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Micro and Macro Economics
The termsµm icro- µ andµmacro-µ economics were first coined and used by Ragnar Fiscer in 1933.Micro-economics studies the
economic actions and behaviour of individual units and small groupsof individual units.In micro-economics, we are chiefly concerned
with the economic study of anindividual household, individual consumer, individual producer, individual firm, individual
industry,particular commodity, etc.Whereas, when we are analysing the problems of the economy as awhole, it is a macro-economic
study.In macro-economics, we do not study an individualproducer or consumer, but we study all the producers or consumers in a
particular economy.
Micro-Economics or Price Theory:
The termµmicro-economics¶ is derived from the Greek prefixµmicro¶, which means small or amillionth part.Micro-economic theory is
also known as µprice theory¶.It is an analysis of thebehaviour of any small decision-making unit, such as a firm, or an industry, or a
consumer, etc.For micro-economics, in contrast to macro economic theory, the statistics of total economicactivity are valueless as
far as providing clues to policy decisions.It does not give an idea of thefunctioning of the economy as a whole.An individual industry
may be flourishing, whereas theeconomy as a whole may be suffering.
In respect of employment, micro-economics studies only the employment in a firm or in anindustry and does not concern to the
aggregate employment in the whole economy.In thecircular flow of economic activity in the community, micro-economics studies the
flow of economicresources or factors of production from the resource owners to business firms and the flow ofgoods and services
from the business firms to households.It studies the composition of suchflows and how the prices of goods and services in the flow
are determined.
A noteworthy feature of micro-approach is that, while conducting economic analysis on a microbasis, generally an assumption of µfull
employment¶ in the economy as a whole is made.On thatassumption, the economic problem is mainly that of resource allocation or
of theory of price.
Importance of Micro-Economics: Micro-economics occupies a very important place in the study
of economic theory.
1.Functioning of free enterprise economy: It explains the functioning of a free enterpriseeconomy.It tells us how millions of consumers and
producers in an economy takedecisions about the allocation of productive resources among millions of goods andservices.
2.Distribution of goods and services: It also explains how through market mechanism
goods and services produced in the economy are distributed.
3.Determination of prices: It also explains the determination of the relative prices of
various products and productive services.
4.Efficiency in consumption and production: It explains the conditions of efficiency both
in consumption and production and departure from the optimum.
5.Formulation of economic policies: It helps in the formulation of economic policies
calculated to promote efficiency in production and the welfare of the masses.
Thus the role of micro-economics is both positive and normative.It not only tells us how theeconomy operates but also how it should
be operated to promote general welfare.It is alsoapplicable to various branches of economics such as public finance, international
trade, etc.
Limitations of Micro-Economics: Micro-economic analysis suffers from certain limitations

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1.It does not give an idea of the functioning of the economy as a whole.It fails to analyse the aggregate employment level of the economy,
aggregate demand, inflation,gross domestic product, etc.
2.It assumes the existence of µfull employment¶ in the whole economy, which is
practically impossible.
Macro-Economics or Theory of Income and Employment:
The termµm acro- econom ics¶ is derived from the Greek prefixµm acro¶, which means a large part.Macro-economics is an analysis of
aggregates and averages of the entire (large) economy, suchas national income, gross domestic product, total employment, total
output, total consumption,aggregate demand, aggregate supply, etc.Macro-economics is the economic theory which looksto the
 statistics of a nation's total economic activity and holds that policy change designed to alterthese total statistical aggregates is the
way to determine economic policy and promote economicprogress.Individual is ignored altogether.Sometimes, national saving is
increased at theexpense of individual welfare.
It analysis the chief determinants of economic development, and the various stages andprocesses of economic growth.Different
macro-economic models of economic growth have beensuggested, one of which most famous is Harrod-Domar Model.It can be
applied to bothdeveloped and under-developed economies.
Importance of Macro-Economics:
1. It is helpful in understanding the functioning of a complicated economic system. Italso studies the functioning of global economy.With
growth of globalisation and WTOregime, the study of macro-economics has become more important.
2.It is very important in the formulation of useful economic policies for the nation to
remove the problems of unemployment, inflation, rising prices and poverty.
3.Through macro-economics, the national income can be estimated and regulated. Theper capita income and the people¶s living standard
are also estimated through macro-economic study.It explains the fluctuations in national income, per capita income, outputand
employment.
Limitations of Macro-Economics:
1.Individual is ignored altogether.For example, in macro-economics national saving isincreased through increasing tax on consumption,
which directly affects the consumerwelfare.
2.The macro-economic analysis overlooks individual differences.For instance, thegeneral price level may be stable, but the prices of food
grains may have gone spellingruin to the poor.A steep rise in manufactured articles may conceal a calamitous fall inagricultural
prices, while the average prices were steady.The agriculturists may beruined.While speaking of the aggregates, it is also essential
to remember the nature,composition and structure of the components.
Equilibrium
The term equilibrium has often to be used in economic analysis.In fact, Modern Economics issometimes called equilibrium
analysis.Equilibrium means a state of balance.When forcesacting in opposite directions are exactly equal, the object on which they
are acting is said to be ina state of equilibrium.
Types of Equilibrium

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Basically, there are three types of any equilibrium:
(a) Stable Equilibrium: There is stable equilibrium, when the object concerned, after
having been disturbed, tends to resume its original position.Thus, in the case of a stable
equilibrium, there is a tendency for the object to revert to the old position.
(b) Unstable Equilibrium: On the other hand, the equilibrium is unstable when a slight
disturbance evokes further disturbance, so that the original position is never restored.In thiscase, there is a tendency for the object
to assume newer and newer positions once there isdeparture from the original position.
(c) Neutral Equilibrium: It is neutral equilibrium when the disturbing forces neither bring it
back to the original position nor do they drive it further away from it.It rests where it has beenmoved.Thus, in the case of a neutral
equilibrium, the object assumes once for all a new positionafter the original position is disturbed.
When the word equilibrium is used to qualify the term value, then according to ProfessorSchumpeter, a stable equilibrium value is
an equilibrium value that if changed by a small amount,calls into action forces that will tend to reproduce the old value; a neutral
equilibrium value is anequilibrium value that does not know any such forces; and an unstable equilibrium value is anequilibrium
value, change in which calls forth forces which tend to move the system farther andfarther away from the equilibrium value.
In the following figure 2, the stable equilibrium is shown.When in equilibrium at point P, theproducer produces an output OM and
maximises his profits.In case the producer increases hisoutput to OM2 or decreases it to OM1, the size of profits is reduced.This
automatically brings inforces that tend to establish equilibrium again at P.
Figure 3 represents the case of unstable equilibrium.Initially the producer is in equilibrium atpoint P, where MR = MC and he is
maximising his profits.If now he increases his output to OM1,he would be in equilibrium output at point P1, where he will obtain
higher profits, because, at thisoutput, marginal revenue is greater than marginal cost.Thus there is no tendency to return to
theoriginal position at P.
Figure 4 represents the situation of neutral equilibrium.In this case, MR = MC at all levels ofoutput so that the producer has no
tendency to return to the old position and every time a newequilibrium point is obtained, which is as good as the initial one.

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Other Forms of Equilibrium
(a) Short-term and Long-term Equilibrium: Equilibrium may be short-term equilibrium or long-
term equilibrium as in case of short-term and long-term value.In the short-term equilibrium,supply is adjusted to change in demand
with the existing equipment or means of production,there being no time available to increase or decrease the factors of
production.However, in caseof long-term equilibrium, there is ample time to change even the equipment or the factors ofproduction
themselves, and a new factory can be erected or new machinery can be installed.
(b) Partial Equilibrium: Partial equilibrium analysis is the analysis of an equilibrium position for a
sector of the economy or for one or several partial groups of the economic unit corresponding to aparticular set of data.This analysis
excludes certain variables and relationship from the totalityand studies only a few selected variables at a time.In other words, this
method considers thechanges in one or two variables keeping all others constant, i.e., ceteris paribus (othersremaining the
same).The ceteris paribus is the crux of partial equilibrium analysis.
The equilibrium of a single consumer, a single producer, a single firm and a single industry areexamples of partial equilibrium
analysis.Marshall¶s theory of value is a case of partial equilibriumanalysis.If the Marshallian method (i.e., partial equilibrium analysis)
is to be effective, even in its
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own terms, when applied to a hypothetical and idealised market, it necessary that the marketshould be small enough so that its
inter-dependence with the rest of the hypothetical economycould be neglected without much loss of accuracy.
(i)
Consumer¶s Equilibrium: With the application of partial equilibrium
analysis, consumer¶s equilibrium is indicated when he is getting maximum aggregatesatisfaction from a given expenditure and in a
given set of conditions relating to priceand supply of the commodity.
(ii)
Producer¶s Equilibrium: A producer is in equilibrium when he is
able to maximise his aggregate net profit in the economic conditions in which he is
working.
(iii)
Firm¶s Equilibrium: A firm is said to be in long-run equilibrium when
it has attained the optimum size when is ideal from the viewpoint of profit and
utilisation of resources at its disposal.
(iv)
Industry¶s Equilibrium: Equilibrium of an industry shows that there is
no incentive for new firms to enter it or for the existing firms to leave it.This willhappen when the marginal firm in the industry is
making only normal profit, neithermore nor less. In all these cases; those who have incentive to change it have noopportunity and
those who have the opportunity have no incentive.
(c) General Equilibrium Analysis: Leon Walras (1834-1910), a Neoclassical economist, in his
book µElements of Pure Economics¶, created his theoretical and mathematical model of GeneralEquilibrium as a means of
integrating both the effects of demand and supply side forces in thewhole economy.Walras¶ Elements of Pure Economics provides a
succession of models, eachtaking into account more aspects of a real economy.General equilibrium theory is a branch of
theoretical microeconomics.The partial equilibrium analysis studies the relationship between
only selected few variables, keeping others unchanged.Whereas the general equilibriumanalysis enables us to study the behaviour
of economic variables taking full account of theinteraction between those variables and the rest of the economy.In partial equilibrium
analysis,the determination of the price of a good is simplified by just looking at the price of one good, andassuming that the prices of
all other goods remain constant.
General equilibrium is different from the aggregate or macro-economic equilibrium.Generalequilibrium tries to give an understanding
of the whole economy using a bottom-top approach,starting with individual markets and agents.Whereas, the macro-economic
equilibrium analysisutilises top-bottom approach, where the analysis starts with larger aggregates.In macro-economic equilibrium
models, like Keynesian type, the entire system is described by relativelyfew, appropriately defined aggregates and functional
relationships connecting aggregatevariables such as total consumption expenditure, total investment, total employment,
aggregateoutput and the like.In macro-economic analysis, many important variables and relationships tendto be disappeared in the
process of aggregation.
There are two major theorems presented by Kenneth Arrow and Gerard Debreu in the framework
of general equilibrium:
(i)
The first fundamental theorem is that every market equilibrium is Pareto optimal
under certain conditions, and
(ii)
The second fundamental theorem is that every Pareto optimum is supported by
a price system, again under certain conditions

UTU Economics Notes

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Uses of General Equilibrium
1.
To get an overall picture of the economy and study the problems involving the
economy as a whole or even large segments / sectors of it.
2.
It shows that the quantities of demanded goods / factors are equal to the quantities
supplied.Such a condition implies that there is a full employment of resources.
3.
It also provides with an ideal datum of economic efficiency.It brings out the fact thatlong-run competitive equilibrium is a standard
of efficiency for the entire economy.Onlywhen the competitive economy obtains general equilibrium shall its economic efficiencybe
at its peak and there shall be no further gains made by any reallocation of resources.
4.
General equilibrium also represents the state of optimum production of allcommodities, because there can be no over-
production or under-production under suchconditions.
5.
It also provides an insight into the way the multitudes of individual decisions are
integrated by the working of the price mechanism.It, therefore, solves the fundamental
problems of a free market economy, viz., what to produce, how to produce, how much
to produce, etc.This analysis shows that such decisions with regard to innumerable
consumers and producers are co-ordinated by the price mechanism.
6.
The general equilibrium analysis also gives us the clue for predicting the
consequences of an economic event.
7.
It also helps in the field of public policy.The formulation of a logically consistentpublic policy requires a complete understanding of
the various sector markets andaspects of individual decision-making units, and the impact of policy on the wholeeconomy.
Limitations of General Equilibrium Analysis
1.
The Walrasian general equilibrium system is essentiallyst at i c.It treats the coefficientof production as fixed.It considers the
supply of resources to be given and consistent. Italso takes tastes and preferences of the society as fixed.
2.
It ignores leads and lags, for it considers everything to happen instantaneously.It issupposed to work just in the same way as an
electric circuit does.In the real world, alleconomic events have links with the past and the future.
3.
Walrasian general equilibrium analysis is of little practical utility.It involvesastronomical volumes of calculations for estimating the
various quantities and practices.This makes its application practically impossible.Even the use of computers cannot beof much help
because such a system cannot aid in collecting and recording theinnumerable sets of prices and quantities that are required to
formulate these equations.The critics further argue that even if such a solution exists, the price mechanism may notnecessarily
cover it.
4.
Last but not least, the general equilibrium analysis falls to the ground as its star
assumption of perfect competition is contrary to the actual conditions prevailing in the
real world.

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General Disequilibrium (Keynesian Theory)
Neoclassical economics thinks in terms of a market system in which supply equals demand inevery market, so that no
unemployment could ever occur.But this is an assumption.Keynessuggests a market system in which Disequilibrium can occur in
some markets, including labourmarket, and in which the disequilibrium can spread contagiously from one market to another.Keynes¶
idea was that, when this spreading disequilibrium settles down, there would be a kind ofequilibrium ± not supply and demand
equilibrium, but often termed as µgeneral disequilibrium¶.
Take an example of a commodity, say cellular telephone sets, its equilibrium of demand and
supply is shown in the following figure:
In the above figure, MC curve is the marginal cost curve for the commodity.Originally, themarket is in equilibrium at price P1 with
demand curve D1.Then, for any reason, demand for thatcommodity decreases to D2, Neoclassical economists tells us that the new
equilibrium will be atprice P3.But, in fact, the prices do not drop quite that far, instead, prices drop to P2.Perhaps thisis because the
businessmen do not know just how far they need to cut their prices, and arecautious to avoid cutting too much.At a price P2, the
seller can sell only Qd amount of output.Byproducing Qd amount of output at price P2, the producers are not maximising their short-
run profit.We haveµdis equilibr ium ¶ in the sense that production is not on the marginal cost curve.At P2, thesellers can sell
Qd amount of output, but they cannot produce the same amount of output.Hereis a qualification.Producer might temporarily produce
more that Qd, in order to build up theirinventories.But there is a limit to how much inventories they want, so they will cut
theirproduction back to Qd eventually.
With a reduction of demand for cellular phones, any economist would expect a reduction in thequantity of that commodity
produced.Neoclassical economics leads us to expect that the pricewould drop to P3 and output cut back to Qe.At the same time, a
certain number of workers wouldbe laid off and would switch their efforts into their second best alternatives, working in
otherindustries, perhaps at somewhat lower wages.But the µdisequilibrium model¶ states that theproduction and layoffs would go
even further, with output dropping to Qd.A reduction in incomedoes not only reduce the demand for cellular phones, but it also
reduces the demand for all othernormal goods as well.This disequilibrium will spread contagiously through many different
goodsmarkets, through the effect of disequilibrium on income.So every other industry will face areduction in demand because of the
reductions in productions in many other industries.
Harrod Domar Growth Mode
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As we know that one of the principal strategies of development is mobilisation of domestic andforeign saving in order to generate
sufficient investment to accelerate economic growth.Theeconomic mechanism by which more investment leads to more growth can
be described in termsof Harrod-Domar growth model, often referred to as the AK model.
Every economy must save a certain proportion of the national income, if only to replace worn-outor impaired capital goods
(buildings, equipment, and materials).However, in order to grow, newinvestments representing net additions to the capital stock are
necessary.If we assume thatthere is some direct economic relationship between the size of the total capital stock, K, and totalGNP,
Y ± for example, if $3 of capital is always necessary to produce a $1 stream of GNP ± itfollows that any net additions to the capital
stock in the forms of new investment will bring aboutcorresponding increases in the follow of national output, GNP.This relationship
is known as
µcapital-output ratio¶ and is represented as µk¶.in the above case µk¶ is roughly 3:1.
If we further assume that the national savings ratioµS¶ is a fixed proportion of national output (e.g.6%) and that total new investment
is determined by the level of total savings.We can constructthe following simple model of economic growth:
·
Saving (S) is some proportion, s, of national income (Y) such that we have the
simple equation:
S
=
s .Y---------------------------- (i)
·
Net investment (I) is defined as the change in the capital stock,K, and can be
represented byǻK such that:
I
=
ǻK-----------------------------( ii)
But because the total capital stock,K, bears a direct relationship to total national income or
output,Y, as expressed by the capital-output ratio,k, it follows that:
K
=
k
Y
Or
ǻK
=
k
ǻY
Or
ǻK
=
k.ǻY-------------------------------( iii) >
·
Finally, because net national savings,S, must equal net investment, I, we can write
this equality as:
S
=
I
-------------------------------(iv)
But from equations (i), (ii) and (iii), we finally get the following equation:

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I
=
ǻK
=
k. ǻY
Therefore, we can rewrite the equation (iv) as follows:
S
=
s.Y
=
k.ǻY=
ǻK
=
I--------------- (v)
Or simply
s.Y
=
k.ǻY-----------------------------------(vi)
Dividing both the sides of equation (vi) firstY and then byk, we obtain the following expression:
ǻY
=
s-------------------------------------- (vii)
Y
k
Note that the left-hand side of the equation i.e., ǻY / Y represents the rate of change or rate of
growth in GNP (i.e., the percentage change in GNP).
The Harrod Domar Model, more specifically says that in the absence of government, the growthrate of national income will directly
or positively related to the savings ratio (i.e., the more aneconomy is able to save and invest out of a given GNP, the greater the
growth of that GNP willbe.Harrod Domar Model further states that the growth rate of national income will be inversely ornegatively
related to the economic capital-output ratio (i.e., the higher k is, the lower the rate ofGNP growth will be).
The additional output can be obtained from an additional unit of investment and it can bemeasured by the inverse of the capital-
output ratio,k, because this inverse,1 / k , is simply theoutput-capital or output-investment ratio.It follows that multiplying the rate of
new investment,s
= I / Y , by its productivity, 1 / k , will give the rate by which national income or GNP will increase.
For example, the national capital-output ratio in an under-developed country is, let say, 3 and theaggregate saving ratio (s) is 6% of
GNP, it follows that this country can grow ata rate of 2% (i.e.,6% / 3 ors / k or ǻY / Y).Now suppose that the national saving rate
increased from 6% to 15%through increased taxes, foreign aids, and / or general consumption sacrifices ± GNP growth canbe
transferred from 2% to 5% (15% / 3).
According to Rostow and other theorists, the countries that were able to save 15% to 20% ofGNP could grow at a much faster rate
than those that saved less.Moreover, this growth wouldthen be self-sustained.The mechanisms of economic growth and
development, therefore, aresimply a matter of increasing national savings and investment.
The main obstacle or constraint on development, according to this theory, was the relatively lowlevel of new capital formation in
most poor countries.But if a country wanted to grow at, let say,a rate of 7% per annum and if it could not generate savings and
investment at a rate of 21% (i.e.,7% × 3) of national income but could not only manage to save 15%, it could seek to fill this
savinggap of 6% through either foreign aid or private foreign investment.
Limitations of the model:
1.
Economic growth and economic development are not the same. Economic growth is a
necessary but not sufficient condition for development

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2.
Harrod Domar model was formulated primarily to protect the developed countries from
chronic unemployment, and was not meant for developing countries.
3.
Practically it is difficult to stimulate the level of domestic savings particularly in the
case of LDCs where incomes are low.
4.
It fails to address the nature of unemployment exists in different countries.In developedcountries, the unemployment is µcyclical
unemployment¶, which is due to insufficient effectivedemand; whereas in developing countries, there is µdisguised unemployment¶.
5.
Borrowing from overseas to fill the gap caused by insufficient savings causesd eb t
repayment problemslater.
6.
The law of diminishing returns would suggest that as investment increases the
productivity of the capital will diminish and the capital to output ratio rise.
The Harrod-Domar model of economic growth cannot be rejected on the ground of abovelimitations.With slight modifications and
reinterpretations, it can be made to furnish suitableguidelines even for the developing economies.
National Income Accounts
What is National Income Accounting?
National income accounting is a term which is applied to the description of the various types ofeconomic activities that are taking
place in the community in a certain institutional framework.Innational income accounting, we are concerned with statistical
classification of the economicactivity so that we are able to understand easily and clearly the operation of the economy as awhole.In
national income accounting the following distinctions are drawn between:
(a)forms of economic activity, namely, production, consumption, and accumulation of
wealth;
(b)sectors or institutional division of the economy; and
(c)types of transactions, such as sales and purchases of goods and services, gifts, taxes,
and other current transfers.
In national income accounting, a transactor is supposed to keep a set of three accounts in which
transactions are recorded:
(i)
In the first account, incomes and outgoings relating a productive activity of thetransactor are brought together.The difference
between the two shows the profit orgain.
(ii)
The second account seeks to show how this profit and any other income thataccrues to the transactor are allocated to
different uses.The excess of income overoutlay is saving.
(iii)
The third account shows how this saving and any other capital funds are used to
finance the capital expenditure or to give loans to other transactors
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Since in an economy, there are numerous transactors, therefore, they are grouped into sectors.In a sector, accounts of a same type
are consolidated.The µsector accounts¶ form the units in asystem of national income accounting.
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Both national income accounting system and individual income accounting system are
based on the method of double-entry book-keeping.Forexample, under individual income accounting, a cash sale is
recorded as a debit in CashAccount and as a credit in Sales Account.Whereas, in national income accounting, thecash
transactions are not separately presented.Cash balances are recorded in thecapital transaction account.The difference is
that the national income accounting doesnot record the second entry in detail.c
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cIndividual income accounts or private accountsrelate to an individual businessman
or a corporate firm.Whereas, the national income accounts are closely related to all the businessmen or corporate firms in
the community.
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Individual income accounts are usually presented in the formof a Profit and Loss Account or
Income Statement which shows the flow of income and itsallocation during a year.The Balance Sheet shows the stock of
assets and liabilities atthe end of the year.The Profit and Loss Account of a private businessman resembles innational
income accounting to what is called the Appropriation Account.The onlydifference is that in private accounting, the profit
often includes some elements of costssuch as depreciation on plant and machinery and fees paid to the directors of
thecompany.On the other hand, in national income accounting, these incomes are shownnet.There is no counterpart at all
of a Balance Sheet in national income accountingsince there is a great difficulty in collecting such a huge bank of data
accurately andcompletely especially on uniform basis.cc