In this essay we will discuss about Microeconomics and Macroeconomics. After reading this essay you will learn about: 1. Meaning of Microeconomics 2. Scope of Microeconomics 3. Limitations of Microeconomics 4. Importance of Microeconomics 5. Problems of Interrelation and Integration of Micro and Macroeconomics 6. Meaning of Macroeconomics 7. Scope and Importance of Macroeconomics 8. Limitations of Macroeconomics.
- Essay on the Meaning of Microeconomics
- Essay on the Scope of Microeconomics
- Essay on the Limitations of Microeconomics
- Essay on the Importance of Microeconomics
- Essay on the Problems of Interrelation and Integration of Micro and Macroeconomics
- Essay on the Meaning of Macroeconomics
- Essay on the Scope and Importance of Macroeconomics
- Essay on the Limitations of Macroeconomics
Essay # 1. Meaning of Microeconomics:
Microeconomics is the study of the economic actions of individuals and small groups of individuals. This includes “the study of particular firms, particular households, individual prices, wages, income, individual industries, and particular commodities.”
It concerns itself with the analysis of price determination and the allocation of resources to specific uses. The determination of equilibrium output of the firm or industry, the wage of a particular type of labour, the price of a particular commodity like rice, tea, or car are some of the fields of microeconomic theory.
In the words of Ackley:
“Microeconomics deals with the division of total output among industries, products and firms and the allocations of resources among competing groups. It considers problems of income distribution. Its interest is in relative prices of particular goods and services.”
Microeconomics is, in fact, a microscopic study of the economy, according to Maurice Dobb. It is like looking at the economy through a microscope to find out the working of markets for individual commodities and the behaviour of individual consumers and producers.
In other words, in microeconomics we study the interrelationships of individual households and individual firms, and individual firms and individual industries to each other. In this sense, microeconomics involves the study of aggregates.
Essay # 2. Scope of Microeconomics:
“Price and value theory, the theory of the household, the firm and the industry, most production and welfare theory are of the microeconomic variety,”
Thus, microeconomics studies:
(i) How resources are allocated to the production of particular goods and services,
(ii) How the goods and services are distributed among the people, and
(iii) How efficiently they are distributed.
While studying the conditions in which the price of a particular good is determined, microeconomics assumes the total quantity of resources as given and seeks to explain their allocation to the production of that commodity.
The allocation of resources to a particular good depends upon the prices of other goods and the prices of factors producing them. It is, therefore, the relative prices of goods and services that determine the allocation of resources.
In other words, other things being equal, it is the allocation of resources that determines what to produce, how to produce, and how much to produce. This decision, in turn, depends upon the relative prices of goods and services. Thus, microeconomics is the study of price theory: how the price of a particular commodity like rice, tea, milk, fans, scooters, etc. is determined; how the wages of a particular type of labour, interest on a particular type of capital asset, rent on a particular land and profits of a particular entrepreneur are determined; and how efficiently the various resources are allocated to individual consumers and producers.
We briefly study these problems below.
In microeconomics the analysis of price determination and allocation of resources is studied in three different stages:
(i) The equilibrium of individual consumers and producers,
(ii) The equilibrium of a single market, and
(iii) The simultaneous equilibrium of all markets. Individual consumers and producers are unable to influence the prices of goods they buy and sell. A consumer is faced with given prices and he buys that much of the commodity which maximises his utility.
For an individual producer, input and output prices are given and he produces that much of the product which maximises his profits. In the market, the price and quantity bought and sold are determined by the actions of buyers and sellers. The aggregate demand and supply curves are derived from individual demand and supply curves.
The equality of aggregate demand and supply curves determines the price and the quantity bought and sold in the market. It applies both to product and factor markets. By relaxing some of the assumptions of the perfectly competitive market, this analysis is extended to monopoly, oligopoly and monopolistic, competition markets.
Finally, in microeconomics, the interrelations between the different markets are taken so as to determine all prices simultaneously.
Though, it is generally said that microeconomics is related to partial equilibrium analysis which is the study of the equilibrium position of an individual, a firm, an industry or group of industries, yet it is also a study of their interrelationships and interdependences within the economy which falls under the general equilibrium analysis.
First, there is the consumers market in which the quantity of each commodity demanded depends not only on its own price but also on the price of every other commodity available in the market. In this market, consumers meet producers to buy commodities which the former demand and the latter sell.
The demand of consumers for the various commodities depends upon their prices and the prices of the services which they offer. In other words, a consumer earns by selling the productive services he owns and creates demands for commodities.
The price at which a commodity sells depends upon its costs of production. The costs of production, in turn, depend on the quantities of the various productive services employed and the prices paid for them. Thus the supply of commodities in the market depends on the costs of the firms, and the prices and quantities of the various productive services used by them.
Secondly, there is the producers market or factor market. In this market, the demand for productive services (factors of production) comes from the producers, and supply from the consumers. The quantity of a service (factor) used in producing a commodity depends on the relationship between the prices of that service and other services, and on the prices of commodities.
Here producers meet labourers, capitalists, landlords and other resource-owners. In this market, money incomes are earned by resource-owners who own and sell their resources, the majority of whom are consumers. Thus microeconomics is a study of interacting units of consumers, producers, and resource-owners.
In this system, all prices are relative to one another. A change in any one price establishes a ripple which touches both product and factor markets. The interrelation between product and factor markets through prices is shown in Figure 1.
In this system, consumers and firms are linked through the product market where goods and services are bought and sold. They are also linked through the factor market where the factors of production are bought and sold. In the inner circle that consumers who are resource-owners sell productive resources in the factor market which are used by firms.
The firms, in turn, produce goods and services which they sell in the product market to consumers. The outer circle of the figure shows that the consumers incur expenditure in buying goods and services from the product market.
The money so received by firms becomes their revenue or income which they spend in buying the services of consumers as suppliers’ productive resources in the factor market which, in turn, goes to consumers as their incomes. Thus microeconomics is the study of the interdependence of commodity prices, factor prices, their demands and supplies and costs, in relation to individual consumers, firms and industries.
Besides, microeconomics studies how efficiently the various resources are allocated to individual consumers and producers within the economy. Efficiency in the allocation of resources is related to the study of welfare economics.
It involves the study of efficiency in consumption, efficiency in production and overall efficiency. Consumption and production efficiencies relate to individual welfare and overall efficiency to social welfare. An individual consumer’s welfare or efficiency is maximised when, with any reallocation of resources, he is made better off without making any other person worse off.
An individual producer achieves efficiency in production when, with any re-allocation of resources in the production of a commodity, he is able to increase its output without reducing the output of some other commodity.
Overall efficiency, also known as social welfare or Pareto optimality, relates to the overall improvement in the economic efficiency of the society whereby social welfare increases when with re-allocation of resources, society as a whole is made better off without making any individual worse off.
Any re-allocation of resources at this optimum level of efficiency will lead not only to overall economic inefficiency but also to individual consumers’ and producers’ inefficiencies. Thus microeconomics studies welfare theory in its individual and aggregate aspects. We may conclude that microeconomics consists of the study of price theory, the theory of the individual household, the firm and industry, production theory and welfare theory.
Essay # 3. Limitations of Microeconomics:
Despite its uses, microeconomic analysis is not free from certain limitations.
(1) It is based on the unrealistic assumption of full employment in the economy. “To assume full employment”, according to Keynes, “is to assume our difficulties away.” Full employment is not the rule but an exception in the real world. Thus microeconomics is an unrealistic method of economic analysis.
(2) Microeconomics is based on the assumption of laissez-faire. But the policy of laissez-faire is no longer practiced. It ended with the Great Depression of the 1930s. This makes the study unrealistic.
(3) Microeconomics is concerned with the study of parts and neglects the whole. As pointed out by Boulding: “Description of a large and complex universe of facts like the economic system is impossible in terms of individual items.” Thus the study of microeconomics presents an imprecise picture of the economy.
(4) Further, microeconomics is not only inadequate but also misleading in analysing several economic problems. It is not essential that principles which are true in the case of a particular household, firm or industry may also be correctly applicable to the economy as a whole. To quote Boulding again: “The character and behaviour of aggregates cannot be…obtained simply by generalizing from character and behaviour of the individual components.”
Essay # 4. Importance of Microeconomics:
Microeconomics is an important method of economic analysis which Keynes regarded as “a necessary part of one’s apparatus of thought.” It has both theoretical and practical importance.
1. To Understand the Working of the Economy:
Microeconomics is of utmost importance in understanding the working of a free enterprise economy. In such economy there is no agency to plan and coordinate the working of the economic system. Such decisions as how to produce, what to produce, and for whom to produce, how to distribute and what to consume are taken by producers and consumers without any extraneous force.
It follows that the planning authority in a centrally planned economy cannot ensure an efficient working of the economy in the absence of a free enterprise economy. As pointed out by Learner, “Microeconomics teaches us that completely “direct” running of the economy is impossible—that a modern economy is so complex that no central planning body can obtain all the information and give out all the directives necessary for its efficient operation.”
2. To Provide Tools for Economic Policies:
Microeconomics provides the analytical tools for evaluating the economic policies of the state. Price or market mechanism is the tool which helps us in this respect. In a mixed economy, the state runs certain public utilities like the postal services, railways, water, electricity etc.
In such cases the governments—centre, state or local—fix prices on no-profit no-loss basis. These prices, in turn, influence the prices of other goods and services. There are also public enterprises which are run on price-profit policy.
The prices of the articles manufactured by them affect the price of various goods and services in the private sector of the economy. Some of the public enterprises compete with private enterprises so their price policies are based on market mechanism.
They cannot charge prices higher than under the private sector. Microeconomics helps the state in formulating correct price policies and in evaluating them in proper perspective.
3. Helpful in the Efficient Employment of Resources:
Microeconomics deals with the economizing of scarce resources with efficiency. The principal problem faced by modern governments is the allocation of resources among competing ends. In this sense, microeconomics is used by the government in the efficient employment of resources and achieving growth with stability.
4. Help to Business Executive:
Microeconomics helps the business executive in the attainment of maximum productivity with existing resources. It is with its help that he is able to know the consumer demand and calculate the costs of his product.
5. Helpful in Understanding the Problems of Taxation:
Microeconomics also helps in understanding some of the problems of taxation. It is used to explain the welfare implications of a tax. A tax leads to the reallocation of resources from their optimal level. Microeconomics helps in explaining as to whether an income tax leads to a diminution of social welfare or an excise duty or sales tax.
It is the imposition of an excise duty or sales tax that leads to the diminution of social welfare rather than an income tax. Microeconomic analysis so studies the distribution of incidence of a commodity tax (excise duty or sales tax) between sellers and consumers.
6. Helpful in International Trade:
In the field of international trade, it is used to explain the gains from international trade, balance of payments disequilibrium and the determination of the foreign exchange rate It is the relative elasticity’s of demand for each other’s products that determine the gains from international trade.
The disequilibrium in the balance of payments is the inequality between the demand and supply of foreign currency. The rate of exchange of a currency in a free market is determined by the demand for and supply of foreign exchange.
7. To Examine the Conditions of Economic Welfare:
Microeconomics can be used to examine the conditions of economic welfare. “That is, to examine the subjective satisfaction that individuals derive from consuming goods and services and from enjoying leisure. It involves the study of welfare economics which is one of defining an ideal economy.”
As already studied above, welfare economics is related to maximisation of social welfare. This is possible only under perfect competition. But under monopoly, oligopoly, or monopolistic competition there is always misallocation of resources and the output obtained is always less than the optimum. Thus there is considerable wastage of resources.
Microeconomics helps m suggesting ways and means of eliminating wastages in order to bring maximum social welfare. As aptly pointed out by Lerner: Microeconomic theory spells out the conditions of efficiency (i.e., for the elimination of all kinds of inefficiency) and suggests how they might be achieved.
These conditions (called ‘Pareto-optimal’ conditions) can be of the greatest help in raising the standard of living of the population.
8. The Basis for Prediction:
“Microeconomic theory can be used as the basis for prediction. This does not mean that it will enable us to predict the future. Rather, it will enable the possessor to make condition^ predictions. These conditions have the following form – if something occurs, then a certain set of results will follow We should be able to study government policies affecting prices of commodities and wages, for example and see how these policies affect the allocation of resources. Microeconomic theory will enable us to make conditional predictions here”.
9. Construction and Use of Models:
Microeconomics constructs and uses simple methods for the understanding of the actual economic phenomena.
As pointed out by Bilas:
“The theoretical approach to microeconomics utilizes abstract models in an attempt to see how prices are established and how resources are allocated to various uses. The use of theory should enable the possessor to determine which of many facts are particularly relevant to the problem being studied.”
Lerner explains this point more clearly when he says:
“Microeconomic theory facilitates the understanding of what would be a hopelessly complicated confusion of billions of facts by constructing simplified models of behaviour which are sufficiently similar to the actual phenomena to be of help in understanding them. 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. They, thus, help not only to describe the actual economic situation but to suggest policies that would most successfully and most efficiently bring about desired results and to predict the outcomes of such policies and other events.” Thus it is an elegant method of problem solving, according to Ackley.
Essay # 5. Problems of Interrelation and Integration of Micro and Macroeconomics:
This rough division between micro- and macroeconomics is not rigid, for the parts affect the whole and the whole affects the parts:
Dependence of Microeconomic Theory on Macroeconomics:
Take for instance when aggregate demand rises during a period of prosperity, the demand for individual products also rises. If this increase in demand is due to a reduction in the rate of interest, the demand for different types of capital goods will go up. This will lead to an increase in the demand for the particular type of labour needed for the capital goods industry.
If the supply of such labour is less elastic, its wage rate will rise. The rise in wage rate is made possible by increase in profits as a consequence of increased demand for capital goods. Thus, a macroeconomic change brings about changes in the values of microeconomic variables—in the demand for particular goods, in the wage rates of particular industries, in the profits of particular firms and industries, and in the employment position of different groups of workers.
Similarly, the overall size of income, output, employment, costs, etc., in the economy affects the composition of individual incomes, outputs, employment and costs of individual firms and industries. To take another instance, when total output falls in a period of depression, the output of capital goods falls more than that of consumer goods. Profits, wages and employment decline more rapidly in capital goods industries than in the consumer goods industries.
Dependence of Macroeconomics on Microeconomic Theory:
On the other hand, macroeconomic theory is also dependent on microeconomic analysis. The total is made up of the parts. National income is the sum of the incomes of individuals, households, firms and industries. Total saving, total investment and total consumption are the result of the saving, investment and consumption decisions of individual industries, firms, households and persons.
The general price level is the average of all prices of individual goods and services. Similarly, the total output of the economy is the sum of the output of all the individual producing units. Thus, “the aggregates and averages that are studied in macroeconomics are nothing but aggregates and averages of the individual quantities which are studied in microeconomics”.
Let us take a few concrete examples of this macro dependence on microeconomics. If the economy concentrates all its resources in producing only agricultural commodities, the total output of the economy will decline because the other sectors of the economy will be neglected. The total level of output, income and employment in the economy also depends upon income distribution.
If there is unequal distribution of income so that income is concentrated in the hands of a few rich, it will tend to reduce the demand for consumer goods. Profits, investment and output will decline, unemployment will spread and ultimately the economy will be faced with depression. Thus, both macro and micro approaches to economic problems are interrelated and interdependent.
Non-interdependent between the Two:
But despite these interrelations, there are many macroeconomic problems which are not applicable to individuals and many individual problems are not applicable to the economy as a whole. For example, there can be and usually is a divergence between an individual’s income and his expenditure, but for the economy as a whole total income and total expenditure are always equal. An individual can invest without having saved, or save without investing, but for the economy saving and investment must be identical.
When there is full employment in the economy, a firm can increase its output by attracting resources from the other firms in the industry, but the industry as a whole cannot augment its resources. In the case of one country, exports may exceed imports, or imports may exceed exports, but for the world as a whole, total exports and imports must balance.
Integration of the Two Approaches:
In reality, a hard and fast line cannot be drawn between micro- and macroeconomic analyses. A general theory of the economy should cover both. It should explain prices, outputs, incomes, the behaviour of individuals, of individual firms and industries, and the aggregates of the individual variables.
“Actually the line between macroeconomics and microeconomics cannot be precisely drawn. A truly “general” theory of the economy would clearly embrace both: it would explain individual behaviour, individual outputs, incomes and prices, and the sums or averages of the individual results would constitute the aggregates with which macroeconomics is concerned.
Such a general theory exists, but its very generality leaves it with little substantive content. Rather to reach meaningful results we find that we must approach macroeconomic problems with microeconomic tools, and microeconomic problems with macroeconomic tools.”
Thus the need is for a proper integration of the two approaches. Prof. Ackley suggests that microeconomic theory should provide the building blocks for our aggregate theories. But macroeconomics may also contribute to microeconomic understanding.
If we discover, for example, empirically stable macroeconomic generalisations which appear inconsistent with microeconomic theories, or which relate to aspects of behaviour which microeconomics has neglected, macroeconomics may permit us to improve our understanding of individual behaviour.
But in order to proceed in either direction we need to be aware of some rather technical problems of aggregation which point out that “progress in macroeconomics depends on further progress in the microeconomic theory of prices and distribution of income.”
Essay # 6. Meaning of Macroeconomics:
Macroeconomics is the study of aggregates or averages covering the entire economy, such as total employment, unemployment, national income, national output, total investment, total consumption, total savings, aggregate supply, aggregate demand, and general price level, wage level, interest rates and cost structure.
In other words, it is aggregative economics which examines the interrelations among the various aggregates, their determination and causes of fluctuations in them.
Thus in the words of Ackley:
“Macroeconomics deals with economic affairs ‘in the large’, it concerns the overall dimensions of economic life. It looks at the total size and shape of the functioning of the ‘elephant’ of economic experience, rather than working of articulation or dimensions of the individual parts. It studies the character of the forest, independently of the trees which compose it.”
Macroeconomics is also known as the theory of income and employment, or, simply income analysis. It is concerned with the problems of unemployment, economic fluctuations, inflation, deflation, instability, stagnation, international trade and economic growth. It is the study of the causes of unemployment, and the various determinants of employment.
In the field of business cycles, it concerns itself with the effect of investment on total output, total income, and aggregate employment. In the monetary sphere, it studies the effect of the total quantity of money on the general price level. In international trade, the problems of balance of payments and foreign aid fall within the purview of macro-economic analysis.
Above all, macroeconomic theory discusses the problems of determination of the total income of a country and causes of its fluctuations. Finally, it studies the factors that retard growth and those which bring the economy on the path of economic development.
Essay # 7. Scope and Importance of Macroeconomics:
As a method of economic analysis macroeconomics is of much theoretical and practical importance.
1. To Understand the Working of the Economy:
The study of macroeconomic variables is indispensable for understanding the working of the economy. Our main economic problems are related to the behaviour of total income, output, employment and the general price level in the economy.
These variables are statistically measurable, thereby facilitating the possibilities of analysing the effects on the functioning of the economy. As Tinbergen observes, macroeconomic concepts help in “making the elimination process understandable and transparent”. For instance, one may not agree on the best method of measuring different prices, but the general price level is helpful in understanding the nature of the economy.
2. In Economic Policies:
Macroeconomics is extremely useful from the point of view of economic policy. Modern governments, especially of the underdeveloped economies, are confronted with innumerable national problems. They are the problems of overpopulation, inflation, balance of payments, general underproduction, etc.
The main responsibility of these governments rests in the regulation and control of overpopulation, general prices, general volume of trade, general outputs, etc. Tinbergen says: “Working with macroeconomic concepts is a bare necessity in order to contribute to the solutions of the great problems of our times.” No government can solve these problems in terms of individual behaviour. Let us analyse the use of macroeconomic study in the solution of certain complex economic problems.
(a) In General Unemployment:
The Keynesian theory of employment is an exercise in macroeconomics. The general level of employment in an economy depends upon effective demand which, in turn, depends on aggregate demand and aggregate supply functions.
Unemployment is thus caused by deficiency of effective demand. In order to eliminate it, effective demand should be raised by increasing total investment, total output, total income and total consumption. Thus, macroeconomics has special significance in studying the causes, effects and remedies of general unemployment.
(b) In National Income:
The study of macroeconomics is very important for evaluating the overall performance of the economy in terms of national income. With the advent of the Great Depression of the 1930s, it became necessary to analyse the causes of general overproduction and general unemployment.
This led to the construction of the data on national income. National income data help in forecasting the level of economic activity and to understand the distribution of income among different groups of people in the economy.
(c) In Economic Growth:
The economics of growth is also a study in macroeconomics. It is on the basis of macroeconomics that the resources and capabilities of an economy are evaluated. Plans for the overall increase in national income, output and employment are framed and implemented so as to raise the level of economic development of the economy as a whole.
(d) In Monetary Problems:
It is in terms of macroeconomics that monetary problems can be analysed and understood properly. Frequent changes in the value of money—inflation or deflation—affect the economy adversely. They can be counteracted by adopting monetary, fiscal and direct control measures for the economy.
(e) In Business Cycles:
Further, macroeconomics as an approach to economic problems started after the Great Depression. Thus its importance lies in analysing the causes of economic fluctuations and in providing remedies.
3. For Understanding the Behaviour of Individual Units:
Last but not the least, for understanding the behaviour of individual units the study of macroeconomics is imperative. Demand for individual products depends upon aggregate demand in the economy. Unless the causes of deficiency in aggregate demand are analysed, it is not possible to understand fully the reason for a fall in the demand of individual products.
The reasons for increase in costs of a particular firm or industry cannot be analysed without knowing the average cost conditions of the whole economy. Thus, the study of individual units is not possible without macroeconomics.
We may conclude that macroeconomics enriches our knowledge of the functioning of an economy by studying the behaviour of national income, output, investment, saving and consumption. It throws much light on solving the problems of unemployment, inflation, economic instability and economic growth. Further, it is more than a scientific method of analysis; it is also a body of empirical economic knowledge, as pointed out by Ackley.
Essay # 8. Limitations of Macroeconomics:
There are, however, certain limitations of macroeconomic analysis. Mostly, these stem from attempts to yield macroeconomic generalisations from individual experiences.
1. Fallacy of Composition:
In macroeconomic analysis the “fallacy of composition” is involved, i.e., aggregate economic behaviour is the sum total of individual activities. But what is true of individuals is not necessarily true of the economy as a whole. For instance, savings are a private virtue but a public vice.
If total savings in the economy increase, they may initiate a depression unless they are invested. Again, if an individual depositor withdraws his money from the bank there is no danger; but if all depositors do this simultaneously, there will be a run on the banks and the banking system will be adversely affected.
2. To Regard Aggregates as Homogeneous:
The main defect in macro analysis is that it regards the aggregates as homogeneous without caring about their internal composition and structure. The average wage in a country is the sum total of wages in all occupations, i.e., wages of clerks, typists, teachers, nurses, etc. But the volume of aggregate employment depends on the relative structure of wages rather than on the average wage. If, for instance, wages of nurses’ increase but of typists fall, the average may remain unchanged. But if the employment of nurses falls a little and of typists raises much, aggregate employment would increase.
3. Aggregate Variables may not be Important Necessarily:
The aggregate variables which form the economic system may not be of much significance. For instance, the national income of a country is the total of all individual incomes. A rise in national income does not mean that individual incomes have risen.
The increase in national income might be the result of the increase in the incomes of a few rich people in the country. Thus a rise in national income of this type has little significance from the point of view of the community. Boulding calls these three difficulties as “macroeconomic paradoxes” which are true when applied to a single individual but which are untrue when applied to the economic system as a whole.
4. Indiscriminate Use of Macroeconomics Misleading:
An indiscriminate and uncritical use of macroeconomics in analysing the problems of the real world can often be misleading. For instance, if the policy measures needed to achieve and maintain full employment in the economy are applied to structural unemployment in individual firms and industries, they become irrelevant. Similarly, measures aimed at controlling general prices cannot be applied with much advantage for controlling prices of individual products.
5. Statistical and Conceptual Difficulties:
The measurement of macroeconomic concepts involves a number of statistical and conceptual difficulties. These problems relate to the aggregation of microeconomic variables. If individual units are almost similar, aggregation does not present much difficulty. But if microeconomic variables relate to similar individual units, their aggregation into one macroeconomic variable may be wrong and dangerous.