Differences Between Micro And Macro Economics Economics Essay

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I have read and understood NCC Education’s Policy on Academic Dishonesty and Plagiarism.

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Student ID/Registration number: 4-16-03-09-010

Name: Mahabuba Rahman

Centre Name: Daffodil Institute of IT

Module Name: Economics

Module Leader: Mr. Abdullah-Hil-Muntakim

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Due Date: 18th February, 2010

Student’s Signature: Mahabuba Rahman

Date of Submission: 17th February, 2010

Acknowledgement

At last, an arduous journey has come to an end. It was a great experience to make an assignment on economics. For the successful completion of the different areas in the process of writing the assignment, many people extended their helping hands and their practical thoughts as well. Without all those helps from different fields, it would not be possible to ease the entire process and make smooth works. In the first place, I want to express my heartiest gratitude to our respected teacher and mentor, Mr. Abdullah-Hil-Muntakim, for guiding us with necessary advices, whenever needed. This assignment is assigned by NCC Education UK. I would also like to thank NCC Education UK for providing me such an enjoyable assignment like this.

Mahabuba Rahman

Table of Content

Task1………………………………………. 01 to 05

Task2………………………………………. 06 to 14

Task3………………………………………. 15 to 17

Task4………………………………………. 18 to 21

Task5………………………………………. 22 to 24

References & Bibliography………… ….… 25

Task-1

What is Economics?

The Economist’s Dictionary of Economics defines economics as

“The study of the production, distribution and consumption of wealth in human society”.

Another definition of the subject comes from the economist Lionel Robbins, who said in 1935 that [1] 

“Economics is a social science that studies human behavior as a relationship between ends and scarce means which have alternative uses. That is, economics is the study of the trade-offs involved when choosing between alternate sets of decisions.” According to Adam Smith, Economics is a study of “an enquiry into the nature and causes of wealth of nations.”

J. S. Mills says, Economics is a study of “the practical science of the production and distribution of wealth”

Generally, Economics is a study of how people allocate their limited resources such as land, labor and capital to provide for their unlimited wants. [2] 

The basic economic problem is about scarcity and choice since there are only a limited amount of resources available to produce the unlimited amount of goods and services we desire.

In an economy, people have unlimited desire for goods and services i.e. unlimited wants, but the resources in the world are limited and so we cannot satisfy all our wants and are forced to choose as to which goods to produce.

Therefore, scarcity and choice or “limited resources and unlimited wants” sum up the basic economic problem.

We can summarize this idea into the following figure: [3] 

Limited Resources

Can be used to produce

Limited amount of goods & services.

Which then satisfy

Unlimited amount of people wants

FIG: Limited Resources and Unlimited wants

As we are faced with the problem of scarcity, there are 3 important economic decisions to be considered.

What goods and services to be produced and what quantity i.e. how much to be produced?

How or by what method goods and services should be produced?

For who are goods and services to be produced i.e. who are to enjoy the goods and services produced?

Opportunity Cost:

Opportunity cost is the cost we pay when we give up something to get something else. There can be many alternatives that we give up to get something else, but the opportunity cost of a decision is the most desirable alternative we give up to get what we want [4] .

Opportunity cost of satisfying a want is the next best alternative that has to be forgone (i.e. the cost of giving up something in order to obtain something else).

As for example, a person has $5 and he can spend on chocolate or chewing gum or a combination of both.

Price of a bar of chocolate = $0.50

Price of a bar of chewing gum =$0.20

Figure 1 Opportunity Cost

There are 6 attainable combinations available to him using all his money. Assuming that he is consuming 6 bars of chocolate and 10 bars of chewing gum, the opportunity cost of the 8th bar of chocolate is what he must give up in order to get that 8th bar, which in this case is 5 bars of chewing gum.

The line on the above diagram shows a constant opportunity cost of consuming 2 additional bars of chocolate is 5 bars of chewing gum.

Opportunity Cost is represented by the slope of that line. [5] 

In simple terms, opportunity cost of an action A is the next best alternative action B that you give up. For example, if you spend one hour in reading then you are actually giving up one hour of fishing which is say, your next best alternative use of that one hour. [6] 

Reading for an hour means giving up

So opportunity cost of “reading” is “fishing”.

Differences between Micro and Macro Economics

Macro- and microeconomics, and their wide array of underlying concepts, have been the subject of a great deal of writings. The field of study is vast; here is a brief summary of what each covers:

a)

.Microeconomics is the study of decisions that people and businesses make regarding the allocation of resources and prices of goods and services. This means also taking into account taxes and regulations created by governments. Microeconomics focuses on supply and demand and other forces that determine the price levels seen in the economy. For example, microeconomics would look at how a specific company could maximize its production and capacity so it could lower prices and better compete in its industry. [7] 

On the other hand, Macroeconomics is the field of economics that studies the behavior of the economy as a whole and not just on specific companies, but entire industries and economies. This looks at economy-wide phenomena, such as Gross National Product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, and price levels. For example, macroeconomics would look at how an increase/decrease in net exports would affect a nation’s capital account or how GDP would be affected by unemployment rate.

b)

Microeconomics deals with the economics of the firm, examples are Consumer’s Behavior and Production Theory. [8] 

Macroeconomics deals with the aggregates, examples are National Income Accounts and Inflation.

c)

Microeconomics (“small” economics), which examines the economic behavior of agents (including individuals and firms) Microeconomics looks at interactions through individual markets, given scarcity and government regulation. A given market might be for a product, say fresh corn, or the services of a factor of production. The theory considers aggregates of quantity demanded by buyers and quantity supplied by sellers at each possible price per unit. It weaves these together to describe how the market may reach equilibrium as to price and quantity or respond to market changes over time. [9] 

Macroeconomics (“big” economics), addressing issues of unemployment, inflation, monetary and fiscal policy for an entire economy. Macroeconomics examines the economy as a whole to explain broad aggregates and their interactions “top down,” that is, using a simplified form of general-equilibrium theory. Such aggregates include national income and output, the unemployment rate, and price inflation and sub aggregates like total consumption and investment spending and their components. It also studies effects of monetary policy and fiscal policy.

TASK-02

Demand Curve

In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule. [10] 

The demand curve is a graphical representation of the data in the demand schedule. It slopes downwards from left to right indicating that the quantity demanded increases as the price falls. [11] 

The table below is the demand schedule that lists the quantity of a commodity that would be demanded at various price levels with a given income. It shows the relationship between quantity, demanded and price.

Price

Quantity Demanded

50

0

40

1

30

2

20

3

10

4

Quantity

Price

50

40

30

20

10

Fig: Individual demand curve

1 2 3 4 5

Demand curves are used to estimate behaviors in competitive markets, and are often combined with supply curves to estimate the equilibrium price (the price at which sellers together are willing to sell the same amount as buyers together are willing to buy, also known as market clearing price) and the equilibrium quantity (the amount of that good or service that will be produced and bought without surplus/excess supply or shortage/excess demand) of that market

An example of a demand curve

In the diagram, the line labeled “D” shows a plot of that demand curve, say for blue jean prices and number of pairs demanded. Prices are P (in $) and quantity is Q (in number of product units) on this diagram. At a price of $75 (vertical axis), two pairs are demanded (Q on horizontal axis). As the price P on vertical axis is lowered from $75 to $50, the quantity demanded Q is increased from two pairs to three pairs of blue jeans. [12] 

Market Demand Curve: [13] 

The market demand curve is the curve related to the demand of the commodity demanded by the group of people to that different price.

How a market demand curve is derived:

The market demand curve is the horizontal summation of individual demand curves. Individual demand is the key initiator of the production process. It is independent of all factors other than the preference curve, prices and income constraint. The law of demand: lower the price, greater amount demanded, i.e. demand curve is negatively sloped

Fig: Market Demand Curve

Market Demand Schedule and Curve: [14] 

Market demand is the total demand of all the consumers for particular goods. It can also be derived by the lateral summation of the consumer’s demand curves.

Price($)

Market Demanded

Buyer A

Buyer B

80

0

2

2

70

0

3

3

60

0

4

4

50

1

5

6

40

2

6

8

30

3

7

10

20

4

8

12

10

5

9

14

The following demand curve is drawn on the basis of the data for buyer ‘A’, given in the above table.

P

80 0

70

60

50

40

30

20

10 5

0 1 2 3 4 5 6 Q

Fig: A’s Demand Curve

The following demand curve is drawn on the basis of the data for buyer ‘B’, given in the above table. In this graph the price values are set up in the X-axis and the quantity values are set up along Y-axis.

P

2

80

70

60

50

40

30

20

10 9

0 1 2 3 4 5 6 7 8 9 Q

Fig: B’s Demand Curve

Following is the Fig. of a market Demand Curve: [15] 

P

80 (0+2) =2

70

60

50

40

30

20

10 (5+9) =14

0 1 2 3 4 5 6 7 8 9 10 12 14 Q

Fig: Market Demand Curve

The market demand curve is a graph drawn by the combination of the above demand curves. The market demand value is calculated from the demand of buyer ‘A’ and buyer ‘B’. The market demand values are aggregated values for the values of buyer ‘A’ and buyer ‘B’. We have calculated the values in the above table.

In this graph the price values are set up along X-axis and the quantity values are set up along Y-axis.

A Firm’s Output Decision in the short-run:

The short run is a period of time for which two conditions hold:

The firm is operating under a fixed scale (fixed factor) of production, and

Firms can neither enter nor exit an industry.

In the short run, all firms have costs that they must bear regardless of their output. These kinds of costs are called fixed costs.

Costs in the Short Run: [16] 

Fixed cost is any cost that does not depend on the firm’s level of output. These costs are incurred even if the firm is producing nothing.

Variable cost is a cost that depends on the level of production chosen.

TC= TFC+ TVC

Total Cost = Total Fixed Cost + Total Variable Cost.

250

1,000

4

200

1,000

5

333

1,000

3

(2)

TFC

(3)

AFC (TFC/q)

500

1,000

2

1,000

1,000

1

$ €­€­

€¤€±€¬€°€°€°

0

(1)

q

AFC falls as output rises; a phenomenon sometimes called spreading overhead [17] 

In the above figure, when the firm’s production is 0 it has to occur $1000 as a fixed cost. And at the production level of 3 or 5 units, the firm has to occur the same amount of fixed cost. So with increase in the number of production units the average fixed cost is reduced.

Output Decisions:

In the short run, a competitive firm faces a demand curve that is simply a horizontal line at the market equilibrium price. [18] 

A Firm’s Output Decision in the long-run:

Firms expand in the long-run when increasing returns to scale are available. [19] 

Output Decisions:

In a decreasing cost industry, costs decline as a result of industry expansion, and the LRIS is downward-sloping. [20] 

In an increasing cost industry, costs rise as a result of industry expansion, and the LRIS is upward-sloping. [21] 

TASK-3

How an equilibrium price and equilibrium quantity is achieved?

We often show the market equilibrium through a supply and demand diagram shown below. This figure is a combination of the supply curve and the demand curve. Combining two graphs is possible because they are drawn with exactly the same units on each axis.

We find the market equilibrium by looking for the price at which quantity demanded equals quantity supplied. The market equilibrium price comes at the intersection of the supply and demand curve, at the intersecting point. At a particular price, at the intersecting point, firms willingly supply what consumers willingly demanded. When the price is too low, less the price of the intersecting point, quantity demanded exceeds quantity supplied. [22] 

Figure 1: Market Equilibrium Comes at the Intersection of Supply and Demand Curves

A competitive market is in equilibrium if, at the current market price, the number of units that consumers wish to buy equals the number of unit’s producers wished to sell. In other words, market equilibrium occurs where quantity demanded equals quantity supplied. At the equilibrium price, P*, the equilibrium quantity is Qd=Qs=Q*, where Qd is the quantity demanded and Qs is the quantity supplied. The asterisk indicates equilibrium.

In a competitive market, this equilibrium is found at the intersection of the supply and demand curves. There are no storage or surpluses at the equilibrium price.

The effects of excess supply on market equilibrium:

Market equilibrium is the situation, where at a certain price level, the quantity supplied and the quantity demanded of a particular commodity are equal. Thus, the market can clear, with no excess supply or demand, and there is no tendency to change in either price or quantity.

The equilibrium price and quantity will be changed if there is a shift in either or both of the supply or demand curve. Shifts in the supply and demand curves are caused by changes in conditions behind supply and demand – not price changes.

An increase or decrease in supply will also affect the equilibrium position. An increase in supply shifts the supply curve to the right, thus lowering equilibrium price while raising equilibrium quantity. A decrease in supply, which shifts the supply curve to the left, however, raises equilibrium price and lowers equilibrium quantity.

In Figure 2, the quantity supplied at price 0P1 (0Q2) exceeds the quantity demanded. Thus, we have a situation of excess supply or a glut in the market. In order to remove excess supply, sellers will offer to sell at a lower price. The fall in the price results in an expansion of demand, and a contraction in supply (movement along the curves towards the equilibrium point). This will continue to occur as long as there is excess supply, until we reach the intersection of supply and demand, where at price 0Pe, the market clears, that is, the quantity supplied and demanded is equal. [23] 

Figure 1: Excess supply situation

The effects of   excess demand on market equilibrium:

Diagrammatically, market equilibrium occurs where the demand and supply curves intersect, at the point where the quantity demanded is exactly equal to the quantity demanded. Let us first consider the case where there is excess demand, where the current price is below that of equilibrium, as shown in Figure 2: [24] 

Figure 2: Excess demand situation

Figure 2 reveals that at price 0P1, the quantity demanded (0Q2) exceeds the quantity supplied (0Q1). Competition among buyers for the limited quantity of goods available means that consumers will start bidding up the price. The rise in the price results in an expansion in supply and a contraction in demand (movement along the curves towards the equilibrium point). This will continue to occur as long as there is excess demand. Eventually, we will reach the intersection of the supply and demand curves, where at price 0Pe, the quantity supplied 0Qe exactly equals the quantity demanded by consumers.

In conclusion, the market forces of supply and demand interact to bring about the equilibrium price, clearing the market of excess demand or supply. In this way, it is said that the market mechanism achieves consistency between the plans and outcomes for consumers and producers without explicit coordination.

Task-4

Perfect Competition:

In neoclassical economics and microeconomics, perfect competition describes a market in which there are many small firms, all producing homogeneous goods. In the short term, such markets are productively inefficient as output will not occur where marginal cost is equal to average cost, but allocatively efficient, as output under perfect competition will always occur where marginal cost is equal to marginal revenue, and therefore where marginal cost equals average revenue. However, in the long term, such markets are both allocatively and productively efficient. In general a perfectly competitive market is characterized by the fact that no single firm has influence over the price of the product it sells. Because the conditions for perfect competition are very strict, there are few perfectly competitive markets. [25] 

A perfectly competitive market may have several distinguishing characteristics, including:

Infinite Buyers/Infinite Sellers – Infinite consumers with the willingness and ability to buy the product at a certain price, Infinite producers with the willingness and ability to supply the product at a certain price.

Zero Entry/Exit Barriers – It is relatively easy to enter or exit as a business in a perfectly competitive market.

Perfect Information – Prices and quality of products are assumed to be known to all consumers and producers

Transactions are Costless – Buyers and sellers incur no costs in making an exchange.

Firms Aim to Maximize Profits – Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.

Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers

Characteristics of Perfect Competition: [26] 

Large number of sellers.

Only homogeneous products are for sale.

Firms are allowed to enter and exit freely.

Perfect mobility of factors.

Perfect knowledge of all market situations.

Absents of transport cost.

The Fig of Perfect Competition is given below: [27] 

Oligopoly:

In economics, an oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). The word is derived, by analogy with “monopoly”, from the Greek oligoi ‘few’ and poleein ‘to sell’. Because there are few sellers, each oligopolistic is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolistic needs to be taken into account as a likely response of the other market participants. [28] 

This causes oligopolistic markets and industries to be a high risk for collusion. [29] 

Oligopoly is a common market form. As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. [30] 

In short, Oligopoly is a situation in which a particular market is controlled by a small group of firms. [31] 

In other words, Oligopoly is the state of limited competition between few producers or sellers.

Characteristics of Oligopoly: [32] 

Only few companies in the market.

Sell either homogenous products or differentiated products.

Barriers of entry exist.

Mutual interdependence in decision-making

Non-price competition exists.

An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market.

Kinked demand curve is a demand curve made up of two parts; it’s suggested oligopolistic follow each reductions, but not price rises.

Kinked demand curve can be used to explain why prices in oligopolistic markets are often rigid or stable for relatively long periods of time. Price Rigidity is a condition where one follows a decrease in price but not an increase in price. This is due to the ability of other firms to match prices with it and it often leads to a kinked demand curve. [33] 

Task-5

Keynesian economics:

Keynesian economics (also called Keynesianism Theory) is a macroeconomic theory based on the ideas of 20th-century British economist John Maynard Keynes. Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. The theories forming the basis of Keynesian economics were first presented in The General Theory of Employment, Interest and Money, published in 1936; the interpretations of Keynes are contentious, and several schools of thought claim his legacy. [34] 

Keynesian economics advocates a mixed economy-predominantly private sector, but with a large role of government and public sector-and served as the economic model during the latter part of the Great Depression, World War II, and the post-war Golden Age of Capitalism, 1945-1973, though it lost some influence following the stagflation of the 1970s. As a middle way between laissez-faire capitalism and socialism, it has been and continues to be attacked from both the right and the left. The advent of the global financial crisis in 2007 has caused resurgence in Keynesian thought. Keynesian economics has provided the theoretical underpinning for the plans of President Barack Obama, Prime Minister Gordon Brown and other global leaders to rescue the world economy.

Keynesian economics An approach to economic theory and policy derived from the influential writings of the English economist John Maynard Keynes (1883-1946). Prior to Keynes, governments tended to be guided by the argument of laissez-faire economics that an unregulated economy would tend to move towards full employment, and thence equilibrium.

Keynes argued (in The General Theory of Employment, Interest and Money, 1936) that equilibrium could be established before that point was reached, and therefore that governments wishing to achieve full employment had actively to intervene in the economy by stimulating aggregate demand; and, conversely, that if full employment resulted in inflation they should act to reduce aggregate demand, in both cases by using the devices of tax (fiscal) policy, government expenditure, and monetary policy (changes in interest rates and the supply of credit). Keynesianism, though forming the basis of economic policy in most Western societies for three decades after the Second World War, was itself challenged by the appearance of stagflation (simultaneous recession and inflation) in the 1970s, and consequently by the economic theories of monetarism. The dispute between these two approaches currently forms the major axis of disagreement within modern economics. [35] 

Monetarist Economics:

The Monetarists’ theory is a development of earlier Classical theoretical work. Their main contribution is in updating many of these ideas to fit them into a more modern context.