Modern microeconomics is an examination of the purchasing behavior of separate individuals and companies.
Modern microeconomics is an examination of the purchasing behavior of individuals and separate firms that evolved from the economic practice of price theory, which was a fundamental aspect of economic theories along with monetary policy in the early 1940s. It examines what motivates the behavior of individuals and companies when shopping, which directly affects supply and demand, and then these observations of individual behavior are pooled together to gain a broader perspective of economic activity. Microeconomics, however, does not expand this analysis to include larger economic influences on a national or global scale, such as the analysis of gross domestic product (GDP) numbers.
Modern microeconomics may be concerned with how people research and make decisions about major purchases.
When modern microeconomics looks at markets, its main concern is what influences individual buyers and sellers, as this general behavior is what drives prices and output, or productivity, within markets. Because it is a bottom-up approach to economic theory, its most applicable value is for start-ups and individual consumers looking to gain access to a certain market or acquire goods or services at an optimal value for the price. This is where modern microeconomics is a direct descendant of price theory, which is a broad attempt to understand the intrinsic monetary value that humans place on certain goods and services.
While the principles on which modern microeconomics is based may seem simple, such as calculating supply and demand numbers at a local level and expanding them to a broader perspective, the actual determination of human reasoning to set the price is difficult to quantify. . The 18th century Scottish pioneer of economic theory, Adam Smith, noted this problem as early as 1776 with the Diamond-Water Paradox. The Diamond-Water Paradox asks why humans place so little monetary value on water and so high value on diamonds, when water is essential for life and, for the average human being, diamonds have virtually no practical value.
The theory of initial prices, therefore, recognized the fact that prices in a market are based on two different types of valuation by the aggregate actions of people in society. Goods have a use value, as with water, or an exchange value, which diamonds maintain at a very high and compact level. The exchange value of a good is also largely based on the amount of labor required to obtain it, which gives rare items, difficult to obtain even with intensive labor, a high value for individuals. Labor is the basis of price theory and modern microeconomics as it determines the relative scarcity or abundance of all limited resources, and labor itself may be a limited resource that is considered in the calculations.
After determining the prices set for individual purchases and the underlying causes of price levels, modern microeconomics must also try to understand the strength of the market to support a given price. It does this by looking at the availability of general resources and labor and the efficiency with which they are allocated to production. The practice of modern microeconomics, therefore, has micro-foundations that it builds data from individual motivations, but it must also use broader product pricing factors to understand how efficient and stable a market is.
One of the core values of modern microeconomics is that it can predict a market failure before macroeconomics or national economic policy sees it coming on the horizon. This is because modern microeconomics seeks underlying principles that balance supply and demand outside the control of government forces. Where efficiency is not present in production, consumption or distribution, it is a strong indicator that prices and markets are subject to rapid change.
Some weaknesses of microeconomics, however, include that it assumes markets and competition are rational environments that seek a natural equilibrium. The assumptions of price fluctuation are also based on the idea of full employment and that larger influences like trade barriers have no direct impact on the local level. As of 2011, attempts to overcome such limitations involve creating increasingly complex computer models of microeconomic activity that fit the reality of price fluctuations as closely as possible.