Which Tools and Methods are Needed to Undertake Microeconomic Analysis?

ABSTRACT:

This paper covers the concepts and tools needed to under take microeconomic analysis of such problem that arise due to scarcity. The paper will also cover competitive and non-competitive product markets. And why the different markets functions the way they do. The researcher will attain the objectives of the course in this paper by researching on the topic compiling a paper of not less than 15 pages. The writer will also provide minimum of 20 and a maximum of 50 multiple choice questions and answers.

Craig, A. and Depken (2006) explained that economists endeavor to understand how people and organizations reach their decisions. They pointed out that, economists delineate different types of decision makers into three types of economic agents. “An economic agent is any individual, group of individuals’ organization that participates in the allocation of scarce resources to unlimited decisions.” (P.3). According to Craig and Depken, microeconomics is the study of “individual markets, how individual agents interact within those markets, and how individual economic agents make decisions.” (P.4).

From the point of view of Burkett and John (2006), “Oikonomikos” raised four issues that lie near the central problem of economics even today. These are: how limited resources are best allocated to competing needs, what a manager can do to motivate subordinates to work hard, what it takes to be a good manager and how individuals, firms and government are supposed to choose our actions when the consequences of alternative actions are uncertain. These four issues cover the basic principles of microeconomics. They added that, “microeconomics is concerned with how individuals and organizations make decisions about the allocations of scarce resources and how these individuals and organization, interacting in markets, determine relative prices, wages and rents.” Burkett and John further explained that, microeconomics overlaps with management science in its examination of optional business decisions but extend beyond that field into “normative and positive analysis of households, unions government agencies, and international trade.” (P.15).What this means is that, unlike macroeconomics which concerned itself with aggregative results of individual decisions, microeconomics analysis concerned itself with problems individuals and organizations face due to scarcity.

A primary objective of microeconomic theory is to explain how decisions are made by individuals and firms. It also concerns how consumers decide which products to buy and in what quantities. Also, how much it cost business firms to produce the goods and provide the services consumers demand.(Schiller, 1997).

According to Schiller (1997), microeconomic analysis look’s at the daily consumption of the entire American society and breaks the total figure down into per capita expenditure of America; Schiller explained that, American households spend over $5 trillion on consumer goods and services. Which he said worked out to $18,000 for every man, woman and child in the United States (P.439). Schiller also explained that the main concern of Microeconomic analysis is to show all the activities explained in the foregoing. Schiller specifically mentioned that, microeconomic analysis covers the following questions:

(a) “How do we decide how much of any good to buy
(b) How does a change in the Price of a good affect the quantity we purchase or the quantity of money we spend on it?
(c) Why do we buy certain goods but not others?”

In the words of Schiller, “demand as a law attempts to explain all these”. He also pointed out that, we will need to go beyond demand to fashion more complete responses for the question posed.

He added that, we equally need to know; what forces give demand curves then particular shape and try to also know more about using demand curve to predict consumer behavior.

According to Schiller (1997), economists normally focus on demand for goods and services in order to explain consumer behavior. He indicated that, an individual demand for a specific product is determined by a number of such factors as; taste of consumer, income of the consumer, expectations, prices of related commodities” (P.439).

Schiller (1997) argued that, in microeconomic analysis pertaining to consumer behaviors, its objective is not only to explain the behavior of the consumer, but also to predict how consumption patterns change in response to changes in the price of the particular commodities (or related commodities) or to change in underlying tastes due to changing preferences. It also predicts how consumption patterns change in response to changes in underlying tastes due to changing income level of the consumer or changes in related prices of goods and expectations of future changes in prices or incomes.

Economists start on a simple point in microeconomic analysis on the demand for goods and services. They accept consumer taste as the outcome of socio-psychiatric and cultural influences.” (Schiller, 1997, P.441).

Schiller (1997) further pointed out that, economists don’t have a way of measuring how consumer taste originate, but that, they simply note the existence of certain tastes (desires) and investigate to see how those tastes affect consumption decisions. According to Schiller, economists assume that the more additional pleasure a product has, the higher the price people will be willing to pay for it. What this implies is that the lower the additional amount of satisfaction the lower the price people will be willing to pay for it. He therefore pointed out that, the pleasure or satisfaction, attained from a good or service refers to utility.

Schiller (1997) explained that, it would be significant to make a distinction between total utility and marginal utility. According to him, total utility refers to the amount of satisfaction obtained from your entire consumption of a product. While marginal utility refers to the amount of satisfaction you obtain from consuming one more or less unit of a commodity. Schiller indicated, marginal utility is mathematically expressed as the change in total utility as the change in total utility divided by a change in quantity. That is marginal utility (mu) = change in total utility Change in quantity

The concepts of marginal and total utility not only explain why we buy more or less of an item say popcorn while watching a movie, but also why we may stop eating it at some point. Whether one loves eating popcorn and can even afford it or not, is not the key issue, the thrust of the matter is that, even those who love eating it and can afford it may still suffer diminishing marginal utility. The behaviors of popcorn consumers follows a rule that, the amount of additional utility we get from a product decreases as we continue to consume it. “This phenomenon of diminishing marginal utility is so nearly Universal that, economists have fashioned a law around it- the law of diminishing marginal utility.” (Schiller 1997, P.443). The law of diminishing marginal utility states that, each successive unit of a good consumed yield less additional utility.”

Economists discovered a relationship between price, quantity and marginal utility of a commodity consumed. This relationship is usually a juxtaposition of the quantity of the product against consumer’s income, price of the commodity and prices of related goods and services or alternative commodities. Any time economists want to analyze the relationship between quantity and the other forces”, they hold all other factors constant by introducing the “all things being equal assumption or the ceteris paribus assumption (Shchiller, 1997, P. 443). Schiller opined out that, when economics use ceteris paribus assumption it becomes easy to establish the relation between utility theory and the law of demand. Schiller also stated that, the more marginal utility a product delivers, the more a consumer will be willing to pay for it.” What this means is that, the less marginal utility a commodity gives, the less a consumer will be willing to pay for it. This is because as a consumer consumes more of a product, it’s marginal utility declines for every successive unit consumed, and so the less a consumer will be willing to pay for the lower additional satisfaction derived from consuming it. The implication of the foregoing is that, with a given income, tastes, expectations and prices of related commodities, people will be willing to purchase additional quantities of a good if price falls. This therefore means that, as marginal utility of a product diminishes, so does our willingness to pay. The law of demand is thus derived from the law of diminishing marginal utility, with a demand curve sloping downward from left to right-indicating a negative relationship between price or utility and quantity. It is possible for the researcher to use income and substitution effect to determine consumer behavior and the slope of the demand, but he would limit this paper to utility theory and the slope of the demand curve which shows why a consumer buys more of a lower price and less at a higher price. Utility theory also analyses the diamond-water paradox to show that, that behaviour of the consumer is equally not irrational.

Elasticity of demand is the degree of responsiveness of quantity demanded to change on price of the commodity, price of related commodities and the income of the consumer. The measurement of responsiveness of quantity demanded due to change in the key determinants of demand is essential in that, the law of demand and the law of diminishing marginal utility only tell us when consumers demand more or less and not why they crave for more or less of a product, neither do the two laws tell us the extent of the response of quantity demanded due to changes in price of the and commodity, income of the consumer, price of related commodities. According to Schiller (1997). President Clinton proposed an energy tax of 7.5 cents per gallon, with the objective to raise revenue. But that, how much of the revenue could be raised depended on how consumers would respond to higher energy prices. Schiller indicated that, if the energy use changed much, the federal government would receive $22 billion. On the contrary, if the decline in energy consumption was greater than the increase in tax, revenue would fall below $22 billion.

Schiller (1997), further expanded on consumer behavior by saying that’ actual consumer behavior is multidimensional” and that it would not be enough for our discussion to be centered on only single product at varying prices. This is particularly so because, there exists so many goods and this complicates consumption decisions. The consumer is faced with the need to attain the objective of getting as much satisfaction as possible with given income. This therefore requires of him to give up the opportunity to buy some other goods. What this means is that, for example, consuming popcorn entails “a distinct opportunity costs” as the movie goer forgoes playing the video game. (Schiller 1997, P.458).

Consumer choice is within the larger framework of how resources are limited in respected of numerous wants. Choosing or consuming a good and forgoing others, also brings to the fore, the central or core problem of economics, which is scarcity. Due to the fact that, resources are scarce and the existence of alternative uses, with given income, individuals, firms and government usually face the principle of increasing opportunity cost. This is normally illustrated by illustrated by a negatively sloping production possibility frontier (Schiller, 1997).

In using microeconomic analysis to explain consumer behavior, one option is to consider how consumer choice builds on the theory of marginal utility and the law of demand. For instance, you suppose you have a choice between buying a coke and playing a video game. Here, the first proposition of consumer choice says that,” if you think a coke will be more satisfying than playing a video game, you will prefer to buy the coke.” But, the second option postulates of consumer – choice theory that, takes into account the market prices of goods we want to buy. Schiller explained that, even though you may prefer to buy the coke rather than playing a video game is cheaper than a coke, if one play of a video game is cheaper than a coke, “it is possible that your budget may win out over your desires, and you may forgo the coke. In this case, the use of indifference curves and budget lines would clearly illustrate desires and the affordability constest” respectively.

Sehiller added that, as far as he was concerned “there is nothing irrational about a playing a video game instead of buying a coke when you have limited amount of income “ (P.459). the researcher agrees with Schiller in the sense that, rational behavior requires individuals to compare the expected satisfaction of each expenditure with its costs and choose those commodities pleasure for the amount of income available.

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