Individual behaviour underlies much of our social and economic interactions. Some individual behaviours are motivated by self-interest, others are socially motivated. The Arab Spring of 2011 was sparked by individual actions in North Africa that subsequently became mass movements. These movements were aimed at improving society at large. Globalization, with its search for ever less costly production sources in Asia and elsewhere, is in part the result of cost-reducing and profit-maximizing behaviour on the part of developed-world entrepreneurs, and in part attributable to governments opening their economies up to the forces of competition, in the hope that living standards will improve across the board. The increasing income share that accrues to the top one percent of our population in North America and elsewhere is primarily the result of individual self-interest.
At the level of the person or organization, economic actions form the subject matter of microeconomics.
Microeconomics is the study of individual behaviour in the context of scarcity.
Individual economic decisions need not be world-changing events, or motivated by a search for profit. For example, economics is also about how we choose to spend our time and money. There are quite a few options to choose from: sleep, work, study, food, shelter, transportation, entertainment, recreation and so forth. Because both time and income are limited we cannot do all things all the time. Many choices are routine or are driven by necessity. You have to eat and you need a place to live. If you have a job you have committed some of your time to work, or if you are a student some of your time is committed to lectures and study. There is more flexibility in other choices. Critically, microeconomics seeks to understand and explain how we make choices and how those choices affect our behaviour in the workplace and society.
Application Box: The Paradox of Thrift
Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney in 2011 urged Canadian households to increase their savings in order to reduce their record high debt-to income ratio. On an individual level this makes obvious sense. If you could save more and spend less you could pay down the balances on credit cards, your line of credit, mortgage and other debts.
But one household’s spending is another household’s income. For the economy as a system, an increase in households’ saving from say 5 percent of income to 10 percent reduces spending accordingly. But lower spending by all households will reduce the purchases of goods and services produced in the economy, and therefore has the potential to reduce national incomes. Furthermore, with lower income the troublesome debt-to-income ratio will not fall, as originally intended. Hence, while higher saving may work for one household in isolation, higher saving by all households may not. The interactions and feedback in the economic system create a ‘paradox of thrift.’
The paradox can also create problems for government finances and debt. Following the recession that began in 2008/09, many European economies with high debt loads cut spending and increased taxes to in order to balance their fiscal accounts. But this fiscal austerity reduced the national incomes on which government tax revenues are based, making deficit and debt problems even more problematic. Feedback effects, within and across economies, meant that European Union members could not all cut deficits and debt simultaneously.
A critical element in making choices is that there exists a scarcity of time, or income or productive resources. Decisions are invariably subject to limits or constraints, and it is these constraints that make decisions both challenging and scientific.
Microeconomics also concerns business choices. How does a business use its funds and management skill to produce goods and services? The individual business operator or firm has to decide what to produce, how to produce it, how to sell it and in many cases, how to price it. To make and sell pizza, for example, the pizza parlour needs, in addition to a source of pizza ingredients, a store location (land), a pizza oven (capital), a cook and a sales person (labour). Payments for the use of these inputs generate income to those supplying them. If revenue from the sale of pizzas is greater than the costs of production, the business earns a profit for the owner. A business fails if it cannot cover its costs.
In these micro-level behaviours the decision makers have a common goal: to do as well as he or she can, given the constraints imposed by the operating environment. The individual wants to mix work and leisure in a way that makes her as happy or contented as possible. The entrepreneur aims at making a profit. These actors, or agents as we sometimes call them, are maximizing. Such maximizing behaviour is a central theme in this book and in economics at large.
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