Fundamental Concepts

Demand and supply are basic concepts in economic analysis. This is because economics is fundamentally concerned with ends and means. The quantities of various goods demanded are expected to bring satisfaction of different wants or ends, the supply of these goods is conditioned by the availability or scarcity of resources which act as the means of production. Both the terms ‘demand’ and ‘supply’ have technical implications. By demand, we mean the quantity of any commodity that ‘buyers are willing and have the ability to buy.’ Both the conditions must be satisfied together before goods can be demanded. One who smokes wishes to purchase cigarettes but he must have enough money or resources to do so. Similarly, a quantity of a commodity is said to be supplied only when a seller is willing to sell it at the market price.

The two concepts of demand and supply are, however, relative in nature and conveniently interchangeable. For example, a person may visit a distant wholesale market and purchase 50 small cans of beer at a somewhat lower price than what he would have paid in the local market. Therefore 50 cans of beer can be said to be his demand for the commodity. On his way home he meets a friend B who requests for 10 cans of beer at a particular price. If the bargain is acceptable, A will sell 10 cans to B, which will consist of his (that is A’s) ‘supply’ and the remaining 40 cans will then be his demand. Later on if a close relative of A (say C) requests him to part with 5 cans of beer on a ‘no profit no loss’ basis, then that becomes a further part of his ‘supply’ and his demand is reduced to 35 cans of beer. Similarly a shopkeeper who begins with 200 cans of beer (which is his supply) may retain 10 cans for himself and for his family members (this is known as self-consumption). In that case, his supply is reduced to 190 cans and demand would be 10 cans.
Finally demand and supply are mutually opposing concepts, in the sense that demand is an inverse (falling) function of the price, while supply is a direct (rising) function of the price. This is explained in the following sections.

Positive Economic Theory and Analysis

It will be noticed that value judgments and normative elements are unavoidable in economic discussions. Yet economists and researchers take the effort of preserving and developing the scientific content of the subject matter. There is a standard theoretical model generally used and improved upon in most analytical work. This model emerges out of neo-classical techniques introduced at the beginning of this century. Professor Danie M. Hausman in his recent book Inexact and Separate Science of Economics has brought out several basic features of this theoretical model. The important features are :

(A) Marginal Approach: The standard theoretical model used in economics is also called a marginal method or approach. This is because all optimizing decisions are taken ’at the margin’ under this method. Margin or marginal change means infinitesimally small changes in an economic entity under consideration, such as utility, cost, factor services, wage rate, quantity demanded or supplied, etc. Such a small or marginal change is in fact a mathematical tool used in calculus. In mathematics, the first derivative of any algebraic function is known as ’the rate of change.’ In economics, marginal value or quality serves exactly the same purpose. This can be illustrated as:

In each case marginal value indicates the rate of change. With a small variation in the quantity of x, the marginal utility changes at the rate of 2, or with a small change in the quantity of x, marginal revenue changes at the rate of 0.75. In both these examples, the sign of the marginal values is positive. Therefore both marginal utility and marginal revenue tend to increase with every increase in the quantity of x. This however need not always be the case. In the present case, the functions are said to be rising. But there may be falling functions as well, such as that of the cost of production in the initial stages. In that case, value of the marginal cost may be negative. In fact, productive activity normally and beneficially occurs on the falling phase of the average cost curve. This will get clearer as we proceed.

(B)Ceteris Paribus (restrictive) clause : The marginal method of economic analysis deals with the rate of small changes. Moreover, these are instant and isolated changes. We need to concentrate on the effect of such changes on concerned individuals. But actually, economic activity is highly complex and consists of interdependent factors. Therefore such isolated changes can be examined only under highly restricted conditions. We have to make a heroic assumption about the constancy or absence of change in all other related factors or causes. For instance, an individual’s demand for a commodity depends on several conditions such as the price of the commodity (P), prices of its substitutes (Ps), income of the individual (Y), the number of members in his family (N) and the tastes of that individual (Z). Such a relation can be expressed in a functional form as :

d = f (P, Ps, Y, N, Z).
This explains that ’d’, the quantity of a commodity demanded, functionally depends upon five different factors. In other words, any change in any one of these factors can result in a change in the quantity demanded. However, the marginal approach is partial in nature. It attempts to concentrate on any one of these factors at a time, in analyzing its effect. The rest of the factors are assumed to be constant. This is the implication of the Ceteris Paribus a condition which means ’other things remaining equal.’ If we want to concentrate on the isolated effect of changes in the price of the same good (P) on the quantity demanded, then this can be written as :
d = f (P) [Ps, Y, N, Z]const.
Here the second bracket, i.e. […], serves as a Ceteris Paribus assumption in explaining the price-demand relation.

Positive Economic Theory and Analysis

It will be noticed that value judgments and normative elements are unavoidable in economic discussions. Yet economists and researchers take the effort of preserving and developing the scientific content of the subject matter. There is a standard theoretical model generally used and improved upon in most analytical work. This model emerges out of neo-classical techniques introduced at the beginning of this century. Professor Danie M. Hausman in his recent book Inexact and Separate Science of Economics has brought out several basic features of this theoretical model. The important features are :

(A) Marginal Approach: The standard theoretical model used in economics is also called a marginal method or approach. This is because all optimizing decisions are taken ’at the margin’ under this method. Margin or marginal change means infinitesimally small changes in an economic entity under consideration, such as utility, cost, factor services, wage rate, quantity demanded or supplied, etc. Such a small or marginal change is in fact a mathematical tool used in calculus. In mathematics, the first derivative of any algebraic function is known as ’the rate of change.’ In economics, marginal value or quality serves exactly the same purpose. This can be illustrated as:
In each case marginal value indicates the rate of change. With a small variation in the quantity of x, the marginal utility changes at the rate of 2, or with a small change in the quantity of x, marginal revenue changes at the rate of 0.75. In both these examples, the sign of the marginal values is positive. Therefore both marginal utility and marginal revenue tend to increase with every increase in the quantity of x. This however need not always be the case. In the present case, the functions are said to be rising. But there may be falling functions as well, such as that of the cost of production in the initial stages. In that case, value of the marginal cost may be negative. In fact, productive activity normally and beneficially occurs on the falling phase of the average cost curve. This will get clearer as we proceed.

(B)Ceteris Paribus (restrictive) clause : The marginal method of economic analysis deals with the rate of small changes. Moreover, these are instant and isolated changes. We need to concentrate on the effect of such changes on concerned individuals. But actually, economic activity is highly complex and consists of interdependent factors. Therefore such isolated changes can be examined only under highly restricted conditions. We have to make a heroic assumption about the constancy or absence of change in all other related factors or causes. For instance, an individual’s demand for a commodity depends on several conditions such as the price of the commodity (P), prices of its substitutes (Ps), income of the individual (Y), the number of members in his family (N) and the tastes of that individual (Z). Such a relation can be expressed in a functional form as :
d = f (P, Ps, Y, N, Z).
This explains that ’d’, the quantity of a commodity demanded, functionally depends upon five different factors. In other words, any change in any one of these factors can result in a change in the quantity demanded. However, the marginal approach is partial in nature. It attempts to concentrate on any one of these factors at a time, in analyzing its effect. The rest of the factors are assumed to be constant. This is the implication of the Ceteris Paribus a condition which means ’other things remaining equal.’ If we want to concentrate on the isolated effect of changes in the price of the same good (P) on the quantity demanded, then this can be written as :
d = f (P) [Ps, Y, N, Z]const.
Here the second bracket, i.e. […], serves as a Ceteris Paribus assumption in explaining the price-demand relation.

Macro and Microeconomics

These are two branches or rather methods of exposition of the science of economics. The distinction between them can best be explained by comparing their main features. As the terms suggest, macroeconomics deals with the market on a large-scale and its aggregate problems, while microeconomics concerns markets on a small-scale and individual aspects of the problems. There are six distinct aspects of the two approaches that are shown as in the following table:

Microeconomics
Macroeconomics
(a)
Units of the study
Individual consumers, producers workers, traders, etc.
Aggregate units such as state National or International economy.
(b)
Activities
Optimization and maximization of personal gains and profits.
Long term growth, maintenance of high levels of production and employment.
(c)
Origin
Micro activities emerge on the demand side of consumer’s choices.
Problems of long-term growth depend upon the supply of productive resources
(d)
Conditions
This approach is functional under static conditions and small time intervals.
This approach is functional under dynamic conditions and complex long run changes.
(e)
Methods
It is concerned with small adjustments, for which the application of a marginal method is suitable.
It deals with complex, dynamic changes inviting the use of advanced mathematical techniques.
(f)
Levels
Micro adjustments in resource A allocation are made in response to changes in relative prices of goods and services. The aggregate level of income or total economic activities is considered to be constant.
Macro approach attempts to find the conditions of long-term expansions in output as a whole, assuming relative prices as constant (or significant).


This distinction between micro and macroeconomics as presented above is only a matter of theoretical convenience. The two approaches are complementary and not competitive; one cannot consider these to be watertight compartments. Moreover, the distinction is to be understood as relative in nature. The problems of a city municipal corporation are macro in nature as compared to those of individual citizens, but a city unit is micro as compared to the state, and the state unit is micro as compared to the nation and the national unit can be considered micro in the context of the global economy. Again all economic problems and activities, whether micro or macro are ultimately connected with making a choice and optimization. They emerge out of and are concerned with human behavior.