Microeconomics is the study of how individuals and firms make themselves as well off as possible in a world of scarcity and the effects of their actions on markets and the entire economy.1
People choose the goods/services that make them as happy as possible given their limited wealth.
Firms decide what to make, where to make it, how much to make to maximise profit, and how to produce it at the lowest costs.
Governments decide which goods/services to be produced and whether to subsidise, tax, or regulate industries and consumers.
Microeconomics explains how the actions of every buyer and seller determine prices and how prices influence the decisions and actions of individual buyers and seller.
Trade Offs
We can’t have everything, so we make trade-offs.
The three main trade-offs we make are:
Which goods and services to produce: if we want to make more cars, we need to make less of something else because there are few resources (e.g. workers, raw materials, capital, energy) available for production.
How to produce: to produce a certain amount of something, a firm must use more of one input if it uses less of another e.g. if you want to make lemonade but fresh lemons get super expensive, you might use fewer fresh lemons and make up the difference with bottled lemon juice. You get the same pitcher of lemonade, but you spend less money making it.
Who gets the goods and service: the more of society’s goods/services you get, the less someone else gets.
Who Makes the Decisions
There are two main ways a society decides what to build, how to build it, and who gets it:
Government Control (Command Economy)
The state acts as the ultimate boss. It dictates what factories make, what materials they use, and who is allowed to buy the final products.
E.g. In the former Soviet Union, the government decided exactly how many cars to manufacture, what parts went into them, and which citizens were assigned a car.
Market Choice (Free Market Economy)
Prices, production costs, and personal choices make the decisions naturally. Businesses produce goods as cheaply and efficiently as possible, and consumers buy what they value and can afford.
E.g. Why do most people drive a Vauxhall Corsa instead of a Lamborghini? Not because people prefer the Vauxhall, but because a Lamborghini costs 20x more. Price and budget drive the choice, not government.
Prices Determine Allocation
Prices connect buyers, sellers, and producers by silently answering which goods and services to produce, how to produce them, and who gets them.
Prices are constantly pushed up or down by the back-and-forth tug-of-war between what consumers are willing to spend and what businesses are willing to sell for
A market is any place or system where buyers and sellers meet to swap money for goods.
It can be physical: a local farmers’ market, a grocery store, or a town square.
It can be digital: an app on your phone, an online store, or a global stock trading network.
It can be specific: economists usually group markets by a specific product – like “the smartphone market,” “the coffee market,” or “the housing market.
Most of microeconomics is concerned with how prices are determined in a market.
Microeconomics is also sometimes called price theory, because of the important role prices play. ↩︎
