Economics

10 October 2016

Distinguish between Micro economics and Macro economics. Microeconomics may be defined as that branch of economic analysis, which studies the economic behavior of the individual unit, maybe a person, a particular household, or a particular firm. It is a study of one particular unit rather than all the units combined together. In microeconomics, we study the various units of the economy, how they function and how they reach their equilibrium. An important tool used in that of microeconomics is that of Marginal Analysis. In fact, it is an indispensable tool used in microeconomics.

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Some of the important laws and principles of microeconomics have been derived directly from marginal analysis. The following are the fields covered by microeconomics: •Theory of Product pricing with its two constituents, namely, the theory of consumer behavior and the theory of production and costs. •Theory of Factor pricing. •Theory of Economic Welfare. Microeconomics Those who have studied Latin know that the prefix “micro-“ means “small,” so it shouldn’t be surprising that microeconomics is the study of small economic units. The field of microeconomics is concerned with things like: •Consumer decision making and utility maximization Firm production and profit maximization •Individual market equilibrium •Effects of government regulation on individual markets •Externalities and other market side effects Micro Economics: 1. Micro Economics studies the problems of individual economic units such as a firm, an industry, a consumer etc. 2. Micro Economic studies the problems of price determination, resource allocation etc. 3. While formulating economic theories, Micro Economics assumes that other things remain constant. 4. The main determinant of Micro Economics is price.

Macro Economics may be defined as that branch of economic analysis which studies the behavior of not one particular unit, but of all the units combined together. Macroeconomics is a study of aggregates. It is the study of the economic system as a whole i?? total production, total consumption, total savings and total investment. The following are the fields covered by macroeconomics: •Theory of Income, Output and Employment with its two constituents, namely, the theory of consumption function, the theory of investment function and the theory of business cycles or economic fluctuations. Theory of Prices with its constituents of the theories of inflation, deflation and reflation. •Theory of Economic Growth dealing with the long-run growth of income, output and employment. •Macro Theory of Distribution dealing with the relative shares of wages and profits in the total national income. The study of macroeconomics is indispensable as it is the main agent for formulation and successful execution of government economic policies. It is also indispensable for the formulation of microeconomic models. Macroeconomics Macroeconomics can be thought of as the “big picture” version of economics.

Rather than analyzing individual markets, macroeconomics focuses on aggregate production and consumption in an economy. Some topics that macroeconomists study are: •The effects of general taxes such as income and sales taxes on output and prices •The causes of economic upswings and downturns •The effects of monetary and fiscal policy on economic health •How interest rates are determined •Why some economies grow faster than others Macro Economics: 1. Macro Economics studies economic problems relating to an economy viz. , National Income, Total Savings etc. 2.

Macro Economics studies the problems of economic growth, employment and income determination etc. 3. In Micro Economics economic variables are mutually inter-related independently. 4. In Micro Economics economic variables are mutually inter-related independently. The Relationship between Microeconomics and Macroeconomics There is an obvious relationship between microeconomics and macroeconomics in that aggregate production and consumption levels are the result of choices made by individual households and firms, and some macroeconomic models explicitly make this connection.

Most of the economic topics covered on television and in newspapers are of the macroeconomic variety, but it’s important to remember that economics is about more than just trying to figure out when the economy is going to improve and what the Fed is doing with interest rates. 2. State the principles of Economics. Marginal and Incremental Principle This principle states that a decision is said to be rational and sound if given the firm’s objective of profit maximization, it leads to increase in profit, which is in either of two scenarios •If total revenue increases more than total cost. If total revenue declines less than total cost. Marginal analysis implies judging the impact of a unit change in one variable on the other. Marginal generally refers to small changes. Marginal revenue is change in total revenue per unit change in output sold. Marginal cost refers to change in total costs per unit change in output produced (While incremental cost refers to change in total costs due to change in total output). The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost.

If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price. Incremental analysis differs from marginal analysis only in that it analysis the change in the firm’s performance for a given managerial decision, whereas marginal analysis often is generated by a change in outputs or inputs. Incremental analysis is generalization of marginal concept. It refers to changes in cost and revenue due to a policy change. For example – adding a new business, buying new inputs, processing products, etc.

Change in output due to change in process, product or investment is considered as incremental change. Incremental principle states that a decision is profitable if revenue increases more than costs; if costs reduce more than revenues; if increase in some revenues is more than decrease in others; and if decrease in some costs is greater than increase in others. 1. Equi-marginal Principle Marginal Utility is the utility derived from the additional unit of a commodity consumed. The laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the marginal utilities of various commodities he consumes are equal.

It is also defined as the cost of sacrificed alternatives. For instance, a person chooses to forgo his present lucrative job which offers him Rs. 50000 per month, and organizes his own business. The opportunity lost (earning Rs. 50,000) will be the opportunity cost of running his own business. In economics, the principle of opportunity cost is that the real cost of something is what you have to give up to get it. All costs are opportunity costs, not just financial ones. For example, the opportunity cost of taking a certain course in college is another class you could have potentially taken. . Time Perspective Principle According to this principle, a manger/decision maker should give due emphasis, both to short-term and long-term impact of his decisions, giving apt significance to the different time periods before reaching any decision. Short-run refers to a time period in which some factors are fixed while others are variable. The production can be increased by increasing the quantity of variable factors. While long-run is a time period in which all factors of production can become variable. Entry and exit of seller firms can take place easily.

From consumers point of view, short-run refers to a period in which they respond to the changes in price, given the taste and preferences of the consumers, while long-run is a time period in which the consumers have enough time to respond to price changes by varying their tastes and preferences. 4. Discounting Principle According to this principle, if a decision affects costs and revenues in long-run, all those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. This is essential because a rupee worth of money at a future date is not worth a rupee today.

Money actually has time value. Discounting can be defined as a process used to transform future dollars into an equivalent number of present dollars. For instance, $1 invested today at 10% interest is equivalent to $1. 10 next year. FV = PV*(1+r)t Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is the discount (interest) rate, and t is the time between the future value and present value. 1) Opportunity cost principle: By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. For e. g. ) The opportunity cost of the funds employed in one’s own business is the interest that could be earned on those funds if they have been employed in other ventures. b) The opportunity cost of using a machine to produce one product is the earnings forgone which would have been possible from other products. c) The opportunity cost of holding Rs. 1000as cash in hand for one year is the 10% rate of interest, which would have been earned had the money been kept as fixed deposit in bank. Its clear now that opportunity cost requires ascertainment of sacrifices. If a decision involves no sacrifices, its opportunity cost is nil.

For decision making opportunity costs are the only relevant costs. 2) Incremental principle: It is related to the marginal cost and marginal revenues, for economic theory. Incremental concept involves estimating the impact of decision alternatives on costs and revenue, emphasizing the changes in total cost and total revenue resulting from changes in prices, products, procedures, investments or whatever may be at stake in the decisions. The two basic components of incremental reasoning are 1. Incremental cost 2. Incremental Revenue The incremental principle may be stated as under: A decision is obviously a profitable one if – •it increases revenue more than costs •it decreases some costs to a greater extent than it increases others •it increases some revenues more than it decreases others and •it reduces cost more than revenues” 3) Principle of Time Perspective Managerial economists are also concerned with the short run and the long run effects of decisions on revenues as well as costs. The very important problem in decision making is to maintain the right balance between the long run and short run considerations. For example; Suppose there is a firm with a temporary idle capacity.

An order for 5000 units comes to management’s attention. The customer is willing to pay Rs 4/- unit or Rs. 20000/- for the whole lot but not more. The short run incremental cost(ignoring the fixed cost) is only Rs. 3/-. There fore the contribution to overhead and profit is Rs. 1/- per unit (Rs. 5000/- for the lot) Analysis: From the above example the following long run repercussion of the order is to be taken into account: 1) If the management commits itself with too much of business at lower price or with a small contribution it will not have sufficient capacity to take up business with higher contribution. ) If the other customers come to know about this low price, they may demand a similar low price. Such customers may complain of being treated unfairly and feel discriminated against. In the above example it is therefore important to give due consideration to the time perspectives. “a decision should take into account both the short run and long run effects on revenues and costs and maintain the right balance between long run and short run perspective”. 4) Discounting Principle: One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a rupee today.

Suppose a person is offered a choice to make between a gift of Rs. 100/- today or Rs. 100/- next year. Naturally he will chose Rs. 100/- today. This is true for two reasons- i) The future is uncertain and there may be uncertainty in getting Rs. 100/- if the present opportunity is not availed of ii) Even if he is sure to receive the gift in future, today’s Rs. 100/- can be invested so as to earn interest say as 8% so that one year after Rs. 100/- will become 108 5) Equi – marginal Principle:

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