2 introduction to microeconomics and macroeconomics
- 1. 2-Introduction to Microeconomics and Macroeconomics In modern times, the study of economics has been divided into two branches i.e. Micro and Macro economics. The terms ‘microeconomics’ and ‘macroeconomics’ were first used in economics by a Norwegian economist Ragnar Frisch in 1933. After Prof. Frisch, the terms earned popularity when J.M. Keynes clearly distinguished between the terms through his book entitled ‘General theory of ‘Employment, Interest and Money’ published in 1936. And now the terms are being used in economics by the economists all over the world.
- 2. 2.1-Meaning of microeconomics:- The word Microeconomics is formed by the two words, ‘micro’ plus ‘economics’. The words ‘micro’ seems to have been derived from Greek word ‘mikros’. In Greek language, ‘mikros’ means small. Therefore, Micro-economics refers to the study of small individual units of an economy. In other words, Microeconomics deals with the analysis of small individual units of the economy such as individual consumers, individual firms and small aggregates or groups of individual units, i.e. output of particular goods and services produced by single firms or industries, particular households, individual prices of goods and services, individual wages, incomes etc.
- 3. In this regard K.E. Boulding has given a definition as ‘Microeconomics is the study of particular firm, particular household, individual price, wage, income industry and particular commodity.’ Thus, microeconomics is the study which seeks to explain how a consumer uses his limited income in various goods and services, how he maximize his satisfaction. Similarly, it also seeks to explain how a firm decides what, how and for whom to produce, This is how microeconomics studies small economic units and their and behaviour but not the economy as a whole.
- 4. Microeconomics is concerned with the issues like; How a firm determines the sales price of its products, What amount of output will maximize its profit, How a firm determines the lowest cost combination of different factors of production, How the individual consumer determines the distribution of his/her spending on various goods and services so as to maximize satisfaction, How the prices of individual factors of production are determined, How a firm or an industry allocates limited resources for the production of different good and services, etc. This way microeconomics studies small parts of an economic body but not the economy as a whole.
- 5. 2.2- Meaning of Macroeconomics The word Macroeconomics is formed by the combination of the two words ‘Macro’ plus ‘economics’. The word ‘macro’ seems to have been derived from Greek word ‘makros’. In Greek language ‘makros’ means ‘big’. Hence, Macro-economics denotes to the study of an economy as a whole. In other words, Macroeconomics applies to the study of broad economic aggregates like level of employment, general price level, aggregate national output, income, investment, trade cycle, aggregate demand, aggregate supply etc. In this regard K. E. Boulding has given a definition as, ‘Macroeconomics deals not with individual quantities but with aggregate of these quantities, not with individual income but with national income,
- 6. not with individual prices but with price level, not with individual output but with national output.’ In the view of Edward Shapiro, ’In brief, macroeconomics is the study of total output, employment and price level.’ The above definitions also reveal that macroeconomics is the study of broad economic units, or the economy as a whole, such as national income, national output, general price level, total employment, total saving, total investment and so on.
- 7. Macroeconomics is concerned with the issues like; Why the economy faces the problem of unemployment and how this problem can be overcome? How national income is estimated and how it is affected by various variables of the economy? How a number of producers take decisions for investment and how consumers decide to spend their income? Why there are economic fluctuations and what are the measures to maintain fluctuations? How the general price level, demand for and supply of money are affected interchangeably? How the internal economy is influenced by the changes in external economy etc?
- 8. 3- Functions of Microeconomic theory The functions of microeconomic theory are concerned with the study of economic behavior of consumers, resource owners and business firms who individually can play a decision making role in a free market economy. Microeconomic theory is called price theory due to its functional nature related to individual business activities of households and business firms which studies the circular flow of goods and services from household to business firm and from business firm to household. The theory analyses the composition of such a flow and the way of price determination of goods and services as well as price of resources used. The circular flow of activities are as follow:
- 9. In the above figure the household activities connected to sell the factors land, labor and capital to the business firm through factor market and the business firms buy the inputs. The business firms produce and sell goods and services to the households through goods market. The firms are the sellers and the households are the buyers. Likewise firms spend money-income received by selling goods and services to buy factors like raw materials, labors, capital, land etc. Consumption Expenditure Goods Market Business Firms House holds Factor Market Money Income
- 10. This circular flow continues till the economy exists in the society. This is how the firm and household activities are connected with each other and with an interaction between them price of goods and services and quantities are determined. This is the way micro economic theories function. The functions of microeconomic theory can be explained pointwise as below. 1. Analysis of Individual Behaviour The function of microeconomic theory is to explain the behaviour of individual consumer or household in relation to optimum allocation of limited means for achieving maximum possible satisfaction. Similarly, to explain the behavior of individual producer or firm on account of use of limited resources to make maximum possible profits.
- 11. 2. Pricing The another function of microeconomic theory is to give the idea about the determination the prices of goods and services in different market structures. Similarly it also function to help understanding the determination of factor prices like rent, wages, interest in factor markets. 3. Business Decision Making It is microeconomic theory which provides basic idea for the firm to make better business decisions so that maximum possible profits can be achieved. 4. Formulating Economic Policies Microeconomic theory provides basic tools to formulate various economic policy like tax policy, trade policy, Policy of promoting business, import export etc.