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Until the so-called Keynesian revolution of the late 1930s and 1940s, the
two main parts of economic theory were typically labeled monetary theory and
price theory! "oday, the correspondin# dichotomy is between macroeconomics
and microeconomics! "he motivatin# force for the chan#e came from the macro
side, with modern macroeconomics bein# far more e$plicit than old-fashioned
monetary theory about fluctuations in income and employment %as well as the price
level&! 'n contrast, no revolution separates today(s microeconomics from old-
fashioned price theory) one evolved from the other naturally and without
si#nificant controversy!
"he stren#th of microeconomics comes from the simplicity of its underlyin#
structure and its close touch with the real world! 'n a nutshell, microeconomics has to do
with SUPPLY and DEMAND , and with the way they interact in various mar*ets!
+icroeconomic analysis moves easily and painlessly from one topic to another and lies at
the center of most of the reco#ni,ed subfields of economics! -abor economics, for
e$ample, is built lar#ely on the analysis of the supply and demand for labor of different
types! "he field of industrial or#ani,ation deals with the different mechanisms
%MONOPOLY , CARTELS , different types of competitive behavior& by which #oods and
services are sold! 'nternational economics worries about the demand and supply of
individual traded commodities, as well as of a country(s e$ports and imports ta*en as a
whole and the conse.uent demand for and supply of FOREIGN EXCHANGE ! /#ricultural
economics deals with the demand and supply of a#ricultural products and of farmland,
farm labor, and the other factors of production involved in a#riculture!
0ublic finance loo*s at how the #overnment enters the scene! "raditionally, its
focus was on ta$es, which automatically introduce wed#es %differences between the
price the buyer pays and the price the seller receives& and cause inefficiency! +ore
recently, public finance has reached into the e$penditure side as well, attemptin# to
analy,e %and sometimes actually to measure& the costs and benefits of various
#overnment outlays and pro#rams!
/pplied welfare economics is the fruition of microeconomics! 't deals with the
costs and benefits of 1ust about anythin#2#overnment pro1ects, ta$es on commodities,
ta$es on factors of production %corporation income ta$es, payroll ta$es&, a#ricultural
pro#rams %li*e price supports and acrea#e controls&, tariffs on imports, forei#n e$chan#e
controls, various forms of industrial or#ani,ation %li*e monopoly and oli#opoly&, and
various aspects of labor mar*et behavior %li*e MINIMUM WAGES , the monopoly power
of LABOR UNIONS , and so on&!
't is hard to ima#ine a basic course in microeconomics failin# to include numerous
cases and e$amples drawn from all of the fields listed above! "his is because
microeconomics is so basic! 't represents the trun* of the tree from which all the listed
subfields have branched!
/t the root of everythin# is supply and demand! 't is not at all farfetched to thin*
of these as basically human characteristics! 'f human bein#s are not #oin# to be totally
self-sufficient, they will end up producin# certain thin#s that they trade in order to fulfill
their demands for other thin#s! "he speciali,ation of production and the institutions of
trade, commerce, and mar*ets lon# antedated the science of economics! 'ndeed, one can
fairly say that from the very outset the science of economics entailed the study of the
mar*et forms that arose .uite naturally %and without any help from economists& out of
human behavior! 0eople speciali,e in what they thin* they can do best2or more
e$istentially, in what heredity, environment, fate, and their own volition have brou#ht
them to do! "hey trade their services and3or the products of their speciali,ation for those
produced by others! +ar*ets evolve to or#ani,e this sort of tradin#, and money evolves to
act as a #enerali,ed unit of account and to ma*e barter unnecessary!
'n this mar*et process, people try to #et the most from what they have to sell, and
to satisfy their desires as much as possible! 'n microeconomics this is translated into the
notion of people ma$imi,in# their personal utility, or welfare! "his process helps them
to decide what they will supply and what they will demand!
4hen hybrid corn first appeared in the United 5tates, it was in e$periment
stations, not on ordinary farms! 6ut over a period of decades it became the product of
choice of hundreds of thousands of farmers! /t the be#innin# of the process, those who
adopted the new hybrids made handsome PROFITS ! 6y the time the transition was
complete, any farmer who clun# stubbornly to the old non-hybrid seed was li*ely to be
driven out of business, leavin# only farmers who acted as if they were profit ma$imi,in#)
the ones who did not had failed! 6y a very similar process new varieties of wheat spread
throu#h the 0un1ab and other parts of 'ndia in the 1970s, and new varieties of rice
throu#h the 0hilippines and the rest of 8ast /sia! 4hat economists call ma$imi,in#
behavior e$plains the real-world behavior of these millions of farmers, whose actions
increased the supply of corn, wheat, and rice, ma*in# much more of these products
available to the consumers of the world at lower prices!
5imilar scenarios reveal how ma$imi,in# behavior wor*s on the demand side!
"oday(s te$tiles include vast amounts of artificial fibers, nearly all of them un*nown a
century a#o! "hey con.uered mar*ets for themselves, at the e$pense of the older natural
fibers, because consumers perceived them to be either better or cheaper, or both! 'n the
end, when old products end up on the ash heap of history, it is usually because consumers
have found new products that they #reatly prefer to the old ones!
"he economics of supply and demand has a sort of moral or normative overtone,
at least when it comes to dealin# with a wide ran#e of mar*et distortions! 'n an
undistorted mar*et, buyers pay the mar*et price up to the point where they 1ud#e further
units not to be worth that price, while competitive sellers supply added units as lon# as
they can ma*e money on each increment! /t the point where supply 1ust e.uals demand
in an undistorted mar*et, the price measures both the worth of the product to buyers and
the worth of the product to sellers!
"hat is not so when an artificial distortion intervenes! 4ith a 90 percent ta$ based
on sellin# price, an item that costs :1!90 to the buyer is worth only :1!00 to the seller!
"he ta$ creates a wed#e, mentioned earlier, between the value to the buyer and the return
to the seller! "he anomaly thus created could be eliminated if the distortion were
removed) then the mar*et would find its e.uilibrium at some price in between %say,
:1!;0& where the product(s worth would be the same to buyers and to sellers! 4henever
we start with a distortion, we can usually assert that society as a whole can benefit from
its removal! "his is epitomi,ed by the fact that buyers #ain as they #et e$tra units at less
than :1!90, while sellers #ain as they #et to sell e$tra units at more than :1!00!
+any different distortions can create similar anomalies! 'f cotton is subsidi,ed, the
price farmers #et will e$ceed, by the amount of the subsidy, the value to consumers!
5ociety thus stands to #ain by eliminatin# the subsidy and movin# to a price that is the
same for both buyers and sellers! 'f PRICE CONTROLS *eep bread %or anythin# else&
artificially cheap, the predictable result is that less will be supplied than is demanded!
<ine times out of ten, the e$cess demand will end up bein# reflected in a #ray or blac*
mar*et, whose e$istence is probably the clearest evidence that the official price is
artificially low! 'n turn, economists are nearly always ri#ht when they predict that
pushin# prices down via price controls will end up reducin# the amount supplied and
#eneratin# blac*-mar*et prices not only well above the official price, but also above the
mar*et price that would prevail in the absence of controls!
=fficial prices that are too hi#h also produce curious results! 'n the 1930s the U!5!
#overnment adopted so called parity prices for the ma1or #rains and a few other farm
products! 6asically, if the mar*et price was below the parity price, the #overnment would
pay farmers the difference or buy any unsold crops at the parity price! "he predictable
result was production in e$cess of the amount demanded2leadin# to surpluses that were
bou#ht up %and stored& by the #overnment! "hen, in an effort to eliminate the purchase of
surpluses %but without reducin# the parity price&, the #overnment instituted acrea#e
controls under which it paid farmers to ta*e land out of production! 5ome people were
surprised to see that a ;0 percent cut in wheat acrea#e did not lead to a ;0 percent fall in
the production of wheat! "he reason was that other factors of production could be %and
were& used more intensively, with the result that in order to #et a ;0 percent cut in wheat,
acrea#e had to be cut by 30>40 percent!
8conomists have a better solution! ?ad the #overnment #iven wheat farmers
coupons, each of which permitted the farmer to mar*et one bushel of wheat, wheat
mar*etin# could have been cut by the desired amount! 0roduction inefficiencies could be
avoided by allowin# the farmers to buy and sell coupons amon# themselves! -ow-cost
farmers would buy coupons from hi#h-cost farmers, thus ensurin# efficient production!
"his is *nown as a second-best solution to a policy problem! 't is second rather than
first best because consumers would still be payin# the artificially hi#h parity price for
MONOPOLY represents the artificial restriction of production by an entity havin#
sufficient mar*et power to do so! "he economics of monopoly are most easily seen by
thin*in# of a monopoly mar*up as a privately imposed, privately collected ta$! "his
was, in fact, a reality a few centuries a#o when feudal rulers sometimes endowed their
favorites with monopoly ri#hts over certain products! "he recipients need not ever
produce such products themselves! "hey could contract with other firms to produce the
#ood at low prices and then char#e consumers what the traffic would bear %so as to
ma$imi,e monopoly profit&! "he difference between these two prices is the monopoly
mar*up, which functions li*e a ta$! 'n this e$ample it is clear that the true beneficiary of
monopoly power is the one who e$ercises it) both producers and consumers end up
+odern monopolies are a bit less transparent, for two reasons! @irst, even thou#h
#overnments still #rant monopolies, they usually #rant them to the producers! 5econd,
some monopolies 1ust happen without #overnment creatin# them, althou#h these are
usually short-lived! 8ither way, the proceeds of the monopoly mar*up %or ta$& are
commin#led with the return to capital of the monopoly firms! 5imilarly, labor monopoly
is usually e$ercised by unions, which are able to char#e a monopoly mar*up %or ta$&,
which then becomes commin#led with the wa#es of their members! "he true effect of
labor monopoly on the competitive wa#e is seen by loo*in# at the nonunion se#ment of
the economy! ?ere, wa#es end up lower because the union wa#e causes fewer wor*ers to
be hired in the unioni,ed firms, leavin# a lar#er labor supply %and a conse.uent lower
wa#e& in the nonunion se#ment!
/ final e$ample of what occurs with official prices that are too hi#h is the
phenomenon of RENT SEEKING , which occurs when someone enters a business to earn
a profit that the #overnment has tried to ma*e unusually hi#h! / simple e$ample is a city
that imposes a hi#h official meter rate for ta$is but allows free entry into the ta$i
business! "he fare must cover the cost of payin# a driver plus a mar*et rate of return on
the capital costs involved! -abor and capital will flow into the cab industry until each
ends up #ettin# its e$pected, normal return instead of the hi#h returns one would e$pect
with hi#h fares! 4hat will ad1ust is simply the number of cabs and the fraction of the time
they actually carry passen#ers! Aabs will #et more for each rider, but each cab will have
fewer riders!
=ther situations of rent see*in# occur when artificially hi#h urban wa#es attract
mi#rants from rural areas! 'f the wa#e does not ad1ust downward to e.uate supply and
demand, the rate of urban UNEMPLOYMENT will rise until further mi#ration is deterred!
5till other e$amples are in ban*in# and dru#s! 4hen the mar#in in ban*in# is set too
hi#h, new ban*s enter and3or branches of old ones proliferate until further entry is
deterred! /rtificially maintained dru# prices led, in several -atin /merican countries
%/r#entina, Ahile, and Uru#uay before their ma1or liberali,ations of recent decades&, to a
pharmacy on almost every bloc*!
Bent see*in# also occurs when somethin# of value %li*e import licenses or
radio3"C franchises& is bein# #iven away or sold below its true value! 'n such cases
potential buyers often spend lar#e amounts lobbyin# to improve their chances of
#ettin# the pri,e! 'ndeed, a broad view of rent see*in# easily covers most cases of
lobbyin# %usin# real resources in efforts to #ain le#islative or e$ecutive favors&!
"he #reat unifyin# principles of microeconomics are, ever and always, supply and
demand! "he normative overtone of microeconomics comes from the fact that
competitive supply price represents value as seen by suppliers, and competitive demand
price represents value as seen by demanders! "he motivatin# force is that of human
bein#s, always #ravitatin# toward choices and arran#ements that reflect their tastes! "he
miracle of it all is that on the basis of such simple and strai#htforward underpinnin#s, a
rich tapestry of analysis, insi#hts, and understandin# can be woven! "his brief article can
only #ive its readers a #limpse2hopefully a temptin# one2of the richness, beauty, and
promise of that tapestry!
6utuan Aity
on the
in the
Submitted by:
#$ #%siness A&ministr'tion
(m'(ors in O"er'tions M'n')ement)
Submitted to:
Dr. Jenny Lyn Tindugan-Nalupa