Microeconomic Principles and Their Impact on Business Operations

This report delves into the application of microeconomic principles within a business context. It begins by establishing the importance of economics in business decision-making, emphasizing the impact of resource scarcity. The report then explores key microeconomic concepts such as demand, supply, and elasticity, providing graphical representations and explanations of their dynamics. The law of demand, income effect, and substitution effect are analyzed in detail, along with exceptions to the law. The report also examines the factors influencing demand and supply, and how businesses can use these insights to make informed decisions regarding pricing, production, and market equilibrium. Furthermore, the report touches on market structures, providing a comprehensive overview of how microeconomic principles affect business operations and strategic planning. The analysis uses figures and diagrams to illustrate key concepts and their implications for commercial organizations in the global economy.

Running head: MICROECONOIC PRINCIPLES IN BUSINESS
Microeconomic Principles in Business
Name of the Student
Name of the University
Author Note

1MICROECONOMIC PRINCIPLES IN BUSINESS
Table of Contents
Introduction................................................................................................................................2
Economics in Business Decision Making..................................................................................3
Scarcity of Resources.............................................................................................................3
a) Demand..............................................................................................................................4
b) Supply................................................................................................................................9
c) Elasticity of Demand........................................................................................................13
d) Market Structure..............................................................................................................15
Conclusion................................................................................................................................16
References................................................................................................................................17

2MICROECONOMIC PRINCIPLES IN BUSINESS
Introduction
Economics as a principle discipline has developed substantially over the years, with
the development and dynamics of the global economy. The conceptual framework of
economics, as a subject can be divided into two broad categories- the categories being
microeconomics and macroeconomics. While macroeconomics specifically focusses on
issues or phenomena which have effects on the economy of a region or a country as a whole,
microeconomics is that genre of the subject which deals with the economic behaviour or
phenomena related to one individual household or business entity (Baumol and Blinder
2015). Thus, in simpler words, macroeconomics is the study of a larger domain of economy
and economic issues while microeconomics aims to explore the dynamics in the economic
behaviour of the individual economic agents, both in the household as well as in the business
sectors of an economy.
Keeping this into consideration, it can thus be asserted that economics as a subject
plays a key role in the economic decision makings as well as operational frameworks of the
commercial institutions across the world. Over the years, with the increase in the dynamics of
the global commercial scenario and with international phenomena like Globalisation and
Liberalisation in most of the economies of the world, increasing numbers of businesses are
going global (Gurgul and Lach 2014). The business operations are also becoming
increasingly integrated, multilateral and complex, owing to the increasing inclusions of
events and operations in the business frameworks. The competitiveness among the business
organizations are also increasing owing to the increase in the supply side players and changes
in the taste and preferences of the demand side players (Nicholson and Snyder 2014).
In this context, it becomes immensely crucial for the commercial enterprises to
emphasize on their decision making process and operational aspects such that their objectives

3MICROECONOMIC PRINCIPLES IN BUSINESS
of profit maximization and staying ahead of the competitors, thereby attaining sustainability
in the long run are achieved. Taking this into account, the report tries to analyse and discuss
about the different microeconomic principles and factors which have implications on the
management of commercial organizations in the contemporary global economic scenario.
Economics in Business Decision Making
Scarcity of Resources
One of the primary problems which the businesses face in all parts of the world is the
scarcity of resources which are required for the production of their goods and services. The
problem of scarcity of resources is considered the most vital concern in the domain of
microeconomics and also one of the primary assumptions in the subject (Krautkraemer 2012).
The resources required for production are mainly of four types, which are as follows:
Land resources- The land resources, in economics, not only consider land but also is
inclusive of all the natural resources used for the production of goods and services, which
include resources like water, natural gas, minerals, natural energy resources like oil, coal,
forest resources and other raw materials, which are broadly required for the production of any
commodity or service. These land resources are scarce and the producers using these
resources pay prices in the form of rent (Frank and Cartwright 2013).
Labour resource- This is considered to be the most vital resource used in the productive
activities of any organization. Labour, in terms of economics, is the effort which people give
in the production of goods and services of any organization. The price or income earned by
the labour resources are known as wages (Sapsford 2013).
Capital resources- In general, the non-human, manmade resources which are used for
production of goods and services are categorised under the domain of capital resources in
economics. These resources include the machineries, plants, tools as well as the financial

4MICROECONOMIC PRINCIPLES IN BUSINESS
resources which the suppliers use in producing the different goods and services. However, in
the contemporary economic framework, the term human capital is coming into existence with
increasing prominence (Hanushek 2013). The term, “human capital”, refers to the production
augmenting skills present in specific human resources, mainly inclusive of the abstract
capabilities of thinking and innovating which few people have. Thus, human capital is
different from labour resources. The price of capital resources is paid in the form of interest.
Entrepreneurship or Organization- This factor of production is the one which is required to
combine and manage the other three factors of production efficiently such that the production
and supply of goods and services helps the commercial organizations to earn profit. The
profit earned by the businesses are generally considered to be the remuneration of the
entrepreneurs.
Keeping the fact that all the above-mentioned resources of production are limited, the
primary concern of the business firms is to utilize these resources in such a way that the cost
of production is minimized and the profit of the firm is maximized (Parker 2018).
There are various microeconomic principles which affect the decisions and
operational activities of the business organizations all over the world considerably. These
factors and how they influence the firms and their management are elaborated as follows:
a) Demand
The term “Demand”, in economics, refers to the willingness to buy goods and
services by the customers, backed by their purchasing power at a given price level of the
commodities or services concerned. The Law of Demand, in economic sense, states that there
lies in general an inverse relationship between the price of the commodity or service which
the consumer wants to buy and the demand of the same (Rios, McConnell and Brue 2013).
The demand curve of a normal commodity, can thus, be shown as follows:

5MICROECONOMIC PRINCIPLES IN BUSINESS
Figure 1: Demand curve of normal commodities
(Source: As created by the author)
As can be seen from the above figure, with the price of the concerned commodity
falling from P1 to P2, the quantity of demand for same increases and vice versa, which makes
the demand curve negatively sloped in general (Rutta and Thirtle 2014). The main reasons
behind this negative relationship between the price of a commodity and the quantity demand
of the same, which are known to be the income effect and the substitution effect, are
described with the help of the following figure:

6MICROECONOMIC PRINCIPLES IN BUSINESS
Figure 2: Income effect and substitution effect of an increase in the price of X
(Source: As created by the author)
As can be seen from the above figure, considering a two-commodity economy (the
commodities being X and Y), the increase in the price of the commodity X, keeping the price
of Y same, rotates the budget line from AB0 to AB1, which decreases the total demand for X.
The reasons of these decrease are as follows:
a) Income effect- When the price of X increases, the absolute income remaining the same, the
relative income decreases due to the decreased purchasing power of the individuals, thereby
reducing the demand for the commodity indirectly through the reduction in relative incomes
of the consumers as can be seen from the compensated budget line (red dotted line) in the

7MICROECONOMIC PRINCIPLES IN BUSINESS
above figure. Here, due to the increase in the price of X, the relative income decreases,
thereby decreasing the demand for X from X0 to X0’, owing to the fall in income, which is
known as the income effect (Duranton, Henderson and Strange 2015).
b) Substitution effect- When the price of X increases, the consumers are more likely to shift
from purchasing the same to its substitute products and purchasing more of other products.
This can be seen from the above figure, where due to the increase in the price of X, the
income factor remaining the same the demand for X decreases from X0’ to X1 (Becker
2017).
Thus, the total decrease in the quantity demanded of X can be shown as follows:
X0X1 = X0X0’ (Income Effect) + X0’X1 (Substitution Effect)
Exceptions of the law of demand
The relationship between the price of a commodity and its demand is not always
negative, especially in the case of exceptions like Giffen goods (commodities whose demand
increases with increase in price and vice versa), Snob effects, commodities of addiction like
drugs and absolute necessities like life-saving medicines. In these situations, the demand
curve for the same is not negatively sloped (Kubler, Selden and Wei 2013).
Implications on the business decisions of the firms
Thus, the above discussion shows that the nature of the commodity and the demand
structure of the same play key roles in determining the operational framework and productive
decisions as well as the pricing decisions of the same (Stanley and Doucouliagos 2012). If the
demand for the commodities increase, the firms can increase their price as well as supply and
vice versa, which can be seen from the following figure:

8MICROECONOMIC PRINCIPLES IN BUSINESS
Figure 3: Increase in demand of a commodity
(Source: As created by the author)
From the above figure, it can be seen that with the increase in the demand for a
commodity, the demand curve shifts to the right, which, provided the supply curve remains
the same, increases the price of the product as well as the quantity of the same.
There are several factors which may influence the demand for the commodities and
services produced by a firm and therefore are of crucial importance for the firm’s operational
activities. These factors are as follows:
Income of the consumers- An increase in the income of consumers, in general leads to an
increase in the overall demand in the economy, which in turn is expected to positively
contribute to the demand structure faced by the firms (Friedman 2017).

9MICROECONOMIC PRINCIPLES IN BUSINESS
Price of the commodity- As discussed above there in general exists an inverse relation
between the price of the commodity and its demand. This forces the firms to choose their
pricings optimally so as to cover the cost as well as retain maximum number of customers.
Price of related commodities- If the price of the substitutes increases then the demand for the
products of the concerned company increases. On the other hand, the demand for the
commodities sold by the company falls with an increase in the price of complementary
commodities (Varian 2014).
Future price expectations- If the consumer’s future price expectation about a commodity
increase, then the current demand faced by the firm increases.
Taste and preferences- The demand for the commodities sold by the firms are also subjected
to the changes in the taste and the preferences of the consumers across different places and in
different periods of time (Barreto 2013).
b) Supply
In economics, the term “Supply” refers to the number of commodities or services
which the producers tend to sell at various price levels. The supply of a product or a service,
is in general positively related to the price of the same. Therefore, unlike the demand curve,
the supply curve is in general positively sloped, which is shown as follows:

10MICROECONOMIC PRINCIPLES IN BUSINESS
Figure 4: Supply curve of commodities
(Source: As created by the author)
Given that the demand curve of a commodity in general is negatively sloped and the
supply curve is generally positively sloped, the equilibrium in the market occurs at the point
where the demand and the supply of the same intersects with each other, which can be shown
as follows:

11MICROECONOMIC PRINCIPLES IN BUSINESS
Figure 5: Equilibrium in the demand-supply market
(Source: As created by the author)
Implications on business
As can be seen from the above figure, it becomes crucial for the companies to adjust
their supply of commodities or services on the basis of the demand situations in the market,
such that the equilibrium is reached. Any anomaly in the demand-supply situation may lead
to excess supply or excess demand in the market as can be shown in the following figure:

12MICROECONOMIC PRINCIPLES IN BUSINESS
Figure 6: Discrepancies in demand and supply in the economy
(Source: As created by the author)
There are several factors which contribute in the supply dynamics in the market, thereby
becoming significant ones for the producers to take into consideration, which are as follows:
Cost of inputs and raw materials- When the cost of the inputs of production decreases, the
production process becomes more efficient as in the same cost, the producers can produce
more of their commodities, which increases their supply.
Technology- The technological innovations and progress also increases the cost effectiveness
and efficiency in the production process of the firms, thereby affecting the supply positively
(Bauer 2013).
Government policies- The monetary as well as productive and infrastructural policies of the
government and the tax and subsidy structures also have considerable implications on the
production and supply of the commodities.

13MICROECONOMIC PRINCIPLES IN BUSINESS
Thus, taking these aspects into account, the business firms base their production and supply
decisions such that they can cater to maximum number of customers and their profit as well
as sustainability is maximised.
c) Elasticity of Demand
One of the key principles in the microeconomic theories, having considerable
implications on the demand and supply of goods and services across the world, is the concept
of elasticity of demand for a commodity or a service. The price elasticity of demand of a
commodity or a service shows the degree of responsiveness of the demand for the same to a
unit change in the price of the commodity or the service concerned (Buer 2016).
The elasticity of demand can be divided into three categories, which are as follows:
1) Own price elasticity of demand- This measure shows the change in the quantity demanded
of a commodity due to a one-unit change in the price of the commodity itself. This is usually
negative as with the increase in the price of the commodity the demand falls.
2) Cross price elasticity of demand- The cross-price elasticity of demand shows the change
in demand of a commodity due to the change in the price of the related commodities, both
substitutes as well as complements.
3) Income elasticity of demand- This shows the change in the demand for a commodity due
to the change in the income of the same.
The magnitude of elasticity also determines the demand supply dynamics in the
market for a particular commodity and service. When the quantity demanded of a commodity
changes significantly due to a small change in price then the demand for the commodity is
said to be highly elastic (Babar et al. 2015). On the other hand, if a small change in price does
not change the demand for the same significantly then the demand for the same is said to be
comparatively inelastic, which can be shown as follows:

14MICROECONOMIC PRINCIPLES IN BUSINESS
Figure 7: Elastic and Inelastic demand for commodities and services
(Source: As created by the author)
As can be seen from the above figure, the same change in price can lead to a comparatively
higher change in demand for those commodities whose demand is more elastic than those
commodities whose demand is comparatively inelastic.
Implications on business management
As can be seen from the above discussion, for any pricing decisions to be taken by a
firm, it is of immense important for the firm to consider the nature of commodities or services
which the company is providing in the market and the elasticity of demand of the same. If the
commodities sold by the concerned firm are inelastic in demand, then it is easier for the
concerned firm to increase prices to some extent as the increase in price will not decrease the
demand substantially. On the other hand, those companies selling products with high price
elasticity of demand can decrease their price of the products by a nominal level and enjoy
much higher demand for their products or services.

15MICROECONOMIC PRINCIPLES IN BUSINESS
d) Market Structure
One of the primary factors which affect the operations of any firm and the price and
output decisions of the same is the type of market in which the firm or the industry operates.
In microeconomic conceptual framework, the market structures, as found in real global
scenarios, are divided into different into forms depending on the number of buyers and sellers
present in the market, the types of commodities or services sold in the market, the barriers to
entry and exit from the markets and the market power as well as the access to knowledge
enjoyed by the buyers and the sellers in the market (Chen and Schwartz 2013). The different
types of markets, as defined in the microeconomic framework are as follows:
a) Perfect Competition- In this type of market structure, there are many buyers as well as
many sellers, which in turn implies that that no buyer or seller enjoys more market power
than others. There remains no barrier to entry and exit in this type of market structure and
each of the buyers and the sellers are all price-takers and not price-makers. The products sold
are also homogenous (Azevedo and Gottlieb 2017).
b) Monopoly- This market structure is exactly opposite to that of the former. Here, there is
one seller and many buyers, which gives the seller immense market power and makes him the
price maker. The barriers in the market are also considerably high.
c) Oligopoly- In this type of market structure, there remain many buyers and a few sellers.
Each of the seller enjoys considerable market share and power and are dependent on one
another’s decisions. There remain several entries and exit barriers in this form of market. The
products are also differentiated (Fudenberg and Tirole 2013).
d) Monopolistic Competition- This market structure has traits of both perfect competition as
well as monopoly. There are many buyers and sellers in the market. However, the products
sold each by seller is differentiated from one another.

16MICROECONOMIC PRINCIPLES IN BUSINESS
Implications on business
The firms base their production and pricing decisions on the types of markets in
which they venture and for the operations of a firm to be robust, a detailed analysis of the
market in which they operate and the traits and level of competitiveness are to be considered
by the producers in order to make their venture profitable and sustainable (Mahoney and
Weyl 2017).
Conclusion
As can be seen from the above discussion, the microeconomic factors and principles
are not only theoretical concepts but have considerable implications on the business scenario
across the globe. The different production and pricing decisions are taken by the firms on the
basis of the different microeconomic factors present in their domain of operations and the
factors which have implications on their production, cost, sales, profitability as well as on
their sustainability in the long run in the economy.

17MICROECONOMIC PRINCIPLES IN BUSINESS
References
Azevedo, E.M. and Gottlieb, D., 2017. Perfect competition in markets with adverse
selection. Econometrica, 85(1), pp.67-105.
Babar, M., Nguyen, P.H., Cuk, V. and Kamphuis, I.G., 2015, June. The development of
demand elasticity model for demand response in the retail market environment.
In PowerTech, 2015 IEEE Eindhoven (pp. 1-6). IEEE.
Barreto, H., 2013. The entrepreneur in microeconomic theory: Disappearance and
explanaition. Routledge.
Bauer, P., 2013. Economic analysis and policy in underdeveloped countries (Vol. 3).
Routledge.
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage
Learning.
Becker, G.S., 2017. Economic theory. Routledge.
Buer, M.C., 2016. ELASTICITY OF DEMAND. In Routledge Revivals: Economics for
Beginners (1921) (pp. 36-39). Routledge.
Chen, Y. and Schwartz, M., 2013. Product innovation incentives: Monopoly vs.
competition. Journal of Economics & Management Strategy, 22(3), pp.513-528.
Duranton, G., Henderson, V. and Strange, W. eds., 2015. Handbook of regional and urban
economics. Elsevier.
Frank, R. and Cartwright, E., 2013. Microeconomics and behaviour. McGraw Hill.
Friedman, M., 2017. Price theory. Routledge.
Fudenberg, D. and Tirole, J., 2013. Dynamic models of oligopoly. Taylor & Francis.

18MICROECONOMIC PRINCIPLES IN BUSINESS
Gurgul, H. and Lach, Ł., 2014. Globalization and economic growth: Evidence from two
decades of transition in CEE. Economic Modelling, 36, pp.99-107.. Globalization and
economic growth: Evidence from two decades of transition in CEE. Economic Modelling, 36,
pp.99-107.
Hanushek, E.A., 2013. Economic growth in developing countries: The role of human
capital. Economics of Education Review, 37, pp.204-212.
Krautkraemer, J.A., 2012. Economics of scarcity. Scarcity and Growth Revisited: Natural
Resources and the Environment in the New Millenium, p.54.
Kubler, F., Selden, L. and Wei, X., 2013. Inferior good and Giffen behavior for investing and
borrowing. American Economic Review, 103(2), pp.1034-53.
Mahoney, N. and Weyl, E.G., 2017. Imperfect competition in selection markets. Review of
Economics and Statistics, 99(4), pp.637-651.
Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application.
Cengage Learning.
Parker, S.C., 2018. The economics of entrepreneurship. Cambridge University Press.
Rios, M.C., McConnell, C.R. and Brue, S.L., 2013. Economics: Principles, problems, and
policies. McGraw-Hill.
Ruttan, V. and Thirtle, C., 2014. The role of demand and supply in the generation and
diffusion of technical change(Vol. 21). Routledge.
Sapsford, D., 2013. Labour Market Economics (Routledge Revivals). Routledge.
Stanley, T.D. and Doucouliagos, H., 2012. Meta-regression analysis in economics and
business (Vol. 5). Routledge.

19MICROECONOMIC PRINCIPLES IN BUSINESS
Varian, H.R., 2014. Intermediate Microeconomics: A Modern Approach: Ninth International
Student Edition. WW Norton & Company.