Microeconomics in Action

In order to best understand how microeconomics applies to the real world, we'll go over the case of a car maker, General Motors (GM).

Microeconomic Failure

At one time, General Motors was among America's most profitable companies and a colossus of the automobile industry. By 2008, GM had fallen on hard times, the victim of a slumping U.S. and global economy and a series of microeconomic decisions that turned out to be wrong. Trouble at the microeconomic level began for General Motors several years before its problems worsened in late 2008. As Japanese automaker Toyota (TM) began steadily eating into GM's market share, GM failed to meet its competition head-on.

Toyota made a cheaper car with better gas mileage that was of better overall quality, and was engineered for greater durability than its chief competitor, GM. Consumers naturally gravitated away from GM to Toyota, and demand for the once-popular GM automobiles declined slowly and continually as Toyota and other Japanese cars won an ever-increasing share of the automobile market.

Bad Decision-Making

Although the general economy played a role in GM's fall, which eventually led to its bankruptcy in 2009, several GM management decisions at the microeconomic level contributed to the problem.

First, prior to its bankruptcy, GM was selling eight different brands of cars – Buick, Cadillac, Chevrolet, GMC, Hummer, Pontiac, Saab and Saturn. The number of units manufactured for each of these brands represented too much output, a situation in which the marginal revenue is less than the marginal costs.

Second, as gasoline prices rose, spurred by rising oil prices, GM continued to build gas-guzzling SUVs and pick-up trucks – such as the Hummer – and failed to produce cars that kept pace with the high mileage-per-gallon vehicles produced by Toyota and other Japanese manufacturers. Despite the obvious decline in demand for automobiles that were not fuel-efficient, GM persisted in marketing them, reflecting a microeconomic decision of management that seemed to disregard data on consumer preferences.

Finally, in response to high consumer demand for fuel-efficient or alternative-energy vehicles, GM began developing hybrid vehicles, but only long after its competitors had brought them to the market.

GM's staggering debt and the costs of honoring contracts to provide pensions to its retirees – and handsome health benefits and other costly benefits to its union-represented employees – only  contributed to its decline.

Too many microeconomic decisions at GM proved unsuccessful. The result was a bankruptcy filing and huge government bailout for a firm that once made huge profits and reigned supreme over its industry. (See also: How the U.S. Automobile Industry Has Changed.)

A Happy Ending

Still, as the economy continued to improve following the Great Recession, GM forged an unexpected comeback – despite enduring significant brand damage and costs associated with a massive recall in the years following the bailout. Key to its rebirth were the government-assisted corporate restructuring – complete with a new IPO – a long-needed emphasis on creating quality products and a new focus on satisfying customers with top notch customer service. GM’s sales have climbed each year since the Great Recession, and in 2017, the company ranked fourth on the top 20 global automakers list – bested only by Volkswagen, Renault Nissan and Toyota, according to research from JATO Dynamics.