UNIT 1
Introduction
British economist, Lionel Robbins (1898 – 1984) stated, economic problem is concerned with scare resource which are unlimited. It is a problem of choice, a choice between ends and also a choice of using scarce resources between alternatives uses with the objective of maximizing satisfaction.
The subject matter of modern economics is generally divided into two parts: Microeconomics and Macroeconomics. The terms micro and macro are derived from Greek words ‘mikros’ and ‘makros’ meaning ‘small’ and ‘large’ respectively.
Microeconomics studies the economic behavior of individual decision making units such as consumers, resource owners, business firms and of small groups of individual units like industries and markets. In this connection, microeconomics examines the behavior of the industry with regard to determination of its product price, output and employment. It examines how prices of products and factors are determined and how resources are allocated among various uses. Microeconomics tends to offer a detailed treatment of one aspect of economic behavior but ignores interactions with the rest of the economy, in order to preserve the simplicity of the analysis. Macroeconomics has both theoretical and practical significance. Its principle and concepts are used by firms to make decision regarding pricing, marketing resources utilization and profit analysis.
Macroeconomics studies the functioning of an economy as a whole. It studies aggregate or collective behavior of a society in connection with economic choices. The main areas of study include national income, aggregate demand and supply, employment level, inflation, recession international trade. Macroeconomic analysis is extremely useful in formulation of economic policies by the government and monetary authorities. Business firms use macroeconomic data and analyses to formulate present and future business policies forecasting of future trends is an important part of applied macroeconomics.
1. Market Demand and Supply: One of the most important areas of study in business economics is the market. Producers produce for the market where the interaction between the demand and supply determines the price. The price of a product and its sales determines the total revenue, from which total cost is deducted to arrive at a firm’s profit or loss. A business enterprise’s survival, success and failure depend upon what price the market determines for its product.
2. Production Analysis: Business economics analyses the process of production. A firm tries to make optimum use of the resources available to it in order to maximize production and minimize cost. Laws of Variable Proportions and Laws of Returns to Scale are used to understand production in the short run and the long run, respectively.
3. Cost and Profit Analysis: In order to analyze costs, cost functions are used to make decision regarding optimum utilization of resources. Business economics uses concepts of opportunity cost and implicit cost to determine economic profits and differentiate it from accounting profit. This is done to determine the actual resource utilization in businesses.
4. Market Structures: The study of market structures is a very important part of business economics. Understanding competition makes firms take better decision about their pricing, marketing and production strategies. The study of market structures like perfect competition, monopoly monopolistic competition and oligopoly form an important part of business economics.
5. Pricing: Pricing is one of the most important business decisions that determines a firm’s revenue and profit. Business economics deals with the analysis of different pricing practices and studies their applications in different types of firms. For examples, which pricing practice is appropriate for a multi – product firm or a public sector enterprises?
6. Objectives of the firm: Profit is the primary objective of business firms. Business firms. Business economics studies break – even analysis and profit maximizing equilibrium of a firm. Besides, other objectives of the firm like, sales maximization, growth maximization, growth maximization and satificing behaviour are also studied in business economics.
7. Forecasts and Business Policy: A firm’s decisions are influenced by the larger economic, political and social environment in which it operates. Government policies, national income changes, population changes, business cycles, all affect a firm’s decisions. While studying the impact of the external economic factors that affects a firm’s decision making, business economics uses macroeconomic principles. Business economics uses quantitative techniques (mathematics and statistical techniques) to study how business enterprises forecasts future trends in demand, costs, revenue and profit. Forecasting future trends is extremely important for a firm as the success of its plans depends on how well it can forecast the future. Demand forecasting is an applied component of business economics.
8. Project Planning: Project planning or capital budgeting is done by any investor to determine the criteria on which to make investment decisions. The study of different methods of project planning is one of the most important components of business economics. Methods like pay-back period, net present value and internal rate of return are studied under business economics.
Economic Statics: The term ‘Statics’ is derived from the Greek word ‘Static’ which means ‘bringing to a standstill’. This term denotes several meanings in several sciences. For instance, in Economics, it means a state of the movement at a particular level without any change. In Physical Sciences it denotes a state of rest where there is no movement. According to Simon Kuznet, Economic statics deals with relations and processes on the assumption of uniformity and persistence. According to Prof. Clark economic statics involves the absence of five kinds of change. They are (a) Size of population, (b) Supply of capital, (c) Methods of production, (d) Forms of business organization, (e) Wants of the people.
Economic statics denotes the relationship between two economic variables that relate to the same point of time. It is a timeless analysis. It assumes the simultaneous adjustment of indices. It gives only a stand still picture of an economy, a vision of the movement, disappearing .as soon as it makes its appearance.
Economic Dynamics: The term. ‘Economic Dynamics’ means ‘causing to move’. In Economics it refers to the study of economic changes. It denotes the analysis of the process of change in time. Hence time factor plays an important role in determining the relationship between economic variables. Professor Hicks defined economic dynamics as “that part of economic theory which every quantity must be dated“. Ragnar Frisch considered economic dynamics as a system in which variables at different points of time involved in an essential way.
Thus, economic dynamic is concerned with the changes in the expected values of the variables. For example change in price affects the quantity demanded and supplied of a commodity. The extent of the impact of price on the demand and supply of a commodity depends upon the extent of change in the other variables.
Definition: An inflationary gap, also known as an expansionary gap, is the difference between the real GDP and the full-employment real GDP. In fact, the real GDP outweighs the full employment real GDP because an increase in the real GDP causes the general price level to rise in the long-term.
What Does Inflationary Gap Mean?
What is the definition of inflationary gap? An inflationary gap is always related to a business-cycle expansion and arises when the equilibrium level of an economy’s aggregate output is greater than the output that could be produced at full employment.
For instance, the economy’s total output is $6 trillion and the full-employment real GDP is $4 trillion, the inflationary gap is $2 trillion, which means that the aggregate output has to decrease by $2 trillion to eliminate the inflationary gap. To fight this gap, governments impose a contractionary fiscal policy that increases taxation and decreases government spending to lower disposable income and consumption, thus lowering the aggregate demand and the general price level.
Let’s look at an example.
Example
Saudi Arabia employs all its available resources and produces 11.6 barrels of oil per day. The aggregate demand for oil is estimated at 5 barrels of oil per day because there is a growing uncertainty over oil supplies, regional conflict and price hikes, which lower consumer confidence. In this case, since the aggregate demand (real GDP) is lower than the full-employment real GDP, there is no inflationary gap.
Conversely, if the aggregate demand for oil was 13.2 barrels of day, and consumer confidence was high, there would be an inflationary gap of 1.6 barrels of oil per day because the aggregate demand (real GDP) would be higher than the full-employment real GDP
- Unit of study: According to K.E. Boulding micro economics is the study of individual unit. It focuses attention on the study of the behavior of Micro variable. Thus, it studies only part of the economy and not the whole.
- Method: Micro economics is not concerned with the aggregate. What it really does is to slice (divide) the whole economy into smaller individual unit. So, economists point out that micro economics uses the Slicing method.
- Price theory: Micro economics analysis how the price of individual commodities and services are determined. Micro economics tells us how the price of individual commodity is decided, how the equilibrium of an individual firm reached etc. This is known as Price theory.
- Area of Study: The main area of its study is the theory of product and factor pricing and their reaction to changes in demand and supply condition. Micro economics analyses the markets for the factors of production, that is, labour, capital, land and entrepreneur.
- Vision: Micro economics studies a small part of the economics through partial equilibrium. It studies in detail about behaviour of individual economics unit. Micro economics studies how efficiently the various resources are allocated to individual consumers and producers within the economy. i.e. it examines the tree not the forest.
- Analysis allocation of resources: Micro economics analyses how resources are allocated to production of particular goods and services in the economy. Allocation of resources involves what to produce, how to produce and how much to produce. It also studies how efficiently the various resources are allocated to individual consumers and produces.
- Undertakes general equilibrium analysis: It is generally understood that micro economics does not concern itself with the economy as whole. But this is not correct. Micro economics examines the economy as a whole, but microscopically.
- Analysis of market structures: Micro Economics analyses different market structures i.e. perfect competition, monopoly, Oligopoly, monopolistic competition etc. and describes how prices and quantities are determined different markets.
- Limited scope: Micro Economics studies individual economic units & not the whole economy. It does not deal with the nation-wide problems like unemployment, inflation, deflation, poverty, balance of payment situation, economic growth etc. So its scope is limited.
- Study of aggregates: Macro economics is a study of the aggregates. It is also known as aggregates economics. It studies the economics system as a whole covering all condition of the economy such as total production, total consumption, total saving and total investment. In the words of Prof. Mc connel, “Macro economics examines the forest, not the tree.”
- Lumping method: Macro economics deals with macro quantities and macro variable. Unlike macro economics, it does not split up the economy into small slice but studies in big lumps. Therefore it is called the method of lumping.
- General Equilibrium: Macroeconomic is based on general equilibrium. Whole economy is called general equilibrium. The technique of general equilibrium is applied to study the determination of the general price level, total employment and output.
- Vision: It gives the overall view of the whole economy i.e. it give a bird’s eye view of the whole economy.
- Interdependence: Macro analysis stresses interrelationship between the different Market and sectors in the economy. According to general equilibrium analysis, a change in any one market or sector will have its impact on the other markets or sectors of the economy.
- Income theory: Macro economics is known as income theory. It studies the factors determining national income and employment and the causes of fluctuations in income and employment. According to Edward Shapiro, the major task of macro economics is the explanation of what determines the economy’s income.
- Policy-oriented: Macro economics, according to Keynes’ is a policy-oriented science. Macro-economic analysis helps in formulating suitable economic policies to promote economic growth, to generate employment, to control inflation, to pull the economy out of depression etc.
