Micro and Macro Economics

Economics is omnipresent and form an integral part of our lives. Its name is derived from a Greek word ‘Oikonomikos’. If we break the word up, ‘Oikos’, means ‘Home’, and Nomos’, means ‘Management’. Individual in home or for that matter whole society and country has unlimited needs and wants which are ever increasing and sources that are available to satisfy them are limited. Hence economics is the study of how the available resources are managed and organized (by individual, society and country) to deal with the needs and wants. This is the core theme of Economics. Thus we need to have choice or priorities our wants based on resources. Right choices can make us prosper and wrong one can sink us in debt or plight.

As many of us have not studied the economics subject in depth so, for simplicity, article is like understanding basics of Rocket Science in class 10 and terms will also be explained wherever necessary. Further, though theory of economics says that “man behaves rationally (always looks for profit /loss)”, in reality people do have emotions, prejudice, and non economic reasons to act and behave irrationally. Further, focus of article is on two aspects. First like in science, (to maintain nature’s equilibrium and continuity, nature’s system is such that if we inhale oxygen and exhale carbon-dioxide, plants inhale carbon-dioxide and exhale oxygen) in economics also, two opposite actions must be going on or two opposite groups must exist (sale –purchase, producer-consumer, importer-exporter etc) to balance or to sustain society /country/ world. Also, we all play double role (in pairs) in economic transactions, for example if, as a factory owner we are producer of A thing, we are also consumer of B thing (produced by someone else).  Second is corollary of first, many of virtues like saving (for future) or export (by countries) attributed to single entity if adopted by all individual / countries, they are harmful/ unsustainable in absence of counter action like consumption (against saving) and import (against export) by other group .

To start with, suppose you have 100 rupees with you, the choice of using that money to pay off your bill or spend it on an outing is all an economic decision. Through our choice (of purchasing or not purchasing), we not only influence the prices of the goods and services , but also the goods that will be produced or not produced in society and  the income we earn in our business and job. In turn it decides the economic condition of the country, reflected in, interest rates, inflation (price rise over a period), export import performance and unemployment etc., which also directly affects our finances, growth, and many other areas that permit us to be self-sufficient in our lives.

As said above on the one hand individuals take economic decisions under given conditions (at Macro level) and its study is part of Micro Economics. Thus study of Microeconomics is regarding the choice and allocation of resources and prices of goods and services by individuals. Microeconomics focuses on supply and demand and other forces that determine the price levels (need not be of goods only, it is applicable to services, as well price of one currency against another currency in case of forex transactions) in the economy. On the other hand, study of aggregate behavior of individuals or policy changes that need to / are taken to change such behavior (at Micro level) is part of Macro Economics. It studies the behavior of a country (if we are discussing world economy as a whole, decision of individual countries will be studied as part of micro economics) and how its policies affect the economy as a whole. It analyzes entire industries and economies, rather than individuals or specific companies. To give example, government deciding to lower Corporate Tax, is a Macroeconomic decision ( affecting all industries) and under it how individual industry redraw their own production, sale , profit plan is Microeconomic decision. This article, (mainly) on Microeconomics (as individual constituent), v/s Macroeconomics (aggregate view or effect) is an attempts to analyze and understand these issues and its effects on us. Object of article is to correct many of misgivings we come across while discussing the topic in our groups and educate young ones about true economic process.

Having explained micro and macro economics separately, let us take a few examples to show how micro and macro economics interact, feed on each other and what seems to be good at one level is harmful at the other level. We first take interest rate. In economics, interest rate (per cent per annum) charged by lender (money giver) or paid by borrower (money taker) is nothing but time value of money. It means, if I do have opportunity (if have money) of earning profit but do not have money, I will borrow.  For example if I feel having Rs. 100 /- today (not at a later point of time), I can make Rs. 115/- at the end of year, I will be ready to borrow Rs. 100 at 10 % per annum (time value of money), which leaves me Rs. 5 (Rs. 100 plus Rs 10 interest has to be given back to lender) at the end of year. Now for me at micro level, it is my decision to borrow or not and for me rate of interest at 10 % per annum seems to be fixed. But if in whole country there are ten people like me making total demand for money at Rs. 1000/- (at 10 % interest) and suppose lender (at its disposal) have only Rs. 800, he will raise (lending) interest rate to 12 % per annum, where in only eight people feel confident to earn more than 12 % per annum and are ready to borrow. In reverse way if money available is Rs. 1200/- rate of interest will fall to 8 % so as two more people are ready to borrow. It must be remembered that at macro level everything (lending- borrowing) balance out and interest rate is not fixed. This cascading effect of rate going up/ down is macroeconomic phenomenon. It can be induced by micro constituents (as above), or policy maker to induce behavior change in micro constituents. Now a days when we hear that RBI reduced rate or should reduce rate (as part of monitory policy- policy regarding money supply and rate of interest etc decided by the Central Bank of a country), reasoning is same that money available is more and if people take more money economic activity will go up.

But, above reasoning is from producer (borrower) point of view, which does not have money and wants it at the lowest rate. But lender (Bank) too does not have its own money. In fact it borrows from public and name of this borrowing is “taking deposit” from public. Now if on the demand of producer, rate of interest is lowered, say from 10 % to 8 %, bank will have to reduce rate of interest offered to public from 8 % to 6 % (margin of 2 % for self expanses). This will have two effects. First, people will try to shift money from bank to other assets (things having future value, bank deposit is a type of financial asset, that is why to avoid this banks are asking government to reduce rate of interest on Saving Schemes being offered by it ie Govt.) and banks capacity to lend money will be reduced (This again will raise rate of interest based on demand for money by producers). Second, for large section particularly senior citizens, income from interest is the source of monthly income and their life becomes miserable with reduced income. Thus what is good for one section (producer) is not good for another section (depositor). Story does not end here. Producer will borrow in the hope of selling goods, but lower income in the hands of depositor affect his sales also and his readiness to borrow even at lowered interest rates. So vicious cycle starts and economy enters in down ward cycle and what started good at micro level becomes evil at macro level.

Similar is explanation for Inflation. In simple terms 4 % inflation, in economy means, on an average there is price rise of 4 % in goods and services over a period of one year. Here, two things must be remembered, first falling inflation does not mean prices are falling; it only means there rate of increase is falling. Second, what we hear is general average inflation, and economies consist of thousands of type of   goods and services whose price movement may be different from average inflation. We have just witnessed how prices of Onion have shoot to roof by 700 % within a year. What decides the price of a goods and services? Much like interest rate, it is equilibrium point between what has been offered for sale by trader/producer and how much money consumer does have/ready to pay for it. Goods/ services available for sale are known as supply and Goods/ services likely to be absorbed in economy are known as demand. In economics, Supply and Demand has special meaning. Supply means goods brought in the market at given price and not the stock of goods with the producer/trader. Similarly, for consumer, desire (what he dreams to have) and need (what he supposed to have) are not demand, which means consumer have capacity and willingness to part with money at the given price. So, Supply and demand are function of price. With this explanation in mind, one perception is that present slowdown in Indian Economy is caused by weak demand.

Now let us take example of Onion. Suppose market does have 10 kg onion. Now if consumer is ready to pay Rs. 100 for it, rate will be Rs. 10 per kg. So money and Onion is exchanged fully. Now, if market does have only 5 kg. Rate will shoot up to Rs. 20 per kg. To reduce rate, either supply should be improved or consumer should change preference/ habit in such way that only Rs. 50 (society/ home withdraws rupees 50 meant for Onion and spend it on something else, may be a suitable substitute of Onion)   is available for Onion, this will reduce price to Rs. 10 per kg.  Thus price can go up/ down by way of reduction/increase of goods/ services (supply side) or by way of increase and reduction of money for purchase of goods. That is why when (macro economically) money in circulation increases in the market without actually increase in available physical goods inflation shoots up.

This brings us to most debatable question in Economics, does low inflation and consequent low interest rate era is good for economy? Low inflation leads to low interest rates (they are both two side of a same phenomenon, one reflect demand for goods another for money), which adversely affect depositors (a section of society). Now if, inflation is low and interest rate is above it,( at micro level) it affects decision making process of consumer as well as producer. Let us say I have a Rs. 100/-. Inflation is 5 % and interest rate is 7 %. Now unless I need a item of Rs. 100 very urgently (question of life sustainability), I will deposit money in bank for a year, so I will have rupees 107 /- at the end of year and still I can purchase required item in rupees 105/- at the end of year and save rupees 2/-. So under low inflation condition, generally purchases, like Car, Houses etc are put-off. Producer/ trader of goods also will not produce or store anything beyond what is must for operation. Because any unsold stock bears more cost in terms of interest (and storage etc) than profit in terms of price rise. Thus overall economic activity slows down.

Another function of inflation is, (due to changes in prices,) what is in demand (price rise) and what is not (stable or falling price) gets quickly transmitted. It (inflation) also creates imbalances in market, shortage of A (price rise) stimulates, economic activity for A, surplus of A creates shortage of B and so on, in short what we call progress is nothing but jumping from one problem to another. We may blame, inflation, but it is how country moves up, especially developing country like us. (For example, more cars necessitating wider roads, in turn wider roads pushing more cars on the road). Else we could stagnant at low level of equilibrium, where no one has incentive to produce and consume more. 

Next in discussion is export (goods and services going out of country) and import (goods and services coming in the country), which can also be explained like interest rate and inflation based on demand and supply. But, here more complication arises due to different currencies of exporting- importing country and power of sovereign countries to impose various restrictions on movement of goods and services in and out of country, distorting the demand supply equation. In export- import business, for import you have to first purchase currency of exporting country (to pay for your import, Rupee has no value there) and on export you have to sale currency (received out of export from importing country). Thus we have a separate market for currency (like goods), and rate of each currency against other currency is determined exactly like goods, based on demand and supply of currencies.

To give one example of each, thus even if exporter of USA is selling item A in one dollar (not changing the price), for Indian importer it cost Rs. 70 (if 1USD=Rs 70) and Rs. 72 (if 1USD=Rs 72). Further, even if New-Zealand producer is ready to sale milk at Rs.25 per litre to Indian Consumer, Government is not allowing import of Milk to protect domestic producer. That is why India withdrew from China led the RCEP (Regional Comprehensive Economic Partnership) stating the deal’s potential impact on the livelihoods of its most vulnerable citizens. It was political decision to protect producer as against benefitting consumer. Decision could have been to join group and prepare our producer to compete with exporter by improved efficiencies.

Now, is it possible for “A” country to do only export and not to import anything? Individually possible but for all countries not possible, as mathematically, total export in the world must be equal to total import in the world. Further, world like a society is also run based on “take and give” principal and so, other country “B” can also adopt such policy and affect or paralyze export of country “A” (in to “B”) (Internal example: States like MP and Maharashtra has declared reservation in Job for local and if other states also follow, gain of MP and Maharashtra will be nullified and whole Indian economy will suffer.) Economically also, there are two aspects. First, unless A country imports something from country B, country B will not have currency of country A, to pay for imports (A’s export to B) and country A will also not have any use of currency of country B. Second, each country has “Natural Advantages”, to produce certain type of goods and services at least cost. Producing those goods and services in home country may not be possible at all or possible at higher cost (To give internal example, it is like Tamilnadu state trying to avoid import of Apple from Kashmir and try to produce the same inside the state). Import substitution may be good for self pride or security reason but not always economically profitable.

To conclude, while these two (Micro/ Macro) branches of economics appear to be different, they are actually interdependent and complement one another since there are many overlapping issues between the two fields. Micro and Macro Economics are not contradictory in nature, in fact, they are complementary. As every coin has two aspects- micro and macroeconomics are also the two aspects of the same coin, where one's demerit is others merit and in this way they cover the whole economy. Increased inflation (a macroeconomic effect) would increase the prices of raw materials required by the companies to manufacture products which would in turn also affect the price for the final product charged to the public. Microeconomics and Macroeconomics are both exploring the same things but from different viewpoints. When we talk about macroeconomics while studying the constituents of output in nations economy we also have to understand the demand of single households and firms, which are micro economic concepts. Similarly when we study the investment policies of businesses- a microeconomic concept we cannot do it without learning about the effect of macroeconomic trends in economic growth, taxation policies etc.