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We begin our investigation of microeconomics with an overview of how the preferences of consumers like Lauren (the demand side of a market) combine with the decisions of firms like Rosa’s coffee plantation (the supply side) to determine the quantity sold and price of goods such as coffee. We explore, for example, why consumers’ and suppliers’ responses to price changes differ, and how these differences affect what happens when consumer preferences or production technologies change. And we see how the benefits of a market transaction, such as buying a cappuccino, are split between consumers like Lauren and producers like the coffee shop and Rosa.

After taking this overview, the next section of the book digs a lot deeper into each side of the market, starting with consumers’ decisions. Lauren could have had some drink other than coffee that morning—tea, milk, or a vitaminwater^®—or she could have done something completely different with her time and money, such as buy an Egg McMuffin or watch a download from Netflix. What determines how often she has coffee instead of tea, or how often she goes to Starbucks instead of somewhere else? If Lauren becomes richer, will her choices change? We answer the question of how consumers decide which goods, and how much of each, to consume in the face of the enormous number of goods and services they are offered. Then we see how adding up these decisions across all consumers gives us the total market demand curve.

After investigating consumer behavior in detail, we explore producers’ decisions. For example, how do companies like Rosa’s plantation decide which combination of inputs such as agricultural machinery (capital) and workers (labor) to use in production? As it turns out, those types of decisions for firms are similar in many respects to the decisions consumers make when deciding what products to buy. Once we’ve described firms’ input mix choices, we look at how these affect their costs of production. We pay particular attention to how these costs change with a firm’s output level, as embodied in firms’ cost curves. If Rosa doubles her production, for example, will her total costs double, more than double, or less than double? We focus on cost movements as a firm’s output changes because they are crucial in determining what a market’s supply curve looks like.

The book’s next section compares many possible configurations through which firms supply output to markets. We start with the canonical case of perfect competition. In a perfectly competitive market, all firms take the market price as given (they don’t have any ability to choose the price at which they can sell their products) and decide how much they want to produce. This is close to Rosa’s case. The international coffee market is large and supplied by coffee growers all over the world, so how much coffee Rosa decides to put on the market is not going to noticeably affect its market price. In a perfectly competitive industry, supply reflects the aggregation of the cost curves of Rosa and every other coffee grower, and industry supply combines with market demand to determine price and quantity movements over both the short and long runs.

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After perfect competition, we move to the other extreme: monopoly. When only one firm supplies a good to a market, the situation differs in several ways from perfect competition. Key is that the firm now has the ability to choose the price at which it sells its products. We see that this ability implies that if Rosa were a monopolist selling to the world’s coffee consumers, she would choose to produce less than a competitive industry would—even if she had the capacity needed to produce more. This is because limiting the amount she produces raises the price at which she could sell her coffee. We see why governments might want to (and sometimes do) step into such situations using antitrust laws. Next, we discuss other ways monopolists use their pricing power. This includes ways to charge higher prices to consumers with a greater willingness to pay, or combining products together and selling them as a single bundle to consumers.

In the book’s final look at forms of a market’s supply side, we investigate oligopolies. Oligopolies exist when multiple firms interact strategically in the same market. In such markets, firms have some ability to choose their prices, but their fortunes are determined, in part, by the actions of the other firms in the market. (They dish it out as well as they take it, though: Their own actions also impact other firms.) These sorts of situations are common; few firms are either pure monopolists or perfectly competitive price takers. Strategic interactions among firms raise all sorts of interesting questions that we can analyze using the tools of game theory. For example, how might we expect a firm like Lauren’s favorite coffee shop, say, to respond to a new coffeehouse opening across the street?

After these detailed looks at the basics of markets’ supply and demand sides, we study several specific subjects in the final section of the book. The economic concepts covered here are present in many markets. In some applications, these concepts deepen our understanding of markets by supplementing the basic analytical structure we introduce in the first parts of the book. In other cases, the basic structure may be inadequate to grasp all the necessary elements of economic interactions, so these concepts will be absolutely necessary to understanding the behavior of particular markets.

The first specific topic we explore is the combined role of risk, uncertainty, and time in economic decision making. These features are especially prominent in investment decisions—choices that typically involve paying an upfront cost with the hope of earning a future return—so these decisions are a focus of our exploration. Understanding risk, uncertainty, and time’s interactions in investment choices helps us answer questions such as whether Rosa should invest in a new bean-drying facility, or whether Lauren should go to business school.

Next, we explore how markets are interconnected. Changes in the supply or demand of one good can lead indirectly to similar or opposite shifts in other markets. After studying this interconnectedness, we can see how a supply disruption in China’s tea-growing areas can raise the price at which Rosa can sell her coffee and the price that Lauren must pay for her cappuccino. Once we’re able to tie markets together, we can analyze the conditions that must hold for an economy to operate efficiently. For example, are producers supplying the “right” mix of coffee and tea, and doing so at the lowest possible cost? Being able to answer such questions allows us to determine whether markets are working to maximize the social benefit of a good or service.

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After seeing what must hold for markets to work well, we look in detail at a series of situations in which markets might not work well. One set of situations involves markets in which information about tastes, costs, or product quality is not equally shared by all potential parties in a transaction. For example, if Rosa wants to buy a used tractor for the plantation, she wouldn’t know with 100% accuracy how well the tractor works before buying it, and she might be especially concerned that the current owner was selling the tractor precisely because it didn’t operate up to par. How does this lack of accurate information affect her decision? Or, if Lauren wants to convince a potential employer she would be a hard-working employee before she gets the job, how might she do so?

A second set of situations in which markets may not operate efficiently includes transactions that affect people who are neither the buying nor the selling party, or markets in which a good’s benefits are shared across many people at the same time. An example would be Rosa’s decision whether or not to apply pesticides to her crop. Doing so would not only affect the economics of her own operation, but would also have spillover effects on others. A neighboring coffee plantation might benefit from facing a smaller population of local insects, for instance. On the other hand, other neighbors, workers, and maybe coffee consumers could be harmed by the chemical pollution that pesticide use involves. What makes these situations interesting—and what causes markets to have difficulty delivering the socially optimal outcome—is that Rosa is likely to take into account the pesticide’s impact on her own production when deciding whether to use it or not, but is less likely to consider its effects on neighboring farms, the local population, and coffee drinkers in Seattle.

The book concludes with an exploration of behavioral economics. This study of the intersection of psychology and economics has become an increasingly prominent part of economic research. People often have deeply formed biases and social preferences that limit their ability to act in the completely rational, self-interested way that we often assume in economic analysis. If this is true, then our basic analytical structure—even when supplemented with knowledge of the deeper concepts discussed above—may be inadequate for explaining economic decision making.

All of these topics provide you with microeconomic tools to study the world around you. Over the past fifty years, this set of tools has expanded and changed. Microeconomics has evolved into a more empirical discipline, that is, one that uses much more data analysis and experiments, and not just abstract theory, to explore economic phenomena. The computing revolution made this change possible. As you’ll see throughout this book, when the price of a good decreases, people consume more of it. This has been true of computing. Much more of modern-day economists’ efforts toward understanding the economy center on data and measurement than they did years ago.

By the end of your microeconomics course, you will have the resources necessary to examine the world as an economist does. We’ve already used microeconomic tools to broadly describe a very specific economic exchange between coffee producer Rosa and university student Lauren. But what’s powerful about microeconomics is that it can be applied to any market, not just to a market like the one inhabited by Rosa and Lauren. You can use microeconomics to think rationally about any of the dozens of choices (economic and noneconomic) you face each day. By the end of your study of intermediate microeconomics, you’ll not only be able to think like an economist—you’ll see how useful it is.

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