analysing the pricing of products and factors and the allocation of resources based upon

Besides explain whether the allocation of resources

mechanism, microeconomics also seeks to
the price resources for the production of goods and
determined is effcient. Economic efficiency is the use of
given resources they get maximum
services thatpeople want at the least possiblecost so that from the in production, efficiency in
satisfaction. Economic cficicncy involves three efficiencies; efficiencyconsumption) and allocative
also called efficiency in
distributionof goods among the people (This isMicrocconomic theory shows under what conditions
efhciency, that is, eficicncy in product-mix. factors cause departure from these
these efficiencies are achieved. Microcconomics also shows what possible level.
eficiencies andresult in the decline of satisfaction from the maximum
Efficicncy in production involves producing the maximum possible output of various goods
cfficiency is attaincd. then it is
from the given available amountof resources. When such productive
no longer possible by any reallocation of the productive resources or
factors among the production
reduction in the output of
of various goods and serviccs toincrease the output of any good without a amount of produced
some other good. Eficicncy in consumption consists of distributing the given
way as to maxiMise the
goods and services among millions of the people for consumption in such a possibleby any
total satisfaction of the society. When such an efficiency is achieved it isno longer
redistribution of goods among the peopleto make some people better off withoutmaking some other
ones worse off. Allocative economic efficiency or efficiency in product-mix consists of producing
those goods which are most desired or preferred by the people.
In other words. allocative economic efficiency implies that composition of production
(ie. amounts of the various goods and services produced) should correspond to the desired pattern of
consumption of the people. Even if efficiencies in consumption and production of goods are present. it
may be that the goods which are produced and distributed for consumption may not be those preferred
by the people. There may be some goods which are more preferred by the people but they have not
been produced and vice versa. To sum up, allocative efficiency (optimum product-mir) is achieved
when the resources are so allocated to the production of various goods that the marimum possible
satisfaction of the people is obtained. Once this is achieved, then by producing some goods more
and others less by any rearrangement of the resources will mean loss of satisfaction or efficiency.
The question of economic efficiency is the subject matter of theoretical welfare economics which is
an important branch of microeconomic theory.
That microeconomic theory is intimately concerned with the question ofefhciency and welfare is
evident from the following remarksofA. P. Lerner, a noted American economist. *ln micro-economics
we are more concerned with the avoidance or elimination of waste,or with ineticiency arising from
the fact that production is not organised in the most efficient possible manner. Such inetticiency
means that itispossible, by rearranging the diferent ways in which prodcis are being produced
and consumed, to get more of something that is scarce without giving up anv part of anv other scarce
item,or to replace something by something else that is preferred Microeconomie theory spells out
the conditions of efficiency (i.e, for the elimination of all kinds of inethcieney) andsuggests how
they might be achieved. These conditions (called Pareto-optimal conditions) can be ofthe greatest
help in raising the standard of living of the population."
The four basic economic questions namely, ()what goods shall be produced and in what
quantities. (2) how shall they be produced, (3) how shall the g00ds and services produced be distributed

3. AbbaP Lerner, Microeconome theory, printed in Perspe aws in tonomu s, cdited by Brown, Neubenger
and Palmnatier (Prelininary edition, 1968), p. S0
 among the people and(4) whetherthe production of goods and their distribution for
of microcconomics.
eficient fallwithin the domain

Importance and Uses of Microeconomics

consumption
Microeconomics occupies a vital place in cconomics and it has both theoretical
importance. It is highly helpful in the formulation of economic policies that will promote and practc
ofthe masses. Tillrecently, especially before Keynesian Revolution, the body of the welfae
mainly of microeconomics. In spite ofthe popularity of macrocconomicsthese days, feconomicsconsiste
retains itsimportance, theoretical as well as
market economY with its millions of consumers
practical.
and
It is microeconomics that tells us a
producers microeconomie
work to decide about how fre.
of prodctive resources among the thousands of goods and services. As Professor theWatson allocation
"microeconomic theory explains the composition or allocation of totalI production, why says.
things are produced than of others." He further remarks that microeconomic theory hasmore of some
The greatest of these is depth in understanding of!fhow afree private enterprise economy many uses
Further, it tells us how the goods and services produced are distributed among the operates
for consumption through price or market mechanism. It shows how the relative prices of vanonvarious people
products and factors are formed, that is, why the price of cloth is what it is and why the
engineer are what they are and so on. wages of an
Moreover, microeconomic theory explains the conditions of efficiency in consumptionand
production and highlights the factors which are responsible for the departure from the efficieney ax
economic optimum. On the basis of theseconditions microeconomic theory suggests suitable polcies
topromote economic efficiency and welfare of the people. Thus, not only does microeconomic theor
describe the actual operation of the economy, it has also a normative role in that it suggestspolicies
to eradicate "inefficiency from the economic system so as to maximise satisfaction or welfare of
the people. The usefulness and importance of microeconomics has been nicely stated by Professor
Lerner. He writes, "Microeconomic theory facilitates the understanding of what would be a hopelessly
complicated confusion of billions of facts by constructing simplified models of behaviour which are
sufficiently similar to the actual phenomena to be of help in understanding them. These models at
the same timeenable economists to explain the degree to which the actual phenomena depart from
certain ideal constructions that would most completely achieve individual and social objectives
They thus help not only to describe the actual economic situation but to suggest policies that woud
most successfully and most efficiently bring about desired results and to predict the outcomes ol
such policies and other events. Economics thus has descriptive, normative and predictive aspecb.
We have noted that microeconomics reveals howa decentralised system ofa free private enterprse
economy functions without any central control. It also brings to light the fact that the functionng
of a completely centrally directed cconomy with efficiency is impossible. Modern economy s s
complex that a central planning authority willfind it too difficult toget all the information requu
for the efficient allocation of resources and to give directions to thousands of production e
with various peculiar problems of their own so as to ensure cfficiency in the use ot
quote Professor Lerner again, "Microeconomies eaches us that completely 'direct' resource
economy is impossible that a modern economy is so complex that no central planning runingbodycan
obtain ull the informution and give out all the directives necessary for its efhcient operation. These
would have to inciude directives for adjusting to continual chhanges in the availabilities of millions
of productive resOurces and intermediate products, ... and in the quantities and qualities ofthe
many items to be consumed or to be added to society's productive equipment. The vast task can
be achieved, and in the past has been achieved. only bythe development of a decentralisedsystem
whereby the millions of producers and consumers are induced to act in the general interest without
the intervention of anybody at the centre with instructions as to what one should make and how and
what one should consume."
Microeconomic theory shows that welfare optimum or economic eficiency is achieved when
there prevails perfectcompetition in the product and factor markets. Perfect competition is said to
exist when there are so many sellers and buyers in the market that no individual seller or buyer is
in a position to infuence the price of a product or factor. Departure from perfect competition leads
to alower level of welfare, that is, involves loss of economic efficiency. It is in this context that a
large part of microeconomic theory is concerned with showing the nature of departures from perfect
competition and therefore from welfare optimum (economic efficiency). The power of giant firns or
acombination of fims over the output and price of a product constitutes the problem of monopoly.
Microeconomics shows how monopoly and other forms ofimperfectcompetition leads to misallocation
ofresources and therefore involves loss of economicefficiency or welfare. It also makes important and
useful policy recommendations to regulate monopoly so as toattain economic efficiency or maximum
welfare. Like monopoly, monopsom (that is, when a large buyer or acombination of buyers exercises
control over the price) also leads to the loss of welfare and therefore needs to be controlled. Similarly.
microeconomics brings out the welfare implications of oligopoly whose main characteristic is that
individual sellers (or buyers) have to take into account, while deciding upon their course of action.
how their rivals react to their moves regarding changes in price. product and advertising policy.
Another class of departure from welfare optimum is the problem of externalities. Externalities are
said to exist when the production or consumption ofa commodity affects other people than those who
produce, sell or buy it. These externalities may be in the form of either external economies or external
iseconomies. External economies prevailwhen the production or consumption of acommodity by
an individual benefits other individuals and extermaldiseconomies prevail when the production or
consumption of a commodity by him harms other individuals. Microeconomic theory reveals that
when the externalities erist,freeworking oftheprice mechanism fails to achieve economic efficiency
since it does not take into account the benefits or harms made to those external to the individual
producers and the consumers. The existence of these externalities requires government intervention
for correcting imperfections in the price mechanism in order to achieve maximum social welfare.
Microeconomic analysis is also usefully applied to the various applied branches of economics
such as Public Finance, International Economics. It is the microeconomic analysis which is used to
explain the factors which determine the distributionof the incidence or burden of a commodity tax
between producers or sellers on the one hand and the consumers on the other. Further, microeconomic
analysis is applied to show the damage done to the social welfare or economic efficiency by the
imposition ofa tax. Ifit is assumed that resources are optimally allocated or maximum social wel fare
prevails before the imposition of a tax, it can be demonstrated by microeconomic analysis that what
amount of the damage will be caused to the social welfare. The imposition of a tax on a commodity
(ie., indirect tax) will lead to the loss of social welfare by causing deviation from the optimum
allocation of resources, the imposition of a direct tax (for example, income tax) will not disturb
the optimum resource allocation and therefore will not result in loss of social welfare. Further,
Microeconomic analysis is applied to show the gain from international trade and toexplain the factors
which determine the distribution of this gain among the participant countries. Besides,microeconomics
tinds application in the various problems of international economics. Whether devaluation will succeed
in correcting the disequilibrium in the balance of payments depends upon the elasticities of demand