Microeconomics

Definition: Microeconomics is the study of individuals, households and

firms' behavior in decision making and allocation of resources. It
generally applies to markets of goods and services and deals with
individual and economic issues.

Description: Microeconomic study deals with what choices people

make, what factors influence their choices and how their decisions
affect the goods markets by affecting the price, the supply and
demand.

It is the study of decisions made by people and businesses regarding

the allocation of resources and prices of goods and services. It also
takes into account taxes and regulations created by governments.

Microeconomics focuses on supply and demand and other forces that

determine the price levels in the economy. It takes what is referred to
as a bottom-up approach to analyzing the economy. In other words,
microeconomics tries to understand human choices and resource
allocation.

Having said that, microeconomics does not try to answer or explain

what forces should take place in a market. Rather, it tries to explain
what happens when there are changes in certain conditions.

For example, microeconomics examines how a company could

maximize its production and capacity so that it could lower prices and
better compete in its industry. A lot of microeconomic information can
be gleaned from the financial statements.
Microeconomics involves several key principles including :

 Demand, Supply, and Equilibrium: Prices are determined by the

theory of supply and demand. Under this theory, suppliers offer
the same price demanded by consumers in a perfectly
competitive market. This creates economic equilibrium.
 Production Theory: This is the study of production.
 Costs of Production: According to this theory, the price of goods
or services is determined by the cost of the resources used during
production.
 Labor Economics: This principle looks at workers and employers,
and tries to understand the pattern of wages, employment,
and income.

Macroeconomics
Definition: Macroeconomics is the branch of economics that studies
the behavior and performance of an economy as a whole. It focuses on
the aggregate changes in the economy such as unemployment, growth
rate, gross domestic product and inflation.

Description: Macroeconomics analyzes all aggregate indicators and the

microeconomic factors that influence the economy. Government and
corporations use macroeconomic models to help in formulating of
economic policies and strategies.

Macroeconomics focuses on aggregates which is why it is used by

governments and their agencies to construct economic and fiscal
policy. Investors of mutual funds or interest rate-sensitive securities
should keep an eye on monetary and fiscal policy. Outside of a few
meaningful and measurable impacts, macroeconomics doesn't offer
much for specific investments.
MICROECONOMICS vs. MACROECONOMICS

 Microeconomics studies individuals and business decisions,

while macroeconomics analyzes the decisions made by countries
and governments.
 Microeconomics focuses on supply and demand, and other forces
that determine price levels, making it a bottom-up approach.
 Macroeconomics takes a top-down approach and looks at the
economy as a whole, trying to determine what the economy
should look like.
 Investors can use microeconomics in their investment decisions,
while macroeconomics is an analytical tool mainly used to craft
economic and fiscal policy.

Economics: Methods, Types and Models!

Methods:

The usual methods of scientific studies — deduction and induction, are

available to the economist.

Both methods come from science, viz., Logic. The deductive method
involves reasoning from a few fundamental propositions, the truth of
which is assumed. The inductive method involves collection of facts,
drawing conclusions from them and testing the conclusions by other
facts.

Deduction and Induction:

Deduction:

i. Starts from the general and moves to the particular.

ii. Begins with general assumptions and moves to particular

conclusions.
iii. Develops a theory, and then examines the facts to see if they follow
the theory.

Induction:

i. Starts from the particular and moves to the general.

ii. Begins with particular observations and moves to general

explanations.

iii. Collects observations, then develops a theory to fit the facts.

Positive and Normative Economics:

Positive economics deals with what is i.e., with objective explanations

of the working of the economy. Normative economics is about what
ought to be i.e., it puts forward views based on personal value
judgments. Thus, positive economics deals with questions which, in
principle at least, are testable.

Similarly, ‘A tax on a good will raise its price’ and ‘Business people will
invest more when interest rates are low’, are positive statements about
economics. Normative statements would include ‘the Governments
ought to give more pensions to retired people in poor countries’, and
‘Unemployment is a more serious problem than inflation’.

Positive statements and questions

Examples: ‘Amitabh Bachchan is a Hindi actor’;

‘Is this table made of wood?’

Normative statements and questions:

Examples:

‘Amitabh Bachchan is the best Hindi actor since ‘Dilip Kumar’. ‘Is this a
beautiful table?’

Equilibrium (INTRODUCTION)

Consumers and producers react differently to price changes. Higher

prices tend to reduce demand while encouraging supply, and lower
prices increase demand while discouraging supply.

Economic theory suggests that, in a free market there will be a single

price which brings demand and supply into balance, called equilibrium
price. Both parties require the scarce resource that the other has and
hence there is a considerable incentive to engage in an exchange.

In its simplest form, the constant interaction of buyers and sellers

enables a price to emerge over time. It is often difficult to appreciate
this process because the retail prices of most manufactured goods are
set by the seller. The buyer either accepts the price or does not make
the purchase. While an individual consumer in a shopping mall might
haggle over the price, this is unlikely to work, and they will believe they
have no influence over price. However, if all potential buyers haggled,
and none accepted the set price, then the seller would be quick to
reduce price. In this way, collectively, buyers have influence over
market price. Eventually a price is found which enables an exchange to
take place. A rational seller would take this a step further, and gather as
much market information as possible in an attempt to set a price which
achieves a given number of sales at the outset. For markets to work, an
effective flow of information between buyer and seller is essential.
Market clearing

Equilibrium price is also called market clearing price because at this

price the exact quantity that producers take to market will be bought
by consumers, and there will be nothing ‘left over’. This is efficient
because there is neither an excess of supply and wasted output, nor a
shortage – the market clears efficiently.

How is equilibrium established?

When the supply and demand curves intersect, the market is in

equilibrium. This is where the quantity demanded and quantity
supplied are equal. The corresponding price is the equilibrium price or
market-clearing price, the quantity is the equilibrium quantity.

Market equilibrium refers to the stage where the quantity demanded

for a product is equal to the quantity supplied for the product.

The price when the quantity demanded is equal to the quantity

supplied for the product is known as equilibrium price.

Equilibrium price is also termed as market clearing price, which is

referred to a price when there is neither an unsold stock nor an
unsupplied demand.

The market price refers to a current price at which a product is sold in

the market. It is determined by the collaboration of two functions,
namely, demand and supply. According to economic theory, the market
price of a product is determined at a point where the forces of supply
and demand meet. The point where the forces of demand and supply
meet is called equilibrium point. Conceptually, equilibrium means state
of rest. It is the stage where the balance between two opposite
functions, demand and supply is achieved.
The equilibrium price of a product is determined when the forces of demand and
supply meet. For understanding the determination of market equilibrium price,
let us take the example of talcum Powder shown in Table-10. In Table-10 we have
taken the initial price of talcum powder as Rs. 100.

In this case, the quantity demanded is 80,000, while the supply is 10,000. This
results in the shortage of 70,000 of talcum powder in the market. Due to this
shortage, the sellers get a chance to earn more by increasing the price of the
talcum powder and consumers are ready to purchase at the price quoted by
sellers due to shortage of talcum powder.

This increase in profit results in increase in the production of a product to earn

more profit, which, in turn, increases the supply of the product. The process of
increase in prices goes on till the price of talcum powder reaches to Rs. 300. At
this price, the demand and supply is equal to 40,000. Therefore, equilibrium is
achieved and the equilibrium price is Rs. 300.

The graphical representation of equilibrium of demand and supply is shown in Figure

***(REFER TO THIS ONLY FOR UNDERSTANDING THE CONCEPT. REFER TO THECLASS NOTES FOR
EXPLAINING THE MARKET EQUILIBRIUM AND SHIFTS IN EQUILIBRIUM)

Shifts in Market Equilibrium:

If there is a shift in supply or demand curve, then the equilibrium point also gets
shifted.

The shift in demand curve and equilibrium is shown in Figure-21:

In Figure-21, initially the equilibrium price is found at PQ and quantity at OQ.

However, when the demand curve shifted from DD to D1D1, then equilibrium also
shifts from PQ to MN. Now, the equilibrium price is at MN and the quantity is at
ON. In this case, the supply does not show any changes. It can also be interpreted
from Figure-21 that the equilibrium price has increased with an increase in
quantity, when demand curve shifts.

The shift in supply curve and equilibrium is shown in Figure-22:

In Figure-22, initially the equilibrium price is found at PQ and quantity at OQ.
However, when the supply curve shifted from SS to S1S1, then equilibrium also
shifts from PQ to MN. Now, the equilibrium price is at MN and the quantity is at
ON. In this case, the demand does not show any changes. It can also be
interpreted from Figure-22 that the equilibrium price has decreased and quantity
has increased, when supply curve shifts.

Now, let us determine the effect of simultaneous shifts in the demand and supply
curve on the equilibrium point. It basically depends on the extent of shift in the
demand and supply curves. In case the shift in supply curve is greater than the
demand curve, then equilibrium price decreases and output increases.

It can be better explained with the help of Figure-23:

In Figure-23, initially equilibrium position. E1 is obtained by balancing demand

curve, D1D1 and supply curve, S1S1. Equilibrium price at E1 is P1 and quantity is
OQ1. When the demand curve shifts from D1D1 to D2D2 and supply curve shifts
from S1S1 to S3S3, then equilibrium also shifts from E1 to E3.
In this case, supply shift is greater than the shift in demand; therefore,
equilibrium price falls down to PO and output increases to OQ3. However, if the
shift in demand and supply curve is equal that is D2D2 and S2S2 respectively, then
the equilibrium price remain constant and output increases to Q2.

In case, shift in demand curve is greater than the shift in supply curve, then the
both, equilibrium price and quantity, increase, as shown in Figure-24:

In Figure-24, initially equilibrium position, E1 is obtained by balancing the demand

curve, D1D1 and supply curve, S1S1. Equilibrium price at E1 is P1 and quantity is
OQ1. When the demand curve shifts from D1D1 to D2D2 and supply curve shifts
from S1S1 to S2S2, then equilibrium also shifts from E1 to E2. In this case,
demand shift is greater than the shift in supply; therefore, equilibrium price
increases to P2 and output increases to OQ2.
***(PRACTICE ALL THE NUMERICALS OF MARKET EQUILIBRIUM)

CONSUMER SURPLUS
The amount consumers actually spend is determined by the market price they
pay, P, and the quantity they buy, Q - namely, P x Q, or area PBQC. This means
that there is a net gain to the consumer, because area ABQC is greater that area
PBQC. This net gain is called consumer surplus, which is the total benefit, area
ABQC, less the amount spent, area PBQC. Hence ABQC - PBQC = area ABP.

PRODUCERS’ SURPLUS

Producer surplus is the additional private benefit to producers, in terms of profit,

gained when the price they receive in the market is more than the minimum they
would be prepared to supply for. In other words they received a reward that
more than covers their costs of production.

The producer surplus derived by all firms in the market is the area from the supply
curve to the price line, EPB.