Report on

Microeconomics and Macroeconomics

Reshmy Raphy | 1150100545 | Sec B | SPA Vijayawada

Assignment I - 13 August 2019

The economic theory can be applied to diverse real-life situations, but most of
these are instances of the two divisions into which the economic theory has been
categorised. These are Macroeconomics and Microeconomics.

The term macro means large. Thus macroeconomics is concerned with the
economy as a whole entity and deals with generic problems of the economy like
inflation, poverty etc. Macroeconomics is the study of aggregates and concludes
the general effect on the economy as a whole, due to the summed up changes of
various processes determining the state of the economy.

The term micro means small. Hence microeconomics focuses on individual building
blocks of the economy. The subject matter here is concerned with the individual
units in an economy, like the market demand for the particular product. It applies
economic concepts at the smallest levels of the economy and as a result,
increases our understanding of the functioning of an economy.

For example, it deals with the price of a commodity, supply of a product etc. These
two forces govern all the processes that microeconomic theory deals with. It
assumes that all macroeconomic variables like national income, savings, etc are
constant. The most important tools in the microeconomic toolbox are – demand
and supply.

Central Problems of the Economy

The economic problem (scarcity of resources in comparison to unlimited human

wants) results in some basic problems that every economy faces. Every economy
has to choose as to how to allocate these scarce resources for fulfilment of wants.
The three central problems of an economy are :

What to produce

Resources are scarce in nature and they also have various alternate uses. Hence
an economy needs to decide the wants that it needs to fulfil and in this process
allocate the resources for the fulfilment of the chosen wants. When an economy
decides to allocate a resource towards one want, it does so by sacrificing another
want, that is, it chooses between various alternates for the ultimate goal of
maximum satisfaction.
More of one good generally means less of other good. After it selects the
commodities to be produced, the economy has to further decide the quantity in
which the chosen good have to be produced.

How to produce

Goods and services can be produced by employing various techniques. It involves

selection of the combined inputs to produce commodities. The techniques of
production can be classified generally as –

• Labour intensive technique  – In this production technique employs more

labour and less capital.

• Capital intensive technique  – In this production technique employs more

capital and less labour.
•
The kind of technique undertaken by an economy for production depends upon the
abundance of input in the economy. This means that if there are more people
available then labour-intensive technique will be employed and if more capital is
available then capital-intensive technique will be employed.

For example, the United States employs a capital-intensive technique because of

an abundance of capital and India employs a labour-intensive technique  because
of the abundance of labour.

For whom to produce

This problem is focused on the selection of people for whom goods and services
should be produced ( who will ultimately consume the produced commodities). This
problem is concerned with the distribution of income among the factors of
production.

Opportunity cost – The cost of what’s lost

Whenever we make a choice, we sacrifice what we might have gained by choosing

the next best alternative. Thus when an economy makes choices, it incurs a virtual
cost of the next best alternative foregone.  This concept of opportunity cost is the
true cost of making choices in economics.
For example, let us assume you have 10 rupees and you want to buy an ice cream
and a cold drink. But you can afford to buy only one of the two products. Suppose
you choose to buy an ice cream. Then the opportunity cost of your decision will be
the foregone satisfaction from a bottle of cold drink.

MACROECONOMICS

Macroeconomics takes the larger aspect of economics on its back. It is the study of
economics in regard to aggregates of an economy. It is the part of economic theory
that conceptualises the behaviour of aggregates  of the economy and considers
macro-phenomenon triggered by collective units of an economy.

It was earlier considered that concepts of microeconomics are sufficient enough to

explain economic  behaviours. But then it was observed that economic aspects
differed when applied to two different scales. The concepts of microeconomics
were not able to explain various phenomenon taking place at the highest level of
aggregation. In addition to this, there emerged various paradoxes that
microeconomics wasn’t able to explain.

For example, microeconomics explains that to earn maximum profit producers

should decrease supply when prices are low and increase supply when prices are
high, but if all individual suppliers decrease the supply of a commodity, then
collectively the overall supply would change, and this will have effects on income,
expenditure, taxation policies etc. Thus to overcome the shortcomings of
microeconomic theory, the macroeconomic theory came into existence which
focuses on aggregates and discusses the welfare of the economy as a whole.

MICROECONOMICS

The phenomenon of Demonetisation had occurred very recently. Although it was a

national event, even the smallest households were affected. The economics that
studies the behaviour of individuals is Microeconomics. 
What determines how households and individuals spend their budgets? What
combination of goods and services will best fit their needs and wants, given the
budget they have to spend? How do people decide whether to work, and if so,
whether to work full time or part time? How do people decide how much to save for
the future, or whether they should borrow to spend beyond their current means?

What determines the products, and how many of each, a firm will produce and sell?
What determines what prices a firm will charge? What determines how a firm will
produce its products? What determines how many workers it will hire? How will a
firm finance its business? When will a firm decide to expand, downsize, or even
close? In the microeconomic part of this book, we will learn about the theory of
consumer behaviour and the theory of the firm.

Macroeconomics vs Microeconomics

• Microeconomics deals with individuals whereas macroeconomics deals with

the economy as a whole entity consisting of collective individual units.

• Macroeconomics uses aggregate  demand and aggregate supply to explain

its concepts whereas microeconomics employs demand and supply.

• Macroeconomics focuses on the determination of income and employment in

the economy, on the other hand, microeconomics aims at the determination
of the price of a good or service and factors of production.

• In macroeconomics, the degree of aggregation is highest because while

dealing with the general aspects of the economy, factors have to be
aggregated completely. On the other side, the degree of aggregation in
microeconomics is limited.

• Macroeconomics is known as income theory. Microeconomics is also termed

as price theory.

It can be easily observed that micro and macroeconomics differ on the application
of economic theory to two different scales. Despite all these differences, both of
these are not mutually exclusive of each other. Macroeconomics is the aggregation
of economic behaviour by individual units. Microeconomic aspects can change with
changes in macroeconomic aspects and vice versa.