‘Economics is a science that studies human behaviour as a relationship between ends and scarce resources that have alternative uses’ (Robbins). Ends refer to objectives humans desire to achieve. For an individual who intends to buy a car priced at Rs 6 lakh, the end is the amount of money needed for the purpose.
Resources refer to income or sources of income possessed by the individual. For an individual who possesses a sum of Rs 4 lakh, his or her resource is Rs 4 lakh. The gap between the ends and resources, called the resource gap, is Rs 2 lakh. The individual in question needs to plug this gap in order to buy the desired product.
The problem of raising a sum of Rs 2 lakh to fill the gap is called an economic problem. The activities the individual undertakes for the purpose are known as his or her economic activities. Such activities involve raising of income through production of goods and/or services. This, however, poses a few problems.
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In addition to ‘what’, ‘how’ and ‘for whom’ to produce, the individual may have to face the problem of inefficiency in production and distribution. All these problems faced at the individual level are called the micro problems.
Solutions to these four problems provide the subject matter for theory of price, theory of production, theory of distribution and welfare economics, which, taken together, are grouped under the broad head of microeconomics.
Just as individuals face these economic problems at the individual level, groups of individuals, such as firms, industries as also the nation-states, face them at the group level, perhaps on a much larger scale.
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A State requires funds to provide infrastructure, to maintain law and order, to maintain defence forces for security, to provide education and health services to its people, to generate and supply power and to provide a host of other basic amenities for the sake of common cause. Over and above these services, a state has also to act as a producer of a number of goods. This, it has, mainly to protect the interest of the common people.
Expenditure incurred by a State on such activities is called public expenditure or government spending. The main source of its income is taxation. A State taxes the rich to raise income called public revenue, which it uses to finance public expenditure.
Quite often, public revenue falls short of public expenditure. The gap between the two, analogous to the resource gap of individuals or individual firms, is called the deficit. Governments need to plug it, much the same way as individuals or individual firms do to meet their expenditures.
The only point of difference is that the individuals and the individual firms can resort to cutting expenditures while the government of a welfare State cannot, unless it is prepared to sacrifice some of its social objectives.
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The government, therefore, has to raise its income to the level of its expenditures. The process employed by it for the purpose is called deficit financing. It creates the same sort of economic problems for a State as those faced by individuals or individual firms.
Thus problems such as ‘what’, ‘how’ and ‘for whom’ to produce are faced by a State too in its role as a producer of goods and services. It is a different matter that the welfare States resort to the principle of maximum social advantage while the capitalistic States resort to the tool of price mechanism to solve these problems.
In addition, government of a State faces a few other problems too. They are the ‘problem of unemployment’, the ‘problem of growth and development’ and the ‘problem of inflation’. As a producer, a government has to face the ‘problem of inefficiency’ as well. All these problems are the problems of several units or sectors lumped together.
They are, therefore, referred to as the aggregative problems or the macro problems. The reader is advised to refer to author’s Introductory Microeconomics, a companion volume to this one, for economic problems and their classification under the broad heads of micro and macro problems. Solutions to micro and the macro problems constitute the subject matter of the micro and macro economics.
All the economic problems of a nation or of the lumped units (such as industries) fall within the purview of macroeconomics while all the economic problems of individuals or of individual firms fall within the purview of microeconomics.
The terms microeconomics and macroeconomics were coined and used by a Norwegian economist. Ragnar Frisch, in 1933. The prefixes micro and macro meaning small and large respectively have been derived from Greek language.
However, little attempt was made to analyse the working of the economic system as a whole until the publication of the General Theory of Employment, Interest and Money by Prof. John Maynard Keynes in 1936.