Economic theories broadly fall under two categories: and macroeconomics. In most basic terms, microeconomics deals with the economy at a smaller level or at a smaller scale, such as the market for a particular product (e.g., automobiles) or the behavior of an individual firm in a particular industry (e.g., decisions made by one of the Big Three in the U.S. automobile industry). Macroeconomics, on the other hand, studies the behavior of the overall economy (e.g., the U.S. economy as a whole), although it sometimes also looks at economies of different regions that comprise the overall economy.
Economics in general (and microeconomics in particular) is defined as the social science that deals with the problem of allocating limited resources to satisfy unlimited human wants. Solving this riddle is based on the price mechanism that, in turn, uses forces of supply and demand for different products. Price mechanism refers to an adjustment mechanism in which the price of a product serves as a signal to both buyers and sellers; it is often considered the centerpiece of microeconomic theory. Theories of demand, supply, and the price mechanism are briefly discussed in what follows.
THEORY OF DEMAND, SUPPLY, AND THE PRICE MECHANISM.
The demand for a particular product by an individual consumer is based on three important factors. First, the price of the product determines how much of the product the consumer buys, given that all other factors remain unchanged. In general, the lower the price of the product the more a consumer buys. Second, the consumer's income also determines how much of the product the consumer is able to buy, given that all other factors remain constant. In general, the greater is his or her income, the more a consumer will buy. Third, prices of related products are also important in determining the consumer's demand for the product. The total of all consumer demands yields the market demand for a particular commodity. The market demand curve shows quantities of the commodity demanded at different prices, given that all other factors remain constant; as price increases, the quantity demanded falls.
The amount supplied by an individual firm depends on profit and cost considerations. In general, a producer produces the profit by maximizing output. The total of all individual company supplies yields the market supply for a particular commodity. The market supply curve shows quantities of the commodity supplied at different prices, given that all other factors remain constant; as price increases, the quantity supplied increases.
The interaction between market demand and supply determines the equilibrium or market price (where demand equals supply). Shifts in the demand curve and/or the supply curve lead to changes in the equilibrium price. The market price and the price mechanism play crucial roles in the capitalist system—they send signals to both producers and consumers. The price mechanism is an integral part of the study of market structures that constitute the bulk of microeconomic theory.
Analyses of different market structures have yielded economic theories that dominate the study of microeconomics. Four such theories, associated with four kinds of market organizations, are discussed below: perfect competition, monopolistic competition, oligopoly, and monopoly. Based on the differing outcomes of different market structures, economists consider some market structures more desirable, from the point of view of the society, than others.