Economics is essentially a science of choice. Microeconomic theory and its applied counterpart, empirical microeconomics, is the study of how individuals, firms and political-economic groups in a market society make choices according to their preferences, and according to a set of constraints that they face, such as those given rise to by available budgets or time.
In neoclassical microeconomic theory, individuals are assumed to be rational, self-interested and utility-maximising. Utility is a key determinant in rational choice theory, as it provides a measure of the individual’s preference. The fundamental economic problem of scarcity relates to utility. Neoclassical microeconomics believes resources to be finite but human wants to be infinite – more is always preferred to less inasmuch as economic goods are concerned. It therefore follows that there are never enough resources to satisfy human wants for consumption and production. Through microeconomic optimisation techniques, resources can be allocated efficiently in terms of an objective function that is subject to the current level of technology or production knowledge. In order to reach this equilibrium allocation (equilibrium is another neoclassical economics concept originally emanating from Lyapunov physics and classical mechanics), trade-offs must be made. Trade-offs are economic decisions of how resources are allocated based on the opportunity cost of the preferred alternative.
While still being the predominant microeconomic analytical framework, the neoclassical approach has several shortcomings that we account for in our analyses.
By way of one example that might be rather easy to understand, neoclassical demand and supply analyses, suffer from statistical dependence. The Marshallian supply-demand cross is critically dependent on 2 conditions – namely on that of the factors of production being fixed in the short run on the supply side, and on the budget constraint, given by a composite function of income and wealth being fixed on the demand side, implying that changes in pricing will not affect income and wealth in a market and in the economy as a whole. However, if a market is narrowly defined, while the statistical independence between prices and income and wealth will hold, the assumption of at least one fixed production factor will no longer hold as factors of production may be brought in from other markets or industries in the short run and therefore need to be considered to be all variable. Conversely, if a market is broadly defined, the assumption of at least one fixed production factor in the short run will hold while the statistical independence between prices on the one hand and income and wealth on the other will not, as changes in relative prices will bring about a redistribution of income and wealth.
The result, as we observe from econometric estimations that we carry out using real-world data, is that it is very unlikely that you will be able to get the clean upward-sloping supply curves or downward-sloping demand curves postulated by neoclassical economics. Several of our competitors react to this by imposing their rigid framework and by transforming the data until it looks the way they want it to look. In doing so, we believe that they are just fooling themselves and their clients – and it is therefore not an approach that we endorse.
Rather than trying to massage the data into a form that fits in with a theoretical framework, our approach in microeconomic analysis is to look into the analytical framework itself, to delve into its underlying assumptions, to acknowledge that some or several of these assumptions might not hold empirically and that the neoclassical analytical framework is far from being perfect, and to make use of the latest-available research (both public and that which we carry out in-house) where the run-of-the-mill assumptions are violated and therefore need to be dealt with at the level of the theoretical underpinnings and the empirical results. In doing so, we believe to be giving clients an unbiased view of the real world, rather than a view of the real world from the blurred lens of a rigid theoretical framework.
Our microeconomic modelling allows us to generate a thorough representation of the real world. Microeconomic modelling uses algebraic, econometric, graphical and verbal models to understand and explain how individuals, different socio-economic groups, markets, firms and governments work. Some microeconomic issues that can be modelled include:
- Determinants of demand, supply and prices in a specific market as required by our clients;
- The elasticity of a variable. That is, the responsiveness of that variable to changes in other variables. Some examples include price elasticity of supply, price elasticity of demand, the elasticity of substitution, and wealth-income elasticity of demand.
- Consumer behaviour, which uses observed actions to determine variables of commercial interest and decision-making such as behavioural determinants, welfare effects, substitution effects and income effects;
- Firm behaviour and decision-support such as the firms’ behaviour, structure and costs under different market structures and conditions;
- Market failure issues where the allocation of resources is not efficient (such as environmental harm caused by over-pollution, economic goods with the potential of bringing about a net social benefit that are under-consumed from the viewpoint of society or the exploitation of natural resources).
Economic appraisals are microeconomic tools that assess a problem from an economics perspective.
Economic Impact Assessments (EIA) can also be used to determine the effects that an event will trigger and its upshots for either a particular economic sector or the economy as a whole. Some microeconomic applications of EIAs include how national projects, changes in wages, the labour market and business cost structure drivers can impact the regional or national economy. Through EIAs one can disaggregate the direct, indirect or induced effects of each source of the potential impact.
The team at Equinox Advisory can help you in your microeconomic analyses and decisions by:
- Setting up analytical frameworks and advising you on data capture solutions to test for problems you might identify that have an economics dimension;
- Conducting economic impact assessments for actions or decisions that you are pondering;
- Devising incentive-compatible trade structures and advising lawyers on contractual incentives with the backing of rigorous mathematical modelling;
- Advising on regulatory issues in relation to market structures;
- Assessing the impact of publicly-funded projects or projects with a prospect of obtaining public finance;
- Advising on national policies related to innovation economics, patents and trademarks;
- Advising on labour economics issues such as wage structures, employment, and labour market dynamics.
- Advising on public sector economics like the design of government tax, expenditure and pension policies and their economic effects. Political economy examines the role of political institutions in determining policy outcomes;
Using microeconometric techniques to analyse different microeconomic phenomena that can subsequently be used for business decision making and policy decisions such as demand, supply, prices, profit maximisation and market share under different market structures.