Lynne Pepall

Although micro means small, microeconomics covers a wide set of topics. These include how consumers and businesses make choices and how those choices interact through the forces of supply and demand in the marketplace; when market outcomes might be considered good and why monopoly power and information problems can make those outcomes less good; problems of risk and insurance; and the gains from international trade.

A firm with a given technology makes a choice about how much of each of the factors of production to use to make how much output — and pays the cost for doing so. The question for the firm is how to use its technology and choose its inputs in order to make its profits as large as possible. The way it does so is to choose its inputs in order to make the costs as small as possible.

By itself, total cost doesn't say much about the firm and still less about how it makes its decisions. Economists want to discover a little more about how the firm operates, so they look at the relationship between total cost and the number of units produced. To do so, they divide the cost of production by the number of units produced to derive the average costs.

The most global view of a company is in terms of its total costs (TC), which economists use quite simply to arrive at a number for total profits (you don't need to worry about gross or net terms here). Total costs are simply the overall cost of making a product and serving it to a market after all those relevant cost elements are accounted for.

The breakdowns used for average costs and total costs show costs for a particular level of production. But economists also use another important measure to consider when considering a firm's costs: marginal cost. Meeting marginal cost Put simply, marginal cost (MC) is the cost of adding one extra unit of output to your current output level.

The budget constraint divides what is feasible from what is not feasible. You can use the model of consumer choice and take a look at what a consumer will do to optimize her utility or satisfaction when a constraint exists. To do this, you have to take a look at what happens when you put the indifference curves together with the budget constraint.

Economists look at costs in a particular way, which may not be what you expect. Every firm in every industry in every country incurs costs of one kind or another, and accounting systems provide a way of measuring and recording them. But economists are interested in more than the record of what was done in the past.

One way to think about consumption bundles and preferences on microeconomics is to think about all the possible choices. If you describe the set of possible choices in a diagram, you can see pretty easily which choices the consumer would prefer. For instance, this figure draws an indifference curve for all the consumption bundles for which Bob gets the same amount of utility.