Microeconomics

1. Traditional Economic System

A traditional economic system is the best place to start because it is, quite literally, the most
traditional and ancient type of economy in the world. There are certain elements of a traditional
economy that those in more advanced economies, such as Mixed, would like to see return to
prominence.

Where Tradition Is Cherished: Traditional economies still produce products and services that are a
direct result of their beliefs, customs, traditions, religions, etc. Vast portions of the world still function
under a traditional economic system. These areas tend to be rural, second- or third-world, and closely
tied to the land, usually through farming. However, there is an increasingly small population of
nomadic peoples, and while their economies are certainly traditional, they often interact with other
economies in order to sell, trade, barter, etc.
Minimal Waste: Traditional economies would never, ever, in a million years see the type of profit or
surplus that results from a market or mixed economy. In general, surplus is a rare thing. A third-world
and/or indigenous country does not have the resources necessary (or if they do, they are controlled
by wealthier economies, often by force), and in many cases any surplus is either distributed, wasted,
or paid to some authority that has been given power.
Advantages And Disadvantages: Certainly one of the most obvious advantages is that tradition and
custom is preserved while it is virtually non-existant in market/mixed economies. There is also the fact
that each member of a traditional economy has a more specific and pronounced role, and these
societies are often very close-knit and socially satisfied. The main disadvantage is that traditional
economies do not enjoy the things other economies take for granted: Western medicine, centralized
utilities, technology, etc. But as anyone in America can attest, these things do not guarantee
happiness, peace, social or, most ironically of all, economic stability.
2. Command Economic System
In terms of economic advancement, the command economic system is the next step up from a
traditional economy. This by no means indicates that it is fairer or an exact improvement; there are
many things fundamentally wrong with a command economy.
Centralized Control: The most notable feature of a command economy is that a large part of the
economic system is controlled by a centralized power; often, a federal government. This kind of
economy tends to develop when a country finds itself in possession of a very large amount of valuable
resource(s). The government then steps in and regulates the resource(s). Often the government will
own everything involved in the industrial process, from the equipment to the facilities.
Supposed Advantages: You can see how this kind of economy would, over time, create unrest among
the general population. But there are actually several potential advantages, as long as the
government uses intelligent regulations. First of all, a command economy is capable of creating a
healthy supply of its own resources and it generally rewards its own people with affordable prices (but
because it is ultimately regulated by the government, it is ultimately priced by the government). Still,
there is often no shortage of jobs as the government functions similarly to a market economy in that
it wants to grow and grow upon its populace.
Hand In The Cookie Jar: Interestingly – or maybe, predictably – the government in a command
economy only desires to control its most valuable resources. Other things, like agriculture, are left to
be regulated and run by the people. This is the nature of a command economy and many communist
governments fall into this category.
3. Market Economic System
A market economy is very similar to a free market. The government does not control vital resources,
valuable goods or any other major segment of the economy. In this way, organizations run by the
people determine how the economy runs, how supply is generated, what demands are necessary, etc.
Capitalism And Socialism: No truly free market economy exists in the world. For example, while
America is a capitalist nation, our government still regulates (or attempts to regulate) fair trade,
government programs, moral business, monopolies, etc. etc. The advantage to capitalism is you can
have an explosive economy that is very well controlled and relatively safe. This would be contrasted
to socialism, in which the government (like a command economy) controls and owns the most
profitable and vital industries but allows the rest of the market to operate freely; that is, price is
allowed to fluctuate freely based on supply and demand.
Market Economy And Politics: Arguably the biggest advantage to a market economy (at least, outside
of economic benefits) is the separation of the market and the government. This prevents the
government from becoming too powerful, too controlling and too similar to the governments of the
world that oppress their people while living lavishly on controlled resources. In the same way that
separation of church and state has been to vital to America’s social success, so has a separation of
market and state been vital to our economic success. Yes, there is something wary about a system
which to be successful must foster constant growth, but as a result progress and innovation have
occurred at such incredible rates as to affect the way the world economy functions.
4. Mixed Economic System
A mixed economic system (also known as a Dual Economy) is just like it sounds (a combination of
economic systems), but it primarily refers to a mixture of a market and command economy (for
obvious reasons, a traditional economy does not typically mix well). As you can imagine, many
variations exist, with some mixed economies being primarily free markets and others being strongly
controlled by the government.
Benefits Of A Mixed Economy: In the most common types of mixed economies, the market is more or
less free of government ownership except for a few key areas. These areas are usually not the
resources that a command economy controls. Instead, as in America, they are the government
programs such as education, transportation, USPS, etc. While all of these industries also exist in the
private sector in America, this is not always the case for a mixed economy.
Disadvantages Of A Mixed Economy: While a mixed economy can lead to incredible results (America
being the obvious example), it can also suffer from similar downfalls found in other economies. For
example, the last hundred years in America has seen a rise in government power. Not just in imposing
laws and regulations, but in actually gaining control, becoming more difficult to access while
simultaneously becoming less flexible. This is a common tendency of mixed economies.

Traditional Economic System

A traditional economic system focuses exclusively on goods and services that are directly related to its
beliefs, customs, and traditions. It relies heavily on individuals and doesn’t usually show a significant
degree of specialization and division of labor. In other words, traditional economic systems are the most
basic and ancient type of economies.
Large parts of the world still qualify as traditional economies. Especially rural areas of second- or third-
world countries, where most economic activity revolves around farming and other traditional
activities. These economies often suffer from a lack of resources. Either because those resources don’t
naturally occur in the region or because access to them is highly restricted by other, more powerful
economies.
Hence, traditional economies are usually not capable of generating the same amount of output or
surplus that other types of economies can produce. However, the relatively primitive processes are
often much more sustainable and the low output results in much less waste than we see in any
command, market, or mixed economy.

Command Economic System

A command economic system is characterized by a dominant centralized power (usually the
government) that controls a large part of all economic activity. This type of economy is most commonly
found in communist countries. It is sometimes also referred to as a planned economic system, because
most production decisons are made by the government (i.e. planned) and there is no free market at
play.
Economies that have access to large amounts of valuable resources are especially prone to establish a
command economic system. In those cases the government steps in to regulate the resources and most
processes surrounding them. In practice, the centralized control aspect usually only covers the most
valuable resources within the economy (e.g. oil, gold). Other parts, such as agriculture are often left to
be regulated by the general population.
A command economic system can work well in theory, as long as the government uses its power in the
best interest of society. However, this is unfortunately not always the case. In addition to that,
command economies are less flexible than the other systems and react slower to changes, because of
their centralized nature.

Market Economic System

A market economic system relies on free markets and does not allow any kind of government
involvement in the economy. In this system, the government does not control any resources or other
relevant economic segments. Instead, the entire system is regulated by the people and the law of supply
and demand.
The market economic system is a theoretical concept. That means, there is no real example of a pure
market economy in the real world. The reason for this is that all economies we know of show
characteristics of at least some kind of government interference. For example, many governments pass
laws to regulate monopolies or to ensure fair trade and so on.
In theory, a market economic system enables an economy to experience a high amount of growth.
Arguably the highest among all four economic systems. In addition to that, it also ensures that the
economy and the government remain separate. At the same time however, a market economy allows
private actors to become extremely powerful, especially those who own valuable resources. Thus, the
distribution of wealth and other positive aspects of the high economic output may not always be
beneficial for society as a whole.

Mixed Economic System

A mixed economic system refers to any kind of mixture of a market and a command economic system. It
is sometimes also referred to as a dual economy. Although there is no clear-cut definition of a mixed
economic system, in most cases the term is used to describe market economies with a strong regulatory
oversight and government control in specific areas (e.g. public goods and services).
Most western economies nowadays are considered mixed economies. Most industries in those systems
are privately owned whereas a small number of public utilities and services remain in government
control. Thus, neither the private nor the government sector alone can maintain the economy, both play
a critical part in the success of the system.
Mixed economies are widely considered an economic ideal nowadays. In theory, they are supposed
combine the advantages of both command and market economic systems. In practice however, it’s not
always that easy. The extent of government control varies greatly and some governments tend to
increase their power more than necessary.
In a Nutshell
There are four types of economic systems; traditional, command, market and mixed economies. A
traditional economic system focuses exclusively on goods and services that are directly related to its
beliefs and traditions. A command economic system is characterized by a dominant centralized power. A
market economic system relies on free markets and does not allow any kind of government
involvement. Finally, a mixed economic system is any kind of mixture of a market and a command
economic system.

Types of Markets
Perfect Competition
Perfect competition describes a market structure, where a large number of small firms compete against
each other. In this scenario, a single firm does not have any significant market power. As a result, the
industry as a whole produces the socially optimal level of output, because none of the firms have the
ability to influence market prices.
The idea of perfect competition builds on a number of assumptions: (1) all firms maximize profits (2)
there is free entry and exit to the market, (3) all firms sell completely identical (i.e. homogenous) goods,
(4) there are no consumer preferences. By looking at those assumptions it becomes quite obvious, that
we will hardly ever find perfect competition in reality. This is an important aspect, because it is the only
market structure that can (theoretically) result in a socially optimal level of output.
Probably the best example of a market with almost perfect competition we can find in reality is the
stock market. If you are looking for more information on perfect competition, you can also check our
post on perfect competition vs imperfect competition.

Monopolistic Competition
Monopolistic competition also refers to a market structure, where a large number of small firms
compete against each other. However, unlike in perfect competition, the firms in monopolistic
competition sell similar, but slightly differentiated products. This gives them a certain degree of market
power which allows them to charge higher prices within a certain range.
Monopolistic competition builds on the following assumptions: (1) all firms maximize profits (2) there is
free entry and exit to the market, (3) firms sell differentiated products (4) consumers may prefer one
product over the other. Now, those assumptions are a bit closer to reality than the ones we looked at in
perfect competition. However, this market structure will no longer result in a socially optimal level of
output, because the firms have more power and can influence market prices to a certain degree.
An example of monopolistic competition is the market for cereals. There is a huge number of different
brands (e.g. Cap’n Crunch, Lucky Charms, Froot Loops, Apple Jacks). Most of them probably taste slightly
different, but at the end of the day, they are all breakfast cereals.

Oligopoly
An oligopoly describes a market structure which is dominated by only a small number firms. This results
in a state of limited competition. The firms can either compete against each other or collaborate. By
doing so they can use their collective market power to drive up prices and earn more profit.
The oligopolistic market structure builds on the following assumptions: (1) all firms maximize profits, (2)
oligopolies can set prices, (3) there are barriers to entry and exit in the market, (4) products may be
homogenous or differentiated, and (5) there is only a few firms that dominate the market.
Unfortunately, it is not clearly defined what a «few» firms means exactly. As a rule of thumb, we say
that an oligopoly typically consists of about 5 dominant firms.
An example of an oligopoly is the market for gaming consoles. There are only three dominant players in
this market: Microsoft, Sony, and Nintendo. This gives each of them a significant amount of market
power.

Monopoly
A monopoly refers to a market structure where a single firm controls the entire market. In this scenario,
the firm has the highest level of market power, as consumers do not have any alternatives. As a result,
monopilists often reduce output to increase prices and earn more profit.
The following assumptions are made when we talk about monopolies: (1) the monopolist maximizes
profit, (2) it can set the price, (3) there are high barriers to entry and exit, (4) there is only one firm that
dominates the entire market.
From the perspective of society, most monopolies are usually not desirable, because they result in lower
outputs and higher prices compared to competitive markets. Therefore, they are often regulated by the
government. An example of a real life monopoly could be Monsanto. About 80% of all corn harvested in
the US is trademarked by this company. That gives Monsanto an extremely high level of market power.
You can find additional information about monopolies our post on monopoly power.

In a Nutshell
There are four basic types of market structures: perfect competition, imperfect competition, oligopoly,
and monopoly. Perfect competition describes a market structure, where a large number of small firms
compete against each other with homogenous products. Meanwhile, monopolistic competition refers to
a market structure, where a large number of small firms compete against each other with differentiated
products. An Oligopoly describes a market structure where a small number of firms compete against
each other. And last but not least a monopoly refers to a market structure where a single firm controls
the entire market.
The fundamental issue that arises for a society out of the relative scarcity of goods and services
compared to the demand for them by consumers. Solving the economizing problem for a business
involves making decisions about how best to allocate resources to those demanding them given the
company's objectives.

The foundation of economics is the economizing problem: society's material wants are unlimited
while resources are limited or scarce.

There ain't no such thing as a free lunch (TANSTAAFL), also known as "there is no such thing as a free
lunch" (TINSTAAFL), is an acronym that attempts to describe the cost of decision making and
consumption. "There ain't no such thing as a free lunch" expresses the idea that even if something
seems like it is free, there is always a cost, no matter how indirect or hidden.

In finance, TANSTAAFL refers to the opportunity cost paid to make a decision, as the decision to
consume one product usually comes with the trade-off of giving up the consumption of something else.

Definition of Positive Economics

Positive Economics is a branch of economics that has an objective approach, based on facts. It analyses
and explains the casual relationship between variables. It explains people about how the economy of
the country operates. Positive economics is alternatively known as pure economics or descriptive
economics.
When the scientific methods are applied to economic phenomena and scarcity related issues, it is
positive economics. Statements based on positive economics considers what’s actually occurring in the
economy. It helps the policy makers to decide whether the proposed action, will be able to fulfill our
objectives or not. In this way, they accept or reject the statements.
Definition of Normative Economics
The economics that uses value judgments, opinions, beliefs is called normative economics. This branch
of economics considers values and results in statements that state, ‘what should be the things’. It
incorporates subjective analyses and focuses on theoretical situations.
Normative Economics suggests how the economy ought to operate. It is also known as policy economics,
as it takes into account individual opinions and preferences. Hence, the statements can neither be
proven right nor wrong.

Key Differences Between Positive and Normative Economics

The important differences between positive and normative economics are explained in the points given
below:
Positive Economics refers to a science which is based on data and facts. Normative economics is
described as a science based on opinions, values, and judgment.
Positive economics is descriptive, but normative economics is prescriptive.
Positive economics explains cause and effect relationship between variables. On the other hand,
normative economics pass value judgments.
The perspective of positive economics is objective while normative economics have a subjective
perspective.
Positive economics explains ‘what is’ whereas normative economics explains ‘what should be’.
The statements of positive economics can be scientifically tested, proved or disproved, which cannot be
done with statements of normative economics.
Positive economics clearly define economic issues. Unlike normative economics, in which the remedies
are provided for the economic issues, on the basis of value judgment.
Conclusion
After the above discussion, we can say that these two branches are not contradictory but
complementary to each other, and they should go hand in hand. While laying down laws and theories,
economics should be treated as a positive science, but at the time of practical application, economics
should be treated as a normative science.

The five determinants of demand are:

1. The price of the good or service.

2. Prices of related goods or services. These are either complementary (purchased along with) or
substitutes (purchased instead of).
3. Income of buyers.
4. Tastes or preferences of consumers.
5. Expectations. These are usually about whether the price will go up.

For aggregate demand, the number of buyers in the market is the sixth determinant.

Demand Equation or Function

This equation expresses the relationship between demand and its five determinants:

qD = f (price, income, prices of related goods, tastes, expectations)

It says that the quantity demanded of a product is a function of five factors: price, income of the
buyer, the price of related goods, the tastes of the consumer and any expectation the consumer has of
future supply, prices, etc.

How Each Determinant Affects Demand

You can understand how each determinant affects demand if you first assume that all the other
determinants don't change.

That principle is called ceteris paribus, or “all other things being equal.” So, ceteris paribus, here's how
each element affects demand.

Price. The law of demand states that when prices rise, the quantity of demand falls. That also means
that when prices drop, demand will grow. People base their purchasing decisions on price if all other
things are equal.

The exact quantity bought for each price level is described in the demand schedule. It's then plotted on
a graph to show the demand curve.

If the quantity demanded responds a lot to price, then it's known as elastic demand. If the volume
doesn't change much, regardless of price, that's inelastic demand.

The demand curve only shows the relationship between the price and quantity. If one of the other
determinants changes, the entire demand curve shifts.
Income. When income rises, so will the quantity demanded. When income falls, so will demand. But if
your income doubles, you won't always buy twice as much of a particular good or service. There's only
so many pints of ice cream you'd want to eat, no matter how rich you are. That's where the concept
of marginal utility comes into the picture. The first pint of ice cream tastes delicious. You might have
another. But after that, the marginal utility starts to decrease to the point where you don't want any
more.

Prices of related goods or services. The price of complementary goods or services raises the cost of
using the product you demand, so you'll want less. For example, when gas prices rose to $4 a gallon in
2008, the demand for Hummers fell.

Gas is a complementary good to Hummers. The cost of driving a Hummer rose along with gas prices.

The opposite reaction occurs when the price of a substitute rises. When that happens, people will want
more of the good or service and less of its substitute. That's why Apple continually innovates with its
iPhones and iPods. As soon as a substitute, such as a new Android phone, appears at a lower price,
Apple comes out with a better product. Then the Android is no longer a substitute.

Tastes. When the public’s desires, emotions or preferences change in favor of a product, so does the
quantity demanded. Likewise, when tastes go against it, that depresses the amount demanded. Brand
advertising tries to increase the desire for consumer goods. For example, Buick spent millions to make
you think its cars are not only for older people.

Expectations. When people expect that the value of something will rise, then they demand more of it.
That explains the housing asset bubble of 2005. Housing prices rose, but people bought more because
they expected the price to continue to go up. That drove prices even further until the bubble burst in
2006. Between 2007 and 2011, housing prices fell 30 percent. But the quantity demanded didn't
increase. Why? People expected prices to continue falling. That was due to record levels
of foreclosures entering the market. Demand didn't increase until people expected future prices would,
too. For more, see Subprime Mortgage Crisis Explained.

Number of buyers in the market. The number of consumers affects overall, or “aggregate,” demand. As
more buyers enter the market, demand rises. That's true even if prices don't change. That was another
reason for the housing bubble. Low-cost and sub-prime mortgages increased the number of people who
could afford a house. The total number of buyers in the market expanded, which increased demand for
housing. When housing prices started to fall, many realized they couldn't afford their mortgages. At that
point, they foreclosed. That reduced the number of buyers, driving down demand.

The law of supply is the microeconomic law that states that, all other factors being equal, as the price of
a good or service increases, the quantity of goods or services that suppliers offer will increase, and vice
versa. The law of supply says that as the price of an item goes up, suppliers will attempt to maximize
their profits by increasing the quantity offered for sale.

The law of demand states that, if all other factors remain equal, the higher the price of a good, the less
people will demand that good. In other words, the higher the price, the lower the quantity demanded.
The amount of a good that buyers purchase at a higher price is less because as the price of a good goes
up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a
product that will force them to forgo the consumption of something else they value more. The chart
below shows that the curve is a downward slope.

Types of goods
Normal goods - the quantity demanded of such commodities increases as the consumer’s income
increases and decreases as the consumer’s income decreases. Such goods are called normal goods.

Giffen goods - a Giffen good is an inferior good which people consume more of as price rises, violating
the law of demand.. In the Giffen good situation, cheaper close substitutes are not available. Because of
the lack of substitutes, the income effect dominates, leading people to buy more of the good, even as its
price rises.

Substitutes goods- substitute good for another kind insofar as the two kinds of goods can be consumed
or used in place of one another in at least some of their possible usesn increase in price for one kind of
good (ceteris paribus) will result in an increase in demand for its substitute goods, and a decrease in
price (ceteris paribus, again) will result in a decrease in demand for its substitutes.

Complementary goods - A complementary good or complement good in economics is a good which is

consumed with another good;if goods A and B were complements, more of good A being bought would
result in more of good B also being bought and vice versa eg car and Petrol. If the demand for car
increases then the demand for petrol also increases.