Choices under scarcity
Economics is the study of how people make choices when resources are scarce, and of what those choices mean for individuals and for society as a whole. Its analysis of behaviour starts from one assumption: people are rational. They have well-defined goals and try to achieve them as best they can. Because material and human resources are limited, pursuing a goal usually means a trade-off, giving something up to get something else. Economics is therefore about prioritising needs and wants and allocating limited resources to the goals chosen.
Of the many branches, two are the best known. Microeconomics studies the economy at the small, firm-level scale; macroeconomics studies it on the large, broad scale.
Microeconomics: individuals, firms and prices
Microeconomics studies the behaviour of individuals and their decisions about what to buy and consume at prevailing prices. Those decisions in turn signal where the economy will direct its productive activity. The underlying philosophy is that prices and production levels of goods and services are driven by consumer demand, so microeconomics focuses on the drivers of decision making and on how individual decisions add up to overall supply and demand, and therefore prices.
Extending from individuals to firms, microeconomics also covers the theory of the firm: how firms adopt strategies to increase profits, and their decisions on inputs, outputs, prices, production levels, profits and losses.
It explains how consumers, producers, resource markets and people behave under various assumptions about market structure. And it explains how the prices of products and services get determined, how individuals and firms behave in relation to those prices, and how goods and services are distributed among an economy's participants.
Macroeconomics: the big picture
Where microeconomics looks at households and firms, macroeconomics looks at the whole economy: the factors that influence aggregate supply and demand, such as unemployment rates, gross domestic product, overall price levels, inflation, the savings rate and the investment rate. Most of these are moved by public policy, and two institutions drive public policy. The decisions of the government are collectively fiscal policy; the actions of the central bank are collectively monetary policy. Together they shape economic activity to a large extent.
The syllabus credits John Maynard Keynes with the great emphasis on macroeconomic analysis. His book, the General Theory of Employment, Interest and Money, was revolutionary and brought drastic changes in economic thinking.
It reveals the general state of the economy: domestic production, domestic consumption, general price levels, growth, quality of life. It explains the drivers of income, savings, investment and employment. Its models help governments and central bankers formulate policies for long-run growth with stability. It explains international trade: exports, imports, balance of payments, exchange rate dynamics. And it shows how economies are linked to one another.
What policy makers want, and why they do not always get it
Governments and central bankers try to promote stability and growth. Their continuous aim is low unemployment, price stability with low inflation, and steady growth in output. Yet economies still go through cycles of boom and bust, because many variables influence an outcome and not all can be controlled.
Between 2011 and 2013 the RBI raised interest rates to tame high inflation, the standard policy response. It did not get the desired result because food prices stayed high; rate rises do not grow more food. Policy makers in different countries take different routes to the same goal depending on local conditions.
The sample question offers pairs such as "stock exchanges and government" or "State Bank of India and National Stock Exchange". Exchanges and individual banks do not set economic policy. The answer is the government and the central bank.
- Economics studies choices under scarcity, assumes people are rational with well-defined goals, and turns on trade-offs: limited material and human resources mean choosing one thing means giving up another.
- Microeconomics works at the individual and firm level: prices and production are driven by consumer demand, prices signal where productive activity goes, and the theory of the firm covers inputs, outputs, prices, production, profits and losses.
- Macroeconomics is the big picture: unemployment, GDP, price levels, inflation, savings and investment rates, shaped by public policy. The government (fiscal policy) and the central bank (monetary policy) are the two influencers; Keynes's General Theory of Employment, Interest and Money changed the field.
- Policy makers aim for low unemployment, price stability with low inflation and steady output growth, yet economies still cycle through booms and busts, because not every variable can be controlled: the RBI's 2011 to 2013 rate rises did not tame inflation because food prices stayed high.