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Microeconomics (from Greek prefix mikro- meaning "small" and economics) is a branch of economics that studies the behavior of individual households and firms in making decisions on the allocation of limited resources (see scarcity).[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

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).
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. "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 maximizing 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 their 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 maximize their own utility under a budget constraint and a given consumption set.
Modes of operation
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
Main article: Opportunity cost
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 their 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. This kind of reasoning is a very important part of the calculation of discount rates in discounted cash flow investment valuation methodologies. 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).
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, they are 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 they are giving up valuable time to study, but if they choose 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

United States Capitol Building: meeting place of the United States Congress, where many tax laws are passed, which have direct impact on economic welfare. This is studied in the subject of public economics.
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. 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. 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. 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.
Development

Classic duopoly model of Cournot: reaction functions of both firms are derived by imposing profit maximization, the Nash equilibrium is given by intersection of R1 and R2. At equilibrium no firm has a rational self-interest in changing produced quantities.
The modern field of microeconomics arose as an effort of neoclassical economics school of thought to put economic ideas into mathematical mode. An early attempt was made by Antoine Augustine Cournot Researches on the Mathematical Principles of the Theory of Wealth[5] (1838) in describing a spring water duopoly that now bears his name. Latter William Stanley Jevons's Theory of Political Economy[6] (1871), Carl Menger's Principles of Economics[7] (1871), and Léon Walras's Elements of Pure Economics: Or the theory of social wealth (1874–77)[8] gave way to what was called the Marginal Revolution. Some common ideas behind those works were models or arguments characterized by rational economic agents maximizing utility under a budget constrain. This arose as a necessity of arguing against the labour theory of value associated with classical economists such as Adam Smith, David Ricardo and Karl Marx. Walras also went as far as developing the concept of general equilibrium of an economy.
Alfred Marshall's textbook, Principles of Economics[9] was published in 1890 and became the dominant textbook in England for a generation. His main point was that Jevons went too far in emphasizing utility as an attempt to explain prices over costs of production. In the book he writes:
"There are few writers of modern times who have approached as near to the brilliant originality of Ricardo as Jevons has done. But he appears to have judged both Ricardo and Mill harshly, and to have attributed to them doctrines narrower and less scientific than those which they really held. And his desire to emphasize an aspect of value to which they had given insufficient prominence, was probably in some measure accountable for his saying, "Repeated reflection and inquiry have led me to the somewhat novel opinion that value depends entirely upon utility" (Theory, p. 1). This statement seems to be no less one-sided and fragmentary, and much more misleading, than that into which Ricardo often glided with careless brevity, as to the dependence of value on cost of production; but which he never regarded as more than a part of a larger doctrine, the rest of which he had tried to explain. "
In the same appendix[10] he further states:
"Perhaps Jevons' antagonism to Ricardo and Mill would have been less if he had not himself fallen into the habit of speaking of relations which really exist only between demand price and value as though they held between utility and value; and if he had emphasized as Cournot had done, and as the use of mathematical forms might have been expected to lead him to do, that fundamental symmetry of the general relations in which demand and supply stand to value, which coexists with striking differences in the details of those relations. We must not indeed forget that, at the time at which he wrote, the demand side of the theory of value had been much neglected; and that he did excellent service by calling attention to it and developing it. There are few thinkers whose claims on our gratitude are as high and as various as those of Jevons: but that must not lead us to accept hastily his criticisms on his great predecessors."

Marshall's diagram: SS' is the supply curve, DD' is the demand curve and A is the equilibrium
Marshall's idea of solving the controversy was that the demand curve could be derived by aggregating individual consumer demand curves, which were themselves based on the consumer problem of maximizing utility. The supply curve could be derived by superimposing a representative firm supply curves for the factors of production and then market equilibrium would be given by the intersection of demand and supply curves. He also introduced the notion of different market periods: mainly short run and long run. This set of ideas gave way to what economists call perfect competition, now found in the standard microeconomics texts, even thought Marshall himself had stated:[11]
"The process of substitution, of which we have been discussing the tendencies, is one form of competition; and it may be well to insist again that we do not assume that competition is perfect. Perfect competition requires a perfect knowledge of the state of the market; and though no great departure from the actual facts of life is involved in assuming this knowledge on the part of dealers when we are considering the course of business in Lombard Street, the Stock Exchange, or in a wholesale Produce Market; it would be an altogether unreasonable assumption to make when we are examining the causes that govern the supply of labour in any of the lower grades of industry. For if a man had sufficient ability to know everything about the market for his labour, he would have too much to remain long in a low grade. The older economists, in constant contact as they were with the actual facts of business life, must have known this well enough; but partly for brevity and simplicity, partly because the term "free competition" had become almost a catchword, partly because they had not sufficiently classified and conditioned their doctrines, they often seemed to imply that they did assume this perfect knowledge. "
An early formulation of the concept of production functions is due to Johann Heinrich von Thünen[12] which presented an exponential version of it. The standard Cobb–Douglas production function found in microeconomics textbooks refers to a collaborative paper between Charles Cobb and Paul Douglas published in 1928[13] in which they analised U.S. manufacturing data using this function as the basis of a regression analysis for estimating the relationship between inputs (labour and capital) and output (product): this discussion takes place through the concept of marginal productivity. The mathematical form of the Cobb-Douglas function can be found in the prior work of Knut Wicksell, Von Thunen and Turgot.

One of Marshall's diagrams for monopoly: DD' is the demand curve, SS' the supply curve, QQ' is the monopoly revenue curve and q3 the maximum revenue point. Cournot had already considered the mathematics of monopoly in the Mathematical Principles of the Theory of Wealth but he draw no diagram
A new impetus was given to field when around 1933. Joan Robinson and Edward H. Chamberlin, published respectively, The Economics of Imperfect Competition (1933) and The Theory of Monopolistic Competition (1933), introducing models of imperfect competition. Although the monopoly case was already exposed in Marshall's Principles of Economics and Cournot had already constructed models of duopoly and monopoly in 1838, a whole new set of models grew out of this new literature. In particular the monopolistic competition model results in a non efficient equilibrium. Chamberlin defined monopolistic competition as "challenge to traditional viewpoint of economics that competition and monopoly are alternatives and that individual prices are to be explained in terms of one or the otherby other". He continues: "By contrast it is held that most economic situations are composite of both competition and monopoly, and that, wherever this is the case, a false view is given by neglecting either one of the two forces and regarding the situation as made up entirely of the other".[14]

Stackelberg competition represented as an extensive form game with Infinite action space.
Later on some market models were built using game theory, particularly regarding oligopolies. A good example of how microeconomics started to incorporate game theory, is the Stackelberg competition model published in 1934[15] which can be characterized as a dynamic game with a leader and a follower, and then be solved to find a Nash Equilibrium.
In 1937 The Nature of the Firm[16] was published by Ronald Coase introducing the notion of transaction costs (the term itself was coined in the fifties), which explained why firms have an advantage over a group of independent contractors working with each other. The idea was that there were transaction costs in the use of the market: search and information costs, bargaining costs, etc. which give an advantage to a firm which can internalize the production process required to deliver a certain good to the market. A related result was published by Coase in his “The Problem of Social Cost”[17] (1960) which analyses solutions of the problem of externalities through bargaining, in which he first describes a cattle herd invading a farmer's crop and then discusses four legal cases: Sturges v Bridgman, Cooke v Forbes, Bryant v Lejever and Bass v Gregory. He then states:
"In earlier sections, when dealing with the problem of rearrangement of legal rights through the market, it was argued that such a rearrangement would be made trough the market whenever this would lead to an increase in the value of production. But this assumed costless market transactions. Once the costs of carrying out market transactions are taken into account it is clear that such rearrangement of rights will only be undertaken when the increase in the value of production consequent upon the rearrangement is greater than the costs which would be involved in bringing it about. When it is less, the granting of an injunction (or the knowledge that it would be granted) or the liability to pay damages may result in an activity being discontinued (or may prevent its being started) which would be undertaken if market transactions were costless. In these conditions the initial delimitation of legal rights does have an effect on the efficiency with which the economic system operates. One arrangement of rights may bring about a greater value of production than any other. But unless this is the arrangement of rights established by the legal system, the costs of reaching the same result by altering and combining rights through the market may be so great that this optimal arrangement of rights, and the greater value of production which it would bring, may never be achieved."
This then becomes relevant in context of regulations. He argues against the Pigovian tradition:[18]
"...The problem which we face in dealing with actions which have harmful effects is not simply one of restraining those responsible for them. What has to be decided is whether the gain from preventing the harm is greater than the loss which would be suffered elsewhere as a result of stopping the action which produces the harm. In a world in which there are costs of rearranging the rights established by the legal system, the courts, in cases relating to nuisance, are, in effect, making a decision on the economic problem and determining how resources are to be employed. It was argued that the courts are conscious of this and that they often make, although not always in a very explicit fashion, a comparison between what would be gained and what lost by preventing actions which have harmful effects. But the delimitation of rights is also the result of statutory enactments. Here we also find evidence of an appreciation of the reciprocal nature of the problem. While statutory enactments add to the list of nuisances, action is also taken to legalize what would otherwise be nuisances under the common law. The kind of situation which economists are prone to consider as requiring Goverment action is, in fac, often the result of Goverment action. Such action is not necessarily unwise. But there is a real danger that extensive Goverment intervention in the economic system may lead to the protection of those responsible for harmful being carried too far."
This period also marks the beginning of mathematical modeling of public goods with Paul Samuelson's The Pure Theory of Public Expenditure (1954),[19] in it he gives a set of equations for efficient provision of public goods (he called them collective consumption goods), now know as the Samuelson condition. He then gives a description of what is know called the free rider problem:
"However no decentralized pricing system can serve to determine optimally these levels of collective consumption. Other kinds of "voting" or "signaling" would have to be tried. But, and this is the point sensed by Wicksell but perhaps not fully appreciated by Lindahl, now it is in the selfish interest of each person to give false signals, to pretend to have less interest in a given collective consumption activity than he has, etc."

Used cars market: due to presence of fundamental asymmetrical information between seller and buyer the market equilibrium is not efficient, in the language of economists it is a market failure
Around the seventies the study of market failures came again into focus with the study of information asymmetry. In particular three authors emerged from this period: George Akerlof, Michael Spence and Joseph Stiglitz. Akerlof considered the problem of bad quality cars driving good quality cars out of the market in his know classic “The Market for Lemons”[20] (1970) because of the presence of asymmetrical information between buyers and sellers. Spence explained that signaling was fundamental in the labour market, because since employers cant know beforehand which of the candidates are the most productive, a college degree becomes a signaling device which allows a firm to hire new personnel.[21] A synthesizing paper of this era is "Externalities in Economies with Imperfect Information and Incomplete Markets" by Stiglitz and Greenwald:[22] the basic model consists of households maximizing a utility function, firms maximizing profit and a goverment which produces nothing, collect taxes and distribute the proceeds. An initial equilibrium with no taxes is assumed to exist, a vector x of household consumption and vector z of other variables that affect household utilities (externalities) are defined, a vector π of profits is defined along with a vector E of households expenditures. Since the envelope theorem holds, if the initial non taxed equilibrium is Pareto optimal then it follows that the dot products Π (between π and the time derivative of z) and B (between E and the time derivative of z) must equal each other. They state:
"Except in the special case (which is unlikely to hold generically) where Π and B exactly cancel each other out, the existence of these externalities will make the initial equilibrium inefficient and guarantee the existence of welfare-improving tax measures."
One application of this result is to the already mentioned Market for Lemons which deals with adverse selection: households buy from a pool of goods with heterogeneous quality considering only average quality, since in general the equilibrium is not efficient, any tax which raises average quality is beneficial (in the sense of optimal taxation). Other applications were considered by the authors, such as tax distortions, signaling, screening, moral hazard, incomplete markets, queue rationing, unemployment and rationing equilibrium.

Asymmetric value function in prospect theory: big losses have a much bigger psychological impact than big gains
Kahneman and Tversky published their paper "Prospect Theory: An Analysis of Decision under Risk" in 1979 criticizing the very idea of the rational economic agent. The main point is that there an asymmetry in the psychology of the economic agent which gives a much higher value to losses than to gains. This article[23] is usually regarded as the beginning of behavioral economics and has consequences particularly regarding the world of finance. The authors summed the idea in the abstract as follows:
"...In particular, people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty. This tendency, called certainty effect, contributes to risk aversion in choices involving sure gains and to risk seeking in choices involving sure losses. In addition, people generally discard components that are shared by all prospects under consideration. This tendency, called the isolation effect, leads to inconsistent preferences when the same choice is presented in different forms."
More recently, the continuing Great Recession brought the principal–agent problem again to the center of debate, in particular regarding corporate governance.[24]

Basic Economic Principles 
This unit will identify four principles that underlie the choices individuals must make given scarce resources, as well as five principles that describe how individual choices interact. Over the course you will see that these nine principles serve as the foundation for economic analysis.

Outcomes
After completing this unit, you should be able to:
•	Understand the expectations of the course
•	Identify and explain the basic principles of economics
•	Describe how individuals make economic choices, given scarce resources
•	Explain how individuals' economic choices interact in market
•	Understand Business
•	Etiquette and write professional business etiquette report 

What do you have to do in this unit?
•	Introduce yourself to your instructor and classmates. Complete the unit Reading.
•	Participate in Discussion Board.
•	Complete the unit Assignment.
•	Participate in Seminar or complete alternative assignment.
•	Review the Learning Activities.

Reading
Unit 1 Reading
Textbook Reading:
Krugman, P. & Wells, R. (2012). Microeconomics. New York, NY: Worth Publishers.
•	Chapter 1: "First Principles"
Reading Summary 
In Chapter 1, the authors identify four principles that underlie the choices individuals must make given scarce resources, as well as five principles that describe how individual choices interact. The principles focus on the ideas of choice, scarcity, trade-offs, gains from trade through specialization, and efficiency in markets. Over the course of the book, you will see that these nine principles serve as the foundation for economic analysis. 
Key Concepts
•	Scarcity 
•	Resources 
•	Opportunity costs 
•	Trade-offs and thinking at the "margin" 
•	The role of incentives in influencing individual and market behavior 
•	Gains from trade 
•	The concept of "equilibrium" and how markets adjust 
•	Why resources should be used as efficiently as possible to achieve society's goals 
•	Why markets usually lead to efficiency 
•	When and why governments should intervene to improve society's welfare 

Assignment 
Download your Assignment instructions and grading rubric from Doc Sharing:
•	BU224_Unit1_BusinessEtiquetteAssignment.docx
Before you submit your Assignment, you should save your work on your computer in a location and with a name that you will remember. Make sure your Assignment is in the appropriate format (Word®, Excel®, PowerPoint®, or other), then, when you are ready, you may submit on the Dropbox page.
Dropbox Directions:
Go to the Dropbox to submit the saved file.
•	Click the "Dropbox" tab. 
•	Click "Submit an Assignment". 
•	Using the drop-down box, choose the Assignment. Make sure you have used the correct format (.doc). 
•	Click "Add Attachments". 
•	Click "Browse..." 
•	Go to the folder on your computer that contains your projects. Click on the correct document. The filename should now appear. 
•	Click "Attach file". Wait for the file to upload. 
•	Click "Ok".
Your project has now been submitted.

Seminar
Attending Seminars is important to your academic success. They will allow you to review the important concepts that are presented in each unit, discuss work issues in your lives that pertain to these concepts, ask your instructor questions and allow you to come together in real time with your fellow classmates. There will be a Seminar in units 1 through 9 in this course. You must either attend the Seminar or you must complete the alternative Seminar Assignment in order to obtain the points for this part of the class. You can locate the day and time of your Seminar in the Instructor Information under Course Home and you can access the Seminar using the KHE Seminar Tool as explained in the Syllabus.
You should carefully read the Syllabus and other introductory material and be prepared to ask questions during the Seminar.
Your instructor will also discuss the main concepts of the material in Unit 1. You are expected to have read the chapter in the textbook and other material posted in “Doc Sharing”or “announcements.”
Unit 1 Alternative Assignment 
It is strongly suggested that you attend the graded Seminar at the regularly scheduled time. To obtain full credit, students should post frequently, be actively engaged in the Seminar, provide comments that improve the Seminar quality and advance the discussion by raising new issues and/or ideas. 
If you are unable to attend the Seminar, you must complete the following assignment to obtain points for this part of the class. Write a double-spaced 2–3 page paper, that addresses the following:
•	Discuss scarcity and the decision process individuals make when confronted with scarce resources.
•	Discuss the roles opportunity costs and marginal analysis play in the decision making process.
•	Discuss government intervention and market failure. How can government intervention ensure the efficient allocation of resources in a market?
Once completed submit your paper to the Unit 1 Seminar Dropbox.
Seminars are recorded and will be made available for everyone to review at a later time should you desire. These archived Seminars will remain available for the entire term.

Learning Activities
This section provides additional learning activities and resources for this unit.
Click here for a list of web research resources.