Economic Ideas - Microeconomics and some of the key things I think that we should take note...
I have just finished reading through a relatively thick stack of notes on Microeconomics, namely on demand/supply, elasticity, indifference curves, utility functions, production and cost as well as market structures (well I consider wage theory as under labour economics). Let me briefly run through them and attempt to show you some aspects of theory which I think some of you never really thought about.
Let’s start with the basics, demand and supply (the introduction to Economics bit shall be re-explained by me in my later post). Actually, demand and supply is the basics of everything. Wages, product markets, macro-markets are all about demand and supply and their interaction. So having a good grasp and understanding of this topic is crucial to doing well in Economics.
And to really understand this concept well, we are talking about the marginalist principle. That is, the idea that it is things consumed/produced at the margin that matter, and not the overall consumption/production. To be honest, if I’m not wrong, marginalism really came about because of the idea of consumption (the apparent diamond paradox in Economics was solved only thanks to marginalism). Anyway, the genius who resolved so much problems and created a beautiful framework for us to work in is Alfred Marshall. Now, this is the point. Marshall’s framework is based largely on logic. If you have ever wondered, does his framework actually works in real world? Yes, it does provides a very neat explanation of how our world works, but its more of an idea and not of a theory. I mean, do we seriously expect equilibrium? Oh well, the only thing that I can say is that empirical studies have been conducted recently and they do show that the general shapes of the demand and supply curves are correct. But the equilibrium idea is still a bit fuzzy. Maybe we need to actually check with the Walrasian School of thought.
Now that you realised that marginalism is the most important concept (at least for micro), we shall now move on to elasticity, again a product of Marshall’s (OK, I MUST STRESS, marginalist principle and elasticity were all developed concurrently by separate groups of people, but Marshall was the one who brought the concepts to ‘greater’ heights and applications). I shall quote Marshall on his explanation of elasticity "The elasticity or responsiveness of demand in a market is great or small according as the amount demanded increases much or little for a given rise in price." Hope you will see the amazing huge general application this idea has.
I shall now moved on to production costs. Its nothing much, just plain mathematical stuff, and the concepts are pretty much application of marginalist principle. The key point is that economic costs and benefits are vastly different from standard definition of costs. So when we talk about Costs-Benefits Analysis (CBA), and we are considering whether to steal from somebody’s wallet, we are taking into account a lot of stuff. In monetary terms, stealing does give a huge benefit but little costs. But in terms of economics, there’s actually a huge costs (consider the costs imposed on your value systems – moral costs, costs of friendship, costs and risk of getting caught blar blar blar….) So technically speaking, for someone who places a high value on morals, not stealing is the rational choice.
Market structures are a great way of explaining simple market behaviour. Credit must go to Joan Robinson (she’s from Cambridge, a contemporary of Keynes) for developing imperfect competition (I still find it ridiculous that she was not awarded a Nobel Prize). Imperfection competition enabled us to have a more realistic viewing of the world. I shall add on that even though Perfect Competition is impossible and too theoretical, it offers us with a great starting point for us to make observations of real world economies as well as understand other market structures. Something to share with, there’s also a theory of Contestable Markets developed by Williamson and Baumol and they did a good job of explaining MNCs and stuff. But possibly, they tried to do too much with their framework, causing it to fail under certain conditions. But they did do a good job of providing an alternative to perfect competition. Another thing to note is that Oligopolies behave in a manner, which Game theory predicts real well. In fact, to understand Oligopoly better it will be good if you get to study it with game theory side by side (the explanation is certainly immensely better than a kinked demand theory, anyway Kinked demand just provides an explanation, not exactly a cause of oligopoly…).
But the 2 key concepts that I truly like and feel that they are immensely important is the idea of utility and indifference curves. Utility allows us to use economics in a large spectrum of applications. The idea that having some ‘form’ of unit to measure happiness means that almost everything in this world (including love) can actually be explained using economic theory, as long as it is possible for us to rank our preference (indifference curves). Utility also does a good job in predicting rational economic behaviour, as well as explaining certain behaviour that might appears illogical but in actual fact are perfectly rational economics.
Indifference curves open up such a huge field that it is possible for economist to analyse various different scenarios. The appearance of the iso (iso-costs, iso-profits, isoquants) family of curves means that there is now a much more easier, graphical way for us to explain certain ideas. I mean, demand and supply comes from here. Same for theory of labour as well as production and costs. To some extent market structures as well. Indifference curves are also present throughout in macroeconomic analysis, so understanding indifference curves analysis will play a big role in helping you in your study of Economics.
Ok, above is just a brief account of what I think are the real important parts in Microeconomics. Most are just what I feel, and they are based on my limited knowledge and reading of the subject. I must admit that I’m pretty weak in microeconomics, so please do not treat my views above as super ‘amazing’. However, for a rough guide to the A levels, I think I should have more than surpassed the examination requirements.
Let’s start with the basics, demand and supply (the introduction to Economics bit shall be re-explained by me in my later post). Actually, demand and supply is the basics of everything. Wages, product markets, macro-markets are all about demand and supply and their interaction. So having a good grasp and understanding of this topic is crucial to doing well in Economics.
And to really understand this concept well, we are talking about the marginalist principle. That is, the idea that it is things consumed/produced at the margin that matter, and not the overall consumption/production. To be honest, if I’m not wrong, marginalism really came about because of the idea of consumption (the apparent diamond paradox in Economics was solved only thanks to marginalism). Anyway, the genius who resolved so much problems and created a beautiful framework for us to work in is Alfred Marshall. Now, this is the point. Marshall’s framework is based largely on logic. If you have ever wondered, does his framework actually works in real world? Yes, it does provides a very neat explanation of how our world works, but its more of an idea and not of a theory. I mean, do we seriously expect equilibrium? Oh well, the only thing that I can say is that empirical studies have been conducted recently and they do show that the general shapes of the demand and supply curves are correct. But the equilibrium idea is still a bit fuzzy. Maybe we need to actually check with the Walrasian School of thought.
Now that you realised that marginalism is the most important concept (at least for micro), we shall now move on to elasticity, again a product of Marshall’s (OK, I MUST STRESS, marginalist principle and elasticity were all developed concurrently by separate groups of people, but Marshall was the one who brought the concepts to ‘greater’ heights and applications). I shall quote Marshall on his explanation of elasticity "The elasticity or responsiveness of demand in a market is great or small according as the amount demanded increases much or little for a given rise in price." Hope you will see the amazing huge general application this idea has.
I shall now moved on to production costs. Its nothing much, just plain mathematical stuff, and the concepts are pretty much application of marginalist principle. The key point is that economic costs and benefits are vastly different from standard definition of costs. So when we talk about Costs-Benefits Analysis (CBA), and we are considering whether to steal from somebody’s wallet, we are taking into account a lot of stuff. In monetary terms, stealing does give a huge benefit but little costs. But in terms of economics, there’s actually a huge costs (consider the costs imposed on your value systems – moral costs, costs of friendship, costs and risk of getting caught blar blar blar….) So technically speaking, for someone who places a high value on morals, not stealing is the rational choice.
Market structures are a great way of explaining simple market behaviour. Credit must go to Joan Robinson (she’s from Cambridge, a contemporary of Keynes) for developing imperfect competition (I still find it ridiculous that she was not awarded a Nobel Prize). Imperfection competition enabled us to have a more realistic viewing of the world. I shall add on that even though Perfect Competition is impossible and too theoretical, it offers us with a great starting point for us to make observations of real world economies as well as understand other market structures. Something to share with, there’s also a theory of Contestable Markets developed by Williamson and Baumol and they did a good job of explaining MNCs and stuff. But possibly, they tried to do too much with their framework, causing it to fail under certain conditions. But they did do a good job of providing an alternative to perfect competition. Another thing to note is that Oligopolies behave in a manner, which Game theory predicts real well. In fact, to understand Oligopoly better it will be good if you get to study it with game theory side by side (the explanation is certainly immensely better than a kinked demand theory, anyway Kinked demand just provides an explanation, not exactly a cause of oligopoly…).
But the 2 key concepts that I truly like and feel that they are immensely important is the idea of utility and indifference curves. Utility allows us to use economics in a large spectrum of applications. The idea that having some ‘form’ of unit to measure happiness means that almost everything in this world (including love) can actually be explained using economic theory, as long as it is possible for us to rank our preference (indifference curves). Utility also does a good job in predicting rational economic behaviour, as well as explaining certain behaviour that might appears illogical but in actual fact are perfectly rational economics.
Indifference curves open up such a huge field that it is possible for economist to analyse various different scenarios. The appearance of the iso (iso-costs, iso-profits, isoquants) family of curves means that there is now a much more easier, graphical way for us to explain certain ideas. I mean, demand and supply comes from here. Same for theory of labour as well as production and costs. To some extent market structures as well. Indifference curves are also present throughout in macroeconomic analysis, so understanding indifference curves analysis will play a big role in helping you in your study of Economics.
Ok, above is just a brief account of what I think are the real important parts in Microeconomics. Most are just what I feel, and they are based on my limited knowledge and reading of the subject. I must admit that I’m pretty weak in microeconomics, so please do not treat my views above as super ‘amazing’. However, for a rough guide to the A levels, I think I should have more than surpassed the examination requirements.
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