Monday, 4 January 2016
Basic Problems Of Micro Economics:
Classification of Economics:
Economics has been divided into two categories:
- Applied Economics
- Theoretical Economics
Theoretical Economics:
In theoretical economics, characteristics of various economic systems and different economic theories are discussed. Basic laws we derive by observing facts, based upon neutral inquiries and studies. Such as law of demand, law of supply, law of diminishing marginal utility, law of equi-marginal utility, law of increasing and decreasing returns etc.
We observe behavior of individuals in different sectors of the economy. Such as entrepreneurs behavior in business and production sector while consumers behavior in consumption field.
Moreover, the activities and performance of different economics, social and cultural organizations is also kept before. Theoretical economics is further classified in two types:
- Positive Economics
- Welfare Economics
Positive Economics:
Classical economists David Ricardo, J.S. Mill and N.W.Senior as well as Robbins and Keynes consider economics as a positive science. In this party facts and results are defined: "As they are"
Welfare Economics:
Marshall, Pigou and Canon declared economics as a science of material welfare. They relate it with material requisites of economics and social welfare. They emphasized on basic needs such as; food, clothing, and shelter and also gave suggestions for the attainment of these essentials. That's why they are called " welfare economists"
In micro economics we deal with positive economics. Economics divide positive economics into two parts for economic analysis.
- Micro Economics
- Macro Economics
Micro Economics:
Adam Smith pioneered micro economics as a separate subject and his concepts gained enormous popularity till the theories of Dr. Keynes, were introduced. Micro means small and it equates to " one millionth part" . In this part we analyse economy in individual and small units e.g. consumer's behavior, demand, supply, price, determination of a good in a market, equilibrium position of the firm, firm's behavior and its problems and Resource's pricing and employment theories. While analyzing small entities classical economists used to assume economy at full employment level. Therefore, the problem lies in resource allocation, which can be resolved through price mechanism. Following matters are discussed in micro economics:
- Price theory
- Consumer's behavior theory
- Behavior of the firm
- Wealth distribution theory
Price theory:
Price determination is based upon demand and supply of any particular commodity in the market. Moreover, impacts of price mechanism on free economy are also in ascertained .
Consumer's behavior theory:
This theory focuses upon consumer's behavior that how he/she manages his/her expenditures on consumption goods.
Behavior of the firm:
In this part objectives and problems of a firm and its various types of equilibrium are discussed. Optimal combination of factors of production, firm cost of production, revenue and attainment of maximum profit is focused.
Wealth distribution theory:
In this part Marginal Productivity theory, and modern theory of factor pricing is discussed.
Importance of Micro Economics:
Importance of micro economics is theoretical as well as practical. Theoretical importance is as under:
- Analysis of micro economics focuses on the free economy. It shows how millions of consumers and producers utilize, available resources to produce millions of goods and services.
- It guides us w.r.t. distribution of goods and services under price mechanism.
- It also determines the relative prices of products and services.
- Micro analysis not only depicts efficiency of both the sectors, production as well as consumption of wealth but also defines optimum level of production.
Its practical importance can be judged as it can help in making economic policies to enhance productive efficiency of factors and welfare of common man.
Thus it has both positive and normative role. It not only depicts how economy works but also emphasis how it should work to improve welfare.
Micro economics analysis is applied on various fields of economy, e.g. individual savings, cost minimization, profit maximization etc.
According to Prof. Lerner.
" Micro Economic theory facilitates the understanding of billions of ambiguous and complicated facts through simple models of behavior."
Merits:
Its merits may be assessed as under:
- It reveals important decisions of various people and institutions, e.g. optimum combinations of factors of production to maximize profit with the help of ISO Quant curves. An entrepreneur determines factor pricing according to their value of marginal productivity. A consumer maximize its utility from his/her limited resources by acting upon law of equi-marginal utility.
- If there is any defect in any unit of economy e.g. firm or commercial institution it can be immediately and easily rectified. Since we are aware of the entities of the unit therefore, discrepancy can be detected earlier and remedial measures can be taken without any wastage of time.
- The decisions taken for economic analysis at macro level needs detailed knowledge of micro economics because it is necessary to for see the effects of these decisions on small units and entities.
Demerits:
But micro analysis has following demerits which are harmful for the economy at national level.
- In capitalism, people have economic freedom in making all the decision. Thus personal interest is preferred over the national interest and these decisions are incongruent, that's why economy faces recession due to over production. On the other hand, markets boom with expanded business activities, hence markets remain destabilized and keep on fluctuating. To control such a situation, decisions should be taken at national and international level which is not possible at micro level.
- In micro analysis we just know about the problems of just a part of a unit but problems at national level, and their remedies cannot be judged under micro analysis.
- Sometimes, decisions taken at micro level are beneficial for individuals but are harmful at national level.
(i) If the price of a commodity increases, firms profit rises. On the other hand the problem of inflation arises due to increase in prices, which badly effects consumers purchasing power and unequal distribution of wealth takes place. Thus, a critical issue arises at national level.
(ii) If an entrepreneur decide to reduce the wages of labor, their purchasing power decreases due to which demands for goods decreases, prices decrease and recession period is probably expected. So the profit margin of producers and economic conditions are badly affected.
(iii) Savings are considered good at individual level, but at national level there is no use of savings because any nation cannot progress due to just insurance of money.
Basic Problems of Microeconomic Theory:
An important factor while studying microeconomics is that at the time of analyzing small entities, classical economists assumes economy at full employment level. Thus the basic problem was resources allocation which could be solved through price mechanism. In this system prices have the pivotal role.
Basic problems of micro economics are as under:
- The allocation of resources
- The determination of output composition.
- The distribution of wealth.
- The maintanence and expansion of productive capacity of the economy.
Brief review of these problems is as under:
Allocation of resources:
Resources either natural or man-made have their alternative uses, because various factors can be used in production process of various goods and services. So in micro economics we decide which resource allocation should be used in the production of which commodities. Thus the resource allocation is the core issue. Classical believe in self adjusting mechanism therefore the issue of resource allocation would be solves by "Price Mechanism."
The determination of output composition:
After taking decisions about production of goods and services the problems arises that how much goods should be produced, which consumer items should be produced. While determination of output composition, demand for consumer and capital good is considered. The most demanded goods are produced at large scale while, the things which have limited demand are produced at small scale. At this level while, determining the quantity of goods, how much resources should be utilizedbat present and how much will be left for the future. While determining the level of output entrepreneurs keep their aim of maximization of profit in their minds and output is determined where firms:
MC = MR ( Marginal Cost = Marginal Revenue)
Distribution of Product:
How the production is distributed in different classes of the society is another important issue. It means for whom production is made and how do we divide it into different classes. So that every individual has his/her sufficient share.
Maintenance and expansion of the productive capacity of the economy:
In micro economy classical economists assume economy at full employment level. Thus, the issue is to maintain the productive capacity of the economy at desired level. If economy is in equilibrium above or below full employment level it is resolved by readjusting forces. So that there may not be any possibility of over production and general unemployment. Moreover, the cheapest method of production should be adopted to enhance production capacity.
Macro Economics:
Macro means large. Macro economics concept was first introduced by Dr. Keynes. In this part we discuss problems at national and international level. An overall view of economy is kept before e.g. National income and employment, Aggregate demand, Aggregate supply, Consumption, Saving and Investment at national level, Multiplier, Accelerator, Money, Finance and international trade etc.
According to Prof. R.G.D. Alen:
"The relationship among major economic aggregate is discussed under macro economic analysis."
E. Shapiro says:
"Macro economic theory is the theory of Income, employment, prices and money.
According to Fisher and Dornbusch:
"Macro economics is concerned with the behavior of the economy as a whole."
Prof. Boulding:
"Macro economics is that part of economics science under which overall averages and aggregates of an economic system are studied."
Prof. G. Ackley writes:
"Macro economics is concerned with the aggregate economic activities."
Following concepts are discussed under macro economics:
- National Income and Employment theory
- Business cycle
- Money and Banking
- Public finance
- International Trade
- National income and Employment Theory:
Concept of national income, its determinants and equilibrium of national income is discussed in macro economics.
- Business cycle:
Different phases of business cycle, its properties, hypothesis and its remedial measures are discussed under it.
- Money and Banking:
Concept of money and its function are described here, and also taken into view the effects of changing in the value of money. Functions of central and commercial banks, tools of monetary policy and its objectives, are taken into account.
- Public Finance:
Sources of government revenue, items of expenditure tools and objectives of fiscal policy, Principles of taxation and need of debt, is explained in this part.
- International Trade:
In this part we discuss the theories of International trade, balance of payments, International financial institutions, volume and value of imports/exports etc.
"Merits"
Now we take into account the merits of macro economics:
- Economic planning is needed for comprehensive allocation of national resources, and it has to be discussed under macroeconomic analysis.
- There is a need of such policies at national level for economic stability, which create harmony and correlate individual decisions.
- Mostly economic problem arise at national and international level, eg. global inflation, recession, unemployment, over population, oil crises and disorder in balance payments, which may be solved through national and international policies.
- Government responsibilities have increased now-a-days with the establishment of industries and welfare works. So the importance if macro school of thought has increased.
- Certain decisions are not to be taken at individual level, these decisions should be taken at macro level for example, increase in wage, savings and investments: government subsidies relate in taxes. Moreover, imposition of new taxes or an increase in the rate of taxes going on etc, is the subject matter of macro economics.
Limitations:
- Macro economics cannot depict the effect and response of various sectosectors and entities at the collective decisions taken at national level.
- Macro economics cannot judge, any disturbance in any sector of the economy, moreover, remedial measures cannot be made to remove it, example: through aggregate investment and aggregate saving, we cannot judge in which sector there are less savings and income.
- Aggregate view of the economy cannot present the clear picture of all the firms and institutions, because some firms flourish in even recession and some industries face deficit in boom period also. So the remedial measures taken to reduce the intensity if business cycle can be harmful for such few firms and institutions.
Conclusion:
It can be concluded after having a detail view of micro and macro analysis that for analyzing economic problems and their remedial measures both should be adopted. The problems that are related to macro economics essentially need a study of their minor aspects and same in the case with the problem related too micro economics.
So, both analysis are important, for analyzing economic problems and making economic policies, both view points should be considered and none of them can be neglected because it results in retention of many flaws in economic analysis and consequence of such adopted policies can be dangerous.
This aim of both school of thoughts is same. In price determination and in the solution of basic problems of economic system. Price mechanism plays an important role that relates to micro school of thought. Macro analysis plays an important role in decreasing the intensity of price distortion, achievement of full employment level and to eradicate economic problems are essential for economic analysis.
- Business cycle:
Different phases of business cycle, its properties, hypothesis and its remedial measures are discussed under it.
- Money and Banking:
Concept of money and its function are described here, and also taken into view the effects of changing in the value of money. Functions of central and commercial banks, tools of monetary policy and its objectives, are taken into account.
- Public Finance:
Sources of government revenue, items of expenditure tools and objectives of fiscal policy, Principles of taxation and need of debt, is explained in this part.
- International Trade:
In this part we discuss the theories of International trade, balance of payments, International financial institutions, volume and value of imports/exports etc.
"Merits"
Now we take into account the merits of macro economics:
- Economic planning is needed for comprehensive allocation of national resources, and it has to be discussed under macroeconomic analysis.
- There is a need of such policies at national level for economic stability, which create harmony and correlate individual decisions.
- Mostly economic problem arise at national and international level, eg. global inflation, recession, unemployment, over population, oil crises and disorder in balance payments, which may be solved through national and international policies.
- Government responsibilities have increased now-a-days with the establishment of industries and welfare works. So the importance if macro school of thought has increased.
- Certain decisions are not to be taken at individual level, these decisions should be taken at macro level for example, increase in wage, savings and investments: government subsidies relate in taxes. Moreover, imposition of new taxes or an increase in the rate of taxes going on etc, is the subject matter of macro economics.
Limitations:
- Macro economics cannot depict the effect and response of various sectosectors and entities at the collective decisions taken at national level.
- Macro economics cannot judge, any disturbance in any sector of the economy, moreover, remedial measures cannot be made to remove it, example: through aggregate investment and aggregate saving, we cannot judge in which sector there are less savings and income.
- Aggregate view of the economy cannot present the clear picture of all the firms and institutions, because some firms flourish in even recession and some industries face deficit in boom period also. So the remedial measures taken to reduce the intensity if business cycle can be harmful for such few firms and institutions.
Conclusion:
It can be concluded after having a detail view of micro and macro analysis that for analyzing economic problems and their remedial measures both should be adopted. The problems that are related to macro economics essentially need a study of their minor aspects and same in the case with the problem related too micro economics.
So, both analysis are important, for analyzing economic problems and making economic policies, both view points should be considered and none of them can be neglected because it results in retention of many flaws in economic analysis and consequence of such adopted policies can be dangerous.
This aim of both school of thoughts is same. In price determination and in the solution of basic problems of economic system. Price mechanism plays an important role that relates to micro school of thought. Macro analysis plays an important role in decreasing the intensity of price distortion, achievement of full employment level and to eradicate economic problems are essential for economic analysis.
