Uses, Importance, and Limitations of Microeconomics

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Microeconomics does study about economic behavior of individual units and individual economic variables. It provides a theoretical framework for a systematic analysis of the economic behavior of the individual economic units like individual households, firms, industries, and factor owners. For instance, the determination of the price of the product, determining the payment for the factors of production, maximum or optimum production decision of the business firm, the impact of imposing taxation on the production of certain goods to their demand, etc. are analyzed in microeconomics. Thus microeconomics has a very important place in the study of economic theory. It has both theoretical and practical importance in the sense that it provides the base for economic theories on the one hand and also helps in the formulation of economic policies. The major application or uses or importance and limitations of microeconomics are briefly explained as below;

Uses or Importance of Microeconomics

It Facilitates Understanding the Functioning of an Economy

The study of microeconomics helps in the study of the working of the economy to a great extent. Microeconomics analyzes the economic behavior of individual industries, wage determination, product pricing, individual taxes, international trade, etc. therefore to understand the working of the economy, we have to collect enough information about those micro variables. With the help of microeconomics, it is possible to understand how millions of consumers and sellers behave in an economy. It also helps in understanding the economic reasons behind the decisions like-what to produce, for whom to produce, how much to produce, etc.

To Help in Efficient Allocation of Resources

Economic productive resources are scarce in availability. Microeconomic theories help to utilize all the scarce resources in an optimum manner. The efficient conditions in the area of consumption as well as production both are studies under microeconomics. For example, microeconomics provides the law of substitution by which a consumer will maximize his satisfaction in that condition when the ratio of marginal utilities is equal to the ratio of prices of corresponding commodities. Similarly, a producer will maximize his profit when the ratio of marginal product of the factor of production is equal to the ratio of their prices. Such conditions guide consumers as well as producers for the efficient allocation of scarce resources. The microeconomic theory thus suggests suitable policies to achieve economic growth, prosperity, and stability in the economic system of the country.

Useful in Designing Economic Policies

Microeconomic theories and tools provide the basis for the formulation of economic policies for the welfare of the nation. Microeconomics is useful in policy formulation and its analysis in two ways. The first is that it is useful to analyze the effect of government policies on the allocation of resources and pricing of products with the help of the demand-supply model. Secondly, microeconomics includes different economic models and theories that are necessary to analyze the impact of different theories before their formulation and implementation. For example, if the government is interested to impose a new tax on a particular product then the government has to analyze its implication on demand for that product, revenue to the government, production, consumption, and burden on the consumers. Microeconomic theories are helpful to study all issues needed for policy formulation. 

The basis for Welfare Economics/to Examine the Conditions of Economic Welfare

Microeconomics helps in understanding the condition of economic welfare. The whole framework of welfare economics is based on price theory- a major part of microeconomics. Microeconomics assists in obtaining the information related to the number of products consumed by society to measure the degree of the economic welfare of society. It reveals how under imperfect competition there is a misallocation of resources and how the output obtained is always less than the optimum. Imperfect market conditions also create inefficiencies and lead to a reduction in production, consumption, and social welfare. Therefore, there is considerable wastage of resources in the imperfect market and economics suggests means to correcting the inefficient allocation of resources and eliminating inefficiencies.

Study of Human Behavior/Consumer Behavior

Microeconomics studies many forms of human behaviors with the help of the law of diminishing marginal utility, equi-marginal utility, indifference curve, and revealed preference theory. With the help of such theories microeconomics also helps consumers to achieve efficiency in their decisions.

Use in Public Finance

Microeconomic theories help the government to formulate public finance-related policies at the macro level. The study of demand and supply, market theory, etc. helps fix the tax rate and the type of tax as well as the amount of tax to be charged to the buyer and the seller. It also helps to measure the burden of government tax on buyers or sellers.

Useful in International Trade

The study of microeconomics helps to estimate gains from international trade and the determination of the foreign exchange rate. Microeconomics helps to measure the elasticity of demand for each other’s products and also determines the part of a gain from international trade. In the floating exchange rate regime, the rate of the foreign exchange rate is determined by the demand and supply of foreign currency.

Useful in Business Decision Making

Microeconomics helps business executives in making a production plan and trade decision. It also provides an analytical tool to examine the market mechanism, business firm, production, and pricing policies. Microeconomics is very useful in business decision making in the following areas;

  • Resource Allocation: The productive resources are scarce in the economy and microeconomics tells how productive resources are allocated in the production of various goods and services. It also helps to find out, goods to produce, quantity to produce, and target customers of the targeted product.
  • Production Decision: The business firm has to produce various goods and services with the help of limited resources. They can use the different alternative techniques but they have to choose one that can produce the optimum level of production. Microeconomics helps to find out the optimal production decision
  • Pricing Policy: Microeconomics provides knowledge as to how the price of products is determined. It provides the basis for analyzing the pricing problem. The production and pricing decisions are taken based on the theory of demand, elasticity of demand, consumer behavior, etc.
  • Cost Analysis: Cost analysis is an important area of microeconomics. There are many microeconomic principles and theories to describe several forms of the cost that has to incur by a producer while operating a business. Such as fixed cost and variable cost, average cost and marginal cost, short and long-run cost. Microeconomic theories also help to control the cost by ensuring the efficient allocation of available economic resources.
  • Demand Analysis: Demand analysis plays a key role in business decisions. Demand function and its determinants are the subject matters of microeconomics and with the help of such microeconomic variables; a business firm can forecast the demand of the products.

Limitations of Microeconomics

Microeconomics is very useful for understanding the functioning of the economy on the one hand and to provide guidelines for policy formulation on the other. But the uses and importance of microeconomics are somehow confined by its limitations. Like other social sciences, microeconomics does not provide a readymade solution to real-life economic problems. It only provides tools and techniques for finding the best fitting solution to real-life problems. Moreover, its applicability has been confined due to various limitations of microeconomics. Most of the limitations have arisen from the assumptions that it has undertaken in its analysis. Some major limitations of microeconomics are briefly discussed below;

  • Microeconomics in its study assumes a given level of macroeconomic variables. It means in microeconomics the major macroeconomic variables assume constant or given but in reality, these variables are not constant. They keep on changing with the change in the factors affecting such variables. Due to such the validity of microeconomics and its theories may be limited.
  • Microeconomics mainly assumes the existence of a free-market economy or invisible hand, absence of government intervention in the economic activities of the society. In practice, the government controls and regulates all economic activities. Therefore such impractical assumptions of microeconomics themselves have made it limited in its application.
  • The subject matter of microeconomics is chiefly related to the economic behavior and relations of individual parts of the whole economy by ignoring the aggregate or whole approach. Thus microeconomics only provides a partial analysis of economic relations and variables. Thus its theories may not apply in the complex economic system in which all are subject to one.
  • Microeconomic theories generalize based on the results from the individualist approach and models. The result obtained so may not be applied for general applicability.

Conclusion

From the article, we know the matters concerning the uses, importance, and limitations of microeconomics. Microeconomics deals with the analysis of small units of the economy such as individual consumers, firms, and a small group of individual units individual markets, etc. It is an atomic study of the economy.  It guides all the economic agents in their optimum decision-making and helps a country to achieve a sustained growth rate and stability in the economy. The study of microeconomics is always helpful for personal/individual decisions as well as the decision-making of businesses incorporating the behavior of millions of small units of the economy. Like other social sciences, microeconomics/economics does have its own limitations that emerged from its assumptions.

References and Suggested Readings

Adhikari, G.M. (2012). Microeconomics. Kathmandu: Asmita Publication

Dhakal, R. (2019). Microeconomics for Business. Kathmandu: Samjhana Publication Pvt. Ltd.

Dwibedi, D.N. (2003). Microeconomics Theory and Applications. Delhi: Vikas Publishing House Pvt. Ltd.

Kanel, N.R. and et.al. (2016). Microeconomics. Kathmandu: Buddha Publication.

Koutsoyiannis, A. (1979). Modern Microeconomics. London: ELBS/Macmillan.

Mankiw, N.G. (2009). Principles of Microeconomics. New Delhi: Centage Learning India Private Limited

Salvatore, Dominick. (2003). Microeconomics: Theory and Application. Oxford University Press, Inc.

Shrestha, P.P. and et.al. (2019). Microeconomics for Business. Kathmandu: Advance Sarswati Prakashan.

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