Microeconomics — Understanding the basic concepts
Economics is an interesting as well as intimidating subject for many. There are two categories Microeconomics and Macroeconomics. The branch which deals with individuals decision making and allocating resources. Whereas, Macroeconomics deals with things at a larger scale.
Let me explain the meaning and few of the important concepts of microeconomics. Microeconomics is the branch of economics which studies the individual behavior to assess their patterns in decision making and resource allocation. This individual can be a person, a group of people (like firm, organization), etc.
Understanding the individual behavior helps to determine many things like what is the demand or how much supply is required. In order for the nation to take decision while making government policies taking microeconomics into consideration is of prime importance.
So with that introduction, let me explain some of the important concepts:
Demand and Supply:
Demand as per definition means, a want backed by the ability to pay. Which brings us to the important factor which distinguishes want from demand. A want can be anything which a person desires, but all wants are not demand. To convert a want into demand you must have the ability to afford it.
Supply means the availability of the goods/services to fulfill the demand. Now how this relates to individual’s behavior.
The connection between demand and supply is divine. All of the demand is generated by the individual subjects in the economy. The concept of ‘demand and supply’ helps in determining many things mainly the price of a product/service.
If the demand for a good/service is high but its supply is low then it creates scarcity resulting in high prices. Whereas, if the supply is more than the demand it results in overstocking which may result in reduction in prices.
On the basis of demand vs supply the prices fluctuate. If the demand is high and supply is low then sellers tend to increase the prices so that some of the customers drop the idea of buying due to increased prices. Whereas if the supply is more than demand then sellers tend to offer products/services at a discount to reduce the chances of overstocking and possible wastage.
If we plot a graph for demand and supply we will get two curves depending on the nature of change in demand and supply at various price points. The point at which a demand curve and supply curve intersect each other is known as ‘equilibrium’ . At equilibrium the price is just right to satisfy the customer and seller. This is one of the basic yet important concepts.
Price Equilibrium from demand and supply curve:
As we can see from the above image, red curve indicates demand and blue curve indicates supply. The demand for quantity is high at a lower price whereas supply for the quantity is high when the price is highest.
This gives us an intersection point which is called ‘equilibrium’. At the equilibrium the demand and supply for the product is equal and it is a ‘win-win’ situation.
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Marginal Utility:
Utility is the usefulness or satisfaction derived from consuming a product/service. In terms of economics we have to dwell deep into the concept of utility.
The concept of ‘marginal utility’ revolve around the utility derived from each additional unit of product/service that is consumed by the consumer. In theory, it is said that with every additional unit that is consumed the utility goes down till a point that it is unable to add any further value.
For example, if you are hungry then your demand will be for food. For this example we will take apple to satisfy the hunger. You are hungry so you bought 10 apples, with the first bite of the first apple the satisfaction level will be the highest. By the time you finish the first apple, your hunger is half satisfied but you still have enough space to eat one more. So the concept of marginal utility says that even though apple satisfy your need the utility derived from each bite/unit diminishes over the time.
At a certain point you will be so full that you cannot eat another bite. At this point the marginal utility reaches zero. If some body insists to take another bite you are likely to throw out the eaten pieces. At this point the marginal utility will be negative.
Opportunity cost in microeconomics:
Understanding the concept of opportunity cost or alternate cost is simple. It means that we have to choose from various options. Each option comes with its own cost, returns, utility, etc. But the amount or resources that we have are limited hence we are left with choosing one option from them and letting the others go.
The cost related to options that you had to let go denotes ‘opportunity cost’. This concept comes handy when we have to compare the returns generated from our choices. The other options serve as benchmark against which you can compare your returns/results.
If I have 3 options but enough money to choose only 1 so I chose option no. 2 and let go option 1 and 3. Opportunity cost simply means what could have happened if I had chosen any other option rather than option no. 2. This will give me the insight whether my decision was right or wrong. If the returns that I generated are more than any of the other option then I was right otherwise I was not.
This is how simple the basic concepts of microeconomics are. In the upcoming blog-posts I will try to cover dew of the basic concepts of Macroeconomics followed by their impact on the personal finance of an individual.
