7 Zooming in on firms

So far, we have concentrated on the study of macroeconomics, but have not focused on the economics of individual firms or markets. To understand microeconomic theory, we study the activities of firms, their production processes and the markets where goods and services are traded. The idea of firms and production should be familiar to you, for instance, when we discussed how changes in the level of investment by firms influences aggregate demand and overall GDP. Section 7 will explore the activities of firms in more detail. We will begin to look at activities such as how production processes can be modelled in economics, and how the prices of specific goods and services – the market price – depend on how much firms are willing to supply, but also the quantity which consumers are willing and able to buy.

The section examines how firms can grow by increasing output and reducing cost. It looks at how production can be organised efficiently, and also shows that in any market there will be winners and losers. The economic theory in the section is closely linked to examples of real firms and markets that can be used to demonstrate how you can apply microeconomic theory to everyday news and events. It will help you to understand why the price of fresh food rises when supply is scarce, and why some firms make large profits while others struggle to survive.