Importance Of Microeconomics In Business

Introduction

Managing a business firm is a critical task as it requires knowledge of different theories that are necessary to make the firm successful. Among such theories, microeconomic theories are most important as these theories impact every decision of a firm related to production. Theories of microeconomics gives the notion of the understanding cost of production, price of products and stricture of the market a business belongs to. All these parts are necessary for a firm to understand all the aspects of the business. This report aims to analyse the impact of microeconomic theories on a small business firm.

Microeconomic theories impacting business

The basic theories of microeconomics that small business entrepreneur needs to consider in order to run the business successfully are theory of production and cost, theory of demand and supply and theory of market structure. All these can be together regarded as theory of firm because all are directly related to the operation of a business firm.

Theory of production and cost

Production of any service or good is the basis of any business firm. The production enables a firm to gain market and thereby helps in making profit. Production of goods depends majorly on two factors that are labour and capital. These are known as production factors. A good is produced by a combination of the two. The efficient use of production factors are necessary to produce more by using minimum possible resources (Karl et al. 2019). Less is the number of factors used by a firm to produce a certain amount of goods makes the firm more productively efficient. Lower the cost more will be firms’ ability to earn profit. There various cost that a firm need to consider while producing a good and they are marginal cost, average cost, variable cost and fixed cost. However, fixed cost is only present in the short-run because in the long run no factors are fixed (Yao and Hamori, 2019). The price of product is highly impacted by its cost of production because with rise in cost and firm cannot keep its price low and hence due to rise in price the firm may lose its market share.

Theory of demand and supply

Demand and supply is the main part of the business because around it every business runs. Demand is the key as without demand for any product firms do not have to produce anything, rather there would be no such thing as business firm (Kachlami, Yazdanfar and Ohman 2018). Therefore, every firm should thoroughly keep tracking the demand for its product. With fall in demand, price of products fall and vice versa. Again, supply of product is decided upon the demand of the product. A market is said to be in equilibrium when the demand and supply of product matches (Arutyunov, Pavlova and Shananin 2018). The price of a product and its quantity that is to be traded in the market is decided from the equilibrium. This true for the entire market but for a firm it depends on the structure of the market it belongs to.

Theory of market structure

It is important for a firm to know about the market structure it operates in. This is because the market structure defines how a firm should act. There are four types of markets structure and they are monopoly, oligopoly, monopolistic competition and perfect competition. In monopoly market structure there is only one firm that dominates the market with its extreme market power (Li et al. 2019). As a monopoly firm serves the entire demand of the market it charges high price and earn a supernormal profit (Hicks 2019). Entry to this kind of market is highly. The firms that operate in this type of market are huge in size. Secondly, comes the oligopoly markets structure in which there is few firm that the serve all the buyers. Therefore, firms in this market have significant amount of market power and charge comparatively high price but lower than monopoly price. Entry to this market is also restricted. The firms if cooperate with each other and make collusion then the firms can charge price as high as monopoly firm and earn super normal profit. Firms are big in this kind of market. Monopolistic competition and perfect competition are mostly similar only the products are differentiated in the case of former and identical in the case of latter (Parenti, Ushchev and Thisse 2017). In both the market structure, there are numerous sellers and buyers. There is negligible barriers to entry and exit in case of monopolistic competition and none in case of perfect competition. The firms earn normal profit and are small in case of both of the markets.

Microeconomic theories and small business

For a small business, it is important to identify the market of the product and then it should decide upon the operation. Small business can never operate or enter a market which is characterized by monopoly or oligopoly structure due to high fixed cost associated. Therefore, a small business operates either in monopolistic competition or perfectly competitive market (Boitier 2019). Small business earns normal profit and can never charge its own price. It need to adhere to the market price which is determined by the free market forces. A small business firms if operates in perfectly competitive market then it is said to be productive and allocative efficient. However, unlike monopoly or oligopoly firms a small firm in monopolistic competition or perfect competition is free to exit the market if making loses. Therefore, it can be said that microeconomic theories are beneficial for entrepreneurs of small business firms in decision-making problems.

Conclusion

From the above discussion on impact of microeconomic theories on small business firms, it can be inferred that every decision of a small firm depends on these theories. From production to the selling, every aspect of a business depends on microeconomic theories. Market structure a product sells in, its demand and availability of factors of production can be described by the above-discussed theories. Therefore, the discussion leads to the remark that microeconomic theories are highly impactful on business.

Reference

1. Arutyunov, A.V., Pavlova, N.G. and Shananin, A.A., 2018. New conditions for the existence of equilibrium prices. Yugoslav Journal of Operations Research, 28(1), pp.59-77.
2. Boitier, V., 2019. Growth and ideas in a perfectly competitive world. Structural Change and Economic Dynamics.
3. Hicks, M.J., 2019. Indiana has a Monopoly Problem in Healthcare; Preliminary evidence and recommendations. Center for Business and Economic Research, Ball State University.
4. Kachlami, H., Yazdanfar, D. and Öhman, P., 2018. Regional demand and supply factors of social entrepreneurship. International Journal of Entrepreneurial Behavior & Research.
5. Karl, E., Case, F., Oster, R. and Sharon, E., 2019. Principles of Microeconomics. Pearson.
6. Li, S., Cai, J., Feng, Z., Xu, Y. and Cai, H., 2019. Government contracting with monopoly in infrastructure provision: Regulation or deregulation? Transportation Research Part E: Logistics and Transportation Review, 122, pp.506-523.
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8. Yao, W. and Hamori, S., 2019. The long-run relationship between farm size and productivity. China Agricultural Economic Review.