional laws. Today, having a formalized code of business ethics is more
important than ever. For a business to grow, it not only needs to increase its bottom line, but it
also must create a reputation for being socially responsible. Companies also must endeavor to
keep their promises and put ethics at least on par with profits. Consumers are looking for
companies that they can trust, and employees work better when there is a solid model of ethics
in place.

On an individual level, if you make morally correct decisions at work, then everyone's
happiness will increase. However, if you choose to do something morally wrong—even if legal
—then your happiness and that of your colleagues, will decrease.

Utilitarian Ethics

"Rule" Utilitarian Ethics

An example of rule utilitarianism in business is tiered pricing for a product or service for
different types of customers. In the airline industry, for example, many planes offer first-,
business-, and economy-class seats. Customers who fly in first or business class pay a much
higher rate than those in economy seats, but they also get more amenities—simultaneously,
people who cannot afford upper-class seats benefit from the economy rates. This practice
produces the highest good for the greatest number of people.

And the airline benefits, too. The more expensive upper-class seats help to ease the financial
burden that the airline created by making room for economy-class seats.

"Act" Utilitarian Ethics

An example of act utilitarianism could be when pharmaceutical companies release drugs that
have been governmentally approved, but with known minor side effects because the drug is able
to help more people than are bothered by the side effects. Act utilitarianism often demonstrates
the concept that “the end justifies the means”—or it's worth it.

Quantitative Utilitarism vs. Qualitative Utilitarism

Quantitative utilitarianism is a branch of utilitarianism that was developed out of the work of
Jeremy Bentham. Quantitative utilitarians focus on utility maximization, that is, maximizing the
overall happiness of everyone, and use a hedonic approach to determine the rightness or
wrongness of actions. Bentham defined as the foundation of his philosophy the principle that “it
is the greatest happiness of the greatest number that is the measure of right and wrong”.

Qualitative utilitarianism is a branch of utilitarianism that arose from the work of John Stuart
Mill. Qualitative utilitarians categorize pleasures and pains in a more qualitative manner,
depending on the level of their consequences, and disregarding any quantifiable proof of their
importance.

Quantitative vs. Qualitative

Qualitative utilitarianism argues that mental pleasures and pains are different in kind and
superior in quality to purely physical ones. Quantitative utilitarianism argues that mental
pleasures and pains differ from physical ones only in terms of quantity.3

The Limitations of Utilitarianism

In the workplace, though, utilitarian ethics are difficult to achieve. These ethics also can be
challenging to maintain in our business culture, where a capitalistic economy often teaches
people to focus on themselves at the expense of others. Similarly, monopolistic
competition teaches one business to flourish at the expense of others.

 A limitation of utilitarianism is that it tends to create a black-and-white construct of

morality. In utilitarian ethics, there are no shades of gray—either something is wrong or
it is right.
 Utilitarianism also cannot predict with certainty whether the consequences of our actions
will be good or bad—the results of our actions happen in the future.
 Utilitarianism also has trouble accounting for values like justice and individual rights.
For example, say a hospital has four people whose lives depend upon receiving organ
transplants: a heart, lungs, a kidney, and a liver. If a healthy person wanders into the
hospital, his organs could be harvested to save four lives at the expense of his one life.
This would arguably produce the greatest good for the greatest number. But few would
consider it an acceptable course of action, let alone an ethical one.
So, although utilitarianism is surely a reason-based approach to determining right and wrong, it
has obvious limitations.

What Are the Principles of Utilitarianism?

Utilitarianism puts forward that it is a virtue to improve one's life better by increasing the good
things in the world and minimizing the bad things. This means striving for pleasure and
happiness while avoiding discomfort or unhappiness.

What Is a Utilitarian?

A utilitarian is a person who holds the beliefs of utilitarianism. Today, these people might be
described as cold and calculating, practical, and perhaps selfish—since they may seek their own
pleasure at the expense of the social good at times.

What Is Rule Utilitarianism?

Rule utilitarians focus on the effects of actions that stem from certain rules or moral guidelines
(e.g. the "golden rule", the 10 commandments, or laws against murder). If an action conforms to
a moral rule then the act is moral. A rule is deemed moral if its existence increases the greater
good than any other rule, or the absence of such a rule.

What Is Utilitarian Value in Consumer Behavior?

If a consumer buys something only for its practical use-value, in a calculative and rational
evaluation, then it is of utilitarian value. This precludes any sort of emotional or sentimental
valuing, psychological biases, or other considerations.

What Is the Role of Utilitarianism in Today’s Business Environment?

Because its ideology argues for the greatest good for the greatest number, a business acting in a
utilitarian fashion should increase the welfare of others. However, in practice, utilitarianism can
lead to greed and dog-eat-dog competition that can undermine the social good.

The Bottom Line

Utilitarianism offers a relatively simple method for deciding the morally right course of action
for any particular situation. Over the years, the principle of utilitarianism has been refined and
expanded in many variations. Utilitarians today describe benefits and harms in terms of the
satisfaction of personal preferences or in purely economic terms of monetary benefits over
monetary costs, rather than in terms of "happiness" and "pleasure".4

Crowding out effect

Crowding out effect is an economic term referring to government spending driving down
private sector spending, and can have several more specific meanings.Crowding out can refer to
when government borrowing absorbs all the available lending capacity in the economy. This
causes interest rates to rise. As a result, private businesses and individuals find it cost
prohibitive to borrow money to fund growth and expansion. This, in turn, can create a
downturn in the economy, which lowers tax revenue and thus increases the need for the
government to borrow even more money. In another example, higher taxes required for the
government to fund social welfare programs can leave less discretionary income for individuals
and businesses to make charitable donations. Further, when the government funds certain
activities, there is little incentive for businesses and individuals to spend on those same
things. From this perspective, private business does not enter into a market segment because the
government provides a service that makes that segment unprofitable or undesirable. For
instance, more and more roads are being funded and built by private companies, which
construct them as toll roads to make a profit. But if the government increases its spending on
public roads, growth in the private toll road business will decline. Finally, crowding out can
also refer to the government conducting activities that were traditionally performed by the
private sector. For instance, an increase in government investment and grants to private
businesses crowds out the financial entities, such as venture capital firms, that traditionally do
this themselves.
Investopedia / Madelyn Goodnight

What Is the Invisible Hand?

The invisible hand is a metaphor for the unseen forces that move the free market economy.
Through individual self-interest and freedom of production and consumption, the best interest
of society, as a whole, are fulfilled. The constant interplay of individual pressures on market
supply and demand causes the natural movement of prices and the flow of trade.

The term "invisible hand" first appeared in Adam Smith's famous work, The Wealth of
Nations, to describe how free markets can incentivize individuals, acting in their own self-
interest, to produce what is societally necessary.

KEY TAKEAWAYS

 The invisible hand is a metaphor for how, in a free market economy, self-interested
individuals operate through a system of mutual interdependence.
 This interdependence incentivizes producers to make what is socially necessary, even
though they may care only about their own well-being.
 Adam Smith introduced the concept in his 1759 book The Theory of Moral
Sentiments and later in his 1776 book An Inquiry Into the Nature and Causes of the
Wealth of Nations.
 Each free exchange creates signals about which goods and services are valuable and how
difficult they are to bring to market.
 Critics argue that the invisible hand does not always produce socially beneficial
outcomes, and can encourage greed, negative externalities, inequalities, and other harms.

 The Invisible Hand and Market Economies

 Business productivity and profitability are improved when profits and losses accurately
reflect what investors and consumers want. This concept is well-demonstrated through a
 famous example in Richard Cantillon’s An Essay on Economic Theory (1755), the book
from which Smith developed his invisible hand concept.3

 Smith's An Inquiry Into the Nature and Causes of the Wealth of Nations was published
during the first Industrial Revolution and the same year as the American Declaration of
Independence. Smith’s invisible hand became one of the primary justifications for an
economic system of free-market capitalism.

 As a result, the business climate of the U.S. developed with a general understanding that
voluntary private markets are more productive than government-run economies. Even
government rules sometimes try to incorporate the invisible hand.

 Former Fed Chair Ben Bernanke explained the "market-based approach is regulation by
the invisible hand" which "aims to align the incentives of market participants with the
objectives of the regulator."4

 Example of the Invisible Hand

 Consider an example of a small business facing stiff competition. To best position itself
in the market, the small business decides it will invest in higher quality materials for its
manufacturing process as well as reduce its prices. though the small business may be
doing so out of the best interest of its company (i.e. to drive sales and steal market
share), the invisible hand is at work as the market now has access to more affordable yet
higher quality goods.

 Another example of the invisible hand is the ripple effect a retail company can have
when attempting to meet consumer demand. Consider a hardware store that anticipates
demand for yard maintenance tools. The hardware store will coordinate with a
manufacturer to secure the appropriate goods. Meanwhile, the manufacturer will
communicate with a raw materials distributor to ensure it has the items it needs.

 In this second example, each entity is acting in its own best interest. However, each
entity is also creating economic activity for other parties. In addition, the entities are
 stringing together a process that results in a consumer receiving a product it needs.
Though each individual action taken by itself may not amount to much, the invisible
hand helps move resources along a process to deliver a final product.

 Why Is the Invisible Hand Important?

 The invisible hand allows the market to reach equilibrium without government or other
interventions forcing it into unnatural patterns. When supply and demand find
equilibrium naturally, oversupply and shortages are avoided. The best interest of society
is achieved via self-interest and freedom of production and consumption.

 How Is the Invisible Hand Used Today?

 As former Fed Chair Ben Bernanke explained, the "market-based approach is regulation
by the invisible hand" which "aims to align the incentives of market participants with the
objectives of the regulator."4

 What Did Adam Smith Say About the Invisible Hand?

 Adam Smith wrote about an invisible hand in his writings during the 1700s, noting that
the mechanism of an invisible hand benefits the economy and society thanks to self-
interested individuals. Smith mentions "an" invisible hand, which is the automatic
pricing and distribution mechanisms in the economy that interact directly and indirectly
with centralized, top-down planning authorities.

 Why Is the Invisible Hand Controversial?

 Critics argue that the idea that self-interested, profit-driven actors will converge on some
social optimum is clearly false, and that instead it naturally leads to negative
externalities, economic and social inequalities, greed, and exploitation. Moreover,
competition driven by the invisible hand can ultimately result in monopolies and the
concentration of economic power, both of which are undesirable for society.
  Other critiques hone in on the fact that the concept relies on the assumption that
producers can easily switch from producing one type of good to any other, depending on
its relative profitability at a given moment. This does not account for the sometimes
enormous costs of switching and the idea that people may engage in a business that they
enjoy doing, or which has been passed down in a family, regardless of profitability.

 The Bottom Line

 The invisible hand is the idea that specialization in production can lead self-interested
individuals to produce what is socially necessary and for the good of all. This is because
increased specialization naturally leads to a web of mutual interdependencies, such that a
shoemaker will need others to produce their house, food, clothing, etc.; while a
homebuilder will rely on the shoemaker for shoes and others for their own clothing,
food, and so on. Market forces and competition will incentivize producers to make what
is most profitable at the lowest cost, also encouraging technological progress and
innovation, for the benefit of all.

What Is a Monopolistic Market?

A monopolistic market is a theoretical condition that describes a market where only one
company may offer products and services to the public. A monopolistic market is the opposite
of a perfectly competitive market, in which an infinite number of firms operate. In a purely
monopolistic model, the monopoly firm can restrict output, raise prices, and enjoy super-normal
profits in the long run.

KEY TAKEAWAYS

 A monopoly describes a market situation where one company owns all the market share
and can control prices and output.
 A pure monopoly rarely occurs, but there are instances where companies own a large
portion of the market share, and ant-trust laws apply.
  Altria, the tobacco manufacturer, has monopolistic-type control over the tobacco market.

Understanding Monopolistic Markets

A monopolistic market is a market structure with the characteristics of a pure monopoly. A

monopoly exists when one supplier provides a particular good or service to many consumers. In
a monopolistic market, the monopoly, or the controlling company, has full control of the
market, so it sets the price and supply of a good or service.

Purely monopolistic markets are scarce and perhaps even impossible in the absence of
absolute barriers to entry, such as a ban on competition or sole possession of all-natural
resources.

When they do occur, the monopoly that sets the price and supply of a good or service is called
the price maker. A monopoly is a profit maximizer because by changing the supply and price of
the good or service it provides it can generate greater profits. By determining the point at which
its marginal revenue equals its marginal cost, the monopoly can find the level of output that
maximizes its profit.

With generally only one seller controlling the production and distribution of a good or service,
other firms cannot enter the market. There are typically high barriers to entry, which are
obstacles that prevent a company from entering into a market. Potential entrants to the market
are at a disadvantage because the monopoly has the first-mover advantage and can lower prices
to undercut a potential newcomer and prevent them from gaining market share.

Since there is only one supplier, and firms cannot easily enter or exit, there are no substitutes for
the goods or services. Therefore, a monopoly also has absolute product differentiation because
there are no other comparable goods or services.

Effects of Monopolistic Markets

The typical political and cultural objection to monopolistic markets is that a monopoly, in the
absence of other suppliers of the same product or service, could charge a premium to their
customers. Consumers have no substitutes and are forced to pay the price for the goods dictated
by the monopolist. In many respects, this is an objection against high prices, not necessarily
monopolistic behavior.

The standard economic argument against monopolies is different. According

to neoclassical analysis, a monopolistic market is undesirable because it restricts output, not
because of monopolist benefits by raising prices. Restricted output equates to less production,
which reduces total real social income.

Even if monopolistic powers exist, such as the U.S. Postal Service’s legal monopoly on
delivering first-class mail, consumers often have many alternatives such as using standard mail
through FedEx or UPS or email. For this reason, it is uncommon for monopolistic markets to
successfully restrict output or enjoy super-normal profits in the long run.

Regulation of a Monopolistic Market

As with the model of perfect competition, the model for a monopolistic competition is difficult
or impossible to replicate in the real economy. True monopolies are typically the product of
regulations against the competition. It is common, for instance, for cities or towns to grant local
monopolies to utility and telecommunications companies.

Nevertheless, governments often regulate private business behavior that appears monopolistic,
such as a situation where one firm owns the lion's share of a market. The FCC, World Trade
Organization, and the European Union each have rules for managing monopolistic markets.
These are often called antitrust laws.

Both Republican and Democratic politicians have been sounding alarms about market power in
the United States, arguing that a few companies such as Amazon, Facebook, and Google have
become too dominant. In July 2021, the White House issued an executive order
and statement doubling down on antitrust law enforcement, with a promise to reign in “corporate
consolidation” and “bad mergers” in the interest of US consumers.
A growing body of research supports this notion, pointing to a regulatory leniency over the past
few decades that is driving concentration across US markets and segments. Stanford’s C. Lanier
Benkard and Ali Yurukoglu and Chicago Booth’s Anthony Lee Zhang provide more support for
this claim—in part. The researchers find abundant evidence of rising concentration at the broader
market level, with more mergers, fewer players, and a rise in organizations with high market
share.

But they find a different picture at the level of individual products, where more concentration has
led to more competition.

Monopolies are generally considered to be bad for consumers and the economy. When markets
are dominated by a small number of big players, there’s a danger that these players can abuse
their power to increase prices to customers. This kind of excessive market power can also lead to
less innovation, losses in quality, and higher inflation.

Thus, US legislators have historically sought to limit the market power of large corporations.
Three major antitrust laws have been passed by Congress over the past century, all aimed at
prohibiting price-fixing, preventing monopolies, and driving free competition as the rule of
trade.

But the discussion about concentration has traditionally centered on the number of companies
operating and competing in different segments, with less attention paid to the situation at the
individual product level. When there are fewer players producing goods and services, does it
follow that there are fewer goods and services to choose from—and therefore less choice for
consumers in terms of prices?

The researchers analyzed newly available data from MRI-Simmons, a provider of attitudinal and
behavioral US consumer insights, to reexamine and reassess trends in concentration in US
product markets between 1994 and 2019. Indeed, they see divergent patterns emerge when it
comes to companies and products.

In the area of household goods, for instance, corporate concentration has increased. Procter &
Gamble and Phoenix Brands, among other larger companies, have systematically acquired the
makers of brands such as Tide, Cheer, Ajax, and Fab in the detergents category.

t he American consumer enjoys more choices than ever before, or so it seems. A trip to the
grocery store reveals aisle after aisle of varied products marketed under countless brand
names to countless specifications. Big e-commerce sites like Amazon feature a still greater
plethora of choices.

Yet all is not what appears to be. Take eyeglasses, for example. One can shop for them at
Lenscrafters, Pearl Vision, or Target, and pick brands as varied as Oakley, Ray Ban and
Gucci. But one company owns all these outlets and brands plus more, and this ownership
controls most of the eyewear market. As of this writing that company, Luxxotica,
is seeking to combine with lens-maker Essilor to gain even more dominance of everything
optical.

Then there is Proctor and Gamble. Trying to decide which is the best paper towel, Bounty or
Charmin? P&G owns them both. Best Shampoo? P&G owns Aussie, Head and Shoulders,
Vidal Sassoon, and Herbal Essences. Best diaper? Whether you chose Pampers or Luvs,
P&G wins. Best product to get your clothes clean? Tide, Gain, Downy, and Fairy all
compete for your business, except they don’t really because they are all owned by P&G.
Other brands you might think of as independent–from Old Spice to Gillette, from Tampax to
Crest are actually anything but, as P&G controls them all.

The soft drinks aisle is even more monopolized. Pepsi and Coca-Cola control 69.5
percent of the soft-drink market between them. Their next largest rival, Dr. Pepper Snapple
Group, controls another large portion, so that the three collectively account for 86 percent of
the entire industry. These firms, like so many others, acquire competitors to ensure they will
control emerging markets as well as old standbys. Coca-Cola acquired Zico beverages, a
producer of coconut water, in 2013, and in 2016 it purchased a soy-based drink brand–
AdeS. In 2016, Dr. Pepper Snapple bought Bai Brands, a maker of a coffee fruit drink,
while Pepsi bought KeVita, a Kombucha-brewer.

It’s a similar story with food products. Brands that seem to be independent and competing
with each other often aren’t. As of 2014, Kraft owned Oscar-Meyer, Planters, Maxwell
House, Jell–O, and Philadelphia Cream Cheese, while Heinz owned Weight Watchers frozen
meals, Ore-Ida potatoes, and other brands alongside its massive condiment business. But in
2015, the two merged, so that now one company owns all of these brands and others.

Often even brands that are owned by different companies are produced by the same supplier
so they don’t really offer the consumer any choice at all except in labels. Pet-owners
witnessed this firsthand in 2007 when a recall of pet food from one factory expanded to
cover dozens of brands–from Walmart’s store brand to higher-end products like Purina and
Iams.

Just as the choice between different consumer products is often an illusion, so too is the
choice between different retailers. The grocery stores Stop & Shop, Giant, Food Lion,
Martin’s, and Peapod are all owned by one company–Ahold Delhaize.

Similarly, whether you shop and Albertson’s or Safeway you are doing business with the
same company. An astounding 385 grocery mergers took place between 1996 and 1999.
By 2012 just four companies claimed more than half of all grocery spending nationwide,
and in many small towns across America Walmart was the only grocer left. Today, after a
further round of mega mergers culminating in Amazon’s takeover of Whole Foods, the
industry is even more concentrated and in danger of becoming monopolized by
Amazon even in large metro areas.

In drug stores, the concentration is even greater. CVS, Walgreens, and Rite Aid collectively
control 99 percent of the industry, and the latter two have sought to merge. Similarly, when
you shop at Bloomingdales, you are really shopping at Macy’s, which itself long ago
absorbed many of its other competitors, from Filene’s and Marshal Fields. Walmart
meanwhile, not only monopolizes the grocery business in many locations, but also every
other product category, from hardware, electronics, and garden supplies, to clothes, urgent
care and car repairs.

When giant retailers like Amazon or Walmart put rivals out of business, this leads to a loss
of consumer choice simply because there are fewer and fewer retail outlets. But monopoly
also leads ultimately to there being fewer and fewer truly unique products for sale as well.

One reason is what’s called the “category captain system.” A dominant retailer like Kroger,
for example, will take the biggest suppliers in a product category, such as, say, Frito-Lay in
snacks, and make it the “captain” of its snack aisle, with responsibility for determining
where competing snack products appear on the shelves of that section. What this means in
practice is that Kroger gets a price concession (or legal kickback) from Frito-Lay’, while
Frito-Lay gets to strangle its competitors by giving them inferior product placement, say at
foot level rather than eye-level.

This system allows dominant producers to become even more powerful over their remaining
competitors. Consumers, from whom this entire system is hidden, find their choices
manipulated and limited by the arrangement, as growing market concentration reduces
competition for the consumer’s dollar.

Another way consumer’s choice is limited by concentration comes when giant retailers strip
profits and power away from their suppliers. This leverage is known as “ monopsony power”
and big retailers use it to bend suppliers to their will. Walmart, for instance, has told
companies as powerful as Coca-Cola, Levi’s, and Disney what to put in their products. As
Charles Fishman detailed in this book The Wal-Mart Effect, the company uses its purchasing
power to pressure all its suppliers to cut wages and outsource production, which often
means that suppliers must compromise product quality, variety, and innovation.

Another example of how monopsony power limits consumer choices comes from Amazon,
which has forced book publishers to lower prices and thereby surrender more and more of
their profits. This in turn has led to publishers taking far fewer risks on new writers and
ambitious book projects, and to the collapse of the business model that previously sustained
the production of books for a wide-variety of niche audiences.

To defend themselves against Amazon, publishers have merged frantically with each other,
making an already highly concentrated publishing industry even more concentrated. The
same dynamic is occurring throughout the consumer economy. Procter & Gamble acquired
its longtime rival Gillette in 2005, in part to gain power in negotiations with Walmart.
Colgate-Palmolive, facing the same pressures, followed suit–acquiring Tom’s of Maine in
2006 and Sanex in 2011.

These mergers and acquisitions among suppliers mean that consumers have fewer real
choices in the products they buy, particularly over the long-term. Not only does the number
of suppliers shrink, but as dominant firms become more and more entrenched, they become
less innovative and less inclined to take risks on new or niche products,

This pattern of diminishing choice and rising concentration reflects a profound change from
decades past. Throughout much of the twentieth century, Americans used anti-monopoly
policies to preserve competition and guarantee decentralized markets in sectors as varied as
retail, farming, eyeglasses, and airlines. The Robinson-Patman Act, for instance, allowed
consumers to enjoy the benefits of shopping with a large and innovative retailer like Sears,
while constraining Sears’ ability to undercut other retailers with predatory pricing.
Similarly, federal regulation and anti-trust policies allowed for grocery stores to evolve into
more efficient, convenient supermarkets, but did not allow chains like the A&P to grow so
large that they squashed competition and denied consumers choices about where they
purchased their food.

Since the late 1970s, however, deregulation and a retreat from anti-trust enforcement has
permitted growing monopolization–and declining choice–in not just retailing, but almost
every sector of the economy, from airlines to hospitals, banks to communication companies.
Meanwhile, industries which didn’t exist thirty years ago, like broadband internet, feature
much less choice than they would if they weren’t dominated by a few monopolistic firms.
Monopolies often present themselves as champions of consumer choice, but that is rarely
true.

First Mover: What It Means, Examples, and First Mover Advantages

What Is a First Mover?

A first mover is a service or product that gains a competitive advantage by being the first to
market with a product or service. Being first typically enables a company to establish strong
brand recognition and customer loyalty before competitors enter the arena. Other advantages
include additional time to perfect its product or service and setting the market price for the new
item.

First movers in an industry are almost always followed by competitors that attempt
to capitalize on the first mover's success and gain market share. Most often, the first mover has
established sufficient market share and a solid enough customer base that it maintains the
majority of the market.

KEY TAKEAWAYS
  A first mover is a company that gains a competitive advantage by being the first to bring
a new product or service to the market.
 First movers typically establish strong brand recognition and customer loyalty.
 The advantages of first movers include time to develop economies of scale—cost-
efficient ways of producing or delivering a product.
 The disadvantages of first movers include the risk of products being copied or improved
upon by the competition.
 Amazon and eBay are examples of companies that enjoy first-mover status.

Examples of First Movers

Businesses with a first-mover advantage include innovators, Amazon (NASDAQ: AMZN) and
eBay (NASDAQ: EBAY). Amazon created the first online bookstore, which was immensely
successful. By the time other retailers established an online bookstore presence, Amazon had
achieved significant brand recognition and parlayed its first-mover advantage into marketing a
range of additional, unrelated products. According to Forbes's "The World's Most Innovative
Companies" 2019 ranking, Amazon ranks second. It has annual revenues of $280 billion and,
through the end of 2019, had a 20% annual sales growth rate.

eBay built the first meaningful online auction website in 1995 and continues to be a popular
shopping site worldwide. It ranked 43rd on the Forbes list of innovative companies. The
company generates $287 billion in annual revenues, with a 2.8% annual sales growth rate.

Advantages of First Movers

Being the first to develop and market a product comes with many prime advantages that
strengthen a company's position in the marketplace. For example, a first-mover often gains
exclusive agreements with suppliers, sets industry standards, and develops strong relationships
with retailers. Other advantages include

 Brand name recognition is the main first-mover advantage. Not only does it engender
loyalty among existing customers, but it also draws new customers to a company's
product, even after other companies have entered the market. Brand name
 recognition also positions companies to diversify offerings and services. Examples of
dominant brand name recognition of a first-mover include soft drink colossus Coca-
Cola (NYSE: KO), auto-additive giant STP (NYSE: ENR), and boxed-cereal titan
Kellogg (NYSE: K).
 Economies of scale, particularly those regarding manufacturing or technology-based
products, is a massive advantage for first movers. The first mover in an industry has a
longer learning curve, which frequently enables it to establish a more cost-efficient
means of producing or delivering a product before it competes with other businesses.
 Switching costs let a first-mover build a strong business foundation. Once a customer
has purchased the first mover's product, switching to a rival product may be cost-
prohibitive. For example, a company using the Windows operating system likely would
not change to another operating system, because of the costs associated with retraining
employees, among other costs.

Disadvantages of First Movers

Despite the many advantages associated with being a first mover, there are also
disadvantages. For example, other businesses can copy and improve upon a first mover's
products, thereby capturing the first mover's share of the market.

It costs approximately 60% to 75% less to replicate a product than it costs to create a new
product.
Also, often in the race to be the first to market, a company may forsake key product features to
expedite production. If the market responds unfavorably, then later entrants could capitalize on
the first mover's failure to produce a product that aligns with consumer interests; and the cost to
create versus the cost to imitate is significantly disproportionate.