Understanding the Application of Microeconomics in Business

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Often, success in business hinges on making the correct – and most optimal – choices within particular frames of context. The positive outcome of such decisions regularly boils down to how much experience you have, which is, of course, in short supply if you are a new business owner or an aspiring entrepreneur.

However, a lot of things in the market are predictable, thanks to centuries of research and studies by economists. To this end, there are two primary fields in economics: microeconomics and macroeconomics. From an entrepreneurial point of view, the former is perhaps more pertinent than the latter.

Indeed, knowledge of the basics of microeconomics can give you, as a small business owner, a vital edge in the marketplace. Before exploring that in detail, though, here is a quick primer on microeconomics, and how it differs to macroeconomics from an entrepreneurial perspective.

Microeconomics in Business

An economy is made up of many activities, such as production, consumption, and the sale of all kinds of goods and services. Many entities are involved in these activities, ranging from individual consumers to small and medium-sized businesses, as well as large multinational corporates (MNCs), governments, and other institutions.

Essentially, microeconomics focuses on how all these myriad entities behave in the marketplace. Resources are scarce and everyone in the market, including huge MNCs, have to be careful when choosing what to do with the resources that they have.

Microeconomics, therefore, tries to understand why organisations make specific decisions, and how it can impact others around them. For instance, if your business decides to lower the price of your product, it can have a ripple effect; it might attract new buyers, and force your competitors to react by either reducing their rates or providing other forms of incentives. This can, in turn, transform your entire industry.

Through the careful study of such behaviours, microeconomics tries to explain what might happen when you make specific business decisions. The ability to anticipate how others in the market – particularly important groups, such as your customers – will behave is hugely valuable for a business owner.

Microeconomics vs Macroeconomics

Macroeconomics, on the other hand, looks at the bigger picture: the entire economy and its gross domestic product (GDP); the changes in laws and regulations; global trade; fluctuations in inflation; unemployment rates, and more. These are all important external factors that you need to be aware of as a business owner, of course.  

In the day-to-day running of your business, however, you will be more focused on the demands of your clients and buyers, the availability of skilled labour, the supply and pricing of raw materials, and other core operational interactions. Microeconomics is focused on these dynamics within the context of the economy and in specific markets.

While a working knowledge of both branches is beneficial to a small business owner, microeconomics has more to offer in terms of direct gains. This can be better gauged by how its central themes affect decision making in a small business organisation, the key tenets of which are utility, supply and demand, and pricing – as illustrated below:

Economic Utility

Customer satisfaction is vital for any business, and to succeed, you must be able to deliver a product or service that has a utility to the buyer. In economic theory, the utility of a product is its ability to provide useful value to the consumer, satisfying a particular need or want.

In any marketplace, consumers are always trying to maximise utility and, in a free-market economy, they usually have the freedom of choice that is afforded by the overabundance of multiple brands. If consumers are to choose your product over a competitor, it should offer something extra.

This could be increased quantity at a lower price, extra features, or indeed anything that offers more for less; with a deluge of competing products, you need to invest in better products, better marketing – or both. An understanding of microeconomics encourages you to consider the broader impact your product is having on consumers.

It also forces you to take a closer look at what the competition is offering as an alternative. How do their products or services compare to yours in terms of features, price, and overall value proposition?

In addition, another critical microeconomic theory linked to utility is that of opportunity cost. When your business invests money in specific areas, such as machinery, or a particular marketing strategy, it is missing out on alternative uses for that cash. Increased awareness of those alternatives regularly results in better decision making and, by definition, increased success.

Supply and Demand

This is one of the most critical concepts in microeconomics and, indeed, business in general. Virtually every strategic action that you take in a particular market is influenced and driven by the demand among consumers for a specific product or service.

Of course, higher demand means the potential for more sales. But this can also have negative consequences, as a popular product means more and more competitors entering the fray. For a small business, this can have serious implications; if you are venturing into an already saturated market, then the risk of failure is high.

On the other hand, if you are entering into a niche market, or creating an innovative product or service for a hitherto uncharted sector, then there is a much higher chance of significant success. But this too has drawbacks; there are a lot of risks involved when selling something novel that has not tried and tested.

A sudden increase in demand for a particular product can also impact your business plans. Take the surge in demand for face masks, sanitisers, and other safety products during the ongoing COVID-19 crisis; many businesses are stepping into uncharted sectors in an attempt to fill in supply gaps. 

Pricing

In every industry, formulating a pricing strategy carries with it an element of the Goldilocks dilemma. Setting your prices too high forces buyers to seek alternatives for maximum utility, but going too low means that you end up taking losses due to production costs.

Luckily, there are many pricing strategies available to business owners looking to find an equilibrium. Any price that increases profits and revenues while providing maximum utility to consumers can be considered an ideal price.

Yet despite their differences, all pricing strategies are dependent on the microeconomic concept of price elasticity. For example, some products will always have a demand regardless of price hikes, such as alcohol, cigarettes, and oil; these commodities are considered inelastic.

Other products, however, such as consumer electronics and cars, can suffer (or benefit) from fluctuations in demand depending on the change in price. These are called elastic goods. Elasticity is a huge factor in the pricing of products in the market. 

Microeconomics in Action

To gives these concepts a real-world application, consider the example of the consumer electronics giant, Apple. Thanks to shrewd marketing and its restrictive product ecosystem, it is one of the most successful brands in the world. Yet, due to high pricing, iPhones don't sell well in key developing markets such as Asia, Latin America, and Africa. Buyers there have access to cheaper options that offer maximum utility at far lower costs, and since mobile phones are highly elastic goods, this exacerbates Apple's problems in those regions.

Considering this issue from a microeconomic viewpoint has enabled the company to implement something of a solution, however. Since these are all enormous markets with millions of potential customers, Apple has designed a relatively cheaper device that offers the company's signature quality and brand value, but at a more attractive price point. Indeed, many experts argue that this is the core reasoning behind the release of the iPhone SE in 2020. 

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When even trillion-dollar companies are beholden to the forces of microeconomic factors, it illustrates just how significant their impact can be on small businesses. The concepts mentioned in the article are just the tip of the proverbial iceberg, of course; there are many other important microeconomic concepts and theories that can help business owners make better decisions.

Therefore, getting to grips with such concepts can add real value to your decision making and operational management going forward. You don't need a PhD in economics to identify the subtle effects of microeconomics in business, but understanding the issue discussed in this article is a healthy place to start. After all, in a post-COVID-19 world where every business decision will potentially have wide-ranging consequences, it's vital to put yourself in the best possible position.

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