Importance of Microeconomics

Importance of Microeconomics in Business Decision Making:

 Microeconomics plays an important role in business decision making. It helps the business managers in making production plans and trade decisions. It provides an analytical tool to examine the market mechanisms and helps business firms to take decision about their production and pricing policies.

The following are the points that represent the importance of microeconomics in business decision making.

importance of microeconomics

a) Optimal resource utilization

Microeconomics tells how productive resources are allocated in the production of various goods and services as productive resources are scarce in the economy. It also helps to find out, what to produce, how much to produce, and for whom to produce.

b) Demand analysis

The microeconomic analysis helps the business firms to forecast the demand for their product. As we know, the demand for the firm’s product would change in response to change in the price of the firm’s product, prices of other goods, which may be a substitute or complementary, consumer’s income, his tastes and fashion, his expectations about future changes in price, changes in the age composition of the population, change in total population, etc.

c) Cost analysis

Cost analysis is an important area of microeconomics. There are many theories to explain the different conditions of cost in microeconomics such as fixed cost and variable cost, average cost and marginal cost, short-run cost, and long-run cost.These all help the business manager to compare the cost of production of different periods and thereby to evolve suitable policies in controlling costs and deriving suitable profits.

d) Optimal production decision

The production decision is concerned with the proper product mix. What factors are to be combined in what manner to produce a given product? Microeconomics deals with different production techniques that help to find out the optimal production decision.

e) Pricing policy

The pricing of the product is the chief function of a firm. This depends upon the cost of production and at the same time price of substitutes and the nature of competition. Price affects profits which in turn determine the existence and the growth of the firm.  The microeconomic analysis provides the business manager a thorough knowledge of the theories of production and pricing in order to make sure that the firm gets profits continuously. Thus, the role of microeconomics is both positive and normative. It not only tells us how the economy operates but also how it should be operated to promote the general welfare.

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Limitations of Microeconomics

The following are the limitations of microeconomics:

1. Static analysis: In the study of microeconomics, mostly static analysis is used. In it, many economic variables are assumed to be constant. In practice, however, economic variables are changing. Therefore, microeconomics 1s unrealistic to a large extent.

2. Wrong conclusions: The conclusions drawn from the study of microeconomics are in many cases not valid from the point of view of macroeconomics. For instance, in microeconomics, we say that saving is a virtue so far as an individual is concerned but if it is viewed from a macroeconomic angle, that is, if the entire population begins to save more than before, there will be a fall in production and employment. In other words, it will cause misery in the economy. Thus, what is individually a virtue may become socially vice.

3. Unrealistic assumptions: Microeconomic analysis is based on many unrealistic assumptions like the existence of full employment and perfect competition in the economy. But in the real-life situation, both full employment and perfect competition are not found. Hence, the assumptions of microeconomics are unrealistic,

4. Limited scope: Microeconomics has limited scope. The study of many important economic policies and problems like, fiscal policy, monetary policy, inflation, unemployment, etc. are outside its scope.

5. Ignores the role of the government: Generally, microeconomic theories assume the existence of a free enterprise system in which the ‘invisible hands’ or market forces are assumed to play their roles freely. Microeconomics assumes also the absence of government intervention in the economic activities of the society. In practice, however, government controls and regulations of economic activities are rules of the day and are all-pervasive.

Scopes of Microeconomics

The scope or the subject matter of microeconomics is concerned with:

Commodity pricing

The price of an individual commodity is determined by the market forces of demand and supply. Microeconomics is concerned with demand analysis i.e. individual consumer behavior, and supply analysis i.e. individual producer behavior.

Factor pricing theory

Microeconomics helps in determining the factor prices for land, labor, capital, and entrepreneurship in the form of rent, wage, interest, and profit respectively. Land, labor, capital, and entrepreneurship are the factors that contribute to the production process.

Theory of economic welfare

Welfare economics in microeconomics is concerned with solving the problems in improvement and attaining economic efficiency to maximize public welfare. It attempts to gain efficiency in production, consumption/distribution to attain overall efficiency and provides answers for ‘What to produce?’, ‘When to produce?’, ‘How to produce?’, and ‘For whom it is to be produced?,markets%20lead%20to%20desirable%20allocations.

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