Besides Macroeconomics, the other basic way to view economics is the “Microeconomic” view. This view concerns itself with the particulars of a specific segment of the population or a specific industry within the larger population of good and service providers. More importantly, from a financial standpoint microeconomics concerns itself with the distribution of products, income, goods and services. Of course it is this distribution, which directly affects financial markets and the overall value of any particular resource at a specific point in time. If there is one concept integral to an understanding of microeconomics it is the law of supply and demand. A more detailed look at supply and demand as well as how they affect price will be helpful in understanding microeconomics.
Before discussing supply and demand it is helpful to understand what price is as a concept and how it relates to supply and demand. Price is essentially the feedback both the buyer and seller receive about the relative demand of a product, good or service. When the price is high then demand will be low and when the price is low demand will be high.
There are two laws intrinsically related to microeconomics. These two laws are the Law of Supply and the Law of Demand. A closer look at each will illustrate how they relate to pricing and the distribution of goods and services.
According to the LAW OF DEMAND, as price goes up; the quantity demanded by consumers goes down. As the price falls, the quantity demanded by consumers goes up. This law concerns itself with the consumer side of microeconomics. It tells us the quantity desired of a given product or service at a given price.
The LAW OF SUPPLY concerns itself with the entrepreneur or business, which supplies the products and services. This law tells us the amount of a product or service businesses will provide at a given price. Essentially, if everything else remains the same, businesses will supply more of a product or service at a higher price than they will at a lower price. This is because the higher price will attract more providers who seek to make a profit on the good or service. By the same token a low price will not attract additional suppliers and as a result the overall supply will remain low.
These two laws help to determine the overall price level of a product with a defined market. When evaluating the prices of an undefined market then another factor must be considered. This additional factor is called OPPORTUNITY COST. Opportunity cost is the relative loss of opportunity one must deal with in making a decision to invest time and money in something else. Needless to say, determining opportunity cost is very complicated and hard to evaluate in terms of economics.
Opportunity Cost is also used in evaluating the net cost of any good or service currently being utilized by an individual or the market as a whole. This can be illustrated by the decision a city makes to allocate a zone of land toward public recreation in the form of a park. The opportunity cost in this situation would be the loss of revenue the city would suffer by allocating the park instead of zoning the land for industrial use. Most situations involving opportunity cost are not so clear though.
The important concept to take away from opportunity costs is that for every purchasing or investing decision made there are other alternatives, which one is giving up. Therefore one is not just investing $5000 in government bonds but one is choosing to invest in bonds over funding the education of a child or of taking a vacation to the Bahamas for the entire family. Whether the investment is good or not depends on the value the family and the individual places on the alternative. These are the type of insights a microeconomic view can give the individual investor when applied correctly.