Unit 1 - Basic Concepts of Economics

Introduction to Economics

Economics has been taken as a most important knowledge in human life from the very beginning of human civilization. The thoughts on economics found in different eastern and western philosophies, Greek and Hindu literatures, etc. prove this fact. The term Economics has been derived from the ancient Greek word "Oeconomicus" which in economics is related to the study of household management or rules of household. Thus, economics means to manage household affairs with limited fund available in the most economic manner possible. Indeed, each individual household's success or betterment depends mainly on its ability to make wise economic decisions while being involved in different economic activities. 

Economics is the study of different economic activities like production, exchange, consumption of commodities. It is the study of man's livelihood. It studies the economic behavior of the people, the society and the economy as a whole. Prosperity of a nation depends on how it uses its available limited resources to fulfill unlimited desire of the people. Thus, it is the science of making effective choices and decisions to allocate scarce resources among unlimited wants of the public. It tells about how individuals and the nation act in an economic way. In short, economics explains about how economy works and how economic units interact with each other for the betterment of them. 

Some Definition of Economics

1. "Economic is the science of household management".     - Xenophon
2. "Economics is not only the science of household management but also the science of exchange".     - Aristotle
3. "Economics is the study of material welfare".     - Cannon
4. "Economics is what economists do".     - Jacob Viner
5. "Economics is a social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services".     - Webster Dictionary
6. "Economics is all about how people make choices".     - Duesenberry 
7. "Economics al all around you. It is about how society deals with the problem of scarcity. We cannot have everything we wan, whether it refers to continuous holiday or perfectly clean air. We have to make choices. Economics is the study of how society makes these choices. Economics is not just about incomes, prices and money. Sometimes it makes sense to use markets; sometimes we need other solutions. Economic analysis helps us to decide when to leave things to the market and when to override the market".     - David Begg, Stanley Fischer and Rudiger Dornbusch

Thus, several economists have defined economics differently. But most widely discussed definitions of economics are as follows: 

Development of Economics 

Since early days, many economists belonging to different school of thought have described the subject matter of economics in different ways. The present stage of economics is the outcome of the contribution of all such economists. The development of history of economics as a separate discipline of social science can be classified into three periods. They are as follows: 

Video Link:   Basic Concepts of Economics

Wealth Definition (Classical Definition): Adam Smith

Adam Smith (1723-1790), Scottish philosopher, the father and foremost among the classical economists, defines economics as the science of wealth. His book "An Inquiry into the Nature and Causes of Wealth of Nations" which published in 1776 A. D. is itself the definition of economics. This book gave birth to economics as a separate discipline than that of other disciplines like politics, ethics, logic, etc. It also leads to the systematic analysis of economics. This is the major reason behind introducing smith as the father of economics.

According to Adam Smith, "Political economy, considered as a branch of the science of a statesman or legislator, proposes two distinct objects; first, to provide a plentiful revenue or subsistence for the people, or, more properly, to enable them to provide such a revenue or subsistence for themselves; and, secondly, to supply the state or commonwealth with a revenue sufficient for the public services. It proposes to enrich both the people and the sovereign."

It is concerned with production and increase of national wealth. As per the wealth definition, the main source of national wealth is employed labor. Employed labor makes use of land and physical capital available in the nation and produces additional amount of wealth in the or for the nation.

Characteristics of Wealth Definition of Adam Smith

1. Emphasis to Wealth/Study of Wealth

According to Adam Smith, wealth is the major factor of shaping life every human being. So, economics is concerned only to the study of wealth. Every economic activity is carried out with the motive of earning and increasing the volume of wealth. The problems of poverty, unemployment, etc., faced by a nation, can be solved by the production, expansion and equitable distribution of wealth. Thus, economics is related with consumption, production, exchange and distribution of wealth and only those material goods, which are scarce are included in wealth. .

2. Source of Wealth

Adam Smith identified three factors of production: land, labor, and capital as the major contributors to a nation's wealth. But, he has presented wage earned by labor as the most important source of wealth. According to him, productivity of labor can be increased through the division of labor. Thus, the wealth of nation depends upon the degree of productivity of labor and the number of labors employed.

3. Study of Economic Man

Adam Smith states that, economics is only concerned with the activities of economic man. The sole objective of economic man is earning more and more wealth. Economic man thinks nothing other than accumulating wealth throughout his life. People who are directly or indirectly involved in economic activities like production, consumption, exchange, distribution, etc. are defined as economic men by Adam Smith.

4. Second Priority to the Study of Man

Adam Smith has given first priority to the study of wealth and the second priority to man. According to him, man is for wealth but wealth is not for man. In other words, man is a means and wealth is an end. Wealth is the means of getting higher satisfaction.  Thus, study of wealth has got primary importance in Adam Smith's definition of economics.

Criticism of Wealth Definition

Adam Smith's definition of economics has been supported and followed by classical economists like David Ricardo, T.R. Malthus, J. B. Say, J.S. Mill, David Ricardo, F.A. Walker etc. However, the economists like Marshall, Ruskin, Carlyle, etc. have criticized the wealth definition on several grounds. Some economists have criticized this definition as 'science of bread and butter', 'science of getting rich, 'gospel of mammon', 'a dismal science', etc. By criticizing Smith's opinions on Economics Ruskin called Smith as the ''half breed and half-witted man.''

It has ignored the higher values of life, narrow concept of wealth, consideration of material goods only, keeping man to secondary place, ignoring of the problem of the scarcity etc. are the major drawbacks of wealth definition. Some major criticisms of Adam Smith's definition are as follows:

1. Too much Emphasis to Wealth

The definition of economics given by Adam Smith gives primary importance to wealth and secondary importance to man. It ignores the importance of man’s welfare. Indeed, wealth is not be all and the end all of all human activities. In reality, the study of man is more important than the study of wealth. Wealth is the only means of fulfilling human wants and needs.

2. Narrow Meaning of Wealth

The word 'wealth' as defined by Smith includes only material goods such as table, chair, book, pen etc. But, it does not include non-material goods like services of doctors, teachers, nurses, etc. Critics opine that, such types of services are also regarded as a part of wealth. So, Smith limited the scope of economics.

3.    Concept of Economic Man

According to Smith, men work only for their self-interest, i.e. increasing personal wealth. Social interest is downgraded in the background. But Marshall opined that, economics does not study a selfish man involved only in economic activities, but it studies a common man. Human being can get more satisfaction from the feelings of love, honesty, self-esteem, friendship, etc. than from the wealth. Thus, the concept of economic man as given by Smith is wrong.

4. Emphasis on Single Source of Wealth

Adam Smith regarded wage earned by active laborer as the single and major source of wealth. But, in fact, the creation or accumulation of wealth depends on the combined use of several resources like human resources, natural resources, physical and capital resources.

5. Incomplete Definition

Adam Smith's definition of economics is incomplete in itself. It gives emphasis on the earning and spending of wealth and ignores the means or resources which are scarce for the earning of wealth.

Video Link: Adam Smith's Wealth Definition of Economics

Welfare Definition(Neo-Classical Definition): Alfred Marshall

British Economist Alfred Marshall (1842-1924), the leader of Neo-Classical Economists, gave economics a reputed place by publishing the book entitled Principles of Economics in 1890 A.D. He criticized Adam Smith's wealth definition of economics and introduced economics as a science of material welfare. 

According to him, promotion of human welfare is the ultimate aim of studying economics and wealth is only a secondary thing, a tool towards achieving that ultimate aim. According to Marshall, "Political economy or economics is the study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of well-being." He further opined that economics is on the one side the study of wealth and on the other and more important side, a part of the study of the man. Thus, Marshall gave secondary importance to wealth and primary importance to mankind.

Characteristics of Welfare Definition of Alfred Marshall

1. Emphasis on the Study of Man

According to this definition, economics is the study of mankind in relation to wealth. Wealth is attained for the benefit of man. It is not be all and end all of man. It is a part of human welfare. Hence, it is used to increase the material welfare of human being. Thus, this definition gives primary importance to the study of man and secondary importance to wealth.

2. Study of Ordinary Man

According to Marshall, economics does not study only about economic man as said by Adam Smith. It also studies about the activities of ordinary men, who are trying to get satisfaction by experiencing love, affection, goodwill, prestige, etc., along with accumulation of wealth. Thus, it studies about how ordinary people earn wealth and how they spend it to promote their material welfare. Welfare definition of economics ignores the activities of irrational or extra-ordinary man like 'Sadhu', isolated person, priest, hermit, sanyasi etc.

3. Material Welfare

Welfare refers to the human feeling of 'well-being' or 'satisfaction'. Material welfare is a part of totality of human welfare. According to Marshall, the primary aim of economics is only to promote material welfare, but not total human welfare. Economics deals with human activities related to material welfare only. Thus, how a common man tries to achieve greater satisfaction or utility from the consumption of physical goods, is the subject matter of economics.

4. Social Science

According to Marshall, the activities of extra-ordinary people like Sadhus, Sanyasi and monks or isolated people of the society like Robinson Crusoe are not studied in economics. Thus, economics is a social science as it studies the activities of those people, who are rational and live in society.

Criticism of Welfare Definition

Alfred Marshall's definition of economics has been supported and followed by neo classical economists like A. C. Pigou, Edwin Cannon, Beveridge, etc. It remained popular for a long time. But after the arrival of Lionel Robbins, it was criticized on several grounds. Robbins criticized Marshall's definition of economics and gave the modern definition of economics. The major criticisms of Marshall's definition as mentioned by Robbins are as follows:

1. Classificatory

The definition of economics given by Alfred Marshall is classificatory rather than analytical. He has only classified human activities into material and non-material welfare but has not made clear-cut distinction between them. In fact, it is difficult to separate material welfare from other types of welfare. Same action can be material as well as non-material according to the nature and purpose of the work. For example, service of a singer to his son at home becomes non-material as he does not get money. But, if he gives singing training at a cultural center, the same service becomes material as he earns money.

2. Narrow Scope

Marshall has included material activities of human being into the subject matter of economics and excluded non-material activities like services of doctors, lawyers, singers, dancers, teachers. According to Robbins, it is wrong to ignore the immaterial services of actors, doctors, etc. Their activities also come into the subject matter of economics. Thus, Marshall's definition has narrowed the scope of economics.

3. Concept of Welfare is not Fixed

Marshall's definition of economics has tried to establish connection between welfare and economics. But concept of welfare differs from person to person, country to country and from time to time. Robbins opines that it is difficult to identify the things that would lead to welfare. Economics is not at all concerned with material welfare. It studies the problems caused by scarcity of resources. Though conflict and war do not promote material welfare, they occur due to the economic problems faced by the societies and countries. Similarly, economics also studies some activities that are not conducive to welfare, like production of wine, cigarettes, etc. because they are scarce and have a price. Thus, there is no rigid definition of welfare as said by Marshall.

4. Ignores Human Science

According to Marshall, economics studies about the people participating in social activities and excludes people being isolated from the society like yogis, monk, hermit etc. But Robbins opined that economics is not only a pure social science but also a human science. Everyone, either living in society or out of society is facing the problems caused by scarce resources. So, economics should study about all human beings whether they actively participate in social activities or not.

5. Neglects Central Economic Problem

Welfare definition has ignored the central economic problem of scarcity and choice. Though it made the scope of economics wider as compared to wealth definition yet it has not given clear concept on why economic activities are undertaken. According to Robbins, economic activities are directed towards the allocation of limited resources to fulfill human wants. Thus, economics tries to address the economic problems that have arisen due to scarcity of resources. 

Quiz: Alfred Marshall's Definition of Economics

Video Link: Alfred Marshall's Welfare Definition of Economics

 Scarcity Definition ( Modern Definition): Lionel Robbins

Modern economist/leader of modern economic literature Lionel Robbins (1898-1984) was British citizen and professor of economics at London School of Economics, had highly criticized welfare definition of economics given by Alfred Marshall and defined economic as a science of scarcity and choice in his book 'An Essay on the Nature and Significance of Economic Science' in 1932.

He explained that economic problems are the outcome of unlimited human wants and limited resources to fulfill them. According to Robbins, "Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses".

The main ideas of Robbin's definition are as follows: 

1. Human beings have innumerable wants or needs;
2. The means or resources to satisfy them are limited or scarce;
3. These scarce resources have alternative uses;
4. Human beings have, therefore, to choose between these wants.

This definition is most scientific and widely accepted definition of economics and still generally used today. 

Characteristics of Scarcity Definition of Robbins

1. Unlimited Wants

Human beings have unlimited wants, such as food, clothing, shelter, education, entertainment, leisure etc. When one want is fulfilled, immediately another want crops up. For example, when basic need like food, clothes and shelter are fulfilled, human beings immediately feel the need of furniture, radio, TV etc. There is no end to human wants. The existence of economic problem is due to the unlimited wants. 

2. Scarce Means

Means to satisfy human wants are scarce or limited. For example, human beings have limited money, limited resources, limited time etc. The scarcity of means leads to the economic problems. If human beings can have all the goods they want freely, there would no economic problems. Scarcity is relative term not absolute. For instance, nobody would like to have garbage. Therefore, it is not scarce. But as soon as people learn to turn garbage into fertilizer; then people start demanding for it. Then it becomes scarce.

3. Alternative Uses of Means

According to Robbins, resources or means are limited in relation to their demand. But the means have alternative uses. So, they can be put for different purposes according to the intensity of want. For example, a man can use his labor for producing milk or coffee. Raw materials like steel can be used for making furniture, for making machines and so on. According to the necessity and ability to pay, the society has to decide for which purpose such resources are to be used. Thus, allocating scarce resources among unlimited human wants is the subject matter of economics.

4. Positive Science

According to Robbins, economics is a positive science. It explains cause and effect relationship between economic variables. It explains the things as they are. It does not provide the judgment like which wants are to be satisfied and which not. It only tells the way of attaining given wants with best alternative use of available resources.

Criticism of Scarcity Definition

Robbins has given a more scientific definition of economics as compared to Marshall. He defined economics as a science of scarcity and choice. He highlighted the fundamental economic problem, i.e., allocation of resources among various uses due to their limitedness. Thus, Robbins broadened the scope of economics. This made his definition most popular and widely accepted definition of economics. 

However, it is not free of criticism. Considering economics only as positive science, restricting the study of economics only up to the theory of product and factor pricing, static nature of definition, ignorance of modern burning economic issues, treatment of economics only as a science, etc. are major drawbacks of the modern/scarcity definition of economics. The economists like Barbara Wotton, William Beveridge, Boulding, Durbin, etc. have criticized Robbins' definition of economics on the following grounds:

1. Nature of Economic Problem

According to Robbins, economic problems arise due to scarcity of resources. But critics say that economic problems can also arise from abundance of resources. For example, most of the developing countries are facing the problem of unemployment due to abundance of human resources in relation to its demand. Similarly, 1930s world depression is the outcome of overproduction. But, Robbins has neglected this aspect.

2. Incomplete Definition

Economic growth and development, poverty, unemployment, inflation, etc. are burning issues of modern economy. But Robbins definition of economics is silent towards such economic problems. Indeed, he only concentrated on microeconomic concepts like product and factor pricing and so on. Macroeconomic issues like generation and distribution of national income, causes of instability in price, output and unemployment etc., are ignored. But the study of such modern burning issues is getting importance in the society. Thus, Robbins definition is incomplete. It has narrowed the scope of economics.

3. Neglects Normative Aspects (Value Judgment)

By defining economics as a positive science, Robbins says that economics is neutral between ends. It remains silence regarding which ends or wants are to be satisfied and which not. But critics opine that economics is not only a positive science but also a normative science. To promote social welfare and for achieving various objectives of the society, it should help in deciding what is good and what is bad. It must be a problem-solving science.  Economists are of the opinion that the function of the economists is not only to explain and explore but also to pass judgment.

4. Self-Contradictory

According to Robbins, economics is neutral between ends. But at the same time, he states that economics is the science of choice. In reality, choice between ends and allocation of resources is not possible without ranking the relative importance and need of different ends. Thus, Robbins' definition of economics is self-contradictory.

5. Similar to Marshall's Definition

Though Robbins criticized Marshall's welfare definition, yet his scarcity definition also includes the concept of welfare. Allocation of scarce resources to fulfill multiple human wants is nothing rather than maximizing satisfaction or welfare. Marshall had also said that, wealth should be used to maximize satisfaction or material welfare. Thus, Robbins definition of economics is similar to Marshall's definition.

Quiz: Lionel Robbin's Scarcity Definition of Economics

Video Link: Lionel Robbins' Scarcity Definition of Economics

Superiority of Robbins's Definition

As compared to Marshallian definition, Robbins definition of economics is superior on the following grounds:

1. Scientific in Nature: It is scientific in nature. It does not classify between material and non-material.
2. Wider Scope: It is wider in scope. Because it covers all types of human wants whether material or non-material. It has not restricted the study of economics to wealth and activities relating to material welfare of human beings.
3. Scientific: All classical and neo-classical economists regard economics both as science and art. But according to Robbins's definition it is mainly science.
4. Neutral as regards to ends: According to Robbins, economics is neutral as regards to ends. It does not pass any judgment. For example, economics does not say anything regarding whether smoking is good or bad. It doesn’t cover ethical subject-matters. From this point economics is positive science.

Comparison of Marshall’s Definition of Economics with that of Robbins

Similarities
Basis	Robbins Definition (Scarcity and Choice)	Alfred Marshall (Material Welfare)
1.       Subject Matter of Study	2.       Robbins has said economics is a human action.	1.       Marshall has said that economics is a human behavior.
2.       Optimization	3.       Robbins has said that limited amount of resources should be allocated to secure maximum satisfaction (welfare).	3.       Marshall has said limited amount of wealth should be allocated properly to secure maximum material welfare.
4.       Basic Pillars	5.       Consumption, production, exchange and distribution of wealth	4.       Consumption, production, exchange and distribution of wealth

 

 

Differences
Basis	Robbins Definition (Scarcity and Choice)	Alfred Marshall (Material Welfare)
1.      Definition	Robbins' definition of economics is a study of human behavior as relationship between various human unlimited ends and scarce means plus their alternative uses.	Marshall defines economics as study of human behavior in ordinary course of human life. How, a man earns income and how he utilizes it. Thus, on the one hand it is study of wealth and other most important aspect study of mankind.
2.      Supporter	Robbins' definition of economics was supported and led by modern economists.	Marshall's definition was supported and led by neo- classical economist.
3.      Positive vs. Normative	Robbins' definition is based on positive science which seeks to established causes and effect relation.	Marshall's definition is based on normative science which is related to ethics.
4.      Human vs. Social Science	Robbins definition study economics as human science. So, it is study social and non- social activity.	Marshall's definition study economics as social science. So, it studies only social activity.
5.      Analytical vs. Classificatory	Robbins' definition is analytical definition.	Marshall's definition is classificatory definition.
6.      Value Judgment	In Robbins' definition, there is no scope of value judgment.	In Marshall's definition, economic analysis can be done by using value judgment.
7.      Material Vs. Immaterial	Believes in both material and immaterial activities to deal with the problem of choice for optimization	Believes in material activities that result in material welfare
8.      Quantitative Vs. Qualitative	Concept of scarcity is a quantitative aspect and we can measure it	Concept of welfare is qualitative incident and we cannot measure it

Positive and Normative Economics

Positive and normative are two stream or branches of modern economics. While positive economics deals with the various economic phenomena, normative economics focuses on what economics should be and the value of its fairness. In simpler words, positive economics is regarded as the 'what' branch, whereas normative economics is the 'should be' or 'ought to be' section of economics. 

Positive Economics

The economists like Adam smith, J. B. Say, David Ricardo, Friedman, Boulding, Lionel Robbins have defined economics as a positive science. Positive economics explains the cause and effect relationship between economic variables. It deals with facts and value free descriptions of economic system. It avoids value judgments. It makes positive statements which can be proven right or wrong. 

Positive economics deals with objective reality. It describes what exists and how it works. For example, positive economics answers the questions like what is the level of personal income and employment in Nepal, what determines the wage rate of laborer?, how inflation affects poor people?, etc. But positive economics does not comment on the existing situation of the economy. It does not say what ought to be and should be. Thus, positive economics is the study of what is and how economics works.

Normative Economics

Economists like Marshall, Pigou, Fisher, etc. are the supporters of Normative economics. Normative economics observes the outcomes of economic activities/behaviors and says whether they are good or bad and how they can be made better. Thus, it is the study of what should be or ought to be the things. Normative economics deals with subjective opinions and judgements. It deals with the questions like what should be the level of per capita income, what should be the wage rate, what should be the saving and investment rate of the economy, etc.

Normative economics makes normative statements which are based on ethical, moral, philosophical and religious beliefs of the people. It is impossible to prove such statements right or wrong as they are based on individual values. For example, some may say that government should spend the tax revenue for security while others may say that it should be used for providing subsidy to the poor. It is impossible to say who is wrong and who is right.

Difference between Positive and Normative Economics

Basis	Positive Economics	Normative Economics
Meaning	A stream of economics based on data and facts	A stream of economics based on values, opinions and judgments
Judgments	It avoids value judgments of individuals or economic units. It explains the things as they are.	It is based on subjective opinions and judgments. It explains about what is right or wrong.
Nature	Stands descriptive in nature	Stands prescriptive in nature
What it does	Analyzes cause and effect relationship	It offers subjective ideas
Testing	Statements can be tested, proved or disproved tested using scientific methods	Statement cannot be tested
Verification	Can be verified with real world data	Cannot be verified by actual data
Dealing of situation	Deals with actual or realistic situation	Deals with idealistic situation
Economic issues	Deals with how an economic problem is solved	Deals with how an economic problem should be solved
Example	It deals with the questions like what is the level of per capita income in Nepal, how poverty affects society?, etc.	It deals with the questions like what should be the level of per capita income, what should be the wage rate, what should be done to control poverty?, etc.
Supporters	Economists like Adam smith, J. B. Say, D. Ricardo, M. Friedman, K.E. Boulding, Lionel Robbins are the supporters of positive economics.	Economists like A. Marshall, A. C. Pigou, I. Fisher, are the supporters of normative economics.

Quiz: Positive and Normative Economics

Video Link: Positive and Normative Economics

Micro and Macro Economics

Economists develop economic principles and models at two levels. These two levels are the branches of economics: Microeconomics and Macroeconomics.

Microeconomics (Topics of Interest)	Macroeconomics (Topics of Interest)
Supply and demand for goods and services in the market	Aggregate demand and aggregate supply
Worker's decision, employment in an industry	Employment and unemployment
Price of a product	General price level and inflation
Commodity market, labor market, etc.	Financial market, stock exchange
Domestic trade	International trade
Firms' profit, household income	National Income, GDP
Mortgage loan interest	General interest rate
Government regulations, government failure	Government economies policies – fiscal and monetary policies

Microeconomics

Microeconomics is derived from Greek word 'mikros', meaning small. Thus, microeconomics examines/studies the behavior and decision-making of the individual economic units or players or agents like individual producer, individual consumers, individual firms, etc. For example, the income of a particular individual, the output of a particular firm, etc. are studied in microeconomics.

Microeconomics looks at the economy through a microscope. It examines a part of the whole economy. K.E. Boulding has rightly said that microeconomics is the study of particular firms, particular households, individual prices, wages, incomes, individual industries. Prices are considered as the core of microeconomics. It deals with the price determination of goods and services as well as prices of factors of production. Thus, it is also known as price theory of economics. Most of the part of Marshallian economics is related with microeconomics. Microeconomics is a partial equilibrium analysis as it generally analyses the behavior of individual economic units keeping other things constant. For example, price and output in one firm are considered independent of those in other firms.

The subject matter of economics or the area covered by microeconomics are as follows:

1. Theory of Product Pricing

Study of the theory of demand for and supply of goods and services, theory of production and cost, etc.

2. Theory of Factor Pricing

Study of the theories related to determination of prices of factors of production like land, labour, capital and organization.

3. Resource Allocation

Study on how available resources are allocated to the production of various goods in a particular period of time.

4. Theory of Economic Welfare

Study on economic conditions and welfare of a section of people (or study on how consumers/producers and entrepreneurs can maximize their satisfaction).

Importance of Microeconomics

1. Price Determination

The concept of microeconomics guides the entrepreneurs when determining price of goods and services. It also guides them in analyzing the cost of factors of production during the process of producing goods and services.

2. Factor Payment

Microeconomics has become a very useful tool to study about and make decisions on factor payment of land, labor, capital and organization in terms of rent, wage, interest and  profit, respectively.

3. Economic Decisions

Economic decisions in any plan, policy and program are made after detailed study or research on the subject concerned. The microeconomic study through the method of cost benefit analysis is most essential while making economic decisions in any socio-economic project.

4. Solving of Contemporary Problems

The concept of microeconomics is equally useful in solving contemporary problems of a nation such as problem of pollution, poverty, inequality, deficit balance of trade, negative balance of payments of a nation.

5. Economic Welfare

Microeconomics gives guideline to welfare of the society due to it studies each and every individual of the society. So, we can say that all people gain welfare or not.

6. Policy Implementation

It helps government to prepare and implement various economic policies such as fiscal policy, monetary policy, trade policy, industrial policy and development policies in the country.

Macroeconomics

Macroeconomics is derived from the Greek word 'makros', meaning large. Thus, Macroeconomics examines the behavior of the whole economy at once. In other words, macroeconomics is focused on the overall structure and performance of the national or global economy. It is concerned with the analysis of aggregates. For example, total production, total employment, total consumption, aggregate investment, the rate of inflation, the rate of economic growth, international trade, FDI etc. are studied in macroeconomics.

Macroeconomics looks at the aggregates related to the whole economy. It is the study of the economic system as a whole. In the words of K.E. Boulding, "Macroeconomics deals not with individual quantity as such, but with aggregates of these quantities, not with individual incomes but with the national income; not with individual prices but with price level, not with individual output but with national output."

Macroeconomics mainly deals with determination of income and employment. So, it is also known as theory of income and employment. The later works of Keynes is related to macroeconomics. It is a general equilibrium analysis as it studies interdependence of markets-commodity market, labor market, bond market and money market.

The subject matter of macroeconomics or the area covered by macroeconomics are as follows:

1. Theory of income and employment: Study of theory of consumption and investment function, business cycle.
2. Theory of general price level: Study of inflation, deflation, etc.
3. Theory of economic growth: Study of growth of income, output and employment.
4. Theory of distribution: Study about the determination of aggregate prices of factors of production (land, labor, capital and organization) and their relative share in the national income.

Importance of Macroeconomics

Macroeconomics is useful in several ways. Some of them are discussed under the following headings.

1. Formulation of Macroeconomic Policy

It is useful to formulate aggregate price policy, aggregate tax policy, aggregate trade policy, aggregate investment policy, monetary policy, which are required for rapid and smooth economic development of a nation.

2. Solving various Social Problems

Macroeconomics is also useful to study about various problems of the society such as unemployment, poverty, inequality, regional imbalance, and make necessary arrangements to solve those problems.

3. Measurement of National Income

Macroeconomics is also useful to calculate and measure the value of national income annually. It is also necessary to make analysis on components of national income such as GDP, GNP, per capita income of a nation.

4. Economic and Monetary Stability

A nation should establish smooth economic relationships and price stability for its sustainable development. Macroeconomics helps to formulate such economic and monetary policy to accelerate the rate of economic growth and to control inflation and deflation in the country.

Difference between Micro and Macro Economics

	Microeconomics	Macroeconomics
Definition	Microeconomics is derived from Greek word 'mikros', meaning small. It studies the behavior of individual economic units like individual producer, individual consumers, etc.	Macroeconomics is derived from the Greek word 'makros', meaning large. It studies the behavior of the whole economy at once.
Major tools	Demand and supply of a particular factor or commodity are the main tools of microeconomics.	Aggregate demand and aggregate supply of a whole economy are the main tools of macroeconomics.
Main focus	It is focused on price determination and allocation of resources. So, it is also called Price Theory.	It is focused on determination of level of income and employment. So, it is also called Theory of Income and Employment.
View	Bottom-up view of the economy	Top-down view of the economy
Determinant of problem	According to microeconomics, price is the main determinant of microeconomic problems.	According to macroeconomics, income is the main determinant of macroeconomic problems.
Parameter	Price	National income
Equilibrium analysis	It is a partial equilibrium analysis as it generally analyses the behavior of individual economic units keeping other things constant.	It is a general equilibrium analysis as it studies interdependence of different types of market.
Subject matter	Theory of product pricing, factor pricing, resource allocation and economic welfare are the major subject matters of microeconomics.	Theory of income and employment, general price level, economic growth and distribution are the major subject matters of macroeconomics.
Example	The income of an individual person, savings of an individual, determination of price of a commodity, etc. are the examples of microeconomics.	Total production of a country, national income,  total level of employment, total consumption, aggregate investment, the rate of inflation, the rate of economic growth, poverty etc. are the examples of macroeconomics.

Interdependence of Micro and Macro-economics.

In reality micro and macro-economics are inter-dependent and they are also complementary to each other.  Microeconomics studies individual units and macroeconomics studies an entire economy.  Thus, when we study both these approaches side by side, then only we can have better understanding of the economic problem.  In this respect, Prof. Samuelson writes there is really no opposition between macro and micro-economics.  Both are absolutely vital.  And you are only half-educated if you understand one and unaware of the other".

Quiz: Microeconomics and Macroeconomics

Video Link: Micro and Macro Economics

Terminology Relates with Basic Concepts of Economics

Economics: Economics is the branch of knowledge that studies the economic activities of human beings. Economics is the science of making effective choices and decisions to allocate scarce resources among unlimited wants and needs of the people.

Classical Definition (Wealth Definition of Adam Smith): It is concerned with production and increase of national wealth. As per the wealth definition, the main source of national wealth is employed labor. Employed labor makes use of land and physical capital available in the nation and produces additional amount of wealth in the or for the nation.

Welfare Definition (Neo-Classical Definition of Alfred Marshall): Promotion of human welfare is the ultimate aim of studying economics and wealth is only a secondary thing, a tool towards achieving that ultimate aim.

Modern Definition (Scarcity Definition of Lionel Robbins): Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.

Wealth: Wealth refers to the stock of all those assets which are a source of income. It is expressed as a point of time.

Welfare: Welfare is taken to mean a sense of satisfaction and happiness, a sense of well-being among the people.

Material Welfare: Material welfare means satisfaction that can be derived from the consumption of material things or tangible things/goods. It can be measured in terms of money. 

Non-material Welfare: Non-material welfare is the happiness or well-being derived from the consumption of intangible things/services. It cannot be measured in terms of money.

Economic Man: Economic man is a person who has solely objective of earning wealth or money. A self-guided person to earn money is called an economic man.

Want: Want is an effective desire for a particular thing, which can be satisfied by trying to acquire it.

Need: A need is something essential to survive. This includes things like food, water, and shelter.

Desire: Desire is the wish to have something. It is not associated with price, time, quantity, market, etc.

Means: Means refers to available resources. The resource could be anything such as land, raw materials, time, money, labor, capital etc.

Scarcity: Scarcity in economics is a  situation in which there are insufficient resources to satisfy people's want. It  is the root cause of the creating of the economic problem.

Choice/Selection: Choice refers to the process of selection from available limited alternatives. It emerges because of scarce resources and their alternative uses.

Allocation of Resources: Allocation of resources is the allotment or distribution of productive assets among different uses.

Economic Activities: Any action that involves producing, distributing or consuming products or services is an economic activity. Economic activities are performed to make money, gaining wealth, and creating and producing items that can be offered to the public for sale.

Consumption: Consumption means using goods and services for the satisfaction of wants.

Production: Production is the process of creating a utility to the consumers. In other words, transformation of various raw materials or inputs into a final output  is called production.

Exchange: The process of sell and purchase of goods and services in the market is called an exchange.

Distribution: The way how national income is distributed among various factors of production is called distribution.

Public Finance: It is the subject deals with revenue and expenditure of the government.

Positive Economics: Positive economics explains the cause and effect relationship between economic variables. It deals with facts and value free descriptions of economic system. It avoids value judgments. It makes positive statements which can be proven right or wrong.

Normative Economics: Normative economics observes the outcomes of economic activities/behaviors and says whether they are good or bad and how they can be made better. Thus, it is the study of what should be or ought to be the things. Normative economics deals with subjective opinions and judgements.

Microeconomics: Microeconomics examines/studies the behavior and decision-making of the individual economic units or players or agents like individual producer, individual consumers, individual firms, etc.

Macroeconomics: Macroeconomics examines the behavior of the whole economy at once. In other words, macroeconomics is focused on the overall structure and performance of the national or global economy.

Partial Equilibrium Analysis: Partial equilibrium is a condition of economic equilibrium which takes into consideration only a part of the market (with all other parts remaining constant) to attain equilibrium.

General Equilibrium Analysis: General equilibrium analyzes the economy as a whole, rather than analyzing single markets like with partial equilibrium analysis. 

Video Link: Terminology Relates With Basic Concepts of Economics