Micro & Macroeconomics and their impact on daily life - Essay Example

Micro & Macroeconomics and their impact on daily life Part To, Assembled Professionals, This letter purports to elucidate certain relevant facts about Micro and Macroeconomics. Differences between Micro and Macroeconomics Modern economics has two main branches – Microeconomics and Macroeconomics. Both the branches study economic issues and provide logical solutions to economic problems at different levels. While Microeconomics studies economic problems at an individual level, where the individual could be a person, a household or a firm; Macroeconomics studies them at the aggregate/national level as a whole. Microeconomics: The term ‘micro’ has been derived from the Greek word ‘mikros’ which literally means small. Thus Microeconomics studies economic actions and behavior of individual units and small groups of individual units. Hence, Microeconomics engages in microscopic study of the economy and seeks to determine the mechanism by which different economic units attain their positions of equilibrium, proceeding from individual units to narrowly defined groups. In a modern economy Microeconomic theories and postulates play a very significant role in understanding economic behavior of rational units of an economy. Operation of an economy: Microeconomics explains how a free enterprise operates and functions. Most economies of the world are mixed economies consisting of both public and private sector enterprises where the private sector is much larger than the public sector. Microeconomics explains how a market economy with millions of customers and producers decides the allocation of scarce productive resources among millions of goods. Efficient use of scarce resources: One of the principal problems faced by every economy is to ensure efficient employment of scarce resources between competing ends. Microeconomics helps to understand the mechanisms involved in this regard and assists policy makers to take rational decisions that would achieve economic growth with stability. Economic welfare: The whole structure of welfare economics is built upon the Microeconomic theory of Perfect Competition since maximization of economic welfare is possible only under Perfect Competition. Under other forms of market structure like monopoly, oligopoly or monopolistic competition there is generally misallocation of scarce resources leading to considerable loss of economic welfare. Microeconomics helps is identifying ways and means of reducing wastage so that economic welfare is maximized (Pigou, 2001). Managerial Economics: One of the most potent uses of Microeconomic theory is the application of its analytical tools to solve business problems. Price Theory of Microeconomics when used by business executives to take commercially prudent decisions takes on the name of Managerial Economics. Its knowledge empowers business executives to take informed decisions with regard to demand analysis, cost analysis and setting up of prices of the final output of the organization (Rajan & Zingales, 1998). Economic predictions: Organizations that are able to correctly predict future movement of economic variables are always one step ahead of their competitors. Most of such predictions follow certain principles of Microeconomic theory. As for example, if demand for a commodity increases, its market price would most likely increase too, provided supply of that commodity does not increase to match the demand. Helpful in International Trade: Every economy depends on the other economies of the world either for goods, or services, or technical knowhow, or managerial skill. Microeconomics tells us how two or more than two economies can gain from international trade. It is the relative elasticity of demand and supply between the two countries that determine the basis of international trade. Also, exchange rate determination between two countries is dependent on Microeconomic variables of demand for and supply of foreign exchange. Macroeconomics: The term ‘macro’ is derived from the Greek term ‘makros’ which literally means large. In it we study the economic system as a whole and analyze aggregates or averages covering the entire economy such as total employment, national income, national output, total employment, total investment, total consumption, total saving, aggregate demand, aggregate supply and similar aggregates. Till the Great Depression of 1930, economists were mostly concerned with solving Microeconomic problems with the exception of classical economists as Ricardo and Pigou who did discuss economy wide aggregates. However, the Great Depression altered things for ever as economists realized that aggregate output and total employment were in fact not parameters as they thought all along but were variables that needed to be analyzed and monitored for the overall health of the economy. In 1936, Lord John Maynard Keynes published the General Theory of Employment, Interest and Money where he clearly stated that underemployment and unemployment can exist for long periods (Keynes, 1997). The harsh reality of Great Depression brought the attention of economists back to Macroeconomics. It has since then been a very vital area of economic analysis and research. Analyses functioning of an Economy: Macroeconomics helps us to understand the functioning of an economy. It also gives us a bird’s eye view of the phenomenon of economic universe. Our main economic problems are related to the behavior of total income, output, employment and general price level in an economy. These variables are statistically measurable and help in making the elimination process understandable and transparent. Behavior of individual units: An example would make this issue easier to understand. Demand for individual products depends on the aggregate demand in the economy. Unless the causes of deficiency in aggregate demand are analyzed, it is not possible to understand fully the reasons for a fall in demand for an individual product. Similarly the reasons for increase in cost of production of a particular firm or industry cannot be analyzed without knowing the cost conditions of the entire economy. Indispensable for accurate knowledge: It would be incorrect to say that the behavior pattern of the forest can be obtained by studying the behavior pattern of individual trees since such an attempt would be highly misleading. Similarly, study of micro variables and cumulating them would never give the true macro picture. The aggregate and its individual components are entirely two different things and characteristics of one do not necessarily pertain to the other. Therefore, Macroeconomics is indispensable for a proper knowledge of the behavior patterns of aggregate variables (Boulding, 1958). Economic Planning: Macroeconomics is extremely helpful to the government in formulation of appropriate economic policies for tackling inflation, adverse balance of payments, unemployment, and under production. Generally governments are more concerned with the regulation of aggregates of the economic system as general price level, general level of production, general volume of trade etc. which make them concerned more about aggregates and averages than with individual micro variables. This is possible only through Macroeconomic analysis. Study of National Income: National Income happens to be the most popular barometer to measure the level of prosperity of an economy. Macroeconomics studies National Income in the most comprehensive manner possible. Differences between Microeconomics and Macroeconomics Microeconomics Macroeconomics 1. Microeconomics deals with one segment of the economy 1. Macroeconomics deals with the whole economy 2. It deals with the economic decision making of individual economic agents, i.e. an individual consumer, producer etc. 2. Macroeconomics deals with averages and aggregates of the entire economy. 3. It deals with the process of price determination in case of individual products and factors of production. 3. It deals with the general price level in any economy 4. Microeconomics is known as price theory as it explains the process of allocation of economic resources having alternative uses on the basis of relative prices. 4. Macroeconomics is also known as the income theory as it explains the changing levels of national income in any economy at one particular time. 5. It assumes homogeneous or similar products 5. It assumes heterogeneous or dissimilar products. 6. It assumes full employment in the economy 6. It assumes under-employment equilibrium in the economy. 7. It helps in formulating appropriate policies for resource allocation at firm level. 7. It helps in formulating appropriate policies for controlling inflation. 8. It deals with optimization of goals of individual consumers and producers. 8. It deals with the optimization of the growth process of the entire economy. 9. Microeconomics assumes partial equilibrium. 9. Macroeconomics assumes quasi-general equilibrium. Example of a Microeconomic phenomenon The process by which an individual consumer maximizes their utility in a multi-commodity environment is a Microeconomic phenomenon. The consumer equates the price paid with the money worth of marginal utility gained for each product and the equilibrium equation for ‘N’ number of commodities would be, (MU1)/P1 = (MU2)/P2 = (MU3)/P3 = … = (MUN)/PN = MUM Where, MU = Marginal Utility, P = Price of the commodity and MUM is Marginal Utility of Money which is assumed to be constant. Example of a Macroeconomic phenomenon In every economy three activities never stop: (i) production of goods and services, (ii) generation of income (in terms of wages, interest, rent and profit), and (iii) expenditure (in terms of consumption expenditure and investment expenditure). Production of goods and services causes generation (or distribution) of income. Income causes expenditure (or disposition). By generating demand, expenditure once again causes production. Consequently, again there is generation of income and disposition of income. The flows of production, income and expenditure form circularity with no beginning or end. This is known as circular flow of income. A Microeconomic Decision Taken by me I had decided to buy a mobile telephone but upon getting confirmed information that its price is going to be reduced within a week I decided to postpone the purchase till the price came down. The factor that influenced my decision was obviously the information that there will be a reduction in price. That meant that I could get the same commodity at a lower price if I delayed my consumption and I did it. A Macroeconomic Event and its impact on me The constantly rising prices on account of inflation have reduced purchasing power of money and now I can buy lesser quantity of almost all goods and service while paying the same price. While my nominal income in terms of money has remained same, my real income in terms of goods and services consumed has reduced significantly. Part 2 United States of America has finally been able to come out of the acute recession it had faced during 2008-2009. The employment level has started showing signs of improvement with creation of more than a million new jobs. Automobile industry has shown profits and stock markets have also been improving steadily. President Barack Obama in his budget speech has clearly mentioned there would be substantial investment in education and job training to improve employability of average Americans. There would also be investments in research and development of industries of tomorrow such as clean energy with an objective of increasing employment in those sectors. There would be investment towards improving the existing infrastructure so that communication and transportation networks are further improved. This would enable industries situated in any corner of America to send their output to any corner of the world without any difficulty. All this would lead to increase in the number of jobs within the country and thus usher in a new era of prosperity. Towards this end, tax concessions have been offered to industries that hire unemployed workers and assistance has been offered to States to prevent lay-off of teachers. Small businesses have been offered tax concessions and easy credit so that they can carry on their production and hence help in creation of new jobs. Lowering of income tax for 159 million workers has resulted in each of them enjoying on an average a reduction of $1000 tax. This has substantially increased disposable income of this category of citizens. Further, tax reductions have also been granted to families so that they are able to send their children to colleges for higher education. But the budget also proposes a two year freeze on salaries of government employees and reduction or termination of many government programs that, in the opinion of the President, were not so significant in terms of job creation or improving employability of average Americans. There would also be reduction in defense spending to the tune of $78 billion. The President also proposes a removal of special tax concessions for families earning more than $250,000 per year and also removal of concessional estate duty (Obama, 2011). Thus, what initially seemed to be an expansionary budget turns out to be more of a distributive budget where reduction in expenditure and increased revenue collection in certain areas is resorted to for funding increased expenditure and decrease in revenue collection in other areas. While the economically weaker sections get tax concessions, those that are economically sound would have to live with withdrawal of tax concessions. Moreover, investment would now be directed towards the less glamorous sectors of the society where gestation periods are longer rather than those manufacturing sectors where returns are faster to accrue and probably at higher rate in the short run. References Boulding, K. E. (1958). Principles of Economic Policy. Englewood Cliffs, N.J.: Prentice-Hall. Keynes, J. M. (1997). The General Theory of Employment, Interest, and Money . New York: Prometheus Books . Obama, B. (2011, February 14). The Budget Message of the President. Retrieved February 23, 2011, from Fiscal Year 2012: Budget of the US Government: http://www.whitehouse.gov/sites/default/files/omb/budget/fy2012/assets/message.pdf Pigou, A. (2001). The Economics Of Welfare. New Jersey: Transaction Publishers. Rajan, R. G., & Zingales, L. (1998). Power in a Theory of the Firm. Quarterly Journal of Economics 113 , 387-432. Read More