That is, the utility maximization problem is used by economists to not only explain what or how individuals make choices but why individuals make choices as well. The utility maximization problem is a constrained optimization problem in which an individual seeks to maximize utility subject to a budget constraint. Economists use the extreme value theorem to guarantee that a solution to the utility maximization problem exists.
That is, since the budget constraint is both bounded and closed, a solution to the utility maximization problem exists. Economists call the solution to the utility maximization problem a Walrasian demand function or correspondence. The utility maximization problem has so far been developed by taking consumer tastes i.
However, an alternative way to develop microeconomic theory is by taking consumer choice as the primitive. This model of microeconomic theory is referred to as revealed preference theory. 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 market failures lead to resource allocation that is suboptimal and creates deadweight loss. A classic example of suboptimal resource allocation is that of a public good.
In such cases, economists may attempt to find policies that 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. 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. Supply and demand is an economic model of price determination in a perfectly competitive market.
It concludes that in a perfectly competitive market with no externalities , per unit taxes , or price controls , the unit price for a particular 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.
Elasticity is the measurement of how responsive an economic variable is to a change in another variable. Elasticity can be quantified as the ratio of the change in one variable to the change in another variable, when the later variable has a causal influence on the former. It is a tool for measuring the responsiveness of a variable, or of the function that determines it, to changes in causative variables in unitless ways.
Frequently used elasticities include price elasticity of demand , price elasticity of supply , income elasticity of demand , elasticity of substitution or constant elasticity of substitution between factors of production and elasticity of intertemporal substitution. Consumer demand theory relates preferences for the consumption of both goods and services to the consumption expenditures; ultimately, this relationship between preferences and consumption expenditures is used to relate preferences to consumer demand curves.
The link between personal preferences, consumption and the demand curve is one of the most closely studied relations in economics.
It is a way of analyzing how consumers may achieve equilibrium between preferences and expenditures by maximizing utility subject to consumer budget constraints. Production theory is the study of production, or the economic process of converting inputs into outputs.
This can include manufacturing , storing, shipping , and packaging. Some economists define production broadly as all economic activity other than consumption.
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They see every commercial activity other than the final purchase as some form of production. The cost-of-production theory of value states that the price of an object or condition is determined by the sum of the cost of the resources that went into making it.
The cost can comprise any of the factors of production : labour , capital , land , entrepreneur.
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Technology can be viewed either as a form of fixed capital e. In the mathematical model for the cost of production, the short-run total cost is equal to fixed cost plus total variable cost. The fixed cost refers to the cost that is incurred regardless of how much the firm produces. The variable cost is a function of the quantity of an object being produced. The economic idea of opportunity cost is closely related to the idea of time constraints.
One can do only one thing at a time, which means that, inevitably, one is always giving up other things. The opportunity cost of any activity is the value of the next-best alternative thing one may have done instead. Opportunity cost depends only on the value of the next-best alternative. Opportunity costs can tell when not to do something as well as when to do something. For example, one may like waffles, but like chocolate even more.
If someone offers only waffles, one would take it. But if offered waffles or chocolate, one would take the chocolate. The opportunity cost of eating waffles is sacrificing the chance to eat chocolate. Because the cost of not eating the chocolate is higher than the benefits of eating the waffles, it makes no sense to choose waffles. Of course, if one chooses chocolate, they are still faced with the opportunity cost of giving up having waffles. But one is willing to do that because the waffle's opportunity cost is lower than the benefits of the chocolate. Market structure or market form refers to features of a market, including the number of firms in the market, the distribution of market shares between them, product uniformity across firms, how easy it is for firms to enter and exit the market, and forms of competition in the market.
Different forms of markets are a feature of capitalism and market socialism , with advocates of state socialism often criticizing markets and aiming to substitute or replace markets with varying degrees of government-directed economic planning. Competition acts as a regulatory mechanism for market systems, with government providing regulations where the market cannot be expected to regulate itself. One example of this is with regards to building codes , which if absent in a purely competition regulated market system, might result in several horrific injuries or deaths to be required before companies would begin improving structural safety, as consumers may at first not be as concerned or aware of safety issues to begin putting pressure on companies to provide them, and companies would be motivated not to provide proper safety features due to how it would cut into their profits.
The concept of "market type" is different from the concept of "market structure. Perfect competition is a situation in which numerous small firms producing identical products compete against each other in a given industry.
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Perfect competition leads to firms producing the socially optimal output level at the minimum possible cost per unit. Firms in perfect competition are "price takers" they do not have enough market power to profitably increase the price of their goods or services.
A good example would be that of digital marketplaces, such as eBay , on which many different sellers sell similar products to many different buyers. Consumers in a perfect competitive market have perfect knowledge about the products that are being sold in this market. In economic theory, imperfect competition is a type of market structure showing some but not all features of competitive markets.
Monopolistic competition is a situation in which many firms with slightly different products compete. Production costs are above what may be achieved by perfectly competitive firms, but society benefits from the product differentiation. Examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. A monopoly is a market structure in which a market or industry is dominated by a single supplier of a particular good or service. Because monopolies have no competition they tend to sell goods and services at a higher price and produce below the socially optimal output level.
However, not all monopolies are a bad thing, especially in industries where multiple firms would result in more costs than benefits i. An oligopoly is a market structure in which a market or industry is dominated by a small number of firms oligopolists. Oligopolies can create the incentive for firms to engage in collusion and form cartels that reduce competition leading to higher prices for consumers and less overall market output.
Game theory is a major method used in mathematical economics and business for modeling competing behaviors of interacting agents. The term "game" here implies the study of any strategic interaction between people. Labor economics seeks to understand the functioning and dynamics of the markets for wage labor.
Labor markets function through the interaction of workers and employers. Labor economics looks at the suppliers of labor services workers , the demands of labor services employers , and attempts to understand the resulting pattern of wages, employment, and income. In economics , labor is a measure of the work done by human beings.
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