EC 1 Economics 1: Microeconomic Principles and Market Analysis

This report provides a comprehensive overview of microeconomic concepts, beginning with an introduction to microeconomics and its fundamental principles. It delves into the concepts of substitute and complementary goods, illustrating their impact on demand through examples and graphical representations. The report further explores factors affecting demand, including consumer income, and differentiates between normal and inferior goods. It then discusses economic efficiency, market structures such as oligopoly and monopolistic competition, and their graphical representations. The report also examines market failures, discussing various reasons for their occurrence and potential government interventions to correct them, such as taxation, subsidies, and regulation. The analysis utilizes examples and graphical representations to enhance understanding of key concepts, concluding with a summary of the importance of microeconomic principles in understanding the behavior of economic units and maintaining market equilibrium.

Running Head: Concepts of Microeconomic Studies
Microeconomics

Concepts of Microeconomic Studies 1
Introduction
The economics studies basically covers two major aspects i.e. Microeconomics and
Macroeconomics. Microeconomics deals with studying the behavior of an individual, households
or a firm of an economy, in their decision making process and also allocation of resources. The
microeconomic theory usually applies to the goods and service markets and deals with various
issues at individual or economic level. There are different concepts that are required to be studied
in order to understand the microeconomic condition of an economy. Such concepts are discussed
further.
Different microeconomic concepts
There are majorly two types of goods: substitute goods and complement good. Economists
define substitute goods as the goods that have to experience increased demands with the increase
in the prices of other goods which are considered as their alternative and vice-versa. Substitute
goods can be used by the consumers in replacement of goods that they are called substitutes of.
For example: Pepsi and Coke, Tea and coffee, oranges and apples etc. Different brands of a
particular good can be called as its substitutes. It is the general tendency of humans to consume
more quantity of a product that has lower prices than the goods that have higher prices. However,
complement goods are defined as the goods that are used with one another. In other words, goods
are called complementary to each other, when usage of one requires the usage of other
(Economicalpedia, 2016). These goods have to experience increased demands when the price of
their complement goods decreases and vice-versa. Car and gasoline, Tooth paste and Tooth
brush.

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Taking an example of tea and coffee, the behavior of individuals in case of substitute goods
can be understood. Suppose, the price of brand X of a car in the current market has increased to £
15 million from £ 10 million and also there is an availability of other brands of the car in the
market which are comparatively cheaper than the new prices of car X in the market.
Automatically, the demand of other brands will increase, assuming other factors to remain
constant. This will happen because of the human tendency to pay less to achieve the same or
comparable degree of satisfaction. The graph given below can clearly show the increase in
demand of brand Y cars when the prices of brand Y car also remains same.
Figure 1: Demand curve of substitute products
Next, taking the example of car and tires, the relationship between the demand and price of
complementary goods can be studied. Suppose, the price of same car X has increased and
therefore its demand in the market has declined. This will automatically reduce the demand of
tires used in such cars. The graph given below can clearly show the impact of increase in demand
of brand X cars on the demand of tires, assuming that price of tires remains constant in market.

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This shows that there is inverse relationship between the price and demand of two products that
are substitute for each while there is a direct relationship between the price and demand of
complementary goods.
Figure 2: Demand curve of complementary products
There are various factors that affect the demand of the product in the market such as price
of the concerned product, price of other products that are related to the concerned product, the
tastes or preferences of the ultimate consumers, the expectations of consumers in the market
about the quality and standards of product and the number of consumers in the market (Econport,
2006). The impact that the consumer’s income has on the quantum of product they are willing
and capable of buying primarily depends on the type of product in concern. For majority of
goods, there remains a positive or direct relationship between the income of the consumer and
the quantum of goods demanded by them to buy. If the income of the consumer rises, they are
capable and willing of consuming more of what they need or desire and when they have lower
income, they have to face funds constraints and hence they are not willing and capable of buying
more quantities of the products they need or want (Andreyeva, Long & Brownell, 2010). This

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happens in the case of normal goods. However, there are certain goods in the market which
experiences reverse relationship between the consumer income and their demand for such goods.
For example, a low quality ground beef is generally bought by the people who have low incomes
or lesser funds because it is inexpensive to be bought (Fuchs, Prandelli & Schreier, 2010). But,
when their income rises, they might decide to switch to leaner cuts of the ground beef or even
they might give up on beef entirely to favor beef tenderloin. In such cases, there is the inverse
relationship between the quantity demanded of goods and the consumer income. In economic
terms, such goods are called as inferior goods.
To graphically illustrate the direct relationship between consumer income and their
demand of normal goods can be undertaken using the example of a normal individual who is
earning a monthly income of £ 10000 and at this level of income he consumes 3 packets of
yogurt per month. However, if his income of increases by further £ 10000 i.e. it becomes 20000,
the consumption of yogurt will also increase.
Yogurt Packets per month Monthly income
3 £ 10,000.00
6 £ 20,000.00
9 £ 30,000.00
12 £ 40,000.00
15 £ 50,000.00

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3 6 9 12 15
£0.00
£10,000.00
£20,000.00
£30,000.00
£40,000.00
£50,000.00
£60,000.00
Yogurt Packets per month Montly income
Figure 3: Effect of consumer income on quantity demanded
Economic efficiency is the situation when all the resources in the economy are optimally
utilized in the society’s best interest. In case of efficient economy change in the production of a
particular product would affect the other product’s production. Economic efficiency can be
achieved if there is proper equilibrium in the demand and supply factors of economy (Page,
2013). When an economy is operating at its efficiency, the change in resource allocation would
affect some units of economy because of the fact that it is not possible to increase an individual,
company and community’s welfare all at once with the limited number of resources available. To
deal with the economic efficiency in an economy, maximum output must be produced with
available scare resources (Higher Rock Education, 2018).
Oligopoly is achieved when there are only few firms to dominate the entire market of a
particular product or service and hence there is less competition. But, monopolistic competition

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markets are those markets where there is a presence of large number of firms that are dealing in
same or similar product and services. Though oligopoly and monopolistic competition market
are both the examples of imperfect market competition, their characteristics varies in the various
ways. Oligopolistic markets have higher entry barriers than the monopolistic market.
Monopolistic competition markets are more appropriate in distribution and retail sectors as in
such sectors the market can easily be bifurcated into smaller segments without experiencing
diseconomies of scale whereas oligopoly is generally present in those markets to be controlled by
few but large firms (Mazzeo, 2002). Oligopolistic markets are generally found in manufacturing
sectors or insurance and banking industries. In certain cases, the dominance of the market is
determines its type of market structure (Brakman & Heijdra, 2001). If a market constitutes 4000
firms that are similar in nature it is called as monopolistic competition but the market where the
same number of the firms is operating but only 4 or 5 firms are there to dominate the market,
then it becomes the oligopoly market. Also, the geographical area determines the market
structure as a particular industry might fall in oligopolistic market form when it is functioning in
small cities or towns because of few numbers of firms and when the same industry operates in a
big city it might fall in monopolistic competition because of presence of large number of firms
(Brakman & Heijdra, 2001). Graphical representation of oligopoly and monopolistic competition
is shown below:

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Figure 4: Demand curve of Monopolistic Competition Market
Figure 5: Demand curve of Oligopoly Market
Market is a place where group of buyers of a specific product meets the group of sellers or
providers of such product. A market attains its efficiency in the circumstances when it is
perfectly competitive. However, when a market is not perfectly competitive, it has to face its
failure. Market failure also results from inefficient allocation of resources in the free market
(Fisk & Atun, 2008). In UK economy various markets had to face several failures because of
different reasons such as negative (environmental pollution) and positive (provision of facilities

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like education and healthcare) externalities in the market, existence of merit or demerit goods
and public goods, factor mobility etc.
To address the above-mentioned issues, UK government can formulate and execute
various policies with the aim of correcting the market failures such as imposition of taxes on the
negative externalities and granting subsidies for the positive externalities. Taxing the negative
externalities will not only control the problems like pollution but it will generate revenue to
further develop the economy. Provision of subsidies to the positive externalities can encourage
people to strengthen the UK economy more by providing adequate employment by imparting
proper education and healthcare services. Also, changing or assigning the property rights could
be another policy to deal with market failures as in the case of occurrence of negative
externalities, the owners of the properties can sue the individuals damaging or polluting the
properties. Imposition of stringent laws and regulations can also restrict the unhealthy consumer
behavior such as bans on drunk driving and legalizing an age for smoking. Also, the government
can make it necessary for the firms operating in the economy to obtain pollution permit from the
environmental regulators (Bromley, 2007).
Conclusion
It can now be summarized that economics is the integral branch of economic studies and is it
vital to understand each concept of microeconomics in details to identify the behavior of the
individual units of an economy such as individuals, firms, domestic units or industries etc. The
equilibrium in the market can only be maintained if there is proper supply and demand of the
products. If it is not maintained, the market becomes inefficient.

Concepts of Microeconomic Studies 9
Andreyeva, T., Long, M.W. and Brownell, K.D., 2010. The impact of food prices on
consumption: a systematic review of research on the price elasticity of demand for
food. American journal of public health, 100(2), pp.216-222.
Brakman, S. and Heijdra, B.J. eds., 2001. The monopolistic competition revolution in retrospect.
Cambridge University Press.
Bromley, D.W., 2007. Environmental regulations and the problem of sustainability: Moving
beyond “market failure”. Ecological Economics, 63(4), pp.676-683.

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Economicalpedia, 2016. Difference Between Complementary and Substitute Goods. Available at:
https://economicalpedia.wordpress.com/2016/03/16/difference-between-complementary-and-
substitute-goods/ Accessed on: 18.07.2018.
Econport, 2006. Factors Affecting Demand. Available at:
http://www.econport.org/content/handbook/Demand/Factors.html Accessed on: 18.07.2018.
Fuchs, C., Prandelli, E. and Schreier, M., 2010. The psychological effects of empowerment
strategies on consumers' product demand. Journal of Marketing, 74(1), pp.65-79.
Higher Rock Education, 2018. Economic Efficiency. Available at:
https://www.higherrockeducation.org/glossary-of-terms/economic-efficiency Accessed on:
18.07.2018.
Mazzeo, M.J., 2002. Product choice and oligopoly market structure. RAND Journal of
Economics, pp.221-242.
Page, T., 2013. Conservation and economic efficiency: an approach to materials policy. RFF
Press.
Fisk, N.M. and Atun, R., 2008. Market failure and the poverty of new drugs in maternal
health. PLoS medicine, 5(1), p.e22.