Beginners’ Guide to Micro and Macro Economics

Beginners’ Guide to Micro and Macro Economics!

Micro Economics:

Meaning of Micro Economics:

The Micro Economics is the study of particular firms, particular households, individual prices, wages, income, individual industries and particular commodities.

It is related to the analysis of price determination and the allocation of resources of specific uses. It is the study of the economic actions of individuals and small groups of individuals.

Definition of Micro Economics:

The important definitions of Micro Economics are as follows:

1. According to Ackley:

“Micro Economics 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.” It is a microscopic study of the economy.

2. According to Maurice Dobb:

“Micro Economics 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.” It is the study regarding the relationships of individuals households and individual firms and individual industries to each other. It is the study of aggregates.

Scope of Micro Economics:

If we analyse and see the various aspects of Micro Economics it can be said that under the purview on Micro Economics Price and Value theory, the theory of household, the firm and the industry and most production and welfare theory are of the Micro Economics aspects.

Thus, the studies of Micro Economics are:

1. In the production of goods and services and how resources are allocated.

2. How the distribution of goods and services are made among the people.

3. With how much efficiency this distribution takes place.

The allocation of resources of the production of a particular goods depends upon the prices of other goods and the prices of factors producing the goods. It means the relative prices of goods and services determine the allocation of resources.

Further, any allocation of resources on the quantity of production is determined i.e., what should be produced, how to produce and how much to produce. Next, Micro Economics is called the study of price theory, i.e., how the price of a particular commodity like rice, tea, milk, fans etc. is determined. Again, it also studies, how wage and interest are determined.

The analysis of price-determination and allocation of resources are determined under three different stages:

(a) The equilibrium of individual consumers and producers,

(b) The equilibrium of a single market, and

(b) The simultaneous equilibrium of all markets.

A consumer is faced with given prices and he buys that much of the commodity which maximises his unity. 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 quantity bought and sold in the market. This studies applies both to product and factor markets. If we relax some assumptions of the study, this analysis can be used and extended to monopoly, oligopoly and monopolistic competition markets.

Further, it has been said that it is also the study of the inter-relationships and inter dependencies within the economy which falls under the general equilibrium analysis. In the market there is consumer’s 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.

The price at which a commodity sells depends upon its costs of production. The costs of production also depend on the quantities of the various productive services employed and the prices paid for them.

Importance/Utility of Micro Economics:

The importance/utility of Micro Economics is as follows:

1. Micro Economics is important to understand the working of a free enterprise economy:

In free enterprise there is no agency to plan and co-ordinate the working of the economic system. Here, we cannot assure efficient working of the system. In this connection Lerner has said—”Direct running of the economy is impossible because the 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. It provides an analytical tool for evaluating the economic policies of the state:

Price or market mechanism is the tool which helps us in this respect. There are certain public utilities items like postal services, railways, water, electricity etc., which are run by government which fixes prices on no profit no loss basis. This study helps the state government in formulating correct price policies and in evaluating them in proper manner.

3. It is helpful to business executive:

This study helps the business executive in the attainment of maximum productivity with the resources available. Further, it helps in knowing of consumer’s demand and in calculation of costs.

4. It is helpful in the efficient use of available resources:

This approach deals in economizing of scarce resources with efficiency. Proper utilisation of available resources helps in achieving growth and stability.

5. It helps in understanding the various problems of taxation:

It is the tax which compels to the re-allocation of resources from their optimum. This analysis helps in the study of distribution of incidence of a commodity tax (excise duty or sales tax) between sellers and consumers.

6. It is helpful in international trade:

In the field of international trade we can know and understand as to how much there will be gain in international trade and balance of payments and how foreign exchange rates are determined.

7. It is helpful in the construction and uses of simple methods for the understanding of the actual economic phenomenon:

In this connection R. A. Bilas has said, “The theoretical approach to Micro Economics 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 processor to determine which of many facts are relevant to the problem being studied.”

Limitations/Dis-Utility/Dis-Advantages of Micro Economics:

The important limitations of this approach are as follows:

1. This analysis is unrealistic:

It is based on unrealistic assumptions of full employment in the economy. According to Keynes—”To assume full employment is not proper. Full employment is not the rule but an exception in the real world. This study is unrealistic method of economic analysis”. Ackley has said, “it is an elegant method of Solving Problem.”

2. It is the study of parts and neglects the whole:

As Boulding has said—”It is the study of imprecise picture of the economy

3. It is not only inadequate but misleading also in analysing several economic problems:

It is not essential that one principle can be applicable and used in the economy as a whole.

4. This analysis is based on the assumption of Laissez-Faire:

But the policy of Laissez Faire is no longer followed and practiced. It has ended with the Great Depression of 1930. This study can be said as unrealistic. To quote Boulding—”The character and behaviour of aggregate cannot be obtained simply by generalizing from character and behaviour of the individual components.”

Macro Economics:

Meaning of Macro Economics:

Macro Economics is the study of “aggregates or averages covering the entire economy such as total employment, toted unemployment, national income, national output, toted investment, total consumption, total savings, aggregate supply, aggregate demand and general price-level, wage-level, interest rates and cost structure.”

This analysis 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 and international trade and growth”. Some economists have given the name of “Aggregative Economics”-which examines the inter-relations among the various aggregates, their determination and causes of fluctua­tions in them.

Definition of Macro Economics:

According to Ackley:

“Macro Economics 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 rather than working of dimensions of the individual parts.

Macro Economics is the study of the causes of unemployment and the various deter­minants of employment.

In the field of business cycle:

It is concerned with the effect of investment on total output, total income and aggregate employment.

In the monetary sphere:

It studies the effect of total quantity of money on the general price level.

In the international trade:

The problem of balance of payments and foreign aid fall within the purview of this analysis. Therefore, it discusses the problems of determination of the total income of a country and causes of its fluctuations. Finally, it can be said that it studies the factors that retard growth and those which bring the economy on the time of economic development.

Importance of Macro-Economics:

Macro-Economic has got theoretical and practical importance.

Its importance is as follows:

1. This analysis is indispensable for understanding the working of the economy:

Our main economic problems are related to the bahaviour of total income, output, employment and the general price-level in the economy. These are measurable and can help in analysing the effects, on the functioning of the economy. As Tinbergen view is “that this concept helps in making the elimination process understandable.”

2. This concept is extremely useful from the point of economic policy:

In underdeveloped economies the problems of over-population, inflation, balance of payments, general under production etc. The main responsibilities of these governments are to control the over-population, inflation, general price-level and volume of trade etc.

In this connection Timbergen has said—”Working with macro-economic concepts is a bare necessity in order to contribute solutions of the general problems of the time. No government can solve these problems in terms of individual behaviour.”

(a) In General Unemployment:

The Keynesian theory of employment has set the study of macro-economics. Employment depends upon effective demand i.e., an aggregate demand and aggregate supply function. Unemployment is caused by deficiency of effective demand. Effective demand should be raised by increasing total investment, total output, total income and total consumption.

This economics has special importance in studying the causes effects and remedies of general employment.

(b) In Economic Growth:

The economics of growth is also a study of macro-economics. On the basis of this economics the resources and capabilities of an economy are evaluated. Under this the plans for the over-all increase in national income, output and employment is framed and implemented, so as to raise the economy as a whole.

(c) In National Income:

The study of macro-economics is helpful in the construction of National Income Data. This National Income Data is helpful in forecasting the level of economic activity and to understand the distribution of income among different groups of people.

(d) In dealing with Monetary Problems:

As we are aware that inflation or deflation affects the economy adversely. They can be solved by adopting monetary, fiscal and direct control measures for the economy as a whole.

(e) In Understanding the Behaviour of Individual Units:

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 and decide fully the reason for a fall in the demand of individual products.

(f) In Business Cycle:

The importance of macro-economic lies in analyzing the causes of economic fluctuations and in giving proper remedies. By seeing the above facts it can be said that Macro-Economics throws much light on solving the problems of unemployment, inflation economic instability and economic growth.

As Ackley has said that “Macro-economics is more than a specific method of analysis. It is also a body of “empirical economic knowledge.”

Limitations of Macro-Economics:

Limitations of Macro-Economics are as follows:

1. This analysis is nothing but a fallacy of composition:

In this analysis, these perhaps have been forgotten that what is true of individuals is not necessarily true of the economy as a whole.

For example:

Savings are a Private Virtue but a Public Vile. If total savings in the economy increases they may initiate a depression unless they are invested. Similarly, 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. This analysis regards the aggregates as homogeneous without caring about their internal composition and structure:

The average wage in a country is the total of wages in all occupations i.e., wages of clerks, teachers, nurses etc. But the aggregate employment depends on the relative structure of wages rather than the average wage.

For example:

If the wages of nurses increase but that of clerks fall, the average may remain unchanged. But if the employment of nurses falls a little and of clerks rises much, aggregate employment would increase.

3. The aggregate variables which form the economic system may not be of much significance:

For example:

Suppose, the national income of a country is the total of all individual income of a country in the total of all individual incomes. A rise in national income does not mean that individual’s incomes have risen. The increase in national income might be the efforts of 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.

4. An indiscriminate use of this analysis in analysing the products may be misleading:

For example:

Measures adopted at controlling general prices cannot be applied with much advantage for controlling prices of individual products.

5. The measurement of this analysis involves a number of conceptual difficul­ties:

For example:

If micro-economic variables relate to similar individual units their aggregation into one macro-economic variables may be wrong and dangerous.

Distinction between Micro-Economics and Macro-Economics:

Regarding the difference between Micro and Macro-Economic Ackley has written that “the difference between micro and macro-economics is a difference of degree and not of kind, but the degree is so great as to approach a difference of kind.”

Other important differences are as follows:

1. Use of Aggregates:

The Micro Economics uses aggregates relating to individual households, firms and industries, while Macro Economics uses aggregates which relate them to the “economy wide total”.

2. Based on Study:

Micro and Macro Economics are the study of aggregates. But the aggregates in Micro Economics are different from that in Macro Economics.

In Micro Economics the inter-relationships of individual households, individual firms and individual industries to each other deals with aggregation. Here, the concept of ‘industry’ means aggregate of numerous firms or even products.

For example:

Consumer demand for shoes is an aggregate of the production of many households and the supply of shoes is an aggregate of the production of many firms. The demand and supply of labour is an aggregate concepts and comes under the study of Micro Economics but the expenditure incurred in business investment expenditures are the study of Macro Economics.

3. Based on Objective:

The objective of Micro Economics on the demand side is to maximise utility where as on the supply side is to minimise profits at the minimum cost. On the other-hand the main objectives of Macro Economics are full employment; price stability, economic growth and favourable balance of payments.

4. Based on Origin:

The word ‘Micro’ has been derived from the Greek word ‘mikros’ which means small. Micro Economics is the study of individuals and small groups of individuals. It includes the study of particular households, particular firms, particular industries, particular commodities and particular prices.

The word ‘Macro’ has also been derived from the Greek word ‘MAKROS’ which means large. It deals with aggregates of these quantities and not with individual incomes and individual prices. It is the study of Total Output and National Output.

5. Basis of Difference:

The basis of Micro Economics is the Price mechanism which operates with the help of demand and supply forces. These forces help in the determination of equilibrium prices in the market. On the other-hand, the basis of Macro Economic study is the national income, output, employment and the general price-level which are determined by aggregate demand and aggregate supply.

6. Based on Assumptions:

Micro Economics is concerned with the rational behaviour of individuals where as the assumptions of Macro Economics are based on aggregate-volume of the output of an economy and the size of the national income and general price-level.

7. Partial-Equilibrium and General Equilibrium:

Micro Economics is based on the partial equilibrium analysis which explains the equilibrium conditions of an individual, a firm and an industry. On the other hand Macro Economics is based on the general equilibrium analysis which an elaborate and extensive study of a number of economic variables, their inter-relations and interdependences of the working of the economic system as a whole.