Donald A. Coffin
Microeconomics
Between the middle of 1999 and the middle of 2000, gasoline prices have almost doubled. In the year before that, they fell by about 30%. Now, they're falling again. Why has this happened?
Between 1970 and 2000, per capita consumption of red meat (beef, lamb, and pork) in the U.S. has declined from 131.7 pounds per year to 108.3 pounds per year. Over the same period, per capita consumption of poultry (chicken and turkey) has increased from 33.8 pounds per year to 74.1 pounds per year. Are people "eating healthier," or has something else changed?
In 1985, the leading word processing program in the U.S. was WordStar; today, it's Microsoft Word. Did this happen because Microsoft is a monopolist, or are other forces at work?
In 1970, we used 0.432 kilowatt hours of electricity to produce one dollar's worth of real output. In 2000, we're using only 0.396 KWH of electricity to produce $1 of real output. This may not sound like much, but it means we are using nearly 10% less electricity than we'd use if we still produced things the way we did in 1970. What has caused us to produce so differently?
What all of these questions have in common is that they deal with decisions people and businesses make about what to do--what to produce or consume, what price to pay or to charge, how to produce. These types of questions make up the primary subject matter of microeconomics.
Economists look at microeconomic issues and problems by developing theories of behavior.
For example, we ask what people are trying to accomplish as buyers of products and how they seek to do that. We believe that people make decisions as buyers of products by trying to make themselves as well off as possible, within the constraints they face. (For example, most of us have limited incomes.) We conclude, among other things, that people will in general seek to buy less of a product when its price rises and more of a product when its price falls, which is hardly a controversial conclusion. (This is the core of what we call the theory of demand.)
But we also conclude that it's not just the level a product's price that matters, it's the price of one product relative to the price of another product.
Here's an example. Between the middle of 1999 and the middle of 2000, the price of unleaded, self-serve, regular gasoline in northwest Indiana rose from about $1.00 per gallon to about $1.80 per gallon. During the same period, the price of unleaded, self-serve, premium gasoline rose from about $1.20 per gallon to about $2.00 per gallon. So we would conclude that people would try to buy less gasoline, right? Right.
But what about the mix of regular and premium? Would we expect that to change? In mid-1999, you had to give up about 1.2 gallons of regular to buy one gallon of premium. In mid-2000, you have to give up only 1.1 gallons or regular to buy one gallon of premium. The relative price of premium gasoline has gone down. So what do economists expect? We expect to see people's consumption of gasoline to shift so it includes a higher percentage of premium and a smaller percentage of regular gasoline. And it has.
On the other side--the supply side--of things, economists think sellers are motivated mostly by the pursuit of profit. Producers will try to produce in ways that lead to larger rather than smaller profits, to charge prices that generate larger rather than smaller profits. Among other things, this means paying attention to costs of production. It also means paying attention to the demand for your product.
Producers pay, as a result, careful attention to changes in the prices of resources--like labor, energy, capital equipment, and so on. And, in particular, they will pay attention to the price of one resource relative to the prices of resources that can be substituted for it.
Here's an example of that. During the 1970s, the minimum wage for labor rose on a nearly annual basis. As a result, firms employing a large amount of labor at the minimum wage had to be conscious of how the increase in the minimum wage affected them. And some of these firms reacted in fairly visible ways. Take Burger King, for example. In many of their restaurants, they moved the soft-drink equipment out into the restaurant, and allowed customers to fill their own soft drink cups. This substituted some capital (they still needed equipment behind the counter for drive-through customers) and the unpaid labor of their customers for the labor.
Again, in microeconomics, we develop a theory of the behavior of producers, so we can understand and explain what they have done, and predict what they might do, in response to changes that affect them.
And, finally, we look at how the behaviors of buyers and sellers interact to determine prices charged and amounts sold of products. And we can use these theories to examine what is likely to happen to prices and to quantities when something important changes. For example, we can look at the effects of rent controls on housing markets (both rental markets and the market for owner-occupied housing), or the effects of import quotas for steel not only on the market for steel, but also on the market for automobiles, or the effects of taxing (or raising or lowering the taxes on) a particular product, like gasoline or cigarettes.
And while the answers might not always be clear-cut, at least the approach that we take using microeconomic theory provides us with a consistent, flexible, and powerful tool to look at these issues.
To see a current syllabus for Introduction to Microeconomics (Economics E103), click here.
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