How microeconomics relates to the banking industry - Research Paper Example

Macro & Micro Economics 12 December How Microeconomics Relates to the Banking Industry Microeconomics is very relevant inthe banking industry. Despite the fact that they are usually ignored, microeconomic factors are what greatly contributes to the macroeconomics, and consequently success of failure in business. Microeconomics is significant in monetary policy objectives, since they determine price level stability. Today, a lot of attention is paid to microeconomic factors especially in the banking sector.

Microeconomics can be defined to as “small or insignificant economies” (Jain 15). Boulding defined microeconomics as “the study of particular firm, particular household, individual price, wage, income, industry, and particular commodity” (Khanna and Jain 22). Thus microeconomics is the study of price theory, and it shows how prices of a particular thing affect the bigger economy. Economists stated that “a bank is an institution whose current operations consist of granting loans and receiving deposits from the public” (Khatib 64).

The main activities of a bank are mainly deposits and loans. The banking industry is a service industry (Mukerjee 61). Banks are financial intermediaries, which collect deposits from people and lend the deposits to borrowers, hoping to make a profit at the end of the day. Banks often have costs during the exchange process, and therefore their net profits rely on how efficiently they conduct these transactions (Nicholson and Synder 265). Microeconomics helps the banks to minimize costs, if the costs are associated with any one particular financial product, and fall when the banks expand their offering of other products.

The banking industry has been guided by two models, which are the structure-conduct-performance and the efficient-structure theory. The structure-conduct-performance states that the conduct of banks is influenced by the degree of concentration in a banking market, while the degree of concentration also affects interest rates, loan and deposit factors, and other factors of consumer welfare that are determined by market outcomes ( Hoose 53), this means that structure-conduct-performance hypothesis gives greater concentration, and gives banks more market, which with time leads to fewer loans and deposits, and higher loan rates which reduces consumer welfare.

Banks relate to microeconomics in the following ways: (Jain and Ohri 248). 1. Capital formation. Banks mobilize the idle savings of the people, and invest them in productive activities. This helps in capital formation and speeds up the rate of the microeconomic development. 2. Inducement to innovations. This is done by providing credit to the businessmen and entrepreneurs, consequently helping banks to encourage these people to be innovative. As a result, new products are introduced to the market, and this creates a favorable outcome on the microeconomic development. 3. Investment-friendly interest rate structure.

Banks are the determinants of low interest rates, so that they can encourage and motivate the business oriented people, and entrepreneurs to do more investments, this helps in boosting production rate and trade, hence increasing the development of microeconomics. 4. Development of rural sector. Banks give the rural people liberal concessional interest rates, so that the farmers are able to purchase seedlings and agricultural tools, and as a result the agricultural sector is improved. Banks are opened in rural areas to gather together idle savings, and put these idle savings to productive use, creating a favorable microeconomic development. 5. Increase market demand.

The demand and supply of consumer goods is inadequate in low underdeveloped countries, this is because of low incomes and people of low standards of livelihood. Banks help these people by pushing up their aggregate demand, when they provide consumer credit to these people. Banks have helped to raise the standards of these people by the production of more consumer goods, and industries. The microeconomics of the banking industry can also be termed as the microeconomic of any firm. Banks main role is to produce money from money, but they also require inputs such as labor, and capital (Eyler 100).

Lending of money in the banks takes place in three forms. These are private concerns, firms and household, to others banks in an inter-market, or buying of government debt securities. When banks are allocating benefits or assets they depend on the matching marginal revenue, and the marginal costs for each and every loan (Eyler 101). Marginal revenue and marginal cost can be linked to each other; this is because when one market changes, so does the other market. Banks maximize their profits by allocating benefits, until the three markets are able to produce loan-able funds, where the marginal revenue is equal to marginal cost (Eyler 101).

Banks can therefore be said to be risk-takers and their role is to protect the consumer. To attain and maintain price stability is not the role of the central banks. It has been noted that the appropriate macroeconomics policies are vital, so as to achieve a balance in the economy, but these macroeconomics are not sufficient enough to maintain and this is because they have to be supported by the microeconomics conditions (Enoch and Green 45). The main role of microeconomics in a sound banking industry can be defined by a concept such as solvency.

The macroeconomics aims for price stability can be supported by the necessary microeconomic conditions in several different ways. In the first way “a sound banking system is typically needed for monetary policy signal to be appropriately transmitted through economy” (Enoch and Green 46). Microeconomics can cause many problems in the banking sector. It causes problems like poor banking systems, which may lead to losses through the mismanagement of administration of credit and other risks, or fraud (Andrews and Josefsson 4).

When dealing with a weak banking industry, it is vital to solve the underlying problems of microeconomics. Banks use microeconomics risk management to minimize the risks that come with individual characteristics of borrowers (Stieglitz et al. 84). In conclusion, microeconomics can be defined as an economic activity that is concerned with economic units as consumers, resource owners and business firm, but many people have defined microeconomic in different ways. Nevertheless, we can say that microeconomic is the study of price theory, and it shows how prices of certain goods affect the entire economy.

Banks are defined to be institutions whose current operations consist of granting loans, and receiving deposits and loans. Banks are mostly known as financial intermediaries, where one can deposit from people and lend the deposits to borrowers, and they hope to make profits at the end of the day. With the aid of microeconomics, banks are able to operate effectively. The banking industry has been developed by two models the structure-conduct-performance and the efficient theory. There are various ways in which microeconomics development relate to the banking industry and some of them are like the capital formation, inducement to innovation, investment-friendly interest rate structure, and development of the rural sector.

Microeconomic plays a major role in how the banks operate, once the banking industry is affected by the microeconomic forces, this factor affects the entire market, which in turn it affects the people. Microeconomics of banking industry can be defined as the microeconomic of any firm. Banks main agenda is to produce money from money, for example by the deposits and borrowers. Banks often allocate money depending on the matching marginal revenue and the marginal costs of every loan.Marginal revenue and marginal cost can be linked to each other, this is basically because when a market changes, so does the other market.

The main aim to start a bank is for maximization of profits, by allocating benefits until the three markets are able to produce a profitable fund, where the marginal revenue is equal to marginal cost. Finally, it can be concluded that microeconomic plays a major part in the well-being of the banks. Works Cited Andrews, M. and Josefsson Mats. What Happens After Supervisory Intervention? Considering Banks Closure Options. Washington DC: International monetary fund, 2003. Print. Enoch, Charles and Green J.H. Banking Soundness and Monetary Policy.

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