Limitations of Economic Theories

Economics is the study of how individuals, governments, and nations make use of scarce resources to best satisfy their unlimited wants. Microeconomics is the field of economics that looks at the decisions of firms and individuals as they try to make themselves as well off as possible, and how these decisions can influence the market and even the entire economy within which they operate. Although these theories are very useful in explaining why consumers make the decisions they make, there are still some limitations of these theories that need to be taken into consideration. This essay will outline some of these limitations including: static theories, imperfect knowledge, number of goods in a utility function, behavioural changes around others and profit maximisation.

One of the limitations of economic theory is that in order to show the relationship between price and quantity demanded or quantity supplied other factors that influence quantity demanded, for example the price of a substitute good, or quantity supplied, for example the price of an input, are held constant. These factors are held constant, because in reality, they are constantly changing. This can make it difficult to determine how one factor, such as price, can affect another factor, such as quantity demanded or supplied, because other constantly changing factors are influencing quantity demanded or supplied at the same time. This is a limitation because these other factors have an influence on quantity demanded or supplied, and can therefore influence the outcomes of decisions by individuals and firms. For example, a Pie Firm might decide to lower the price of their apple pies believing it will increase individuals demand for apple pies because they are now relativ...

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...its profit. Profits from the decision are not made until significantly after the decision is made, because of the large cost of purchasing the pie-making machine, and knowledge of how much additional profit the pie-making machine generates per pie will not be available until the end of month accounts are prepared.

Although economics is useful in understanding why individuals and firms make the decisions they make, or predicting the outcomes of decisions by individuals or firms, there are still some important limitations that should be considered when using the information. However, these limitations do not diminish the usefulness of economic theory when making predictions or understanding individuals and firms decisions.

Reference List:

Perloff, J. M. (2014). Microeconomics with calculus (Third edition, global ed.). United States of America: Pearson Education