Dynamic Optimization in Microeconomics

Optimization_in_Microeconomics

Microeconomics, one of the most celebrated and popular branches of economics, deals with the study of individual behavior and firms making informed and economically viable decisions regarding the use of scant recourses. It studies how firms should make the best of scarce resources to build on their product and services while maximizing profits and unit margins.

Microeconomics and its Applications

The critical importance of the microeconomic study is to delve deeper into the market mechanisms and ensconce the interaction between various factors that determine things like relative pricing of the product and services, quantity, and quality of the goods and services to be produced on an individual level. All this is studies under the constraint that the resource is its human resource, financial resource, etc., are optimally utilized, leading to no wastage. It also suggests alternative uses of the available resources to decide the extent and quality of interactions among the various factors.

In the same vein, a section of microeconomics is also concerned with determining the elements to ensure a free and fair market where economic order and writ is followed and one where returns are progressive rather than diminishing. Another facet of microeconomic is the assessment of market failure to ensure that such catastrophe is not repeated in future and there is strict adherence to fair market regulations thereby producing fruitful and efficient results.

Theories of Dynamic Optimization

Microeconomics can be thought of as a small grain that can be used to give a total of the entire economic activity in the context of a larger picture. It deals with issues like the gross domestic product (GDP), inflation and deflation, infrastructure development, bond market, currency fluctuation, etc., on an individual and localized level. For example, if satisfied farmers start growing wheat instead of rice, then what would be the impact be on a local level and how the same will dealt on a more substantial scale.

It also forms the basis for the impact of economic policies for any government like taxation, subsidies, fiscal deficit, etc., to develop a sound microeconomic structure. Most governments rely extensively on microeconomic models and predictions to establish their policies ranging from developing budgets, taxation policies, subsidies, price of government bonds, imports and export policies, managing currency fluctuations, etc.

For example, consider a country suffering from high and prolonged inflation. In such a scenario, the government uses the microeconomics framework to gauge the real cause of inflation. The boom may be seasonal and due to natural calamities like famine, drought, etc., or maybe due to external factors like an increase in petroleum prices or may be due to excessive lending by banks, etc. Based on the microeconomic analysis, the government can conclude that the root cause of inflation is an increase in the prices of agricultural products.

Importance of Dynamic Optimization

Using microeconomic analysis, the government can take several steps like reducing the cost of fertilizes for a particular product or particular geography by giving subsidies. It helps reduce the input cost of farming or put a ceiling on the quantum of exports or increase imports or even fix the price of the farm produce in an open market. All this will be done for an individual section in an isolated manner to ensure that other economic activities are not hindered. All such mechanisms and course correction fall under the purview of microeconomics and its policies. Microeconomics is centered around optimum utilization of resources, and the dynamic optimization can be an integral part of microeconomics.

Dynamic optimization refers to using the resource on a need basis to ensure that the funds are optimally utilized. For example, consider the foreign reserves of a country. If a country is suffering from a recession, any government would prefer to use the foreign reserves to push economic activity in the country. The international reserves can be deployed to drive demand by increasing the disposable income in the hands of the common man. However, things are not so simple as this might only address the cause and not the symptoms. The recession might be due to falling productivity levels, lack of education, or expenditure on foreign-made goods. In such a scenario spending the reserves on increasing the demand would not solve the problem. Instead, it might only aggravate the problem in the long run.

Hence in such a scenario, dynamic optimization in microeconomic policies should be followed. The government should use the reserves on developing human capital in the country to ensure that the productivity levels of the ordinary people at the individual level go up. Also, the government could stop importing certain goods and commodities to prevent the overflow of products and services in the market. 

Dynamic Utilization in Economy

Furthermore, the concept of dynamic utilization also encompasses the building of long-term physical infrastructure of any economy. For any big-ticket infrastructure project, resources like financing needs, human power, land, and labor must be dynamically allocated to ensure optimum utilization of scant resources. Most of the infrastructure projects suffer from cost overrun and are not completed on time due to a lack of proper use of resources.

For example, the construction of national highways, the crucial concepts is how much land should be allocated, which areas should it pass through, etc. They research what would be the feasibility once the highway is operational, will there be commercial traffic on the road, after how many years will the cost of the project be recovered, what should be the toll tax for the highway, etc. These are only a few of the questions which can be answered successfully and comprehensively by applying dynamic optimization in the microeconomic scenario. In the above case, the government could build a railway station at a certain point in the national highway to develop it as a hub for commercial activities, thus making the whole project more feasible. 

Hence by using the concept of dynamic optimization, microeconomic policies can be framed and implemented in a more beneficial, holisticOptimization_in_Microeconomics, and targeted manner.

Dynamic optimization has various applications and it is an important concept for microeconomics and econometrical studies.


References:

http://econ.lse.ac.uk/staff/wdenhaan/teach/ch1.pdf

http://econ.nyu.edu/user/debraj/TapanMitra/Papers/Mitra%20(Book%20chapter)%202000.pdf

https://eml.berkeley.edu/~obstfeld/ftp/perplexed/cts4a.pdf

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1020 Words

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Sep 16, 2020

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3 Pages

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