Student’s Guide to the Economy: Microeconomics vs. Macroeconomics
December 18, 2020
Global markets instinctively respond to events impacting the economy, such as natural disasters, economic recessions, and pandemics. The rules and principles of two interdependent categories of economics — microeconomics and macroeconomics — govern economies of all sizes.
Microeconomics vs. Macroeconomics: What’s the Difference?
Microeconomics and macroeconomics are two distinct categories of economics that complement each other.
Key Terms to Know
Microeconomics is the study of individual and business decisions regarding the allocation of resources and prices of goods and services. The term also considered taxes, regulations, and government legislation. It doesn’t try to explain which actions should take place in a market, but rather the effects of changes in certain conditions. Microeconomics has applications in trade, industrial organization and market structure, labor economics, public finance, and welfare economics.
Macroeconomics is the study of the decisions of countries and governments. The term analyzes entire industries and economics rather than individuals or specific companies. Macroeconomics tries to determine the optimal rate of inflation and factors that may stimulate economic growth. For instance, macroeconomics may analyze how the unemployment rate affects the gross domestic product. Macroeconomics describes relationships among national income, savings, and overall price level.
Key Principles of Microeconomics
One of the microeconomics’ core principles involves demand, supply, and equilibrium, as they collectively influence prices. Another principle involves production theory, which explores how goods and services are created or manufactured. A third principle involves the costs of production, which ultimately determine the price of goods and services. Finally, the principle of labor economics attempts to explain the relationship between wages, employment, and income.
Key Research Areas in Macroeconomics
One of macroeconomics’ key research areas involves economic growth, which refers to an increase in aggregate production in an economy. This can be modeled as a function of physical capital, human capital, labor force, and technology. Another key research area involves business cycles, an area of macroeconomics that considers variables like employment and national output. The Great Depression of the 1930s spurred the development of modern macroeconomic theory.
A Brief History of Economics
Since its beginnings in the 1800s, the field of economics has expanded to try to address the complexity of today’s economies and systems.
In the 1800s, economics was simply the study of how human societies managed the production, distribution, and consumption of goods and services. The concept essentially began with Adam Smith, a Scottish philosopher regarded as the father of economics, who authored The Wealth of Nations in 1776. Smith believed that an invisible hand guides individuals to maximize their well-being and provide the best overall result to society as a whole.
The Great Depression puzzled economists, as they could offer no plausible explanation for the extreme market collapse of the 1930s. In the time between the publication of Smith’s book and the Great Depression, economists assumed that the study of individual markets would explain the behavior of variables like unemployment and output.
The Birth of Macroeconomics
John Maynard Keynes, considered the founding father of macroeconomics, wrote The General Theory of Employment, Interest and Money in 1936. In the book, he introduced the simultaneous consideration of equilibrium in goods, labor, and finance. He also introduced the concept of disequilibrium economics, which is the study of departures from general equilibrium.
The Intersection of Microeconomics and Macroeconomics
Since the Keynesian revolution, economists have tried to merge microeconomics and macroeconomics by developing microeconomic foundations for macroeconomic models. The rationale behind these efforts is the belief that individual households and firms act in their best interests.
The Four Building Blocks of International Economics
There are four key areas that influence international economics: International trade, international finance, multinational corporations, and economic globalization.
International trade is defined as the exchange of goods and services between countries. Global trade allows a country to focus on exporting products or services it can provide more efficiently than other countries. Specialization reduces opportunity cost and maximizes efficiency in acquiring goods. The rise of international trade has led to the creation of a global economy in which global events affect supply, demand, and prices.
International finance is defined as the study of monetary interactions between two or more countries. The concept is governed by multiple concepts. The first concept, the Mundell-Fleming model, is defined as the interaction between the goods market and the money market, based on the assumption that the price levels of goods are fixed.
The second concept, the International Fisher effect, is an international finance theory that assumes nominal interest rates reflecting fluctuations in the spot exchange rate between nations. A third concept is the optimum currency area theory, defined as the adoption of a single currency in a geographical region will maximize economic efficiency.
Another theory is the purchasing power parity theory, which defines the measurement of prices in different areas using a specific good or set of goods to compare the purchasing power of various currencies. Finally, the interest rate parity theory represents a state of equilibrium where investors are indifferent to interest rates attached to bank deposits in two separate countries.
A multinational corporation has facilities and other assets located in at least one country outside of its home country. It also derives at least a quarter of its revenue from outside its home country. Early examples of these corporations include the East India Company, The Swedish Africa Company, and the Hudson’s Bay Company, all of which were founded in the 17th century.
There are numerous benefits associated with multinational corporations, including reduced prices, an increase in consumer purchasing power, spurring job growth in local economies, and increasing the variety of goods and services produced.
Globalization is defined as the spread of products, information, technology, and jobs across national borders. On one hand, globalization brings jobs and technology to developing economics. On the other hand, globalization potentially means that an economic downturn in one country could have global repercussions.
Better Understanding, Better Decisions
Economics is a complex field with many fixed factors and variables affecting the financial health of individuals, households, companies, and governments. A firm grasp of the principles and theories governing microeconomics and macroeconomics will help professionals make wise decisions concerning nearly all areas of business.