Microeconomics is the analysis of individual economic units and their interactions. It includes the theories of the consumer (i.e., of households), the producer (i.e., firms), and the markets in which they interact. The tools of microeconomic analysis are also employed in other fields, such as the theory of optimal taxation in public economics. Microeconomics is often contrasted with macroeconomics which is concerned with economic aggregates, such as aggregate consumption and aggregate production, unemployment, or with economic growth in general.

Models of microeconomic decisions: Economics proceeds by building models of behavior. These models are supposed to be simplified representations of reality which specify how variables in a system relate to each other. Economists use many techniques in the construction and analysis of economic models, but most of the techniques fall into the categories of optimization analysis and equilibrium analysis.

Nearly all models of individual behavior in microeconomics are models of optimizing behavior which can broadly be interpreted as rational behavior. In building a model of behavior, economists are naturally led to identify agents that make the choices, the kinds of choices that are feasible for them, how the choices of other agents constrain them, and so on. Once the economist is able to write down an optimizing problem describing an economic choice, he or she can apply the standard mathematical methods of microeconomic analysis.

Once we have understood the nature of the optimal choice problem facing individual agents, we can investigate how these choices fit together. In general, some of the variables that influence a given agent´s behavior – such as prices – will be determined, at least in part, by the behavior of other agents. An economic equilibrium is a situation of consistent optimal choices: No agent has an incentive to change any of his choices, given his perceptions of the behavior of other agents.

Literature: Varian (1987)

Entry by: Joachim Winter

June 17, 1999
Direct questions and comments to: Glossary master