Micro Economics is that branch of economics that studies the behaviour of individuals
and firms in making decisions regarding the allocation of scarce resources and the
interactions among these individuals and firms. In micro economics, the following
theories are dealt with:
Demand theory deals with consumers’ behaviour. It answers such questions
as: How do the consumers decide whether or not to buy a commodity? How do
they decide on the quantity of a commodity to be purchased? When do they stop
consuming a commodity? How do the consumers behave when price of the
commodity, their income and tastes and fashions, etc., change? At what level of
demand, does changing price become inconsequential in terms of total revenue?
The knowledge of demand theory can, therefore, be helpful in making the choice
of commodities, finding the optimum level of production and in determining the
price of the product.
Production theory explains the relationship between inputs and output. It
also explains under what conditions costs increase or decrease; how total output
behaves when units of one factor (input) are increased keeping other factors
constant, or when all factors are simultaneously increased; how can output be
maximized from a given quantity of resources; and how can the optimum size of
output be determined? Production theory, thus, helps in determining the size of the
firm, size of the total output and the amount of capital and labour to be employed,
given the objective of the firm.
Price theory explains how price is determined under different kinds of market
conditions; when price discrimination is desirable, feasible and profitable; and to
what extent advertising can be helpful in expanding sales in a competitive market.
Thus, price theory can be helpful in determining the price policy of the firm.
Price and production theories together, in fact, help in determining the optimum
size of the firm. Profit making is the most common objective of all business
undertakings. But, making a satisfactory profit is not always guaranteed because a
firm has to carry out its activities under conditions of uncertainty with regard to: (i)
demand for the product, (ii) input prices in the factor market, (iii) nature and
degree of competition in the product market, and (iv) price behaviour under
changing conditions in the product market, etc. Therefore, an element of risk is
always there even if the most efficient techniques are used for predicting the future
and even if business activities are meticulously planned. The firms are, therefore,
supposed to safeguard their interest and avert or minimize the possibilities of risk.
Profit theory guides firms in the measurement and management of profit, in
making allowances for the risk premium, in calculating the pure return on capital
and pure profit and also for future profit planning.
- Teacher: Dr. Priyanka Sahni