Microeconomics vs. Macroeconomics: Key Economic Concepts

Posted on Feb 5, 2025 in Economy

Microeconomics vs. Macroeconomics

Factors of Production

Factors of Production is the technical term economists use for resources. All things used in producing goods and services are called resources:

• Land: Everything on the earth in its natural state, or the earth’s natural resources.
• Labor: All the people who work in the economy.
• Capital: The money needed to start and operate a business.
• Entrepreneurship: The skills of the people willing to risk their time and money to run a business.
• Infrastructure: The physical development of a country.

Price Mechanism

Price mechanism refers to the system where the forces of demand and supply determine the prices of commodities and the changes therein. It is the buyers and sellers who actually determine the price of a commodity.

Trade Cycle

Trade cycle: The wave-like movement of the fluctuations in general business activity, spread over a number of years, is called a trade cycle. These fluctuations result in changes in the level of national income and employment, and create not only economic but also social and political problems.

Fiscal Policy

Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.

Monetary Policy

Monetary policy refers to the use of monetary instruments under the control of the central bank to regulate magnitudes such as interest rates, money supply, and availability of credit with a view to achieving the ultimate objective of economic policy.

Outsourcing

Outsourcing is a business practice in which a company hires a third-party to perform tasks, handle operations, or provide services for the company.

Globalization

Globalization is the process of rapid integration or interconnection of countries. MNCs are playing a major role in the globalization process. More and more goods and services, investments, and technology are moving between countries. There is one more way in which the countries can be connected. This is through the movement of people between countries.

Law of Demand

The law of demand states that, “other things remaining constant, there is an inverse relationship between price and demand. When price increases, demand decreases, and vice-versa.”

Assumptions (other things remaining constant):

1. Price of related goods does not change.
2. Income of the consumer does not change.
3. Taste and preference do not change.
4. Climate does not change.

From the above schedule demand diagram, we can see that, as price increases from ₹1 to ₹5, demand decreases from 50kg to 10kg. By joining all the points, we get a downward-sloping demand curve.

Law of Supply

The law of supply states that, “other things remaining constant, there is a direct relationship between price and supply. When price increases, supply increases, and vice-versa.”

Assumptions (other things remaining constant):

1. Price of related goods does not change.
2. Income technology does not change.
3. The tax rate does not change.
4. Price of raw materials does not change.

From the above schedule supply diagram, we can see that, as price increases from ₹1 to ₹5, supply increases from 20 to 100. By joining all the points, we get an upward-sloping supply curve.

Economic Methods

Deductive Method: Deductive means using knowledge about things that are generally true in order to think about and understand particular situations or problems. In this method, reasoning people proceed from general to particular or from universal to individuals. Inferences are drawn from general cases to establish a particular case.

Inductive Method: Inductive means using particular facts and examples to form general rules and principles. In the inductive method, reasoning proceeds from particular to the general or from individual to the universal. A general case is made from individual cases.

Economic Problems

• What to produce?
• How to produce?
• For whom to produce?
• Are the resources economically used?
• Problem of full employment?
• Problem of growth?

WTO: Objectives

WTO (World Trade Organization) was established in 1995 as the heir organization to the GATT (General Agreement on Trade and Tariff). GATT was founded in 1948 with 23 nations as the global (international) trade organization to serve all multilateral trade agreements by giving fair chances to all nations in the international exchange for trading prospects. WTO is required to build a rule-based trading government in which countries cannot place unreasonable constraints on trade. Objectives include:

• To raise the standard of living in member countries.
• Development of a multilateral trading system.
• To reduce tariff and non-tariff barriers.
• To eliminate discriminatory treatment in international trade relationships.
• To coordinate trade policies, environmental policies, and sustainable development.

Inflation: Main Reasons

Inflation is an economic indicator that indicates the rate of rising prices of goods and services in the economy. Ultimately, it shows the decrease in the buying power of the rupee. It is measured as a percentage. This percentage indicates the increase or decrease from the previous period. Inflation can be a cause of concern as the value of money keeps decreasing as inflation rises.

Reasons/Causes of Inflation:

• Increase in Public Spending
• Increased Velocity of Circulation
• Exports
• Trade Unions
• Tax Reduction
• Imposition of Indirect Taxes

Unemployment

Unemployment is a term referring to individuals who are employable and actively seeking a job but are unable to find a job. Included in this group are those people in the workforce who are working but do not have an appropriate job. Usually measured by the unemployment rate, which is dividing the number of unemployed people by the total number of people in the workforce, unemployment serves as one of the indicators of a country’s economic status.

Reasons/Causes of Unemployment:

• High Population Growth
• Absence of Employment Opportunities
• Seasonal Employment
• Joint Family System
• Increasing Turnout of Students from Indian Universities
• Slow Development of Industries
• Insufficient Rate of Economic Progress

Elasticity of Demand: Types and Application

Elasticity of Demand: Demand extends or contracts respectively with a fall or rise in price. This quality of demand by virtue of which it changes (increases or decreases) when price changes (decreases or increases) is called Elasticity of Demand. There are three types of elasticity of demand:

Price Elasticity of Demand: The ratio of proportionate change in the quantity demanded of a good caused by a given proportionate change in price.

Income Elasticity of Demand: The ratio of percentage change in the quantity of a good purchased, per unit of time, to a percentage change in the income of a consumer.

Cross Elasticity of Demand: The percentage change in the demand of one good as a result of the percentage change in the price of another good.

Economies of Scale

Economies of scale may be defined as the cost advantages that can be achieved by an organization by the expansion of their production in the long run. Therefore, the advantages of large-scale expansion are known as Economies of Scale. The lower average cost per unit achieves the advantage in cost. Economies of scale refer to the situation in which increasing the scale of production reduces the unit cost of production. Generally, the larger the scale of production, the lower the average cost of production.

Types of Economies of Scale:

Internal Economies: Internal Economies are the real economies that arise from the expansion of the organization. These economies are the result of the growth of the organization itself.

External Economies: External Economics are the economies that originate from factors outside the organization. These economies result in the increase in the main organization by the increase in the quality of factors outside the organization like better transportation, better labor, infrastructure, etc. Due to the betterment of these external factors, the cost of production per unit of an item in the organization decreases.

Diseconomies of Scale

A firm or an industry enjoys economies only up to a certain limit. Having reached this limit, these economies turn into diseconomies. When the scale of production enlarges beyond a particular limit it leads to diseconomies.

Types of Diseconomies of Scale:

Internal Diseconomies of Scale: Internal Diseconomies of Scale are the diseconomies resulting from the internal difficulties within the organization. The Internal Diseconomies are the factors that raise the cost of production of an organization, like lack of supervision, lack of management, and technical difficulties.

External Diseconomies of Scale: External Diseconomies of Scale are the external factors that result in the increase in the production per unit of a product within an organization. The external factors that act as a restraint to expansion may include the cost of production per unit, scarcity of raw materials, and low availability of skilled laborers.

Perfect Competition: Features and Price Determination

Perfect Competition: Perfect Market is a market situation which consists of a very large number of buyers and sellers offering a homogeneous product. Under such a condition, no firm can affect the market price. Price is determined through the market demand and supply of the particular product, since no single buyer or seller has any control over the price. Perfect Competition cannot be found in the real world.

Features of Perfect Competition:

1. All producers of a good sell the same product.
2. There are no barriers to entry or exit in the market.
3. Firms are “price takers” and cannot set prices.
4. A large number of small firms exist in the market.
5. All buyers and sellers have perfect knowledge of market conditions.

Price Determination under Perfect Competition:

When determining price under perfect competition, we will also use the equilibrium method. Equilibrium is the process where demand and supply intersect at a single point; it’s called Equilibrium.

Law of Return to Scale

The term returns to scale refers to the changes in output as all factors change by the same proportion. Returns to scale relate to the behavior of total output as all inputs are varied and is a long-run concept.

Returns to scale are of the following three types:

Increasing Returns to Scale: Increasing returns to scale indicate a greater percentage increase in output than the percentage increase in input. It means when the output increases in a greater proportion than the increase in all inputs, it is called increasing return to scale. If all inputs increase by 100%, then the output increases by more than 100%.

Constant Returns to Scale: When a proportionate increase in total output is equal to the proportionate increase in inputs, it is constant return to scale. If all the inputs are increased by 100%, then the output also increases by 100%.

Diminishing Returns to Scale: When a proportionate increase in total output is less than the proportionate increase in inputs, it is diminishing return to scale. If all the inputs are increased by 100%, then the output increases by less than 100%.

Market Structure

Market: Basically, when we hear the word market, we think of a place where goods are being bought and sold.

In economics, a market is a place where buyers and sellers are exchanging goods and services with the following considerations such as:

• Types of goods and services being traded.
• The number and size of buyers and sellers in the market.

Market Structure:

1. Perfect or Pure Market
2. Imperfect Market (Monopoly, Monopolistic, Oligopoly)

Perfect Competition:

1. Big number of small companies.
2. All companies manufacturing standard products.
3. Companies are free to enter and leave the market.
4. Information is available for all the companies.
5. Stock markets, food markets, etc.

Monopoly: Monopoly comes from a Greek word ‘monos’ which means ‘one’ and ‘polein’ means to ‘sell’. There is only one seller of goods or services.

Features of Monopoly:

• There is only one producer or seller of goods and only one provider of services in the market.
• New firms find extreme difficulty in entering the market. The existing monopolist is considered a giant in its field or industry.
• There are no available substitute goods or services, so that it is considered unique.
• It controls the total supply of raw materials in the industry and has no control over price.
• It owns a patent or copyright.
• Its operations are under economies of scale.

Monopolistic Competition: Market situation in which there are many sellers producing highly differentiated products. Monopolistic competition is also perfect competition plus product differentiation.

Features of Monopolistic Competition:

• A large number of buyers and sellers in a given market act independently.
• There is limited control of price because of product differentiation.
• Sellers offer differentiated products or similar but not identical products.
• New firms can enter the market easily. However, there is greater competition in the sense that new firms have to offer better features of their products.
• Economic rivalry centers not only upon price but also upon product variation and product promotion.

Oligopoly: Oligopoly comes from the Greek word “oligo” which means ‘few’ and “polein” means ‘to sell’. A small number of sellers, each aware of the action of others. All decisions depend on how the firms behave in relation to each other.

Characteristics of Oligopoly:

• There are a small number of firms in the market selling differentiated or identical products.
• The firm has control over price because of the small number of firms providing the entire supply of a certain product.
• There is extreme difficulty for new competitors to enter the market.