Microeconomics assumes two basic principles: Individuals seek to maximize their overall well-being, and firms seek to maximize profits. Both firms and individuals operate with limited resources, and both parties set restraints on the other. Firms restrain individuals by setting prices, determining output and affecting the supply of goods and services. Consumers affect firms by choosing which products to buy and, more importantly, at what price.
Though firms and individuals have been working in tandem since the origin of commerce, Investopedia.com states that scholars began studying this relationship in the early 18th century. Investopedia.com cites the late 1600s mathematician Nicholas Bernouli’s papers on consumer behavior as the earliest evidence of microeconomic theory. In the 1700s, Adam Smith’s economic theory of laissez-faire, explained in his book, “Wealth of Nations,” states that the economy functions most efficiently when firms and individuals are self-regulated without the intervention of government. Economist Alfred Marshall expanded these ideas in the 1890s in his book, “Principles of Economics.” He introduced many common economic terms like price elasticity, consumer utility and the demand curve.
In the early to mid-1900s, John Maynard Keynes used microeconomic principles to create the field of macroeconomics. He studied microeconomic principles, like individual taxation, and applied them to understanding overall market forces and how government policies affect the economy. Since Keynes, a few other economists have contributed to microeconomics. Austrian economist Oskar Morgenstein elaborated on the concept of utility in the 1950s and Milton Friedman expounded on the concept of corporate responsibility (or lack thereof) in the 1970s.
Governments sometimes affect the relationship of firms and individuals. They can subsidize, tax and set tariffs on businesses and individuals. They can implement price floors and price ceilings. The government can set safety and compliance standards, break up monopolies and provide federal assistance to failing corporations. Microeconomic graphs detail how government intervention affects the natural equilibrium of supply and demand. In some cases, like subsidies and tariffs, "deadweight loss" is created. Roger A. Arnold, author of “Microeconomics,” explains that effects of implementing a price ceiling, or a government-mandated maximum price, are fewer exchanges, shortages, rationing, black market transactions and tie-in sales. These unintended negative consequences of government intervention are one reason many prominent economist like Milton Friedman, Frederick Von Hayek and Adam Smith advocate against government intervention.
The book “Microeconomics: Theory and Application,” authored by D.N. Dwivedi, explains that studying this field assists firms and individuals make rational, well-planned decisions. Economics is the study of behavior, decisions and consequences of those actions. Additionally, the book states that economic theory assists with formulating public policy and regulating economic activity.
Microeconomic theory cannot account for very real, yet intangible costs like pollution. No traditional microeconomic graph, for instance, can chart the effects of pollution on society. This problem is simply referred to as a ”moral hazard,” but this label provides no mathematical usefulness. Microeconomic theory often fails to account for disastrous economic effects like housing and tech bubbles.