Every day, the news is blanketed with stories about global economies, unemployment, government spending, currencies and stock market performance – all components of macroeconomics. But underpinning all these is microeconomics. If the average person or business doesn't spend money, nothing else matters. The word economics comes from the ancient Greek word “oikonomos” – “one who manages a household.” This is the heart of microeconomics – from buying coffee to batteries to houses, it’s all about why everyday people spend money, on what, how and where.
The Relevance of Microeconomics
Microeconomics helps businesses understand why consumers choose to spend their money and on what. The science behind the way consumers and even businesses purchase can influence what is sold, how and why.
Ultimately, nearly all business is about supply and demand. Ideally, someone has something to sell; someone needs that something, or vice versa. This is probably the most widely-known principle of microeconomics, but it goes so much further than that.
Microeconomics is essentially about choice. Very few people in the world can buy everything they want. For most consumers, money is a limited resource. To spend money, they make choices about wants versus needs.
They need a place to live, so any four walls and a roof could meet that need. When it comes to everything else about that shelter – the bedrooms, quality of interior finishings, design, neighborhood and the amenities – then those choices are their wants.
Consumers can’t have what they can’t afford, though, and this is where microeconomics comes into the equation because it helps to understand why someone will sacrifice a spare bedroom for a larger kitchen whereas someone else will compromise on everything else to have that spare bedroom.
And this goes to the heart of microeconomics – the value of one choice over another. Those values, though, change from person-to-person and company-to-company. That’s why it’s such a complex thing to predict. There are many varying principles and thoughts in the study of microeconomics that influence these values choices.
An Everyday Example of Microeconomics
For businesses, microeconomics both guides their daily choices on how they spend their money and why, as well as dictating whether, and why or why not, their target audience patronizes their business.
As an example of a choice guided by microeconomics for a business, take the dilemma of whether to spend marketing funds on getting a new branded awning for the storefront or designing a new website. Both cost the same amount of money. Both are replacing something that’s already existing, but which of them works since both the website and the awning are functioning just fine as-is. So where do they spend the money, and why?
The awning that's in place keeps the rain off and shows the company name, McCally’s Crafting. It’s an older logo, does the job but makes the company look old-fashioned and not very appealing to passers-by. The website works fine, but it’s not search engine optimized and it’s loading slow, which means they're losing visitors. A new awning would look great, but it would be preaching to the converted – people who already know about McCally's and are trying to find it – or else it’ll be seen by a limited audience, those who are in the neighborhood or passing by.
Meanwhile, a search engine optimized site will mean the specialty crafting store has a stronger web presence, can be found by a whole new audience and may even create a shipping-based business to enhance sales beyond walk-in traffic.
On a day-to-day basis, the owner decides the money spent on the website will outperform that spent on an awning, so the company goes with a website redesign.
Meanwhile, a few months later, a customer needs to buy glue for the models they’re making. A local company sells a serviceable glue, but it’s not professional-grade glue because it doesn't dry completely clear and doesn’t have an extra-long adhesive life.
He’s found a website for McCally’s Crafting. Their glue costs 15 percent more plus the shipping fee, too. Should he spend more? He decides his model schooner will be more attractive and durable with the professional glue. It’ll tap out his disposable budget for the week, but he can skip buying lunch at work for two days since he’s got dinner leftovers. His savings on lunches will cover the shipping. Later, maybe his schooner will look so good he could sell it on e-Bay.
Despite the higher prices, he chooses McCally’s glue because he decides he will ultimately get more out of a better product and may even have a saleable item at the end of it, which could make him a profit.
These cost-benefit ratios are something people do every single day when making purchasing decisions. What’s the added value? Is the added value worth the extra cost?
The Microeconomic Business Environment
Microeconomic theory in business concerns itself with questions of supply versus demand, elasticity versus inelasticity, substitution and other more intricate questions.
Elasticity is a big variable in microeconomics. It’s the idea of how much demand a product has in relation to changes in its pricing. For instance, a medication to treat a disease, such as insulin, is required no matter what the price is because lives depend on it. If the price goes up, people will still need insulin to live, and its sales are assured. If the price goes down, it also has no impact on sales. The demand will be nearly constant and consistent, regardless of the price point. This is the definition of inelastic.
Meanwhile, Apple, the makers of the iPhone Xs, are testing the elasticity of their product by increasing the price, so they’re now nearly $2,000 for the top model. Market watchers noted that, at the same time as the phone’s release, Apple stated they would no longer report the number of models sold, just the profits and losses. Market saturation and pricing mean their product has become elastic, as demand is going down for the new release due to customers doing a cost-benefit analysis on the price of the phone and its tech versus the one they already own.
Substitution is another concern in microeconomic theory. It’s based on the concern of products being similar and the consumer's value proposition encouraging purchasing one brand over another. As a result, consumers are constantly under a deluge of products touting a new attribute or improved performance, all in the hopes of making the purchaser feel the product can't be substituted by a competing product.
Vying to overcome substitution is in part why just buying toothpaste has become such a challenging task now. Is “night mint” superior to “fresh mint?” And should you get plaque-buster, or is whitener more important? Beyond same-product substitution, there’s the threat of “close enough” substitution, like if the price of coffee goes too high, at what point will consumers decide to substitute their coffee habit with tea, to save money?
Consumers increasingly prefer environmentally-friendly packaging and will pay more, but at what cost does packaging become untenable for the consumer and how low can it be priced while still turning the company a profit? Will increased volume of sales from “going green” mean that the company can buy more raw goods at a better price, lowering the cost of production and thus offsetting the higher cost of packaging?
All of these are examples of daily business decisions, and consumer choices, made through microeconomics.
That’s Just the Beginning
Hopefully, you’re inspired to learn more about what goes into the way people choose where their dollars go. Macroeconomics may cover the world at large and help us to understand market theory and economic models on a grand scale, but it’s arguable that the day-to-day business of microeconomics affects us on a wider scale.
Understanding what we buy, and why, has radically changed the way business and marketing operate. Today, microeconomics has evolved with sub-categories like neuro-economics and behavioral economics, as psychology meets consumerism and helps business to influence consumer spending habits in entirely new ways. With the advent of behavioral sciences, microeconomics now goes far beyond just the question of supply versus demand and cost-benefit analysis. It’s a fascinating subject for anyone interested in business and sales and will help them understand what motivates the public to choose as they do.