Thus, microeconomic theory seeks to determine the mechanism by which the different economic units attain the position of equilibrium, proceeding from the individual units to a narrowly defined group such as a single industry or a single market.
Microeconomic theory shows under what conditions these efficiencies are achieved. Likewise, microeconomic theory studies the behaviour of the individual firms in regard to the fixation of price and output and their reactions to the changes in the demand and supply conditions. We thus see that microeconomic analysis is a very useful and important branch of modern economic theory.
An important part of microeconomics is examining whether and how all the different cells get adjusted at the same time. Externalities are said to exist when the production or consumption of a commodity affects other people than those who produce, sell or buy it.
These models at the same time enable the economists to explain the degree to which the actual phenomena depart from certain ideal constructions that would most completely achieve individual and social objectives.
Baumol's introductory essays to the book's major sections take up the threads from this autobiographical piece and follow them to the development of concepts central to economic theory, applications, and methodology.
General equilibrium analysis is the microscopic examination of the inter-relationships of parts within the economy as a whole.
Another class of departure from welfare optimum is the problem of externalities. Microeconomic theory reveals that when the externalities exist free working of the price mechanism fails to achieve economic efficiency, since it does not take into account the benefits or harms made to those external to the individual producers and the consumers.
It also makes important and useful policy recommendations to regulate monopoly so as to attain economic efficiency or maximum welfare. Economics thus has descriptive, normative and predictive aspects. These externalities may be in the form of either external economies or external diseconomies.