The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). The graph depicts a right-shift in demand from D₁ to D₂ along with the consequent increase in price and quantity required to reach a new market-clearing equilibrium point on the supply curve (S).

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Microeconomics (from Greek prefix micro- "μικρό" meaning "small" + "economics"- "οικονομια") is a branch of economics that studies the behavior of individual households and firms in making decisions on the allocation of limited resources.^[1] Typically, it applies to markets where goods or services are bought and sold. Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services.^[2][3]

This is in contrast to macroeconomics, which involves the "sum total of economic activity, dealing with the issues of growth, inflation, and unemployment."^[2] Microeconomics also deals with the effects of national economic policies (such as changing taxation levels) on the aforementioned aspects of the economy.^[4] Particularly in the wake of the Lucas critique, much of modern macroeconomic theory has been built upon 'microfoundations'—i.e. based upon basic assumptions about micro-level behavior.

One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market failure, where markets fail to produce efficient results, and describes the theoretical conditions needed for perfect competition. Significant fields of study in microeconomics include general equilibrium, markets under asymmetric information, choice under uncertainty and economic applications of game theory. Also considered is the elasticity of products within the market system.

Assumptions and definitions[link]

The theory of supply and demand usually assumes that markets are perfectly competitive. This implies that there are many buyers and sellers in the market and none of them have the capacity to significantly influence prices of goods and services. In many real-life transactions, the assumption fails because some individual buyers or sellers have the ability to influence prices. Quite often, a sophisticated analysis is required to understand the demand-supply equation of a good model. However, the theory works well in situations meeting these assumptions.

Mainstream economics does not assume a priori that markets are preferable to other forms of social organization. In fact, much analysis is devoted to cases where so-called market failures lead to resource allocation that is suboptimal by some standard (defense spending is the classic example, profitable to all for use but not directly profitable for anyone to finance). In such cases, economists may attempt to find policies that will avoid waste, either directly by government control, indirectly by regulation that induces market participants to act in a manner consistent with optimal welfare, or by creating "missing markets" to enable efficient trading where none had previously existed.

This is studied in the field of collective action and public choice theory. It also must be noted that "optimal welfare" usually takes on a Paretian norm, which in its mathematical application of Kaldor–Hicks method. This can diverge from the Utilitarian goal of maximising utility because it does not consider the distribution of goods between people. Market failure in positive economics (microeconomics) is limited in implications without mixing the belief of the economist and his or her theory.

The demand for various commodities by individuals is generally thought of as the outcome of a utility-maximizing process, with each individual trying to maximise their own utility. The interpretation of this relationship between price and quantity demanded of a given good assumes that, given all the other goods and constraints, the set of choices which emerges is that one which makes the consumer happiest.

Modes of operation[link]

It is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output. Given this assumption, there are four categories in which a firm's profit may be considered to be.

• A firm is said to be making an economic profit when its average total cost is less than the price of each additional product at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price.
• A firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total cost equals price at the profit-maximizing output.
• If the price is between average total cost and average variable cost at the profit-maximizing output, then the firm is said to be in a loss-minimizing condition. The firm should still continue to produce, however, since its loss would be larger if it were to stop producing. By continuing production, the firm can offset its variable cost and at least part of its fixed cost, but by stopping completely it would lose the entirety of its fixed cost.
• If the price is below average variable cost at the profit-maximizing output, the firm should go into shutdown. Losses are minimized by not producing at all, since any production would not generate returns significant enough to offset any fixed cost and part of the variable cost. By not producing, the firm loses only its fixed cost. By losing this fixed cost the company faces a challenge. It must either exit the market or remain in the market and risk a complete loss.

Opportunity cost[link]

Opportunity cost of an activity (or goods) is equal to the best next alternative foregone. Although opportunity cost can be hard to quantify, the effect of opportunity cost is universal and very real on the individual level. In fact, this principle applies to all decisions, not just economic ones. Since the work of the Austrian economist Friedrich von Wieser, opportunity cost has been seen as the foundation of the marginal theory of value^{[citation needed]}.

Opportunity cost is one way to measure the cost of something. Rather than merely identifying and adding the costs of a project, one may also identify the next best alternative way to spend the same amount of money. The forgone profit of this next best alternative is the opportunity cost of the original choice. A common example is a farmer that chooses to farm his or her land rather than rent it to neighbors, wherein the opportunity cost is the forgone profit from renting. In this case, the farmer may expect to generate more profit alone. Similarly, the opportunity cost of attending university is the lost wages a student could have earned in the workforce, rather than the cost of tuition, books, and other requisite items (whose sum makes up the total cost of attendance). The opportunity cost of a vacation in the Bahamas might be the down payment for a house.

Note that opportunity cost is not the sum of the available alternatives, but rather the benefit of the single, best alternative. Possible opportunity costs of a city's decision to build a hospital on its vacant land are the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money that could have been made from selling the land, or the loss of any of the various other possible uses — but not all of these in aggregate. The true opportunity cost would be the forgone profit of the most lucrative of those listed.

One question that arises here is how to determine a money value for each alternative to facilitate comparison and assess opportunity cost, which may be more or less difficult depending on the things we are trying to compare. For example, many decisions involve environmental impacts whose monetary value is difficult to assess because of scientific uncertainty. Valuing a human life or the economic impact of an Arctic oil spill involves making subjective choices with ethical implications.

It is imperative to understand that no decision on allocating time is free. No matter what one chooses to do, he or she is always giving something up in return. An example of opportunity cost is deciding between going to a concert and doing homework. If one decides to go the concert, then he or she is giving up valuable time to study, but if he or she chooses to do homework then the cost is giving up the concert. Any decision in allocating capital is likewise: there is an opportunity cost of capital, or a hurdle rate, defined as the expected rate one could get by investing in similar projects on the open market. Opportunity cost is vital in understanding microeconomics and decisions that are made.

Applied microeconomics[link]

Applied microeconomics includes a range of specialized areas of study, many of which draw on methods from other fields. Industrial organization examines topics such as the entry and exit of firms, innovation, and the role of trademarks. Labor economics examines wages, employment, and labor market dynamics. Public economics examines the design of government tax and expenditure policies and economic effects of these policies (e.g., social insurance programs). Political economy examines the role of political institutions in determining policy outcomes. Health economics examines the organization of health care systems, including the role of the health care workforce and health insurance programs. Urban economics, which examines the challenges faced by cities, such as sprawl, air and water pollution, traffic congestion, and poverty, draws on the fields of urban geography and sociology. Financial economics examines topics such as the structure of optimal portfolios, the rate of return to capital, econometric analysis of security returns, and corporate financial behavior. Law and economics applies microeconomic principles to the selection and enforcement of competing legal regimes and their relative efficiencies. Economic history examines the evolution of the economy and economic institutions, using methods and techniques from the fields of economics, history, geography, sociology, psychology, and political science.

References[link]

Further reading[link]

• Bade, Robin; Michael Parkin (2001). Foundations of Microeconomics. Addison Wesley Paperback 1st Edition. 
• Bouman, John: Principles of Microeconomics - free fully comprehensive Principles of Microeconomics and Macroeconomics texts. Columbia, Maryland, 2011
• Colander, David. Microeconomics. McGraw-Hill Paperback, 7th Edition: 2008.
• Dunne, Timothy, J. Bradford Jensen, and Mark J. Roberts (2009). Producer Dynamics: New Evidence from Micro Data. University of Chicago Press. ISBN 978-0-226-17256-9. 
• Eaton, B. Curtis; Eaton, Diane F.; and Douglas W. Allen. Microeconomics. Prentice Hall, 5th Edition: 2002.
• Frank, Robert A.; Microeconomics and Behavior. McGraw-Hill/Irwin, 6th Edition: 2006.
• Friedman, Milton. Price Theory. Aldine Transaction: 1976
• Hagendorf, Klaus: Labour Values and the Theory of the Firm. Part I: The Competitive Firm. Paris: EURODOS; 2009.
• Harberger, Arnold C., 2008. "Microeconomics," The Concise Encyclopedia of Economics.
• Hicks, John R. Value and Capital. Clarendon Press. [1939] 1946, 2nd ed.
• Hirshleifer, Jack., Glazer, Amihai, and Hirshleifer, David, Price theory and applications: Decisions, markets, and information. Cambridge University Press, 7th Edition: 2005.
• Jehle, Geoffrey A.; and Philip J. Reny. Advanced Microeconomic Theory. Addison Wesley Paperback, 2nd Edition: 2000.
• Katz, Michael L.; and Harvey S. Rosen. Microeconomics. McGraw-Hill/Irwin, 3rd Edition: 1997.
• Kreps, David M. A Course in Microeconomic Theory. Princeton University Press: 1990
• Landsburg, Steven. Price Theory and Applications. South-Western College Pub, 5th Edition: 2001.
• Mankiw, N. Gregory. Principles of Microeconomics. South-Western Pub, 2nd Edition: 2000.
• Mas-Colell, Andreu; Whinston, Michael D.; and Jerry R. Green. Microeconomic Theory. Oxford University Press, US: 1995.
• McGuigan, James R.; Moyer, R. Charles; and Frederick H. Harris. Managerial Economics: Applications, Strategy and Tactics. South-Western Educational Publishing, 9th Edition: 2001.
• Nicholson, Walter. Microeconomic Theory: Basic Principles and Extensions. South-Western College Pub, 8th Edition: 2001.
• Perloff, Jeffrey M. Microeconomics. Pearson - Addison Wesley, 4th Edition: 2007.
• Perloff, Jeffrey M. Microeconomics: Theory and Applications with Calculus. Pearson - Addison Wesley, 1st Edition: 2007
• Pindyck, Robert S.; and Daniel L. Rubinfeld. Microeconomics. Prentice Hall, 7th Edition: 2008.
• Ruffin, Roy J.; and Paul R. Gregory. Principles of Microeconomics. Addison Wesley, 7th Edition: 2000.
• Varian, Hal R. (1987). "microeconomics," The New Palgrave: A Dictionary of Economics, v. 3, pp. 461–63.
• Varian, Hal R. Intermediate Microeconomics. & Company, 7th Edition.
• Varian, Hal R. Microeconomic Analysis. W. W. Norton & Company, 3rd Edition.

External links[link]

Wikibooks has a book on the topic of Microeconomics

• Open Source Introduction to Microeconomics (see wiki article) by R. Preston McAfee – California Institute of Technology
• Amosweb.com homepage – online economics dictionary
• X-Lab: A Collaborative Micro-Economics and Social Sciences Research Laboratory
• Micro Economics – the role of microeconomics in supporting the social fabric of macro economies
• Simulations in Microeconomics

Piero Sraffa (August 5, 1898 – September 3, 1983) was an influential Italian economist whose book Production of Commodities by Means of Commodities is taken as founding the Neo-Ricardian school of Economics.

Early life[link]

He was born in Turin, Italy, to a wealthy Italian Jewish family, to Angelo and Irma Sraffa.^[1] His father was a Professor in commercial law and later dean at the Bocconi University in Milan. Sraffa studied in his town and graduated at the local university with a work on inflation in Italy during and after World War I. Notably, his tutor was Luigi Einaudi, one of the most important Italian economists and later a president of the Italian Republic.

From 1921 to 1922 he studied in London at the London School of Economics. In 1922 he was appointed as Director of the provincial labour department in Milan, then as Professor in Political economy first in Perugia, and later in Cagliari, Sardinia. In Turin he had met Antonio Gramsci (the most important leader of Italian Communist Party). They became close friends, partly due to their shared ideological views. He also was already in contact with Filippo Turati, perhaps the most important leader of Italian Socialist Party, whom he allegedly met and frequently visited in Rapallo, where his family had a holiday villa.

In 1925, he wrote about returns to scale and perfect competition, underlining some doubtful points of Alfred Marshall's theory of the firm. This was amended for British readers and published in 1926 as The Laws of Returns under Competitive Conditions.

Major works[link]

In 1927, Sraffa's yet undiscussed theory of value,^[2] but also his friendship with Antonio Gramsci (a risky and compromising endeavor in the context of the Italian fascist regime, considering Gramsci had previously been imprisoned; Sraffa had brought him the material, literally pens and paper, with which Gramsci would write his Prison Notebooks), brought John Maynard Keynes to prudently invite Sraffa to the University of Cambridge, where he was initially assigned a lectureship.

That Sraffa hated lecturing is normally explained by his shyness. But perhaps he declined teaching an economic theory he found wanting. So, he stopped collaborating in the making of Keynes' General Theory as Keynes used a subjective propensity to consume. After a few years, Keynes created ex novo for Sraffa the charge of Marshall Librarian.

Sraffa joined the so-called "cafeteria group", together with Frank P. Ramsey and Ludwig Wittgenstein, a sort of informal club that discussed Keynes's theory of probability and Friedrich Hayek's theory on business cycles. In 1939, Sraffa was elected to a Fellowship at Trinity College.^[3]

Ricardo's works and correspondence[link]

John Eatwell has written of Sraffa's work on Ricardo:

[Sraffa's] reconstruction of Ricardo's surplus theory, presented in but a few pages of the introduction to his edition of Ricardo's Principles, penetrated a hundred years of misunderstanding and distortion to create a vivid rationale for the structure and content of surplus theory, for the analytical role of the labor theory of value, and hence for the foundations of Marx's critical analysis of capitalist production.^[4]

Sraffian economics[link]

Sraffa's Production of Commodities by Means of Commodities was an attempt to perfect Classical Economics' theory of value, as originally developed by David Ricardo and others. He aimed to demonstrate flaws in the mainstream neoclassical theory of value and develop an alternative analysis. In particular, Sraffa's technique of aggregating capital as dated inputs of labour led to a famous scholarly debate known as the Cambridge capital controversy.

Economists disagree on whether Sraffa's work refutes neoclassical economics. Many post-Keynesian economists use Sraffa's critique as justification for abandoning neoclassical analysis and exploring other models of economic behavior. Others see his work as compatible with neoclassical economics, as developed in modern general equilibrium models, or unable to determine a long-period position, just like the Walrasian approach.^[5]

Nonetheless, Sraffa's work, and particularly his interpretation of Ricardo and his Production of Commodities by Means of Commodities (1960), is seen as the starting point of the Neo-Ricardian school in the 1960s. His approach there has been described as serving "to help judge Ricardo's editor and to illuminate the unity in [his] scientific vision, from before 1926 until death in 1983."^[6][7]

Personal connections[link]

As said above, Sraffa is known also for his close friendship with Italian Marxist thinker Antonio Gramsci and for being instrumental in securing Gramsci's Prison Notebooks from the Fascist authorities after the latter's death in 1937. Norman Malcolm famously credits Sraffa with providing Ludwig Wittgenstein with the conceptual break that founded the Philosophical Investigations, by means of a rude gesture on Sraffa's part:^[8]

Wittgenstein was insisting that a proposition and that which it describes must have the same 'logical form', the same 'logical multiplicity', Sraffa made a gesture, familiar to Neapolitans as meaning something like disgust or contempt, of brushing the underneath of his chin with an outward sweep of the finger-tips of one hand. And he asked: 'What is the logical form of that?'

In the introduction to Philosophical Investigations, Wittgenstein mentions discussions with Sraffa over many years and says: "I am indebted to this stimulus for the most consequential ideas in this book".

Sraffa was described as a very intelligent man, with a proverbial shyness and a real devotion for study and books. His famous library contained more than 8,000 volumes, now partly in the Trinity College Library. A popular anecdote claims that Sraffa made successful long-term investments in Japanese government bonds that he bought the day after the nuclear bombing on Hiroshima and Nagasaki.^[9] Another version of this is that Sraffa bought the bonds during the War, when they were trading at distressed prices, as he was convinced that Japan would honour its obligations (Nicholas Kaldor pages 66–67).^[1]

In 1972, he was awarded an honorary doctorate by Paris's university (Sorbonne), and in 1976 he received another one from Madrid's Complutense university.

Bibliography[link]

• Sraffa, Piero, 1926, "The Laws of Returns under Competitive Conditions", Economic Journal, 36(144), pp. 535–50.
• _____, 1960, Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory. Cambridge University Press. Preview.
• _____ and M.H. Dobb, editors (1951–1973). The Works and Correspondence of David Ricardo. Cambridge University Press, 11 volumes. Online at the Online Library of Liberty.

Further reading[link]

• Steve Keen Debunking Economics: The Naked Emperor of the Social Sciences (2001, Pluto Press Australia) ISBN 1-86403-070-4

References[link]

External links[link]

• Piero Sraffa Archives homepage at Trinity College, Cambridge. Contains an online catalogue of Sraffa's personal and professional papers.