CBSE Class 12 Economics Introduction Set 02

CHAPTER: 1 INTRODUCTION

• Meaning of Macroeconomics
• How Macroeconomics Differs from Microeconomics?
• Scope and Significance of Macroeconomics

I. MEANING OF MACROECONOMICS

The term Macro in English has its origin in the Greek term Makros which means Large. In the context of macroeconomics, 'large' means economy as a whole. Thus, macroeconomics is defined as that branch of economics which studies economic issues or economic problems at the level of an economy as a whole. It studies such economic questions that concern the welfare of all residents of a country. These questions are like of employment for the residents, growth of output in the economy, the problem of price rise (called inflation) or the problem of depression (lack of demand for goods and services across different sectors of the economy) and so on. Macroeconomics also studies how government can improve the state of economy of a country.

In the words of M.H. Spencer, "Macroeconomics is concerned with the economy as a whole or large segments of it. In macroeconomics, attention is focused on such problems as the level of unemployment, the rate of inflation, the nation's total output and other matters of economy-wide significance."

2. HOW MACROECONOMICS DIFFERS FROM MICROECONOMICS?

You have already studied microeconomics at +1 level. Now that you have understood the meaning of macroeconomics, you can draw a distinction between micro and macro economics, as under:

(1) Basis of the Study

Microeconomics studies problems of scarcity and choice at the level of an individual, a household, a firm or an industry.

Macroeconomics studies problems of scarcity and choice at the level of an economy as a whole.

Illustration

Microeconomics studies how a consumer exercises his choice of goods and services so that he maximises his satisfaction with a given income.

Macroeconomics studies how the national resources are used (for the production of defence goods or consumer goods) so that the welfare of all the residents is maximised.

Macroeconomic Variables

Macroeconomic variables are those economic variables which are studied at the level of economy as a whole. These variables are important components of the subject matter of macroeconomics. The important ones are:

• Level of employment in the economy,
• National income,
• Aggregate demand,
• Aggregate supply,
• Consumption expenditure in the economy, and
• Investment expenditure in the economy.

(2) Economic Variables

Microeconomics uses microeconomic variables such as consumer's demand or producer's supply.

Macroeconomics, on the other hand, uses macroeconomic variables such as aggregate demand (referring to demand for all the goods and services in the economy) and aggregate supply (referring to supply of all the goods and services in the economy).

(3) Economic Agents

Economic agents refer to the individuals and institutions who take economic decisions. Individual economic agents include consumers and producers. They focus on the maximisation of personal gains. Institutional economic units include state or statutory bodies [like RBI (Reserve Bank of India), SEBI (Securities and Exchange Board of India) and TRAI (Telecom Regulatory Authority of India)]. They focus on the maximisation of social welfare. At the micro level, economic decisions are taken largely by the individual economic agents, while at the macro level institutional agents play a significant role.

(4) Degree of Aggregation

In microeconomics, there is a limited degree of aggregation of economic variables, compared to macroeconomics.

Illustration

Microeconomics studies equilibrium of an industry; it is an aggregation of all the firms producing a particular commodity.

Macroeconomics studies equilibrium of the economy as a whole; it is an aggregation of all economic units in the economy.

However, important it is to note that with a view to examine structural change in the economy, macroeconomics also studies the level of economic activity in agricultural sector, industrial sector and services sector, separately.

(5) Different Set of Assumptions

Microeconomics and macroeconomics are based on a different set of assumptions. Certain variables are assumed to be constant in microeconomics, whereas they are assumed to be changing in macro; similarly, certain variables that are assumed to be constant in macro are assumed to be changing in microeconomics.

Illustration

In microeconomics, total output and employment are taken as constant while these are important variables in macroeconomics.

In macroeconomics, distribution of output/income is taken as constant, while it is an important variable in microeconomics.

(6) Central Issue

Allocation of resources is the central issue in microeconomics. Determination of the overall level of output (and employment) is the central issue in macroeconomics.

(7) Method of Study

Method of study in macroeconomics is often described as 'general equilibrium analysis'. On the other hand, method of study in microeconomics is often described as 'partial equilibrium analysis'.

Question. Distinguish between partial equilibrium and general equilibrium.
Answer: Partial equilibrium refers to equilibrium in one market (say, commodity market) on the assumption that there is no change in other markets (like labour market or capital market). General equilibrium refers to simultaneous equilibrium in all the markets in the economy. Partial equilibrium is the method of study in microeconomics. General equilibrium is the method of study in macroeconomics.

(8) Micro-Macro Paradox

What is logical at the micro level may not be logical at the macro level.

Illustration

• If an individual saves more, he adds to his future prosperity.
• If all the people in an economy save more (and spend less), demand for goods and services may decline. Consequently, investment may decline; production and employment level may fall. The economy will be driven towards future poverty rather than prosperity.

Question. Is saving a virtue or a vice?
Answer: From the viewpoint of an individual, saving is a virtue. He can deposit his savings in a bank and can earn a regular income. But, from the viewpoint of the economy as a whole, saving may prove to be a vice. When everybody saves more, expenditure tends to decline. It causes a decline in aggregate demand. A fall in aggregate demand causes a fall in investment. Implying a fall in production and a fall in the level of employment. The economy may be driven into the state of depression.

3. SCOPE AND SIGNIFICANCE OF MACROECONOMICS

Scope

Scope of macroeconomics refers to the field of study (or area of study) of macroeconomics. It includes the following leading issues (in accordance with the CBSE syllabus for the +2 graders):

(1) Estimation of National income and Related Aggregates: Macroeconomics starts with the concept of national income. It deals with the definition and estimation of national income and its related aggregates like GDP (Gross Domestic Product) and NDP (Net Domestic Product).

(2) Theory of Employment: Macroeconomics studies the theories related to employment (or unemployment) in the economy. Keynesian theory of employment is of notable significance in this context. It explains the causes of unemployment, and suggests the possible remedies to combat it.

(3) Theory of Money: Creation of money (or creation of credit) by the commercial banks is an important component of macroeconomics. Linked to it, is the role of Central Bank of a country (RBI in India) in regulating the supply of money in the economy.

(4) Theory of General Price Level—Inflationary and Deflationary Gaps: This is yet another significant component of macroeconomics. It reveals the trend path of the general price level leading to inflationary and deflationary gaps in the economy.

(5) Role of the Government (or Government Budget): Macroeconomics studies how government budget impacts the level of economic activity in the economy.

(6) Exchange Rate and Balance of Payments: Determination of exchange rate and the way it is managed (in the international money market) is an important element of the scope of macroeconomics.

Briefly, as a specialised branch of economics, macroeconomics focuses on such issues which explain (i) how an economy functions, and (ii) how can it be managed (or regulated), so that social welfare is maximised.

Significance

The following observations highlight the significance of macroeconomics:

(1) Description of the Economy: Macroeconomics offers a deep description of the economy.

• Estimation of national income (across different sectors) reveals the nature and level of economic activity in the economy.
• Study of unemployment reveals the magnitude of the problem and the way it can be handled.
• Government budget reveals the way economy is regulated by the government.

(2) Roadmap of Growth and Development: Macroeconomics offers a roadmap of growth and development. Programmes and policies of economic growth are drawn by assessing the needs and means of the economy.

(3) Economic Stability: Study of macroeconomics helps achieve economic stability. This is achieved through appropriate monetary policy (pursued by the Central Bank of the country) and fiscal policy/budgetary policy (pursued by the government).

(4) BoP (Balance of Payments) Status: BoP status of a country reveals performance of the economy in relation to rest of the world. Balance of trade (Export and Import) shows our capacity to export and compulsion to import.

(5) Problems of Poverty and Environmental Pollution: Macroeconomics offers insights into the problems of poverty and environmental pollution. It is by using macro-models that these problems are addressed.

(6) Policy Formulation: Information relating to macroeconomic variables (like aggregate demand, aggregate supply, total consumption and investment expenditure in the economy, output across different sectors of the economy and the like) is extremely useful in the formulation of policies for the growth and development of the country.

Emerging challenges of the economy become evident only through macroeconomic data.

In short, we can say that the knowledge of macroeconomic variables and macroeconomic models is extremely essential in understanding the performance of the economy, as well as in the formulation of policies and programmes for its growth and development.

Power Points & Revision Window

Macroeconomics is that branch of economics which studies economic problems (or economic issues) at the level of economy as a whole.

Microeconomics as different from Macroeconomics

• Microeconomics deals with the problem of choice and scarcity at the individual level, while macroeconomics does it at the level of economy as a whole.
• Microeconomics uses microeconomic variables (like consumer's demand and producer's supply), while macroeconomics uses macroeconomic variables (like AD and AS).
• Microeconomics involves lesser degree of aggregation than the macroeconomics.
• Microeconomics and macroeconomics are based on different set of assumptions.
• Allocation of resources is the central issue in microeconomics, while in macroeconomics the central issue is the determination of national income and employment.
• What is ideal at the micro level (like, saving by an individual) may not be ideal at the level of an economy as a whole.

Scope and Significance of Macroeconomics

Scope: (i) Estimation of national income and related aggregates, (ii) Theory of employment, (iii) Theory of money, (iv) Theory of general price level: inflationary and deflationary gaps, (v) Role of the government (or government budget), (vi) Exchange rate and balance of payments.

Significance: (i) Description of the economy, (ii) Roadmap of growth and development, (iii) Economic stability, (iv) BoP (Balance of Payments) status, (v) Problems of poverty and environmental pollution, (vi) Policy formulation.