Editing Microeconomics (section)

== Microeconomic models ==

=== Supply and demand ===
{{main|Supply and demand}}

Supply and demand is an [[economic model]] of [[price determination]] in a perfectly competitive [[Market (economics)|market]]. It concludes that in a [[perfect competition|perfectly competitive market]] with no [[externality|externalities]], [[excise|per unit taxes]], or [[price controls]], the [[unit price]] for a particular [[Good (economics)|good]] is the price at which the quantity demanded by consumers equals the quantity supplied by producers. This price results in a stable [[economic equilibrium]].

[[File:Supply-demand-right-shift-demand.svg|thumb|The [[supply and demand]] model describes how prices vary as a result of a balance between product availability and demand. The graph depicts an increase (that is, right-shift) in demand from D<sub>1</sub> to D<sub>2</sub> along with the consequent increase in price and quantity required to reach a new equilibrium point on the supply curve (S).|alt=A graph depicting Quantity on the X-axis and Price on the Y-axis]]

[[Prices and quantities]] have been described as the most directly observable attributes of goods produced and exchanged in a [[market economy]].<ref>{{cite encyclopedia |last=Brody |first=A. |date=1987 |edition=1st|editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X001748 |doi=10.1057/9780230226203.3325|title=The New Palgrave Dictionary of Economics |pages=1–7 |isbn=978-0333786765 |chapter=Prices and quantities |publisher=Palgrave Macmillan UK }}</ref> The theory of supply and demand is an organizing principle for explaining how prices coordinate the amounts produced and consumed. In microeconomics, it applies to price and output determination for a market with [[perfect competition]], which includes the condition of no buyers or sellers large enough to have price-setting [[market power|power]].

For a given market of a [[Good (economics and accounting)|commodity]], demand is the relation of the quantity that all buyers would be prepared to purchase at each unit price of the good. Demand is often represented by a table or a graph showing price and quantity demanded (as in the figure). [[consumer theory|Demand theory]] describes individual consumers as [[rational choice theory|rationally]] choosing the most preferred quantity of each good, given income, prices, tastes, etc. A term for this is "constrained utility maximization" (with income and [[Wealth (economics)|wealth]] as the [[budget constraint|constraints]] on demand). Here, [[utility]] refers to the hypothesized relation of each individual consumer for ranking different commodity bundles as more or less preferred.

The [[law of demand]] states that, in general, price and quantity demanded in a given market are inversely related. That is, the higher the price of a product, the less of it people would be prepared to buy (other things [[ceteris paribus|unchanged]]). As the price of a commodity falls, consumers move toward it from relatively more expensive goods (the [[substitution effect]]). In addition, [[purchasing power]] from the price decline increases ability to buy (the [[income effect]]). Other factors can change demand; for example an increase in income will shift the demand curve for a [[normal good]] outward relative to the origin, as in the figure. All determinants are predominantly taken as constant factors of demand and supply.

''Supply'' is the relation between the price of a good and the quantity available for sale at that price. It may be represented as a table or graph relating price and quantity supplied. Producers, for example business firms, are hypothesized to be ''profit maximizers'', meaning that they attempt to produce and supply the amount of goods that will bring them the highest profit. Supply is typically represented as a function relating price and quantity, if other factors are unchanged.

That is, the higher the price at which the good can be sold, the more of it producers will supply, as in the figure. The higher price makes it profitable to increase production. Just as on the demand side, the position of the supply can shift, say from a change in the price of a productive input or a technical improvement. The "Law of Supply" states that, in general, a rise in price leads to an expansion in supply and a fall in price leads to a contraction in supply. Here as well, the determinants of supply, such as price of substitutes, cost of production, technology applied and various factors of inputs of production are all taken to be constant for a specific time period of evaluation of supply.

[[Market equilibrium]] occurs where quantity supplied equals quantity demanded, the intersection of the supply and demand curves in the figure above. At a price below equilibrium, there is a shortage of quantity supplied compared to quantity demanded. This is posited to bid the price up. At a price above equilibrium, there is a surplus of quantity supplied compared to quantity demanded. This pushes the price down. The [[Model (economics)|model]] of supply and demand predicts that for given supply and demand curves, price and quantity will stabilize at the price that makes quantity supplied equal to quantity demanded. Similarly, demand-and-supply theory predicts a new price-quantity combination from a shift in demand (as to the figure), or in supply.

For a given quantity of a consumer good, the point on the demand curve indicates the value, or [[marginal utility]], to consumers for that unit. It measures what the consumer would be prepared to pay for that unit.<ref>{{cite encyclopedia |author-link=William Baumol |last=Baumol |first=William J. |date=28 April 2016 |title=Utility and Value |encyclopedia=Encyclopædia Britannica |url=https://www.britannica.com/topic/utility-economics}}</ref> The corresponding point on the supply curve measures [[marginal cost]], the increase in total cost to the supplier for the corresponding unit of the good. The price in equilibrium is determined by supply and demand. In a [[perfect competition|perfectly competitive market]], supply and demand equate marginal cost and marginal utility at equilibrium.<ref name="Hicks">{{cite book |title=Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory |last=Hicks |first=J.R. |author-link=John Hicks|orig-year=1939 |publisher=Oxford University Press |edition=2nd|date=2001 |location=London |isbn=978-0-19-828269-3|title-link=Value and Capital }}</ref>

On the supply side of the market, some factors of production are described as (relatively) ''variable'' in the [[short run]], which affects the cost of changing output levels. Their usage rates can be changed easily, such as electrical power, raw-material inputs, and over-time and temp work. Other inputs are relatively ''fixed'', such as plant and equipment and key personnel. In the [[long run]], all inputs may be adjusted by [[management]]. These distinctions translate to differences in the [[Price elasticity of supply|elasticity]] (responsiveness) of the supply curve in the short and long runs and corresponding differences in the price-quantity change from a shift on the supply or demand side of the market.

[[marginalism|Marginalist theory]], such as above, describes the consumers as attempting to reach most-preferred positions, subject to [[Income#Meaning in economics and use in economic theory|income]] and [[Wealth (economics)|wealth]] constraints while producers attempt to maximize profits subject to their own constraints, including demand for goods produced, technology, and the price of inputs. For the consumer, that point comes where marginal utility of a good, net of price, reaches zero, leaving no net gain from further consumption increases. Analogously, the producer compares [[marginal revenue]] (identical to price for the perfect competitor) against the [[marginal cost]] of a good, with ''marginal profit'' the difference. At the point where marginal profit reaches zero, further increases in production of the good stop. For movement to market equilibrium and for changes in equilibrium, price and quantity also change "at the margin": more-or-less of something, rather than necessarily all-or-nothing.

Other applications of demand and supply include the [[Distribution (economics)|distribution of income]] among the [[factors of production]], including labor and capital, through factor markets. In a competitive [[labor market]] for example the quantity of labor employed and the price of labor (the wage rate) depends on the [[Labour economics#Neoclassical microeconomic model&nbsp;– Demand|demand for labor]] (from employers for production) and supply of labor (from potential workers). [[Labor economics]] examines the interaction of workers and employers through such markets to explain patterns and changes of wages and other labor income, [[labor mobility]], and (un)employment, productivity through [[human capital]], and related public-policy issues.<ref>• {{cite encyclopedia |author-link=Richard B. Freeman |last=Freeman |first=Richard B. |date=1987 |edition=1st |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X001250 |doi=10.1057/9780230226203.2907|title=The New Palgrave Dictionary of Economics |pages=1–7 |isbn=978-0333786765 |chapter=Labour economics |publisher=Palgrave Macmillan UK }}<br />&nbsp;&nbsp; • {{cite encyclopedia |last1=Taber |first1=Christopher |title=The New Palgrave Dictionary of Economics |pages=787–791 |first2=Bruce A. |last2=Weinberg |date=2008 |edition=second |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde2008_L000241 |doi=10.1057/9780230226203.0914|isbn=978-0-333-78676-5 |chapter=Labour economics (new perspectives) |publisher=Palgrave Macmillan UK }}<br />&nbsp;&nbsp; • {{cite book |last=Hicks |first=John R. |date=1963 |orig-year=1932 |edition=2nd |title=The Theory of Wages |publisher=Macmillan|title-link=The Theory of Wages }}</ref>

Demand-and-supply analysis is used to explain the behavior of perfectly competitive markets, but as a standard of comparison it can be extended to any type of market. It can also be generalized to explain variables across the [[economy]], for example, total output (estimated as [[real GDP]]) and the general [[price level]], as studied in [[macroeconomics]].<ref>{{cite book |author-link=Olivier Blanchard |last=Blanchard |first=Olivier |date=2006 |edition=4th |title=Macroeconomics |chapter=Chapter 7: Putting All Markets Together: The AS–AD Model |publisher=Prentice-Hall |isbn=978-0-1318-6026-1}}</ref> Tracing the [[qualitative economics|qualitative]] and quantitative effects of variables that change supply and demand, whether in the short or long run, is a standard exercise in [[applied economics]]. Economic theory may also specify conditions such that supply and demand through the market is an efficient mechanism for allocating resources.<ref>{{cite journal |last1=Jordan |first1=J.S. |date=October 1982 |title=The Competitive Allocation Process Is Informationally Efficient Uniquely |url= http://purl.umn.edu/54971|journal=[[Journal of Economic Theory]] |volume=28 |issue=1 |pages=1–18 |doi=10.1016/0022-0531(82)90088-6}}</ref>