Macroeconomics and Microeconomics: Chit Chat

 

CHIT-CHAT TIME         Commerce Heaven

(In this conversation after getting 1000 Rupees Khalid is going with his friend Tariq to purchase some articles)

Khalid: Hello Tariq, How are you?

Tariq: I am Fine Khalid. What about you?

Khalid: I am also fine. Yesterday, my mom gave me 1000 rupees as a gift on my birthday

Tariq: Oh! Wow! Great. So have you planned where you are going to spend 1000 Rupees?

 Khalid: Yes I have many options. I want to purchase novels, puzzle cube, Fancy bracelets and parker pen (Beta Gold). Will you come with me for shopping?

Tariq: Yeah sure. Let’s go.

Khalid: (At the Shop)

Uncle, please show me some interesting novels, Parker pens,
bracelets and puzzle cube.

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(Shopkeeper showing Khalid all the items demanded)

Tariq: Uncle, please tell me how much amount I have to pay for the items selected.

Shopkeeper: Son, Your bill is of Rs.1200.

(Khalid is bargaining with the shopkeeper, and finally paid 1000 rupees to shopkeeper)

Khalid: Thank you uncle, for this discount.

(Khalid is coming with his friend (Tariq) back to home)

Tariq: Have you ever wondered that if we add whole demand made in Pakistan by all the consumers what amount will it be?

Khalid: Hmm. It will be huge amount. Ok Bye. See you tomorrow.

(Khalid reached home and have conversation with his Baba)

Baba: Hello son, from where are you coming?

Khalid: Today I went to market to purchase some articles from the money I received on my birthday.

Baba: Okay Great! So what did you buy?

Khalid: Parker Pen, One bracelet and 2 novels. This cost Rs.1000 after bargaining.

Baba: Very nice.

Khalid: Dad if we add all the Purchases (demand) made by all consumers in Pakistan and whole of the Sale (supply) by all sellers in our country it will be huge amount. Does someone calculate that amount?

Baba: Yes. When you purchased these things and that seller sold these things. This Purchase and sale was made at Individual person’s level and Individual Firm’s level. This is a small (Micro) Level.

But when we talk about purchases and sales made in whole country then this will be at the Biggest (Macro) level.

Our government collects and uses this data.

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Let’s Understand

(1) MICROECONOMICS AND MACROECONOMICS

Economics is broadly divided into two parts. These are:

• Microeconomics
• Macroeconomics  

(a) MICROECONOMICS

Microeconomics is the study of the economic behavior of individuals, households and firms’ in decision making and allocation of resources.

Microeconomics is concerned with:

• Supply and demand in individual (Textile Market) markets
• Individual consumer behavior. e.g. Consumer choice theory
• Individual producer behavior.
• Individual labor markets, g. demand for labor wage determination in that individual market

(b) MACROECONOMICS

Macroeconomics is the branch of economics that deals with the behavior and performance of an economy as a whole.

It is generally the study of central issues like

• Employment
• The growth rate of National output
• GDP
• Inflation
• General Price level and stability

(2) VITAL COMPONENTS OF MICROECONOMICS

      (a)Theory of consumer behavior

This theory states that a rational Consumer allocates his income for the purchase of different goods and services with the aim to maximize his satisfaction.

      (b) Theory of Producer behavior

This theory states that a rational producer has to decide what to produce and how much with the aim of profit maximization.

      (c) Theory of Price

This is the theory which tells us how prices are determined in the market.

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Top 3 Macroeconomic Factors: GDP-Unemployment-Inflation

 

Macroeconomic factors overview:

The economy of any country, either good or bad, always depends on multiple macroeconomic factors. In order to understand how economies operate and how their performance could be improved, economists collect the economic data and then make an in-depth analysis to figure out the status of the economy.

When macroeconomists assess the health and development of the economy, they find many factors that could affect the economy, however, the most significant among these are GDP, unemployment, and inflation. 

In this article, we will discuss the above three macroeconomic factors and how they affect a regional or national economy. 

 

1-Gross domestic product (GDP)

GDP is the value of final goods and services produced within the borders of a specific country during a specific period, typically a year. This macroeconomic factor is quite useful as it tells us how an economy’s output is growing.

In other words, the GDP is the total output from all the sectors of an economy: 

• Primary sector (agriculture, mining, etc.) 
• Secondary sector (manufacturing and construction; and 
• Tertiary sector (services) 

GDP = C + I + G + (X- M) 

C = Consumption in the economy 

I = Investment in the economy 

G = Government spending in the economy

X = Exports from the economy 

M = Imports into the economy 

We can measure GDP in two ways, nominal GDP and real GDP. Nominal GDP is the value of GDP evaluated at current prices in a specific time period, this includes the impact of inflation and is normally higher than the GDP. 

Real GDP is an inflation-adjusted value of GDP. It expresses the value of goods and services produced in a country in base-year prices. Since it is an inflation-corrected figure, so it is an accurate indicator of economic growth.

 

How GDP affects the economy?

A growing GDP is a sign of a growing economy while declining GDP is a sign of a shrinking economy. Many economists prefer the ideal GDP growth rate between 2% to 3%. More or less from the above rate is not a good indicator of the sound economy.

The economy could suffer from a recession or slowdown if the GDP growth rate is lower than the above, while the higher rate of growth is also an alarming situation for the economy, it may cause price inflation and more unhealthy consequences.

 

2- Unemployment

The unemployment is defined as the state of being without employment and actively searching for work. Unemployment is a waste of resources and can have a high social cost in terms of poverty that might result from it. 

Normally, the longer a person is unemployed, the more difficult it is to find jobs. Likewise, more social problems are created by a large number of unemployed people than by a small number.

Unemployment has both micro and macro-level consequences. The true impact of unemployment will depend on two factors: The unemployment rate, and the duration of unemployment.

In the case of unemployment, the economy could experience various macroeconomic problems.

• Loss of output to the economy

Higher unemployment in the economy reduces the production of goods, consequently it lowers the GDP. This is what we call the opportunity cost of unemployment.

• Tax revenue declining

When salaried workers do not earn because of unemployment, they do not pay taxes. As we know tax revenue is the major source of national income for the economy, hence it adversely affects the economy.

• Increase in government expenditures

Government expenditures increase in case of higher unemployment because the government has to pay out benefits to the unemployed workforce for their support or we can call it unemployment compensation. 

Read about Types of Unemployment

 

3- Inflation

Inflation is a continuous or persistent rise in the general level of prices. When inflation occurs, each dollar of income will buy fewer goods and services than before. Inflation reduces the “purchasing power” of money. However, it does not mean that the prices of all goods are rising during inflation. Even during periods of rapid inflation, some prices may be relatively constant and others may even fall.

As a matter of fact, all prices in the economy are set by demand and supply. As a result, when the economy experiences inflation, we need to make an in-depth analysis in terms of supply and demand.

 

How inflation affects the economy?

Like unemployment, inflation has both micro and macro-level consequences. Inflation is another factor of macroeconomic uncertainty. Inflation can be a bad thing for the economy, particularly if it reaches high or even hyperinflation levels. Different types of inflation are likely to influence the economy in different ways.

The two major inflation impacts are:

• Redistribution of wealth among different social classes.
• Distortions in relative prices and output of various commodities, sectors, in the economy as a whole.

 

Final Thoughts

The above three macroeconomic factors as discussed—gross domestic product, unemployment, and inflation quantify the performance of the economy. Public and private decision-makers use these statistics to monitor changes in the economy and formulate appropriate policies accordingly. Economists use these macroeconomic factors to develop and test theories about how the economy works.

FEW TIPS FOR MA-ECONOMICS,EXTERNAL STUDENTS (URDU)

Production Possibility Frontier

A production possibility frontier (PPF) shows the maximum possible output combinations of two goods or services an economy can achieve when all resources are fully and efficiently employed

Opportunity Cost and the PPF

• Reallocating scarce resources from one product to another involves an opportunity cost

• If we increase our output of consumer goods (i.e. moving along the PPF from point A to point B) then fewer resources are available to produce capital goods

• If the law of diminishing returns holds true then the opportunity cost of expanding output of X measured in terms of lost units of Y is increasing. 

PPF and economic efficiency

• We normally draw a PPF on a diagram as concave to the origin i.e. as we move down the PPF, as more resources are allocated towards Good Y the extra output gets smaller – so more of Good X has to be given up in order to produce Good Y

• This is an explanation of the law of diminishing returns and it occurs because not all factor inputs are equally suited to producing items

PPF and diminishing returns

PPF and Economic Efficiency

Production Possibilities A production possibility frontier is used to illustrate the concepts of opportunity cost, trade-offs and also show the effects of economic growth. Points within the curve show when a country’s resources are not being fully utilised

Combinations of the output of consumer and capital goods lying inside the PPF happen when there are unemployed resources or when resources are used inefficiently. We could increase total output by moving towards the PPF

Combinations that lie beyond the PPF are unattainable at the moment

A country would require an increase in factor resources, an increase in the productivity or an improvement in technology to reach this combination.

Trade between countries allows nations to consume beyond their own PPF.

Producing more of both goods would represent an improvement in welfareand a gain in what is called allocative efficiency.

Concept of Liquidity Trap

In this article we will discuss about the concept of liquidity trap, explained with the help of a suitable diagram.

Liquidity trap refers to a situation in which an increase in the money supply does not result in a fall in the interest rate but merely in an addition to idle balances: the interest elasticity of demand for money becomes infinite. Under normal conditions an increase in money supply, resulting in excess cash balances, would cause an increase in bond prices, as individuals sought to acquire assets in exchange for money, and a corresponding fall in interest rates.

In such a situation, described by Keynes as liquidity trap, individuals believe that bond prices are too high and will therefore fall, and correspondingly that interest rates are too low and must rise They, therefore, believe that to buy bonds would be to incur a capital loss and as a result they hold only money. This means that an increase in the money supply merely increases idle balances and leaves the interest rate unaffected.

Keynes pointed out that during depression when the rate of interest is very low, the demand curve for money (or the liquidity preference curve) becomes completely elastic (horizontal). The rate of interest has fallen enough. It cannot fall further.

The horizontal portion of the liquidity preference curve is referred to as the liquidity trap. In this portion of the curve, the demand for money is infinitely elastic with re­spect to the interest rate. Re­ductions in the interest rate, in this portion only, increases people’s desire to hold cash balances.

The implication here is that any attempt to achieve the internal expansion through increased investment brought about by lowering the interest rates would fall, because any increase in the money supply created in order to reduce the rate of interest would be held in the form of cash balances, making it impossible to use interest rates (monetary policy) to expand the economy. See Fig. 7 which describes such a situation.

Keynes pointed out that the actual rate of interest cannot fall to zero because the expected rate cannot fall to zero. People’s expectations play a very important role in altering the rate of interest. Individuals’ views on the level of bond prices may be summarised in terms of their views about the interest rate.

Keynes’ theory assumes that each individual has his own view about the long-run equilibrium interest rate and that there corresponds to this a critical rate below which are individual holds only money and above which he holds only bonds. Clearly, if everyone is holding money as each one is in the liquidity trap then the current interest rate must be below the lowest critical rate situation.

However, in practice, there is no statistical evidence to support the existence of a liquidity trap. Furthermore, while the hypothesis rests on the view that expectations are regressive it offers no theory of precisely how these are formed.

5 Factors that Affect the Economic Growth of a Country

The term economic growth is associated with economic progress and advancement.

Economic growth can be defined as an increase in the capacity of an economy to produce goods and services within a specific period of time.

In economics, economic growth refers to a long-term expansion in the productive potential of the economy to satisfy the wants of individuals in the society. Sustained economic growth of a country’ has a positive impact on the national income and level of employment, which further results in higher living standards.

Apart from this, it plays a vital role in stimulating government finances by enhancing tax revenues. This enables the government to earn extra income for the further development of an economy. The economic growth of a country can be measured by comparing the level of Gross National Product (GNP) of a year with the GNP of the previous year. The economic growth of a country is possible if strengths and weaknesses of the economy are properly analyzed.

Economic analysis provides an insight into the essentials of an economy. It is a systematic process for determining the optimum use of scarce resources and selecting the best alternative to achieve the economic goal. Moreover, economic analysis helps in assessing the causes of different economic problems, such as inflation, depression, and economic instability. It is performed by taking into consideration various economic variables, such as demand, supply, prices, production cost, wages, labor, and capital.

Meaning of Economic Growth:

Economic growth can be defined as a positive change in the level of goods and services produced by a country over a certain period of time. An important characteristic of economic growth is that it is never uniform or same in all sectors of an economy For example, in a particular year, the telecommunication sector of a country has marked a significant contribution in economic growth whereas the mining sector has not performed well as far as the economic growth of the country- is concerned.

Economic growth is directly related to percentage increase in GNP of a country. In real sense, economic growth is related to increase in per capita national output or net national product of a country that remain constant or sustained for many years.

Economic growth can be achieved when the rate of increase in total output is greater than the rate of increase in population of a country. For example, in 2005-2006, the rate of increase in India’s GNP was 9.1%, while its population growth rate was 1.7%.

In such a case, per capita increase in GNP would be 7.4% (=9.1-1.7). On the other hand, if the rate of increase in GNP and population is same then the actual growth of GNP would be zero, which implies that there is a decrease in per capita income.

As a result, there would be no economic growth. Therefore, in such a case, standard of living of people would not improve even when there is an increase in the total output of a country. However, such a growth is better than the stagnation of an economy.

The economic growth of a country may get hampered due to a number of factors, such as trade deficit and alterations in expenditures by governmental bodies. Generally, the economic growth of a country is adversely affected when there is a sharp rise in the prices of goods and services.

Following are some of the important factors that affect the economic growth of a country:

(a) Human Resource:

Refers to one of the most important determinant of economic growth of a country. The quality and quantity of available human resource can directly affect the growth of an economy.

The quality of human resource is dependent on its skills, creative abilities, training, and education. If the human resource of a country is well skilled and trained then the output would also be of high quality.

On the other hand, a shortage of skilled labor hampers the growth of an economy, whereas surplus of labor is of lesser significance to economic growth. Therefore, the human resources of a country should be adequate in number with required skills and abilities, so that economic growth can be achieved.

(b) Natural Resources:

Affect the economic growth of a country to a large extent. Natural resources involve resources that are produced by nature either on the land or beneath the land. The resources on land include plants, water resources and landscape.

The resources beneath the land or underground resources include oil, natural gas, metals, non-metals, and minerals. The natural resources of a country depend on the climatic and environmental conditions. Countries having plenty of natural resources enjoy good growth than countries with small amount of natural resources.

The efficient utilization or exploitation of natural resources depends on the skills and abilities of human resource, technology used and availability of funds. A country having skilled and educated workforce with rich natural resources takes the economy on the growth path.

The best examples of such economies are developed countries, such as United States, United Kingdom, Germany, and France. However, there are countries that have few natural resources, but high per capita income, such as Saudi Arabia, therefore, their economic growth is very high. Similarly, Japan has a small geographical area and few natural resources, but achieves high growth rate due to its efficient human resource and advanced technology.

(c) Capital Formation:

Involves land, building, machinery, power, transportation, and medium of communication. Producing and acquiring all these manmade products is termed as capital formation. Capital formation increases the availability of capital per worker, which further increases capital/labor ratio. Consequently, the productivity of labor increases, which ultimately results in the increase in output and growth of the economy.

(d) Technological Development:

Refers to one of the important factors that affect the growth of an economy. Technology involves application of scientific methods and production techniques. In other words, technology can be defined as nature and type of technical instruments used by a certain amount of labor.

Technological development helps in increasing productivity with the limited amount of resources. Countries that have worked in the field of technological development grow rapidly as compared to countries that have less focus on technological development. The selection of right technology also plays an role for the growth of an economy. On the contrary, an inappropriate technology- results in high cost of production.

(e) Social and Political Factors:

Play a crucial role in economic growth of a country. Social factors involve customs, traditions, values and beliefs, which contribute to the growth of an economy to a considerable extent.

For example, a society with conventional beliefs and superstitions resists the adoption of modern ways of living. In such a case, achieving becomes difficult. Apart from this, political factors, such as participation of government in formulating and implementing various policies, have a major part in economic growth.

9 Most Important Properties of Indifference Curves

(1) A higher indifference curves to the right of another represents a higher level of satisfaction and preferable combination of the two goods. In Figure 6, consider the indifference curves I₁ and I₂ and combination N and A respectively on them.

Since A is on a higher indifference curve and to the right of N, the consumer will be having more of both the goods X and Y that is, OX1 + OY1 in relation to OX + OY. Even if the two points on these curves are on the same plane as M and A, the consumer will prefer the latter combination, because he will be having more of good X though the quantity of good Y is the same.

(2) In between two indifference curves there can be a number of other indifference curves, one for every point in the space on the diagram.

(3) The numbers I1, I2, I3, I4,………… etc. given to indifference curves are absolutely arbitrary. Any numbers can be given to indifference curves. The numbers can be in the ascending order of 1, 2, 4, 6 or 2, 3, 1, 4 etc. Numbers have no importance in the indifference curve analysis.

(4) The slope of an indifference curve is negative, downward sloping, and from left to right. It means that the consumer to be indifferent to all the combinations on the indifference curves must leave less units of good Y in order to have more of good X. To prove this property, let us take indifference curves contrary to this assumption. In Figure 7 (A) combination B of OX1 + OY1 is preferable to combination A which has a smaller amount of the two goods. Therefore, the indifference curve cannot slope upward from left to right. It is not an iso-utility curve.

Similarly, in Figure 7 (B) combination B is preferable to combination A for combination B has more of X and the same quantity of Y. So the indifference curve cannot be horizontal. In Figure 7 (C) the indifference curve is shown as vertical and again combination B is preferred to A as the consumer has more of Y and the same quantity of X. Therefore, the indifference curve cannot be vertical either. Consequently, the indifference curve will be of negative slope as shown in Figure 7 (D) where A and B combinations give equal satisfaction to the consumer. As he moves from combination A to B he gives up less quantity of Y in order to have more of X.

(5) Indifference curves can neither touch nor intersect each other so that one indifference curve passes through only one point on an indifference map. What absurdity follows from such a situation can be shown with the help of Figure 8 (A) where the two curves I₁and I₂ cut each other. Point A on the I₁ curve indicates a higher level of satisfaction than point B on the I₂ curve, as it lies farther away from the origin. But point C which lies on both the curves yields the same level of satisfaction as points A and B. Thus

This is absurd because A is preferred to B, begin on a higher indifference curve I1. Since each indifference curve represents a different level of satisfaction, indifference curves can never inter­sect at any point. The same reasoning applies if two indifference curves touch each other at point С in Panel (B) of the figure.

(6) An indifference curve cannot touch either axis. If it touches X-axis as 7, in Figure 9 at M, the consumer will be having OM quantity of good X and none of Y. Similarly, if an in difference curve I2touches the У-axis at L the consumer will have only OL of Y good and no amount of X. Such curves are in contradiction to the as­sumption that the consumer buys two goods in combinations.

(7) An important property of indifference curves is that they are convex to the origin. The convexity rule implies that as the consumer substitutes X for Y the marginal rate of substitution diminishes. It means that as the amount X is increased by equal amounts that of Y diminish by smaller amounts. The slope of the curve becomes smaller as we move to the right. To prove this, let us take a concave curve where the marginal rate of substitution of X for Y increases instead of diminishing, i.e., more of Y is given up to have additional units of X. As in Figure 10 (A) the consumer is giving up ab< cd< ef units of Y for be = de =fg units of X. But the indifference curve cannot be concave to the origin.

If we take a straight line indifference curve at an angle of 45° with either axis, the marginal rate of substitution between the two goods will be constant, as in Panel (B) where ab of Y = be of X and cd of Y = de of X. Thus an indifference curve cannot be a straight line.

Figure 10 (C) shows the indifference curve as convex to the origin.

Here the consumer is giving up less and less units of Y in order to have equal additional units of X, i.e., ab> cd> ef of Y for be = de — fg of X. Thus an indifference curve is always convex to the origin because the marginal rate of substitution between the two goods declines.

(8) Indifference curves are not necessarily parallel to each other. Though they are falling, negatively inclined to the right, yet the rate of fall will not be the same for all indifference curves. In other words, the dimin­ishing marginal rate of substitution between the two goods is essentially not the same in the case of all indifference schedules. The two curves I1and I2 shown in figure 11 are not parallel to each other.

(9) In reality indifference curves are like bangles. But as a matter of principle their ‘effective region’ in the form of segments is shown in Figure 12. This is so because indifference curves are assumed to be negatively sloping and convex to the origin. An individual can move to higher indifference curves I1and I2 until he reaches the saturation point 5 where his total utility is the maxi­mum.

If the consumer increases his consumption more than OX or OY, his total utility will fall. If he increases his consumption of X so as to reach the dotted portion of the I₁ curve horizontally from point S to N he gets negative utility. If to compensate himself for this loss of utility, he increases the consumption of Y, he may be again on the dotted portion of the curve, vertically from point S to M. Thus the consumer may be on the concave portion of the circular curve. Since by moving to the dotted portion he gets negative utility, the effective region of the circular curve will be the convex portion.