Divisions of Economics Foundation Economics June 2009
Microeconomics is the study of economic actions of individuals. In microeconomic analysis, we analyse the behavior of specific economic units.
We analyze the economic behavior of million of consumers, producers (firms), workers and suppliers of inputs to determine how they reach their equilibrium states. Eg: We study the demand of an individual consumer and from the same we derive market demand, we study economic behavior of individual firms with regard to fixation of price and output to establish price-output fixation by an industry.
In microeconomic theory we concentrate on individuals and / or narrowly defined groups of individuals.
Microeconomics covers within its ambit:
Study of firms
Location of an industry
Microeconomics is a particular or partial equilibrium analysis as it seeks to analyze the behavior of individual economic units taking other things constant. Eg: Price and output in one industry are considered independent of those in other industries.
Microeconomics suffers from certain limitations such as it throws light upon activities of individual units which might not be true in the case of an economy. We analyze with the assumption of rationality
Micro Economics (contd….)
Macroeconomics is concerned with the behavior of the whole economic system in totality.
It studies the relationships between broad economic aggregates such as total production, total employment, overall prices, rate of change in economic growth etc.
Thus macroeconomics studies the aggregates of quantities rather than individual quantities, national income rather than individual income etc. It deals with the aggregates and averages of the system.
Macroeconomics is a general equilibrium analysis as it considers the disturbance in equilibrium price and quantity in one market, which could lead to a disturbance in other markets.
Macroeconomics thus deals with:
National Income and Output
General Price Level
Balance of trade and balance of payments
Savings and Investment
Financial and fiscal systems of an economy.
Macroeconomic analysis has limitations:
Problem of individuals differ from that of aggregates, it could be wrong to assume that when aggregates are unchanged their inner composition is also unchanged (Example: Manpower of the country is unchanged over 40 years, however it is possible that there is a change in the percentage of young and old age groups which would change the workforce of the country).
It is based upon the assumption of homogeneous groups while in real life we are confronted with heterogeneous groups
Macro Economics (contd….)
Interdependence between micro and macroeconomics
Micro and macroeconomic approaches are not two independent approaches but are complementary to each other.
Theory of individual consumption behavior forms the basis of the theory of aggregate consumption function.
Determination of general price level which is a part of macroeconomics depends on theory of relative prices of products and factors which is a part of microeconomics.
Determination of rate of profit is a microeconomic topic, however, without the knowledge of macroeconomic aggregate a producer cannot determine the same. Profits generally depend on aggregate demand, national income and general price level of the economy.
In microeconomics, production is quite simply the conversion of inputs into outputs. It is an economic process that uses resources to create a good or service that is suitable for exchange. This can include manufacturing, storing, shipping and packaging.
A production process can be defined as any activity that increases the similarity between the pattern of demand for goods and services, and the quantity, form, and distribution of these goods and services available to the market place. The inputs or resources used in the production process are called factors of production by economists
Distribution in economics refers to the way total output or income is distributed among individuals or among the factors of production (labor, land, and capital).
Consumption is defined as the final purchase of goods and services. Other economists define consumption much more broadly, as the aggregate of all economic activity that does not entail the design, production and marketing of goods and services
Exchange refers to the medium through which goods and services changed hands from the producers to the consumers. Initially, there was the barter system of exchange which has now evolved into bank money or credit money in today’ date.
Barter system of exchange: Prior to the invention of money, goods and services were exchanged directly for goods and services. A farmer could exchange his wheat for cloth and so on. However, this system had limitations such as lack of common measure of value, requirement of double coincidence of wants, indivisibility of goods, difficulties in storing wealth.
Barter Commodity Money Paper Money Bank Money or Credit money Live and other Commodities Metals
Due to its limitation, the barter system evolved into commodities and cattle being used as medium of exchange. However, cow, horses, salt, tobacco etc. could not be stored for long duration and lacked uniformity. Thus, people started using metallic coins.
With the expansion of trade and industry it became difficult to cope with growing demand for metallic coins and thus paper money evolved. Paper money is issued by the central bank or the government of a country. Paper money economises the use of standard coins and metals.
This further developed into use of bank money, credit money and wire transfers evolved. In most economies, transactions are carried through cheques and bank money, only small transactions are managed through paper currency.