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Microeconomic theory typically begins with the study of a single rational and utility maximizing
individual. To economists, rationality means an individual possesses stable preferences that are both
complete and transitive. The technical assumption that preference relations are continuous is needed to
ensure the existence of a utility function. Although microeconomic theory can continue without this
assumption, it would make comparative statics impossible since there is no guarantee that the resulting
utility function would be differentiable.

Microeconomic theory progresses by defining a competitive budget set which is a subset of the
consumption set. It is at this point that economists make the technical assumption that preferences are
locally non-satiated. Without the assumption of LNS (local non-satiation) there is no guarantee that a
rational individual would maximize utility. With the necessary tools and assumptions in place the utility
maximization problem (UMP) is developed.

The utility maximization problem is the heart of consumer theory. The utility maximization problem
attempts to explain the action axiom by imposing rationality axioms on consumer preferences and then
mathematically modeling and analyzing the consequences. The utility maximization problem serves not
only as the mathematical foundation of consumer theory but as a metaphysical explanation of it as well.
That is, the utility maximization problem is used by economists to not only explain what or how
individuals make choices but why individuals make choices as well.

The utility maximization problem is a constrained optimization problem in which an individual seeks to
maximize utility subject to a budget constraint. Economists use the extreme value theorem to guarantee
that a solution to the utility maximization problem exists. That is, since the budget constraint is both
bounded and closed, a solution to the utility maximization problem exists. Economists call the solution
to the utility maximization problem a Walrasian demand function or correspondence.

The utility maximization problem has so far been developed by taking consumer tastes (i.e. consumer
utility) as the primitive. However, an alternative way to develop microeconomic theory is by taking
consumer choice as the primitive. This model of microeconomic theory is referred to as Revealed
preference theory.

The supply and demand model describes how prices vary as a result of a balance between product
availability at each price (supply) and the desires of those with purchasing power at each price
(demand). The graph depicts a right-shift in demand from D1 to D2 along with the consequent increase
in price and quantity required to reach a new market-clearing equilibrium point on the supply curve (S).

The theory of supply and demand usually assumes that markets are perfectly competitive. This implies
that there are many buyers and sellers in the market and none of them have the capacity to significantly
influence prices of goods and services. In many real-life transactions, the assumption fails because some
individual buyers or sellers have the ability to influence prices. Quite often, a sophisticated analysis is
required to understand the demand-supply equation of a good model. However, the theory works well
in situations meeting these assumptions.
Mainstream economics does not assume a priori that markets are preferable to other forms of social
organization. In fact, much analysis is devoted to cases where market failures lead to resource allocation
that is suboptimal and creates deadweight loss. A classic example of suboptimal resource allocation is
that of a public good. In such cases, economists may attempt to find policies that avoid waste, either
directly by government control, indirectly by regulation that induces market participants to act in a
manner consistent with optimal welfare, or by creating "missing markets" to enable efficient trading
where none had previously existed.

This is studied in the field of collective action and public choice theory. "Optimal welfare" usually takes
on a Paretian norm, which is a mathematical application of the KaldorHicks method. This can diverge
from the Utilitarian goal of maximizing utility because it does not consider the distribution of goods
between people. Market failure in positive economics (microeconomics) is limited in implications
without mixing the belief of the economist and their theory.

The demand for various commodities by individuals is generally thought of as the outcome of a utility-
maximizing process, with each individual trying to maximize their own utility under a budget constraint
and a given consumption set.

Microeconomic theories are involved with the choices that households and firms make. Some of these
microeconomic concepts include elasticity of demand and supply, market structures and utility.
Microeconomic looks into the way individuals and businesses behave in coming up with decisions to do
with the distribution of rare resources and collaborations between these individuals and the firm. A
production possibility frontier illustrates the maximum probable output combinations of two services or
goods an economy may realise while all other resources are efficiently and wholly engaged. A
production possibility frontier is used to explain the models of opportunity cost, illustrate the effects of
economic development and demonstrate the theory of trade-offs.

Supply and demand is possibly amongst the most crucial conceptions of economics and it is the pillar of
the economy of a market. Demand can be explained as the extent to which a service or a good is desired
by users. The amount demanded is the sum of a commodity individuals are ready to purchase at a
certain given price. Supply on the other hand refers to how much of a product a market can provide. The
supplied quantity is the volume of a particular commodity manufacturers are willing to supply at a
certain price. The relationship between demand and supply trigger the forces as a result of the sharing
of resources. The law of demand states that when all other influences stay constant the higher the price
of a good, the lesser the demand of the given produce. In other word the greater the price the lower the
amount needed. The amount of a good bought by customers at a greater price is lower as the price rises
the opportunity cost of buying a commodity. People will therefore naturally evade buying a commodity
that will need them to sacrifice the use of something else that is more significant to them. Similar to the
law of demand, the law of supply reveals the amounts that will be traded at a certain given price.
Contrasting the law of demand, the supply relationship gives a rising slope. This means that the bigger
the price the greater the quantity in supply. Manufacturers supply more at a high price because selling a
quantity at a higher price rises income. Where demand and supply are the same, the economy is held to
be at equilibrium. At the point of equilibrium the distribution of goods is at its most effectual because
the amount of goods at supply is precisely the same as the volume of goods in demand. Therefore every
individual is contented with prevailing state of the economy.
Elasticity is defined as the degree of receptiveness in demand and supply in relation to fluctuations in
price. If a curve is more elastic then lesser alterations in price will result to a higher change in quantity
used up. If a curve is less elastic it will then cause higher deviations in price to affect a change in amount
consumed. Price elasticity of demand is the extent of responsiveness in quantity demanded in relation
to price. Utility on the other hand is the amount of contentment resulting from the consumption of a
commodity or services at a particular period. Utility is a psychological satisfaction not inherent. It is
dependent on the persons own subjective approximate of satisfaction to be acquired from the
consumption of a commodity. Utility is further divided into marginal utility, total utility and maximizing
utility. Marginal utility refers to the extra utility resulting from the consumption of one extra unit of a
commodity, the consumption of the rest of the goods remaining unaffected. Total utility is refers to as
the number of units of utility that a consumer gains from consuming a given quantity of a good, service,
or activity during a particular time period. The greater a consumers total utility, the larger the
customers level of consumption. The cost to any firm of producing any output evidently depends upon
the physical amounts of real resources. For instance material, labour and machine hours used in
production. As the larger output needs a larger amount of resources, the total cost for larger output
becomes high. Whereas the smaller output requires the smaller resources. The total cost for smaller
output becomes smaller. A company can produce at lower cost when it produces better new techniques
to products. Production with traditional and old method implicates high cost. The maximisation of
returns includes the use of a definite technique to produce that can facilitate the optimal combination
of factors. Production cost is defined as the expenditures by a business in producing a commodity. There
are several kinds of cost concepts, these are marginal cost, total cost and average cost. Total is the cost
of producing a certain output of the product in question. Total cost can be classified into variable cost
and fixed cost. Fixed costs is also known as overhead cost. These are costs which do not differ with
output. The costs will be the same whether the output is ten or twenty or a thousand of a product. Fixed
costs entails interest on bank loans, depreciation of machinery, insurance charges and rent of factory.
Variable costs are also called prime cost. Variable costs differ with alterations in output. The greater the
output, the bigger the variable costs. Average cost is the cost of each unit of output and is achieved by
dividing the total cost by the level of output. It is further divided into two parts, average fixed cost and
average variable cost. Marginal cost is defined as the extra cost incurred by increasing output by one
unit. It is the added cost of producing an additional unit of output. Perfect competition is a market
structure in which the following characteristics are met. All businesses trade the same commodity, all
firms will have a comparatively small market share, all firms are price takers meaning they cannot
control the market price of their goods, the industry is characterized by freedom of entry and exit, and
buyers have complete information about the product being sold and the prices charged by each firm.
Perfect competition is a hypothetical market structure. Under perfect competition there are numerous
buyers and sellers and prices reveal supply and demand. Customers will have several substitutes when
the commodity they wish to buy quality begins to reduce or if it becomes more expensive. News firms
can as well simply enter the market, leading to an extra competition. Monopoly on the other hand is
where there is only one supplier in the market. For the reasons of regulation, monopoly power occurs
where a single business owns 25% or more of a particular market. Monopolies can form for a number of
reasons. For example, government can grant a business monopoly powers, if a firm has exclusive
ownership of a limited resource, producers may have patents over designs for instance, giving them
rights to trade a good or a service and a merger of two or more firms would create a monopoly.
Monopolies have basic characteristics such as, they can maintain super normal returns in the long run, a
monopolist with no substitute would be able to develop the greatest monopoly power and with no close
substitutes, the monopolist can therefore derive supernormal profits.