Microeconomics: Core Principles and Market Dynamics

Posted on Apr 20, 2026 in Economy

1. Core Definitions

Economics: The study of events related to finance and transactions.

Microeconomics: Focuses on transactions between individual agents, such as firms, consumers, and specific markets.

Market: A physical or virtual place where supply and demand meet to exchange goods or services at a specific price.

Utility: A measure of happiness or satisfaction used by economists (based on Bentham’s Utilitarianism) to explain consumer choices.

2. Perfect Competition (P.C.)

For a market to be considered “Perfectly Competitive,” five specific conditions must be met simultaneously:

  • Atomicity: There is a large number of buyers and sellers, so no single agent can influence prices or quantities.
  • Homogeneity: All goods and services in the market are identical.
  • Transparency: All agents have perfect information about prices, technology, and preferences.
  • Free Entry and Exit: No legal or financial barriers prevent firms from entering or leaving the market.
  • Mobility of Factors: Capital and labor can move freely to where they are needed.

Key Consequence: In a P.C. market, agents are price takers, meaning they have no market power to influence the price.

3. The Theory of Demand

Definition: The quantity of a good that consumers are willing and able to buy.

The Law of Demand: For “normal goods,” as price increases, demand decreases (and vice versa).

Exceptions

  • Veblen Goods: Luxury goods where demand increases as price rises because they serve as status signals.
  • Giffen Goods: Inferior goods (like rice or potatoes) with no substitutes where demand rises with price because consumers must cut other spending.

Determinants of Demand

  • Income: For normal goods, demand rises with income; for inferior goods, demand falls.
  • Related Goods:
    • Substitutes: An increase in the price of one (coffee) increases demand for the other (tea).
    • Complements: An increase in the price of one (printers) decreases demand for the other (ink).

4. The Theory of Supply

Definition: The quantity of a good that sellers are willing and able to sell.

The Law of Supply: There is a positive relationship between price and quantity supplied—as price increases, supply increases.

Determinants of Supply

  • Factor Prices: Higher costs for labor or capital reduce supply.
  • Technology: Technological progress lowers costs and increases supply.
  • Expectations: Good future expectations encourage higher current production.

5. Market Equilibrium and Shocks

Equilibrium occurs when the quantity supplied equals the quantity demanded (QS = QD) at a specific equilibrium price (P*).

  • Shortage (D > S): Price is too low, creating scarcity, which eventually pushes the price up toward equilibrium.
  • Surplus (S > D): Price is too high, creating abundance, which eventually pushes the price down.

Exogenous Shocks

  • Positive Demand Shock: Increases both equilibrium price and quantity.
  • Positive Supply Shock: Increases quantity but decreases the equilibrium price.

6. Price Elasticity of Demand

This measures how sensitive demand is to a change in price:

  • Elastic (>1): Demand is very sensitive to price.
  • Inelastic/Rigid (<1): Demand changes very little when price changes (e.g., essential goods).
  • Unit Elastic (=1): Demand change is proportional to price change.