Types of Macroeconomics
Types of Macroeconomics
"According to Prof. Mehta". "Static equilibrium is that equilibrium which maintains itself outside the period of time under
consideration ". It is state of bliss which every individual firm, industry or factor wants to attain and once reached, would not like
to leave. Consumer is in equilibrium when he gets maximum satisfaction from a given expenditure on different goods and
services.Any move on this part to reallocate his expenditure among his purchases will decrease rather than increase his total
satisfaction. A firm is in equilibrium when its profit is the maximum and it has no incentive to expand or contract its output. It is a
position in which neither the adjusting firms have any tendency to live nor for new firms to enter the industry. In other words, an
industry is in equilibrium when all firms are earning only normal profits.
1. Micro static.
3. Comparative static
Micro static:
An economic model refers to relationship among different variables in which one variable appears in more than one
relationship. In the micro static models of price determination, supply and demand relationship determine price at a point of
time which are also constant through time. The given demand and supply functions are
D= (P) ----- I
S= (P) ----II
Where,
D = demand
P = price
S = supply
The equation I shows that demand is inversely proportional to price i.e. if price decrease the demand will rise and if price
increases, the demand will fall keeping other things constant. On the other hand equation II shows that supply is also the
function of price i.e. if price increase supply will rise and if price decrease supply will fall, other things remaining constant.
Generally, the economists are interested in the equilibrium values of the variables which are attained as a result of the
adjustment of the given variables to each other. That is why economic theory has sometimes been called equilibrium analysis.
Till recently, the whole price theory in which we explain the determination of equilibrium prices of the products and factors in
different market categories were mainly static analysis. The values of the various variables such as demand, supply, and price
were taken to be relating to the same point or period of time.
Macro-Static:
The concept of Macro-Static explains the static equilibrium position of the economy. This concept is best explained by Prof.
Kurihara in these words: “If the object is to show a still picture of the economy as a whole, the macro-static method is the
appropriate technique.. This technique is one of investigating the relations between macro-variables in final position of
equilibrium without reference to the process of adjustment implicit in that final position”. Such a final position of equilibrium may
be shown by the equation Y = C + I
Where, Y = Total Income
C = Total consumption expenditure
I = Total Investment expenditure
In a static Keynesian model, the level of equilibrium is determined by the interaction of aggregate supply function and the
aggregate demand function. In diagram OZ shows aggregate supply function and C + I line represents aggregate demand
function. The line OZ and C + I intersect at point E, which determines equilibrium level of income at OY 1. It simply shows a
timeless identity equation without any adjusting mechanism.
Comparative Static:
A Comparative Static analysis compares one equilibrium position with another when data have changed and system has
finally reached another equilibrium position. It does not show how the system has reached the final equilibrium position with a
change in data. It merely explains and compares the initial equilibrium position with the final one reached after the system has
adjusted to a change in data.
Thus, in comparative static analysis, equilibrium positions corresponding to different sets of data are compared.
Let us see few examples of comparative static analyses.
Consider our previous example of static analysis of demand and supply which determine the equilibrium quantity and price. We
can thus think of an analysis in which we start with a system in equilibrium. We now introduce a change and study the ultimate
effect of a change. This can be explained with the following diagram
The original equilibrium between DD the demand curve and SS the supply curve is at E 1. When demand increases to D1D1, as
a result of increase in income, the new equilibrium is at E2 at the price OP2. In comparative static analysis, we are concerned
only with explaining the new equilibrium position at point E2 and comparing it with E1. We are not concerned with the whole path
the system has travelled from E1 to E2. Alfred Marshall has made extensive use of comparative static in his time-period analysis
of pricing under perfect competition.
Although the dynamic analysis of the two equilibrium positions with different sets of data is more comprehensive and
informative.
It fails to predict the path which the market follows when moving from one equilibrium position to another.
It cannot predict whether or not a given equilibrium position will ever be achieved. For this purpose we need dynamic
analysis.
Dynamic Equilibrium
When after a fixed period the equilibrium state is disturbed it is called dynamic equilibrium.
In dynamic equilibrium prices, quantities, incomes, tastes, technology etc are constantly changing.
For e.g. suppose some more persons develop the taste for fish, s a result the demand for fish will increase seller will at once
raise the price and thus change the behavior of the old buyers. The market will be thrown into a state of disequilibrium and will
remain so till the supply of fish is increased to the level of the new demand. When new equilibrium will be brought in by the
forces contenting forces.
The word dynamic means causing to move. In economics, ‘dynamic’ refers to the study of economic change. The essence of
any knowledge lies in formulating relationships between phenomena. There must be thus sequence of events for the
knowledge to be born. The main purpose is to know as to how complex of current events will shape itself I the future. To do so
it is necessary to visualize the way it has itself arisen out of the past events. The moment we talk of sequence of events, the
elements of time creeps into our analysis. Economics is thus a process of change through time.
Micro-Dynamics (cobweb)
It is used to explain the dynamics of demand, supply and price over long period of time. The cob-web model (or Theorem)
analyses the movements of prices and outputs when supply is wholly determined by prices in the previous period.
As prices moves up and down in cycles, quantities produced and also seem to move up and down in a counter-cyclical manner
(e.g. prices of perishable commodities like vegetables).
In order to find out the conditions for converging, diverging or constant cycles: one has to look at the slope of the demand curve
and then of the supply curve.
Assumption
2. The current year’s (t) supply depends on the last year’s (t-1) decisions regarding output level.
5. The parameters determining the supply function have constant values over a series of periods.
6. Current demand (Dt) for the commodity is a function of current price (Pt).
7. The price expected to rule I the current period is the actual price in the last year.
8. The commodity under consideration is perishable and can be stored only for one year.
9. Both supply and demand function are linear .i.e. both are straight line curves which increases or decreases at a
constant proportion.
The Cob-web Model
There are two types of Cob-web Models:
1. Convergent
2. Divergent
3. Continuous
Suppose we start with the price OP1 as shown in the diagram. As the supply will be more due to high price in the market. On
the other hand the demand will be less as compared to the supply OQ2 and the demand will reduced to OQ2. The fall in
demand will force the producer to decrease price to OP2 in next period. But at this price OP2 the demand will be OQ2 which is
more than the supply OQ1 which reduced. This way the prices and quantities will circulate constantly around the equilibrium.
Macro-Dynamics (cobweb)
According to Kurihara,” ‘Macro-Dynamics’ treats discrete movements or rates of change of macro-variables. It can be explained
in terms of the Keynesian process of income propagation (the investment multiplier) where consumption depends on income
i.e. C = f (Yt-1)
Where
C = Consumption
Y = Income
f = function
The function shows that the consumption in the current period (t) depends on the Y in the previous period ( t-1). On the other
hand investment is a function of time and of constant autonomous investment ∆I (Autonomous investment is the investment
which does not changes due to changes in income.i.e. changes in investment does not take place due to change in
income).For e.g. government does the investment for welfare of the people and not for profit expectation. So investment
function can be written as It = f (∆ I). This can be explained with the following diagram.
The above diagram shows that C is the aggregate demand function and 45 0 degree line is the aggregate supply function.
Suppose we start with the time period t0 where with an equilibrium level of income OY1, investment increased from I0 to I1, this
can be seen by the new aggregate demand function line C + I + I 1.But in period t, consumption lags behind and it is still on the
equilibrium point E1. In next period t + 1 consumption increased with the increase in investment, which lead to increase in income
from OY1 to OY2. This is the process of income prorogation which will continue till the aggregate demand function C + I +
I1 intersects the aggregate function 450 line at point E2 in the nth period. The new equilibrium level of income is at OYn. The
curved steps from t0 to E2 show the macro-dynamic equilibrium path.
In fig E is the initial equilibrium point where OQ quantity is demanded and supplied at OP price. With the rise in the price to
OP1, E1 becomes the new equilibrium point but the quantity demanded and supplied remains the same, i.e. OQ. Thus, the
price range PP1 (=EE1) represents neutral equilibrium.
Partial Equilibrium
Partial equilibrium analysis is the analysis of an equilibrium position for a sector of the economy or for one or several partial
groups of the economic unit corresponding to a particular set of data.Partial or particular equilibrium analysis, also known as
micro economic analysis, is the study of the equilibrium position of an individual, a firm, an industry or a group of industries
viewed in isolation. In other words, this method considers the changes in one or two variables keeping all others constant, i.e.,
ceteris paribus (others remaining the same). The ceteris paribus is the crux of partial equilibrium analysis.For Example
(a) Consumer’s Equilibrium: With the application of partial equilibrium analysis, consumer’s equilibrium is
indicated when he is getting maximum aggregate satisfaction from a given expenditure and in a given set of conditions relating
to price and supply of the commodity.
The conditions are: 1) the marginal utility of each good is equal to its price (P), i.e.
And (2) the consumer must spend his entire income (Y) on the purchase of goods, i.e.
It is assumed that his tastes, preferences, money income and the prices of the goods he wants to buy are given and constant.
(b) Producer's Equilibrium: A producer is in equilibrium when he is able to maximise his aggregate net profit in
the economic conditions in which he is working.
(c) Firm's Equilibrium: A firm is said to be in long-run equilibrium when it has attained the optimum size when is
ideal from the viewpoint of profit and utilization of resources at its disposal.
(c) Industry's Equilibrium: Equilibrium of an industry shows that there is no incentive for new firms to enter it or
for the existing firms to leave it. This will happen when the marginal firm in the industry is making only normal profit, neither
more nor less. In all these cases; those who have incentive to change it have no opportunity and those who have the
opportunity have no incentive.
*Assumptions
2. Consumer’s taste and preferences, habits, incomes are also considered to be constant.
3. Prices of prolific resources of a commodity and that of other related goods (substitute or complimentary) are known
as well as constant.
4. Industry is easily availed with factors of production at a known and constant price compliant with the methods of
production in use.
5. Prices of the products that the factor of production helps in producing and the price and quantity of other factors are
General Equilibrium
Leon Walras (1834-1910), a Neoclassical economist, in his book ‘Elements of Pure Economics’, created his theoretical and
mathematical model of General Equilibrium as a means of integrating both the effects of demand and supply side forces in the
whole economy.Elements of Pure Economics provides a succession of models, each taking into account more aspects of a real
economy.General equilibrium theory is a branch of theoretical microeconomics.The partial equilibrium analysis studies the
relationship between only selected few variables, keeping others unchanged.Whereas the general equilibrium analysis enables
us to study the behaviour of economic variables taking full account of the interaction between those variables and the rest of
the economy.In partial equilibrium analysis, the determination of the price of a good is simplified by just looking at the price of
one good, and assuming that the prices of all other goods remain constant. Thus the economy is in general equilibrium when
commodity prices make each demand equal to its supply and factor prices make the demand for each factor equal to its supply
so that all product markets and factor markets are simultaneously in equilibrium.Such a general equilibrium is characterized by
two conditions in which the set of prices in all product and factor markets is such that
1) All consumers maximize their satisfactions and all producers maximize their profits and
2) All markets are cleared which means that the total amount demanded equals the total amount supplied at a positive price in
both the product and factor markets.
To explain it, we begin with a simple hypothetical economy where there are only two sectors, the household and the business.
The economic activity takes the form of flow of goods and services between these two sectors and monetary flow between
them. These two flows, called real and monetary are shown in figure.
Where the product market is show in the upper portion and the factor market in the lower portion. In the product market,
consumers (Household) purchase goods and services from producers (Firms) while in the factor market, consumers receive
income from the former for providing Factor services. The producers, in turn, make payments to consumers for the services
rendered i.e. wage payments for labour services, interest for capital supplied, etc. thus payments go around in a circular
manner from producers to consumers and from consumers to produces, as shown by arrows in the inner portion of the figure.
There are also flows of goods and services in the opposite direction to the money payments flows. Goods flow from the
business sector to the household sector in the product market, and services flow from the household sector to the business
sector in the factor market, as shown in the outer portion of the figure. These two flows are linked by product prices and factor
prices. The economy is in general equilibrium when a set of prices is allowed at which the magnitude of income flow from
producers to consumers is equal to the magnitude of the money expenditure from consumers to producers.
Condition where a market price is established through competition such that the amount of goods or services
Condition where a market price is established through competition such that the amount of goods or services
sought by buyers is not equal to the amount of goods or services produced by sellers.
2. Static equilibrium is
State of bliss which every individual firm, industry or factor wants to attain and once reached, would not like to
leave.
State of bliss which every individual firm, industry or factor wants to attain and once reached, would like to leave.
One equilibrium position with another when data have changed and system has finally reached another
equilibrium position.
One equilibrium position with another when data have changed and system has finally reached the same
equilibrium position.
5. In dynamic equilibrium