Forms of Economic Analysis: Micro vs. Macro

Micro and Macro-economics

The subject matter of economics has been divided into two parts Microeconomics and Macroeconomics. These terms were first coined and used by Ragnar Frisch and have now been adopted by the economists all over the world. Nowadays one can hardly come across a text book on modern economic analysis which does not divide its analysis into two parts, one dealing with microeconomics and the other with macroeconomics.

The term microeconomics is derived from the Greek word mikros meaning “small” and the term macroeconomics is derived from the Greek word makros meaning “largo.” Thus, microeconomies deals with the analysis of small individual units of the economy such as individual firms and small aggregates or groups of individual units such as various industries and markets.

On the other hand, macroeconomics concerns itself with the analysis of the economy as a whole and its large aggregates such as total national output and income, total employment, total consumption, aggregate investment. Thus, according to K E Boulding, “Microeconomics is the study of particular fums, particular households, individual prices, wages, Incomes, individual industries, particular commodities.”

About macroeconomics he remarles, “Macroeconomics deals not with individual quantities as such but with aggregates of these quantities, not with individual incomes but with the national Income; not with individual prices but with the price level; not with individual outputs but with the national output “.

  • MICROECONOMICS

As stated above, microeconomics studies the economic actions and behaviour of individual units and small groups of individual units. In microeconomic theory we discuss how the various cells of economic organism, that is, the various units of the economy such as thousands of consumers, thousands of producers or firms, thousands of workers and resource suppliers in the economy do their economic activities and reach their equilibrium states. In other words, in microeconomics we make a microscope study of the economy.

But it should be remembered that microeconomics does not study the economy in Its totality. Instead, in microeconomics we discuss equilibrium of innumerable units of the economy piecemeal and their interrelationship to each other.

” For instance, in microeconomic analysis we study the demand of an individual consumer for a good and from there go on to derive the market demand for the good (that is, demand of a group of individuals consuming a particular group).

Examples of Microeconomic variables: Demand of a commodity, Supply of a commodity, Income of a consumer, Price of the commodity etc.

Examples of Microeconomic theories/study: Law of demand, Law of supply, Determination of consumer equilibrium, Determination of producer equilibrium etc.

-> Importance of Micro Economics

I. Price Determination:

Micro economics helps in elucidation how the prices of diverse commodities are determined.  It also explicates how the prices of various aspects of production such as rent for land, wages for labour, interest for capital and profits for entrepreneur are decided in the commodity and factor market.

II. Working of a Free Market Economy:

Free market economy is the economy where the economic pronouncements regarding production of goods such as ‘What to produce, How much to produce, How to produce etc.’ are taken by private individuals. These verdicts are based on the inclination of the consumer or demand for the product. Micro economics theory helps in grasping the working of the free market economy.

III. International Trade & Public Finance:

Micro economics helps to elucidate many international trade facets like impacts of tariff, determination of exchange rates, advantages from international trade etc. It is also beneficial in public finance to analyse both, the occurrences as well as effect of a specific tax.

IV. Utilization of Resources:

Micro economics helps in elucidating how the scarce resources can be effectually and efficiently utilized by the producers in order to achieve highest output.

V. Model Building:

Micro economics helps in grasping various complex economic situations with its modest models. It has made an imperative contribution to the science of economics by the development of numerous terms, concepts, terminologies, tools of economic evaluation etc.

VI. Helps in Taking Business Decisions:

Micro economic theories are beneficial to businessmen for taking decisive business decisions. These decisions comprise the cost of production, values, maximum output, consumer’s preferences, demand and supply of the product etc.

VII. Useful to Government:

Micro economics is that subdivision of economics which is related with the study of economic behaviour of individual economic units. It is beneficial in building economic policies such as taxation policy, public expenditure policy, price policy etc.  These policies aid the government to reach its goal of efficient distribution of resources and promoting economic wellbeing of the society.

VIII. Basis of Welfare Economics:

Micro economics endorses economic and social welfare by making finest utilization of the resources, thereby evading wastage.

  • MACROECONOMICS

Macroeconomics is a Study of Aggregates. We now turn to explain the approach and content of macroeconomics. ‘As said above, word macro is derived from the Greek word ‘makros’ meaning large and therefore macroeconomics is concerned with the economic activity in the large.

Macroeconomic analyses the behaviour of the whole economic system in totality or entirety. In other words, macroeconomic studies the behaviour of the large aggregates such as total employment, the national product or income, the general price level of the economy. Therefore, macroeconomics is also known as aggregative economics. Macroeconomics analyses and establishes the functional relationship between these large aggregates. Thus Professor Boulding says, “Macroeconomics deals not with individual quantities as such but with the aggregates of these quantities; not with individual incomes but with the national income, not with individual prices but with the price level; not with individual output but with the national output.

Macroeconomics, then, is that part of the subject which deals with large aggregates and averages of the system rather than with particular items in it and attempts to define these aggregates in a useful manner and to examine their relationships. ” Professor Gardner Ackley makes the distinction between the two types more clear and specific when he writes, macroeconomics concerns itself with such variables as the aggregate volume of output in an economy, with the extent to which its resources are employed, with the size of the national income, with the general price level”. Microeconomics, on the other hand, deals with the division of total output among industries, products and firms and the allocation of resources among competing uses. It considers problems of income distribution. Its interest is in relative prices of particular goods and services.

Examples of Macroeconomic variables : Aggregate supply, Aggregate demand, National income, Total output etc.

Examples of Macroeconomic studies/theories : Determination of equilibrium level of income, Determination of foreign exchange rate, Determination of govt. budget etc.

-> Importance of macroeconomics

Macroeconomics is a vibrant concept that studies the whole nation and works for the welfare of the economy. It is beneficial for the timing of economic variations to prevent or be prepared for any financial crisis or any long – term adverse situations. The system of fiscal and monetary policies rest on entirely on the examination of the widely held macroeconomic situations in the nation. Macroeconomics mainly purposes to help the Government and the financial bodies to fix economic stability in the country. This course of economics gives a broader viewpoint of social or national issues. The ones who want to provide to the welfare of society need to study macroeconomics. It guarantees or keeps a check over the appropriate functioning of the country’s economy and real position. The analysis of macroeconomics concepts and issues helps the economists to understand the causes and possible explanations of such macro-level problems.  Dealing with numerous economic situations through the use of macro-economic data unlocks the door for development in the country.

Global Minimum Corporate Tax

What does this mean? What are its implications? How its going to affect India among other nations?

If you’re a firm that makes tremendous profits year after year by moving money to low-tax jurisdictions, you’re in for some unpleasant news.

Gone are the days when you could produce a lot of money from both tangible and intangible sources, move your money from high-tax countries to low- or no-tax countries, and enjoy the numerous delights of money.

The finance ministers of the world’s seven richest and most affluent countries met in London to continue their ongoing conversation about the global problem of multinational firms evading taxes. The meeting resulted in the ministers agreeing to a minimum global company tax rate of at least 15% at the same table. “After years of discussion,G7 Finance Ministers have reached a historic agreement to reform the global tax system to make it for global digital age”. British finance minister Rishi Sunak told reporters when asked about the same. He expressed gratitude to all of his G7 counterparts for finally being able to reach a historic landmark agreement that would tackle the issue of profit shifting by various firms.

The idea of a global minimum corporate tax isn’t new; there have been discussions about it before, but it has only recently gained traction as one of the world’s major leaders, the United States of America, has been attempting to deal with massive amounts of tax evasion by large American corporations such as Facebook and Amazon,and in same context, US Secretary of the treasury Jane Yellen reiterated the positive implications of having this minimum corporate tax accepted globally. Furthermore, the Biden administration has increased the corporate tax rate from 21% to 28%, and with such high tax rates, multinational firms will seek to open headquarters in nations where they will have to spend much less, resulting in a significant revenue loss for the US.

What does it mean?

As the name implies, the global minimum corporate tax (GMCT) is a tax that will be imposed on businesses and corporations all over the world; no country will be able to keep its corporate tax rates below the suggested minimum of 15%. This is the bare minimum that all governments must adhere to; there is no upper limit to such levies.

Why is it being proposed?

Corporate taxes account for a significant portion of a country’s total revenue. A nation must ensure the social welfare of its residents, which necessitates the expenditure of funds to invest in infrastructure, which will in turn provide jobs for its citizens. It can raise the funds it requires through a variety of methods, including borrowing from international financial institutions and borrowing from the general public. The revenue obtained by the first two methods creates an obligation for the country, but there is no such responsibility in the case of taxes. It is for this reason that taxes are essential for any country to meet its obligations.

Big businesses earn a lot of money and are continually looking for methods to avoid paying higher taxes. If the countries in which they primarily operate impose greater taxes, they attempt to shift their profits to low-tax jurisdictions such as Ireland (12.5 percent tax rate), the Bahamas (0% tax rate), and so on. As a result, their home countries receive less money, while lower tax jurisdictions receive more. According to the Tax Justice Network, the US Treasury loses roughly $50 billion each year as a result of the massive amount of Base Erosion Shifting System. Germany and France are also among the top losers, according to the same analysis.

This concept of a global minimum corporate tax rate was proposed in order to force multinational corporations to pay taxes in the countries where their businesses operate. Having a global minimum tax will ensure that these large corporations do not engage in profit shifting and tax evasion strategies, as well as that they do not compromise on innovation and the use of newly created technologies.

How will it be implemented?

Assume there is a country A with a 15% effective corporate tax rate, i.e. the GMCT, and another country B with a 5% effective corporate tax rate. For a corporation operating in nation A, a tax rate of only 5% would be an appealing force, and it would strive to discover ways to shift its profits to country B in order to avoid paying higher taxes. Opening subsidiaries in another country is one technique for a country to move its earnings to another country. As a result, firm A will establish a subsidiary in Country B and transfer a significant portion of its profit from activities in Country A to Country B. Now, if the subsidiary makes a profit of 100 crores, it will only have to pay taxes of 5%, that is, 5 crores. Following the implementation of the worldwide minimum corporation tax rate, country A can reduce 5 percent (tax in country B) from 15 percent (tax in country A) and require the firm to pay the resulting tax at the rate of 15-5=10% to the home country.

What are its implications?

The proposed global minimum business tax has both favorable and unfavorable consequences.
The following are some of the advantages:

  • Increased accountability of the global corporations.
  • Transparency in the system.
  • Increased employment opportunities in the traditional country.
  • Increased capital formation in the home country.
  •  Reduced liabilities for a nation, liabilities created by internal and external borrowings.
  • Negative Implications:-

    • The investments made my these big multinational companies in lower tax countries are the major source of revenue of those nations. Implementing minimum tax rate would take away a major part of their revenue.

  • A number of employment opportunities are created by companies in poor countries, implementation of new tax regime will devoid them of such opportunities.
  • Foreign direct Investment(FDI) to poor countries will reduce, making it difficult for them to fulfill their import needs.
  • The problem of avoiding the payment of taxes by rampant exploitation of loopholes will still remain.
  • Tax collection is a sovereign right of any nation, that makes it more difficult for making all the nations agree on this
  • proposal.

    What are the challenges in its implementation?

    As already mentioned above, the profits that MNCs shift to lower tax jurisdictions result in creation of newer employment opportunities in such countries and this in turn ensure the welfare of its citizens. A number of poor countries don’t have enough resources to raise money for infrastructure development, the investments made by global companies provide them money to develop required infrastructure and to ensure the fulfillment of other requirements. Considering the importance of such investments in poor countries, its challenging to get them on board.

    Countries such as Ireland, Bahamas, Bermuda and Caribbean nations have benefited to a large extent from the ongoing profit shifting system and its not easy to make all of them agree on foregoing a large amount of money.

    Another global power apart from USA, i.e., China would also pose difficulty in its implementation as Hong-Kong is one of the major tax havens and generates money through foreign direct investments. Also, there is major trade war going on between China and USA and China would not so easily bend down to something proposed by US.

    How it is going to affect India?

    India too isn’t immune to the huge loss caused by the tax evasions of its corporations. According to Tax Justice Network, based in U.K., India loses $10.3 annually to the global tax abuse by multinational corporations. So, the implementation of proposed tax system would mean increased revenue for the government of India and reduction in huge borrowings done by the government.

    According to a report brought out by Press Trust of India, the experts in tax domain believe that India will be most likely benefiting from the GMCT as the effective corporate tax rate in India is 22%, much less than the proposed minimum tax rate of 15% and so India will keep attracting the global companies to come and invest in the country. Also, according to Rakesh Nangia, the chairman of Nangia Andersen India, the major points of attraction in India for Big MNCs are its large internal market, quality labor at cheap rates, strategic locations for exports and a prospering private sector. So, overall, India won’t be much affected even if the implementation of global corporate minimum tax comes into force.

    On the other hand, there are prevailing concerns in India that a lot of companies such as e-commerce ones have a “significant presence in India” but still do not pay taxes to the country. And for this only. the country advocated the idea of implementing ” equalization levy” in 2016. Post 2016, this concept of equalization levy has been extended to e-commerce companies as well. The levy aimed at taxing the income earned by such multinational companies who don’t have any permanent physical presence in India but generate huge amount of income from the country. 

    India has also signed a pact with US for the exchange of country by country report(cbc), through which if there is any US company operating in India through its subsidiaries, it would provide reports about its total revenue to US administration and US will in turn, provide the same to India so that India can tax the generated income according to its tax rates.

    India has also implemented the Multilateral Convention to implement Tax Treaty related measures to prevent Base Erosion profit shifting and ratified the same.

    India already has implemented above discussed reforms in order to ensure the payment of required taxes from global companies. Considering this, India need to be careful of not driving these companies away from India because of a large number of already existing regulations.

    The landmark deal will be discussed once again in the presence of all the countries constituting the group of 20 (G-20) and based on those discussions, further implementation challenges will be worked upon.

    INDIFFERENCE CURVES

    In microeconomics, the study deals with the different individuals and their decisions and its effect on the economy. The decisions such as the level of consumption, savings, investment are never the same. But a consumer strives to get the best deal for his commodities which give him highest satisfaction given the budget constraint. The consumer tries to attain that point in the indifference curve where he can get the most utilities from both goods.

    An indifference curve or IC is the graphical representation of combinations of two goods that yield the same level of satisfaction to the consumer. The indifference curve operates on the principle of diminishing Marginal Rate of Substitution(MRS). Every point on the indifference curve shows that an individual or a consumer is indifferent between the two products as it gives him the same kind of utility.

    There is also a concept of indifference map which is the graphical representation of two or more indifference curves showing the various combination of commodities with different quantities, which a consumer consumes, given his income and the market price of both the commodities.

    Before going forward with IC, let’s look what is Marginal Rate of Substitution.

    Marginal Rate of Substitution is the rate at which a consumer substitutes some units of one good or willing to forego units of one commodity for additional units of another good which provides the same level of utility or satisfaction. MRS measures the changes in the units of consumption of the combination of two goods but does not influence the utility.

    Formula for calculating is MRSxy = MUy / MUx = Px / Py

    where,

    MRSxy – Marginal Rate of Substitution of good x and good y

    MUy and MUx – Marginal utility of good y and good x respectively

    Px and Py- Prices of good x and good y respectively

    The indifference curve is convex to the origin because of the diminishing Marginal Rate of Substitution.

    ASSUMPTIONS OF INDIFFERENCE CURVES

    • There are only two goods, say good x and good y. It is also assumed that the prices of the commodities are constant.
    • The consumers are rational and thus aim to have the highest utility from the pair of goods. The consumer moves to higher indifference curves for attaining maximum satisfaction.
    • The utilities are ordinal because the utility or the amount of satisfaction cannot be quantified.
    • The income of the consumer is fixed. Thus, there is a budget constraint.
    • There is Diminishing Marginal Rate of Substitution where good y is substituted for good x.

    PROPERTIES OF INDIFFERENCE CURVES

    • The indifference curve is convex to the origin due to the decreasing marginal rate of substitution. It can never be concave as it violates law of diminishing marginal utility.
    • The indifference curve is slopes from left to right as one commodity substitutes another.
    • The indifference curves never touch the axes because the assumption states that each point represents different utilities of two goods. If it touches the axes, the utility of one commodity becomes zero.
    • Higher indifference curves represent higher quantities of both the goods and thus higher utility.
    • Two indifference curves never intersect each other because the two curves represent different utilities.

    From the above diagram, we can infer that point c is where the consumer is in equilibrium.

    Consumer equilibrium is a situation in which a consumer purchases a combination of goods which gives him maximum satisfaction given the income and prices, he is not willing to make any changes in it.

    Conditions for consumer equilibrium

    1. Slope of IC = Slope of price line (budget line)
    2. MRSxy=Px / Py

    In U1, points a and e cannot be equilibrium points because there are opportunities for consumer to move to U2. Points b and d cannot be equilibrium points because at both points MRSxy is not equal to Px / Py.

    At point c in U3, MRSxy= Px / Py and thus the consumer is in the state of rest and attains maximum utility.

    The consumer cannot move to U4 because the prices of goods exceed the budget line of the consumer.

    RELEVANT LINKS:https://corporatefinanceinstitute.com/resources/knowledge/economics/indifference-curve/ https://www.economicshelp.org/blog/glossary/indifference-curves/

    FOREIGN EXCHANGE MARKET

    The market or a platform in which the national currencies of various countries are exchanged or converted for each other is called the foreign exchange market. This market covers various institutions such as banks, official government agencies, dealers in foreign exchange etc.

    The foreign exchange market is bifurcated-Spot market and Forward market.

    A spot market handles spot or current transactions in foreign exchange. The exchange rate is Spot rate. The transactions are affected by the prevailing rates at the point of time and delivery of foreign exchange is thus affected.

    A market where the foreign exchange is bought and sold for future delivery is called forward market. It deals with foreign exchange transactions that are contracted today but are implemented in future. The exchange rate prevailing in this market is Forward rate.

    REASONS FOR RISING DEMAND FOR FOREIGN EXCHANGE

    • In a situation of fall in foreign exchange rates, the imports from that foreign country becomes cheaper and thus, there will demand for higher imports. Hence the demand for that foreign currency increases.
    • The price fall in foreign exchange rate also implies foreign currency becomes cheaper than domestic currency and promotes tourism to that country. This increases demand for foreign currencies.

    The situation is just opposite for falling demand for foreign currencies where imports become costly and thus its demand falls.

    REASONS FOR RISING SUPPLY OF FOR FOREIGN EXCHANGE

    • In a situation of rise in foreign exchange rates, then the home country’s goods are cheaper to the foreign countries and thus, it increases the flow of foreign currency into home country by way of exports.
    • A rise in foreign exchange rates also attract foreigners to visit home country as the home country’s currency becomes cheaper. This also increases supply of foreign currencies.

    The situation is just opposite for falling supply of foreign exchange as investment in goods and services become costly for foreigners.

    DETERMINATION OF FOREIGN EXCHANGE RATE

    The exchange rate is determined at that point where demand for foreign exchange equates supply of foreign exchange which is nothing but the equilibrium exchange rate of foreign currency.

    In the diagram above, there are two currencies US dollars(foreign country) and Indian rupees (home country) taken in X- axis and Y-axis respectively.

    In the diagram, the demand curve is downward sloping. The reason of demand curve being negatively sloped, any graph for that matter, is because in general demand for a commodity increases when there is a decrease in its price. Thus, demand and price of that commodity are inversely related to each other. However, supply curve is positively sloped because supply and price have a direct relationship. In the context of foreign exchange market, demand (DD) is negatively sloped which implies less foreign exchange is demanded when exchange rate rises. Supply (SS) is upward sloping which mans that supply of foreign exchange rises with increase in exchange rate.

    In the diagram , both curves intersect at point E which is the equilibrium point. OR is the equilibrium rate and the equilibrium quantity is OQ.

    There are changes in the exchange rate only when there are changes in demand and supply. Suppose, if there is an increase in the demand for US dollars in India, it shifts the demand curve from DD to D’D’. The demand will increase the exchange rate shifting it from OR to OR1. It represents depreciation of Indian currency in terms of US dollars.

    Similarly, a rise in the supply of US dollars will cause supply curve to shift from SS to S’S’ and the exchange rate would also shift from OR to OR2. This leads to appreciation of Indian rupees in terms of US dollars.

    This is the process by which the exchange rate between various currencies take place.

    Relevant links:https://www.ndtv.com/business/rupee-vs-dollar-rate-today-rupee-depreciates-to-74-23-against-dollar-amid-muted-domestic-equities-2475230 https://in.news.yahoo.com/goal-without-proper-plan-destined-074454320.html

    Rural Development – the need of the hour

    India is a diverse nation and one of the most challenging areas of India is majorly included in the rural regions. Rural areas are known as villages and have extremely less population per square kilometer. Even though the population per square kilometer is significantly less, most of the population in India resides in rural areas. The socio-economic census data (2011) revealed that almost 73% of the households were in rural areas. A good amount of GDP arises through rural regions as a significant amount of income is generated by people residing in rural regions through agriculture, Cottage Industries, Pottery, self-employment, services, construction, and much more.

    Importance of Rural Development

    Rural Development implies the actions taken for developing rural areas to improve India’s economy and to improve the standard of living in rural areas.
    Rural development is the need of the hour because the majority of the population resides in rural regions. India’s economy can be improved drastically if the rural regions are developed. Necessities are not accessible in the rural regions and rural development is important because it will make basic needs accessible.
    Some areas need to be developed in rural areas urgently, they include Education, Public Health, Sanitation, Women Empowerment, Employment, and much more.

    Objectives of Rural Development

    The main objectives of developing rural regions by the government are:
    1. Improving productiveness & wages of people residing in rural regions
    2. Increasing the standard of living of people residing in rural regions
    3. Increasing employment and working towards demolishing unemployment
    4. Providing basic needs
    … And so on.

    Rural Areas & Urbanization

    India, in today’s time, has its focus on urban areas. Urban cities are expected to be the main form of growth while the potential of rural regions is mostly ignored. The existing reality and the plight of the rural areas need to be considered. Rural India is far more behind than Urban India in almost most aspects.
    Various indicators conclude the importance of rural development in India:
    1. Majority of families living in rural regions have a monthly income of less than Rs. 5000.
    2. More than half of the rural families do not own land and are into casual labor. Close to 97 percent of the rural employment is in agriculture and informal jobs.
    3. The rate of poverty reduction is higher in Urban Areas than the Rural Areas.
    4. Rural literacy rate is lower than the urban literacy rate.
    5. Rural Regions lack health and sanitation facilities more than the urban regions.

    Conclusion

    The nature of rural areas has changed as globalization as well as urbanization increased.
    Rural development is extremely crucial for the overall development of the country. The majority of Indians are dependent on agriculture and one-third of rural India is still below the poverty line. Therefore, the government needs to develop rural regions and provide them with a better standard of living. Rural India Development is extremely crucial, especially in today’s extremely challenging times. The solutions to the challenges faced by rural people are complicated and funding is not the solution. Funding cannot solve the majority of issues, one of the main ones being poverty. It is a temporary solution. In the long run, skills and opportunities can make a huge difference in developing rural areas.
    Villages have taken a backseat in almost every aspect of socio-economic analysis. The balance between urban and rural development is a must for the well-being of the country especially during COVID where the rural areas have been severely affected and the lack of basic facilities has made the situation for them even worse.