- What kinds of problems do we study in microeconomics?
You watch another customer go to the counter and place an order. She purchases some fried chicken, an order of fries, and a Coca-Cola. The cost is €10. She hands over a bill and gets the food in exchange. It’s a simple transaction; you have witnessed exchanges like it thousands of times before. Now, though, you think about the fact that this exchange has made both the customer and the store better off than they were previously. The customer has voluntarily given up money to get food. Presumably, she would do this only if having the food makes her happier than having the €10. KFC, meanwhile, voluntarily gave up the food to get the €10. Presumably, the managers of the store would sell the food only if they benefit from the deal as well. They are willing to give up something of value (their food) in exchange for something else of value (the customer’s money).
Think for a moment about all the transactions that could have taken place but did not. For the same €10, the customer could have bought two orders of fried chicken. But she didn’t. So even though you have never met the person, you know something about her. You know that—at this moment at least—she prefers having a Coca-Cola, fries, and one order of fried chicken to having two orders of fried chicken. You also know that she prefers having that food to any number of other things she could have bought with those euros, such as a movie theater ticket, some chocolate bars, or a book.
From your study of economics, you know that her decision reflects two different factors. The first is her tastes. Each customer likes different items on the menu. Some love the spicy fried chicken; others dislike it. There is no accounting for differences in tastes. The second is what she can afford. She has a budget in mind that limits how much she is willing to spend on fast food on a given day. Her decision about what to buy comes from the interaction between her tastes and her budget. Economists have built a rich and complicated theory of decision making from this basic idea.
You look back at the counter and to the kitchen area behind it. The kitchen, you now know, is an example of a production process that takes inputs and produces output. Some of the inputs are perhaps obvious, such as basic ingredients like raw chicken and cooking oil. Before you took the economics course, you might have thought only about those ingredients. Now you know that there are many more inputs to the production process, including the following:
- The building housing the restaurant
- The tables and chairs inside the room
- The people working behind the cash register and in the kitchen
- The people working at KFC headquarters managing the outlets in Paris
- The stoves, ovens, and other equipment in the kitchen used to cook the food
- The energy used to run the stoves, the ovens, the lighting, and the heat
- The recipes used to convert the ingredients into a finished product
The outputs of KFC are all the items listed on the menu. And, you realize, the restaurant provides not only the food but also an additional service, which is a place where you can eat the food. Transforming these inputs (for example, tables, chickens, people, recipes) into outputs is not easy. Let us examine one output—for example, an order of fried chicken. The production process starts with the purchase of some uncooked chicken. A cook then adds some spices to the chicken and places it in a vat of very hot oil in the huge pots in the kitchen. Once the chicken is cooked, it is placed in a box for you and served to you at the counter. That production process uses, to a greater or lesser degree, almost all the inputs of KFC. The person responsible for overseeing this transformation is the manager. Of course, she doesn’t have to analyze how to do this herself; the head office provides a detailed organizational plan to help her.
KFC management decides not only what to produce and how to produce it but also how much to charge for each item. Before you took your economics course, you probably gave very little thought to where those prices on the menu came from. You look at the price again: €5 for an order of fried chicken. Just as you were able to learn some things about the customer from observing her decision, you realize that you can also learn something about KFC. You know that KFC wouldn’t sell an order of fried chicken at that price unless it was able to make a profit by doing so. For example, if a piece of raw chicken cost €6, then KFC would obviously make a loss. So the price charged must be greater than the cost of producing the fried chicken.
KFC can’t set the price too low, or it would lose money. It also can’t set the price too high. What would happen if KFC tried to charge, say, €100 for an order of chicken? Common sense tells you that no one would buy it at that price. Now you understand that the challenge of pricing is to find a balance: KFC needs to set the price high enough to earn a good profit on each order sold but not so high that it drives away too many customers. In general, there is a trade-off: as the price increases, each piece sold brings in more revenue, but fewer pieces are sold. Managers need to understand this trade-off between price and quantity, which economists call demand. It depends on many things, most of which are beyond the manager’s control. These include the income of potential customers, the prices charged in alternative restaurants nearby, the number of people who think that going to KFC is a cool thing to do, and so on.
The simple transaction between the customer and the restaurant was therefore the outcome of many economic choices. You can see other examples of economics as you look around you—for example, you might know that the workers earn relatively low wages; indeed, they may very well be earning minimum wage. Across the street, however, you see a very different kind of establishment: a fancy restaurant. The chef there is also preparing food for customers, but he undoubtedly earns a much higher wage than KFC cooks.
Before studying economics, you would have found it hard to explain why two cooks should earn such different amounts. Now you notice that most of the workers at KFC are young—possibly students trying to earn a few euros a month to help support them through college. They do not have years of experience, and they have not spent years studying the art of cooking. The chef across the street, however, has chosen to invest years of his life training and acquiring specialized skills and, as a result, earns a much higher wage.
The well-heeled customers leaving that restaurant are likewise much richer than those around you at KFC. You could probably eat for a week at KFC for the price of one meal at that restaurant. Again, you used to be puzzled about why there are such disparities of income and wealth in society—why some people can afford to pay €200 for one meal while others can barely afford the prices at KFC. Your study of economics has revealed that there are many causes: some people are rich because, like the skilled chef, they have abilities, education, and experience that allow them to command high wages. Others are rich because of luck, such as those born of wealthy parents.
Everything we have discussed in this section—the production process, pricing decisions, purchase decisions, and the employment and career choices of firms and workers—are examples of what we study in the part of economics called microeconomics. Microeconomics is about the behavior of individuals and firms. It is also about how these individuals and firms interact with each other through markets, as they do when KFC hires a worker or when a customer buys a piece of fried chicken. When you sit in a fast-food restaurant and look around you, you can see microeconomic decisions everywhere.
- In microeconomics, we study the decisions of individual entities, such as households and firms. We also study how households and firms interact with each other.
CHECKING YOUR UNDERSTANDING
- List three microeconomic decisions you have made today.