Comprehensive Study Notes on Micro Economics and Macro Economics

Introduction to Microeconomics and Macroeconomics

Microeconomics and Macroeconomics constitute the two primary branches of modern economic science.
The term 'micro' originates from the Greek word Mikros, which translates to "small" or a "millionth part" ( $\frac{1}{1,000,000}$ ).
The term 'macro' originates from the Greek word Makros, which translates to "large".
Both terms were coined in $1933$ by the Norwegian economist Ragnar Frisch of Oslo University.

Biographical Overview of Ragnar Frisch

Full Name: Ragnar Anton Kittil Frisch ( $1895$ – $1973$ ).
Identity & Achievements: A Norwegian econometrician and economist who was the joint winner—alongside Jan Tinbergen—of the very first Nobel Prize for Economics in $1969$ .
Contributions: He was a pioneer in econometrics, defined as the application of mathematical models and statistical techniques to economic data and theories. He coined numerous economic terms.
Coining of Core Terms: In an article on business cycles, he was likely the first individual to refer to the study of individual firms and producers as "Microeconomics," and the study of the aggregate economy as "Macroeconomics."

Historical Evolution of Economic Analysis

Historical Review of Microeconomics

Microeconomic analysis was developed first and represents the traditional approach in economic science.
Origins: Traced back to the era of Classical Economists, including Adam Smith, David Ricardo, and J. S. Mill.
Popularization: Neo-Classical Economist Prof. Alfred Marshall popularized microeconomics through his landmark book, Principles of Economics, published in $1890$ .
Additional Contributors: Prof. Pigou, J. R. Hicks, Prof. Samuelson, and Mrs. Joan Robinson contributed substantially to its ongoing development.

Historical Review of Macroeconomics

Macroeconomic thought existed prior to the formalization of microeconomics:
- 16th and 17th Century: Followers of Mercantilism (a group of English merchants) advocated state policies based on a macroeconomic approach.
- 18th Century: Physiocrats (French thinkers) attempted to analyze national income and national wealth.
- Classical Era: Classical Economic theories of Prof. Adam Smith, Prof. David Ricardo, and Prof. J. S. Mill discussed the determination of national income and wealth, though their macro analysis was combined with micro analysis.
Microeconomic analysis dominated the discipline of economics until the Great Depression of the $1930\text{s}$ .
The Keynesian Revolution: Following the Great Depression, Lord John Maynard Keynes published his groundbreaking book, General Theory of Employment, Interest and Money, in $1936$ . Keynes utilized a macro approach to analyze systemic economic problems, earning him primary credit for developing macroeconomics into a distinct discipline.
Other Major Contributors: Malthus, Wicksell, Walras, and Irving Fisher also made notable contributions to macroeconomic analysis.

Fundamentals of Microeconomics

Meaning of Microeconomics

Micro means a small part of a thing. Microeconomics deals with small, individual components of the national economy.
It investigates the economic actions and individual behaviors of distinct economic units, including individual consumers, individual producers or firms, and the prices of specific commodities or factor inputs.

Definitions of Microeconomics

Maurice Dobb: "Micro economics is in fact a microscopic study of the economy."
Prof. A. P. Lerner: "Micro economics consists of looking at the economy through a microscope, as it were, to see how the millions of cells in the body of economy-the individuals or households as consumers and individuals or firms as producers play their part in the working of the whole economic organism."

Scope of Microeconomics

Microeconomic theory centers on price theory and resource allocation. It is divided into three primary categories:

Theory of Product Pricing:
- The price of an individual commodity is determined by the market forces of demand and supply.
- Encompasses Demand Analysis (studying individual consumer behavior) and Supply Analysis (studying individual producer behavior).
Theory of Factor Pricing:
- Production processes require four primary factor inputs: Land, Labour, Capital, and Entrepreneur.
- Microeconomics determines factor rewards for these inputs in the form of Rent, Wages, Interest, and Profit, respectively:
  - Land $\rightarrow$ Rent
  - Labour $\rightarrow$ Wages
  - Capital $\rightarrow$ Interest
  - Entrepreneur $\rightarrow$ Profit
Theory of Economic Welfare:
- Focuses on efficiency in the allocation of resources to achieve maximum satisfaction for society. Economic efficiency comprises three distinct components:
  - Efficiency in Production: Producing the maximum possible amount of goods and services from a given quantum of resources.
  - Efficiency in Consumption: Distributing produced goods and services among the population in a manner that maximizes the aggregate satisfaction of society.
  - Overall Economic Efficiency: Producing precisely those goods and services that are most desired by the public.

Boundaries and Exclusions of Microeconomics

Microeconomics does not study aggregate phenomena pertaining to the whole economy.
It excludes national problems such as unemployment, poverty, income inequality, economic growth theory, business cycle theory, monetary policy, and fiscal policy.

Features of Microeconomics

Study of Individual Units: Analyzes the behavior of small individual economic units (e.g., individual firm, individual price, individual household).
Price Theory: Concentrates on determining prices for consumer goods/services and factor inputs.
Partial Equilibrium: Analyses the equilibrium position of an individual unit (consumer, firm, industry) in isolation from other forces, holding external conditions constant.
Based on Certain Assumptions: Relies on the foundational assumption of Ceteris Paribus ("Other things remaining constant"), alongside assumptions of perfect competition, laissez-faire policy, pure capitalism, and full employment to simplify economic analysis.
Slicing Method: Splits or divides the entire economy into small individual units to examine each unit thoroughly in detail (e.g., examining individual income out of total national income, or individual demand out of aggregate demand).
Use of Marginalism Principle: Marginal analysis is its core tool. "Marginal" signifies the change brought about in a total quantity by an additional unit. Producers and consumers rely on marginal changes to make optimal economic decisions.
Analysis of Market Structure: Examines various market structures, including Perfect Competition, Monopoly, Monopolistic Competition, and Oligopoly.
Limited Scope: Confined strictly to individual units; excludes nationwide issues such as inflation, deflation, balance of payments, poverty, unemployment, population growth, and macro economic growth.

Importance of Microeconomics

Price Determination: Explains how market prices for diverse goods, services, and production factors are established.
Free Market Economy: Explains the operational dynamics of a free market system where economic decisions—such as "What to produce?", "How much to produce?", and "How to produce?"—are taken at individual levels without government or external intervention.
Foreign Trade: Explains specific foreign trade phenomena, such as tariff impacts on a particular commodity, determination of currency exchange rates between two nations, and specific gains from international trade.
Economic Model Building: Provides fundamental economic variables, terms, terminologies, and analytical tools necessary to build models for understanding complex economic situations.
Business Decisions: Assists business executives in taking decisions regarding cost of production, product pricing, and output/profit maximization.
Useful to Government: Aids governments in formulating taxation policies, public expenditure policies, and price control policies to allocate resources efficiently and promote social welfare.
Basis of Welfare Economics: Explores optimal resource utilization and allocation, while evaluating how taxation affects social welfare.

Fundamentals of Macroeconomics

Meaning of Macroeconomics

Macroeconomics is the branch of economics that analyzes the functioning of the entire economy.
It deals with aggregate economic quantities: total employment, national income, national output, total investment, total consumption, total savings, general price level, interest rates, inflation, trade cycles, and overall business fluctuations.

Definitions of Macroeconomics

J. L. Hansen: "Macro economics is that branch of economics which considers the relationship between large aggregates such as the volume of employment, total amount of savings, investment, national income etc."
Prof. Carl Shapiro: "Macro economics deals with the functioning of the economy as a whole."

Scope of Macroeconomics

Theory of Income and Employment:
- Explains how national income and total employment levels are determined, and what factors cause fluctuations in aggregate output, income, and employment.
- Analyzes the Consumption Function and Investment Function.
- Integrates the Theory of Business Cycles as a core component.
Theory of General Price Level and Inflation:
- Demonstrates how the general price level across the economy is determined.
- Analyzes the causes and consequences of macroeconomic fluctuations in price levels, specifically inflation and deflation.
Theory of Growth and Development:
- Examines economic mechanisms driving growth and long-term economic development.
- Pinpoints the underlying causes of economic underdevelopment and poverty, proposing macroeconomic strategies to accelerate growth.
Macro Theory of Distribution:
- Evaluates the relative distribution shares of total national income allocated to Land, Labour, Capital, and Entrepreneurship (i.e., aggregate shares of rent, wages, interest, and profit).

Features of Macroeconomics

Study of Aggregates: Focuses on the whole economy through aggregate variables such as national income, aggregate output, national employment, general price level, and economic business cycles.
Income Theory: Studies national income concepts, structural elements, social accounting, and measurement techniques. It analyzes aggregate demand and aggregate supply to explain fluctuations leading to inflation or deflation.
General Equilibrium Analysis: Analyzes the behavior and functional relationships of large aggregate variables across the entire economy, evaluating how total demand, total supply, and overall prices achieve equilibrium simultaneously.
Interdependence: Accounts for systemic interrelationships among aggregate variables. For instance, changes in total investment lead to changes in national income, which subsequently alter national output, aggregate employment, and the overall rate of economic growth.
Lumping Method: Analyzes the aggregate economy in its entirety rather than dividing it into individual components. As Prof. Boulding stated: "Forest is an aggregation of trees but it does not reveal the properties of an individual tree."
Growth Models: Formulates theoretical growth models used to analyze economic development strategies (e.g., the Mahalanobis growth model, which prioritized heavy capital goods industries).
General Price Level: Focuses on the determination of and changes in the general price level, defined as the average of all prices of goods and services currently produced in the economy.
Policy-oriented: Following Keynesian principles, macroeconomics is a policy-oriented science that devises actionable policies to encourage economic growth, generate aggregate employment, curb inflation, and pull economies out of depressions.

Importance of Macroeconomics

Functioning of an Economy: Provides critical insights into the operational mechanics of large, complex economic systems and the behavioral patterns of aggregative economic variables.
Economic Fluctuations: Analyzes the fundamental causes of economy-wide fluctuations in income, output, and employment, assisting policymakers in mitigating their severity.
National Income: Provides essential methodologies for compiling national income statistics and social accounts, without which accurate economic policies cannot be formulated.
Economic Development: Provides theoretical framework for understanding severe economic problems in developing nations, including widespread poverty, income and wealth inequality, and standard-of-living disparities.