Microeconomics and Macroeconomics: Microeconomics is the study of the economic behaviour of individual units of the economy such as consumers, firms, industries, and markets. It explains how the prices of various goods and factors of production are determined and how resources of the economy are allocated among goods and services. On the other hand, Macroeconomics studies the functioning of the economy as a whole. It analyses behaviour of the national aggregates such as national income, total consumption, savings, investment; total employment, the general price level and the country’s balance of payments.
Choice as an economic problem: Human wants are unlimited but the means or resources to satisfy these wants are limited or scarce. Resources are not only scarce but they have alternative uses. This give rise to the problem of choice in economics. For example, iron can be used for making tanks, it can be used for making trains, it can also be used for building houses. It is because of the various alternative uses of the resources that we have to decide about the best allocation of resources. Thus, economics develops principles for making the best use of available resources. (If our wants are limited or the resources are unlimited, or if the resources have no alternative uses, then there would have been no economic problem at all).
Central Problems of an economy: Human wants are unlimited but the means or resources to satisfy these wants are limited or scarce. Resources are not only scarce but they have alternative uses. This give rise to the central problems of an economy. These are:
- What to produce and in what quantities? This involves the allocation of scarce resources in relation to the composition of total output in the economy.
- How to Produce? Whether to use labour intensive or capital intensive techniques of production
- For Whom to Produce? This involves the distribution of national income among the members of the society.
- How Efficiently are the Resources being Utilized? This is the problem of economic efficiency or welfare maximization where there has to be no wastage or misuse of resources.
- Problem of Full Employment: An economy must try to achieve full employment not only of labour but of all its resources.
- Problem of Growth: An economy must make sure that it keeps expanding or developing so that it maintains conditions of stability.
Market Mechanism: The market mechanism, works through supply and demand in a free market economy. It acts as the principal organizing force for economic efficiency. It solves all the central problems of an economy by efficiently allocating scarce resources among alternative uses.
- It determines what to produce and how much to produce according to the criterion of maximum profit.
- It allocates the different factors of production among their various uses according to the criterion of maximizing their incomes.
- It brings about an equitable distribution of income by causing resources to be allocated in the right directions.
- It works to ration out the existing supplies of goods and services, utilizes the economy’s resources fully and provides the means for economic growth.
Positive Economics and Normative Economics:
1. Positive economics is concerned with ‘what is’ whereas Normative economics is concerned with ‘what ought to be’.
2. Positive economics describe economic behaviours without any value judgment while normative economics evaluate them with moral judgment.
3. Positive economics is objective while normative economics is subjective.
4. The statement, “ Price rise as demand increase” is related to positive economics, whereas the statement, “ Rising prices is a social evil” is related to normative economics.
Inductive Method and Deductive Method of Economic Analysis: Deductive method involves reasoning or inference from the general to the particular or from the universal to the individual. Deduction involves four steps: (1) Selecting the problems (2) Formulating the assumptions (3) Formulating the hypothesis through the process of logical reasoning whereby inferences are drawn and (4) Verifying the hypothesis.
Inductive method involves reasoning from particulars to the general or from the individual to the universal. This method derives economic generalisations on the basis of experiments and observations. In this method detailed data are collected on certain economic phenomenon and effort is then made to arrive at certain generalizations which follow from the observations collected. (The Engel’s Law and the Malthusian Theory of Population have been derived from inductive reasoning).
Giffen goods: Giffen goods may be any inferior commodity much cheaper than its superior substitutes, consumed mostly by the poor households as an essential consumer good. If price of such goods increases, its demand increases instead of decreasing because in case of a Giffen good the income effect of a price rise is greater than its substitution effect. Thus, the law of demand does not apply in case of Giffen goods. This phenomenon is known as Giffen paradox.
Consumer Surplus: The difference between the price a consumer is willing to pay and the price which he actually pays is consumer’s gain which is referred to as consumer’s surplus. The concept of consumer’s surplus may also be explained in terms of utility. Since Marshall assumes constant MU of money, what a consumer is willing to pay for a commodity indicates his expected utility and what he actually pays measures the actual cost in terms of utility of money. The difference between the utility gained and the utility lost in acquiring the commodity is consumer’s satisfaction which Marshall calls the ‘consumer’s surplus’.
Income-Consumption Curve(ICC): The income-consumption curve may be defined as the locus of points representing various equilibrium quantities of two commodities consumed by a consumer at different levels of income, all other things remaining the same.
Price-Effect: The price-effect may be defined as the total change in the quantity consumed of a commodity due to a change in its price. Price effect is composed of two effects: (1) the income-effect and (2) the substitution effect.
Income-Effect: The income-effect arises due to change in real income caused by the change in price of the goods consumed by the consumer.
Substitution-Effect: The substitution effect arises due to the consumer’s inherent tendency to substitute cheaper goods for the relatively expensive ones.
Inferior goods: Inferior goods are those goods whose demand decrease as the income of the consumer increases. That is, the income-effect on inferior goods is negative.
The Engel Curve: The Engel curve shows the relationship between consumer’s income and his money expenditure on a particular good. The shape of the Engel curve depends on the shape of the income-consumption curve(ICC). As shown in the following figure we can derive the Engel curve from the ICC.
