SSC CGL Tier 1 Study Material Of Economics
SSC CGL Tier 1 Study Material Of Economics
Micro vs. Macro
Definition of economics: Economics comes from Greek word “Oikonomia”. Adam smith explained the definition of economics in his famous “Wealth of Nations” that “Economics is a science which enquires the cause of wealth.
Prof. Marshall said, “A study of man’s action in the ordinary business of life.”
Difference between microeconomics and macroeconomics
The difference between micro and macro economics are below
Economists also look at two realms. There is big-picture macroeconomics, which is concerned with how the overall economy works. It studies such things as employment, gross domestic product, and inflation—the stuff of news stories and government policy debates. Little-picture microeconomics is concerned with how supply and demand interact in individual markets for goods and services.
In macroeconomics, the subject is typically a nation—how all markets interact to generate big phenomena that economists call aggregate variables. In the realm of microeconomics, the object of analysis is a single market—for example, whether price rises in the automobile or oil industries are driven by supply or demand changes. The government is a major object of analysis in macroeconomics—for example, studying the role it plays in contributing to overall economic growth or fighting inflation. Macroeconomics often extends to the international sphere because domestic markets are linked to foreign markets through trade, investment, and capital flows. But microeconomics can have an international component as well. Single markets often are not confined to single countries; the global market for petroleum is an obvious example.
The macro/micro split is institutionalized in economics, from beginning courses in “principles of economics” through to postgraduate studies. Economists commonly consider themselves micro economists or macroeconomists. The American Economic Association recently introduced several new academic journals. One is called Microeconomics. Another, appropriately, is titled Macroeconomics.
Micro and Macro Economics
The terms ‘micro-‘ and ‘macro-‘ economics were first coined and used by Ragnar Fiscer in 1933.Micro-economics studies the economic actions and behaviour of individual units and small groups of individual units. In micro-economics, we are chiefly concerned with the economic study of an individual household, individual consumer, individual producer, individual firm, individual industry, particular commodity, etc. Whereas, when we are analysing the problems of the economy as a whole, it is a macro-economic study. In macro-economics, we do not study an individual producer or consumer, but we study all the producers or consumers in a particular economy.
Micro-Economics or Price Theory:
The term ‘micro-economics’ is derived from the Greek prefix ‘micro’, which means small or a millionth part. Micro-economic theory is also known as ‘price theory’. It is an analysis of the behaviour of any small decision-making unit, such as a firm, or an industry, or a consumer, etc.For micro-economics, in contrast to macro economic theory, the statistics of total economic activity are valueless as far as providing clues to policy decisions. It does not give an idea of the functioning of the economy as a whole. An individual industry may be flourishing, whereas the economy as a whole may be suffering.
In respect of employment, micro-economics studies only the employment in a firm or in an industry and does not concern to the aggregate employment in the whole economy. In the circular flow of economic activity in the community, micro-economics studies the flow of economic resources or factors of production from the resource owners to business firms and the flow of goods and services from the business firms to households. It studies the composition of such flows and how the prices of goods and services in the flow are determined.
A noteworthy feature of micro-approach is that, while conducting economic analysis on a micro basis, generally an assumption of ‘full employment’ in the economy as a whole is made. On that assumption, the economic problem is mainly that of resource allocation or of theory of price.
Examples: Individual Demand, Price of a product, etc.
- Supply and demand in individual markets
- Individual consumer behaviour. e.g. Consumer choice theory
- Individual labour markets – e.g. demand for labour, wage determination
- Externalities arising from production and consumption. e.g. Externalities
Importance of Micro-Economics:
Micro-economics occupies a very important place in the study of economic theory.
- Functioning of free enterprise economy:
It explains the functioning of a free enterprise economy. It tells us how millions of consumers and producers in an economy take decisions about the allocation of productive resources among millions of goods and services.
- Distribution of goods and services:
It also explains how through market mechanism goods and services produced in the economy are distributed.
- Determination of prices:
It also explains the determination of the relative prices of various products and productive services.
- Efficiency in consumption and production:
It explains the conditions of efficiency both in consumption and production and departure from the optimum.
- Formulation of economic policies:
It helps in the formulation of economic policies calculated to promote efficiency in production and the welfare of the masses. Thus the role of micro-economics is both positive and normative. It not only tells us how the economy operates but also how it should be operated to promote general welfare. It is also applicable to various branches of economics such as public finance, international trade, etc.Thus the role of micro-economics is both positive and normative. It not only tells us how the economy operates but also how it should be operated to promote general welfare. It is also applicable to various branches of economics such as public finance, international trade, etc.
Limitations of microeconomics-
Some of the important limitations of microeconomics are listed below:
- Excessive Generalisation:
Despite the immense importance of macroeconomics, there is the danger of excessive generalisation from individual experience to the system as a whole.
If an individual withdraws his deposits from the bank, there is no-harm in it, but if all the persons rushed to withdraw deposits, the bank would perhaps collapse.
2. Excessive Thinking in terms of Aggregates:
Again, macroeconomics suffers from excessive thinking in terms of aggregates, as it may not be always possible to have the homogeneous constituents. Prof. Boulding has pointed out that 2 apples + 3 apples = 5 apples is a meaningful aggregate ; 2 apples + 3 oranges = 5 fruits may be described as a fairly meaningful aggregate ; but 2 apples + 3 sky scrapers constitute a meaningless aggregate ; it is the last aggregate which brings forth the fallacy of excessive aggregative thinking.
- Heterogeneous Elements:
It may, however, be remembered that macroeconomics deals with such aggregates as aggregate consumption, saving, investment and income, all composed of heterogeneous quantities. Money is the only measuring rod. But the value of money itself keeps on changing, rendering economic aggregates immeasurable and incomparable in real terms. As such, the sum or average of heterogeneous individual quantities loses their significance for accurate economic analysis and economic policy.
- Differences within Aggregates:
Under this approach one is likely to overlook the differences within aggregates. For example, during the first decade of planning in India (from 1951-1961) the national income increased by 42% ; this, however, doesn’t mean that the income of all the constituents, i.e., the wage earners or salaried persons increased by as much as that of entrepreneurs or businessmen. Hence, it takes no account of differences within aggregates.
- Aggregates must be functionally related:
The aggregates forming the main body of macroeconomic theory must be significant and mutually consistent. In other words, these should be functionally related. For example, aggregate consumption and investment expenditures—which form part of the macroeconomic theory (Y = C + I) would have no importance, if they were not functionally related to the levels of income, interest and employment. If these composing aggregates are mutually inconsistent or are not functionally related, the study of macroeconomic theory will be of little use.
Macro-Economics or Theory of Income and Employment:
The term ‘macro-economics’ is derived from the Greek prefix ‘macro’, which means a large part. Macro-economics is an analysis of aggregates and averages of the entire (large) economy, such as national income, gross domestic product, total employment, total output, total consumption, aggregate demand, aggregate supply, etc. Macro-economics is the economic theory which looks to the statistics of a nation’s total economic activity and holds that policy change designed to alter these total statistical aggregates is the way to determine economic policy and promote economic progress. Individual is ignored altogether. Sometimes, national saving is increased at the expense of individual welfare. It analysis the chief determinants of economic development, and the various stages and processes of economic growth. It can be applied to both developed and under-developed economies.
Examples: Aggregate Demand, National Income, etc.
Macro economics is concerned with
- Monetary / fiscal policy. e.g. what effect does interest rates have on the whole economy?
- Reasons for inflation, and unemployment
- Economic growth
- International trade and globalisation
- Reasons for differences in living standards and economic growth between countries.
- Government borrowing
Importance of Macroeconomics:
- It helps to understand the functioning of a complicated modern economic system. It describes how the economy as a whole functions and how the level of national income and employment is determined on the basis of aggregate demand and aggregate supply.
- It helps to achieve the goal of economic growth, higher level of GDP and higher level of employment. It analyses the forces which determine economic growth of a country and explains how to reach the highest state of economic growth and sustain it.
- It helps to bring stability in price level and analyses fluctuations in business activities. It suggests policy measures to control Inflation and deflation.
- It explains factors which determine balance of payment. At the same time, it identifies causes of deficit in balance of payment and suggests remedial measures.
- It helps to solve economic problems like poverty, unemployment, business cycles, etc., whose solution is possible at macro level only, i.e., at the level of whole economy.
- With detailed knowledge of functioning of an economy at macro level, it has been possible to formulate correct economic policies and also coordinate international economic policies.
- Last but not the least, is that macroeconomic theory has saved us from the dangers of application of microeconomic theory to the problems of the economy as a whole.
- Fallacy of Composition
In Macro economic analysis the “fallacy of composition” is involved, i.e. aggregate economic behaviour is the sum total of the economy of individual activities. But what is true of individuals is not necessarily true to the fiscal entirely. For instance, savings are a private virtue but a public vice. If total savings in the economy increases, they may initiate a depression unless they are invested. Again, if an individual depositor withdraws his money from the bank, there is no risk. But if all depositors simultaneously do this, there will be a run on the banks and the banking system will be affected adversely.
- To Regard the Aggregates as Homogenous
The main defect in macro analysis is that it regards the aggregates as homogenous without caring about their internal composition and structure. The average wage in a nation is the sum total of wages in all professions, 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 typist rises much aggregate employment would increase.
- 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 income. A hike 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 nation. Thus a rise in the national income of this type has little significance from the point of view of the community.
- Indiscriminate Use of Macro Economics Misleading
An indiscriminate and uncritical use of macro economics in analysing the complexities of the real world can frequently be misleading. For instance, if the policy measures needed to achieve and maintain full employment in the economy are applied to structural redundancy in individual firms and industries, they become irrelevant. Likewise, measures aimed at controlling general prices cannot be applied with much advantage for controlling prices of individual products.
- Statistical and Conceptual Difficulties
The measurement of macro economics concepts involves a number of statistical and conceptual complexities. These problems relate to the aggregation of micro economic variables. If individual units are almost similar, aggregation does not present much difficulty. But if micro economic variables relate to dissimilar individual units, their aggregation into one aggregation into one macro economic variable may be incorrect and hazardous.
The scope of macroeconomics includes the following parts:
Clearly, the study of the problem of unemployment in India or general price level or problem of balance of payment is macroeconomic study because these relate to the economy as a whole.
Differences between Micro and Macro Economics
The points given below explains the difference between micro and macro economics in detail:
- Microeconomics studies the particular market segment of the economy, whereas Macroeconomics studies the whole economy, that covers several market segments.
- Micro economics stresses on individual economic units. As against this, the focus of macro economics is on aggregate economic variables.
- While microeconomics is applied to operational or internal issues, environmental and external issues are the concern of macro economics.
- Microeconomics deals with an individual product, firm, household, industry, wages, prices, etc., while Macroeconomics deals with aggregates like national income, national output, price level, etc.
- Microeconomics covers issues like how the price of a particular commodity will affect its quantity demanded and quantity supplied and vice versa while Macroeconomics covers major issues of an economy like unemployment, monetary/ fiscal policies, poverty, international trade, etc.
- Microeconomics determine the price of a particular commodity along with the prices of complementary and the substitute goods, whereas the Macroeconomics is helpful in maintaining the general price level.
- While analysing any economy, micro economics takes a bottom-up approach, whereas the macroeconomics takes a top-down approach into consideration.
- It helps in the determination of prices of a particular product and also the prices of various factors of production, i.e. land, labour, capital, organisation and entrepreneur.
- It is based on a free enterprise economy, which means the enterprise is independent to take decisions.
- The assumption of full employment is completely unrealistic.
- It only analyses a small part of an economy while a bigger part is left untouched.
- It is helpful in determining the balance of payments along with the causes of deficit and surplus of it.
- It makes the decision regarding economic and fiscal policies and solves the issues of public finance.
- Its analysis says that the aggregates are homogeneous, but it is not so because sometimes they are heterogeneous.
- It covers only the aggregate variables which avoid the welfare of the individual.
As microeconomics focuses on the allocation of limited resources among the individuals, the macro economics examines that how the distribution of limited resources is to be done among many people, so that it will make the best possible use of the scarce resources. As micro economics studies about the individual units, at the same time, macro economics studies about the aggregate variables. In this way, we can say that they are interdependent.
Micro and Macro Economics are not contradictory in nature, in fact, they are complementary. As every coin has two aspects- micro and macroeconomics are also the two aspects of the same coin, where one’s demerit is others merit and in this way they cover the whole economy. The only important thing which makes them different is the area of application.
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