Macroeconomics vs Microeconomics

Differences Between Macroeconomics and Microeconomics

The heading says it all and I guess you already have an idea about it. Nevertheless for those who don’t have much of an idea, Microeconomics and Macroeconomics [herein micro and macro economics] are the two broad branches in the vast field of ‘Economics’ and I say ‘vast’ because together, both the branches include policy, development, agriculture, politics, governance, labour and what not! Adam Smith is considered the ‘Father of Economics’ especially as the ‘Father of Microeconomics’ and John Maynard Keynes [Keynes is pronounced like Cairns] is arguably considered the ‘Father of Macroeconomics’ – perhaps two of the greatest economists of our generation.

In this article we look at the following –

• What is Macroeconomics?
• What is Microeconomics?
• Macroeconomics vs Microeconomics – Commonalities
• How does Macro affect Micro?
• How does Micro affect Micro
• Macroeconomics vs Microeconomics – Key Differences
• A tinge of Important History
• Conclusion

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What is Macroeconomics?

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In short, Macroeconomics is a ‘top-down’ approach and is in a way, a helicopter view of the economy as a whole. It aims at studying various phenomena like the country’s GDP (Gross Domestic Product) growth; inflation and inflation expectations; the government’s spending, receipts and borrowings (fiscal policies); unemployment rates; monetary policy etc. to ultimately help understand the state of the economy, formulate policies at a higher level and conduct macro research for academic purposes. For example, Central Banks of all the countries majorly look at the macroeconomic situation of the country and also the globe in order to make crucial decisions like setting the country’s policy interest rates. But it is worth mentioning that they look at micro aspects also.

Example: If you have been following recent global financial and economic events, the most talked about is the topic of the USA Federal Reserve’s course of interest rate hikes. In a year, the Federal Reserve holds eight scheduled meetings for two consecutive days to decide and convey their policy stance known as ‘FOMC meetings’ (Federal Open Market Committee meetings). The meeting majorly focuses on macro policy and stability based on data analysis and research, the conclusion being whether they should hike their policy interest rate or not. This meeting is part of a macroeconomic policy given that it looks at the economy as a whole and the outcome is a macro event.

 

What is Microeconomics?

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Microeconomics in short, is a ‘bottom-up’ approach. Detailed, it comprises the basic components that make up the economy which include the factors of production (Land, Labour, Capital and Organization/Entrepreneurship). The three sectors of the economy – Agriculture, Manufacturing, and Services/Tertiary sectors and the components thereof understandably come up because of the factors of production. Microeconomics largely studies supply and demand behaviours in different markets that make up the economy, consumer behaviour and spending patterns, wage-price behaviour, corporate policies, impact on companies due to regulations etc.

Example: For those who have been following the Indian growth story, you would be aware of the fact that the monsoon could have an impact on inflation especially food inflation. A bad monsoon could increase inflation given that the supply of fodder, vegetables etc. doesn’t match the demand and a good monsoon could decrease/stabilize inflation due to obvious reasons. This affects the spending behaviour of individual consumers, agrarian based corporates and their like. [More on supply and demand coming up!]

Yes, you saw it coming – macro and micro economics are two sides of the same coin i.e., they have several things in common despite looking like seemingly different topics. Though there’s no thin line of difference between the two, they are interrelated. So let’s see what they have in common.

Macroeconomics vs Microeconomics – Commonalities

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The following section will surely help you appreciate economics a lot more with many interesting concepts that one comes across, than just know the commonalities between the two.

Of course, the basics – Demand and Supply Relationship

The basic rationale is that ‘assuming all other factors remaining the same/equal,’ the quantity demanded decreases as price increases and the quantity demanded increases as price decreases (inverse relationship). All other factors remaining the same, the quantity supplied increases as price increases and the quantity supplied decreases as price decreases (direct relationship). This relationship between demand and supply attains the ‘state of equilibrium’ or the optimal relationship when the quantity demanded and quantity supplied are equal. When they aren’t equal, what arises is either a shortage or excess which gets adjusted to achieve equilibrium again.

The graph above looks complex isn’t it? Honestly….it isn’t. The graph is a depiction of the concept of ‘Equilibrium’, the vertical axis (Y-axis) representing ‘Quantity’ both demanded and supplied whereas the horizontal axis (X-axis) represents the ‘Price’ of the product/service. The explanation below should make it simpler for you!

A higher price set by sellers would cause a surplus of stock (Surplus/Excess Quantity supplied) forcing them to lower prices (from Surplus Prices to the Equilibrium Price) to match the corresponding demand. A lower price set by sellers would cause a shortage of stock (Shortage of Quantity supplied) forcing prices to go up (from the Shortage Price to the Equilibrium Price) to keep pace with the corresponding demand.

[Note: By ‘higher’ and ‘lower’ prices, we mean the price relative to the ‘Equilibrium Price’ – that which a buyer should ideally bid/buy for (OR) the price relative to that which a seller should ideally ask/offer.]

This is a fundamental law that governs economics and daily life, be it macro or micro economics. Whether equilibrium is attained always, the dynamics beyond demand and supply is a totally different topic!

How does Macro affect Micro?

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Let’s assume the nation’s Central Bank cuts the policy interest rate (a macro impact) by 100 basis points (100 bps = 1%). This should ideally lower the borrowing costs of commercial banks with the Central Bank, helping lower their deposit rate, thus giving room to lower the rate on the loans they make to individuals and corporate. This is expected to cause a rise in borrowings aka ‘credit growth’ given cheaper access to credit and therefore greater investment helping corporate invest in new assets, projects, expansion plans etc. which are developments on the micro front. This is just one of several examples where macro policies and decisions affect the micro economy. Additional examples can include:

• Income tax changes;
• Changes in subsidies;
• Currency related policies (ex: China depegging the Yuan/Renminbi to the US Dollar) amongst others;
• Unemployment rates in the economy could help understand how many jobs a company might create amongst other factors

How does Micro affect Macro?

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One of the multiple factors that set macro policies is the condition of the micro economy. To continue with the earlier example of the Central Bank given that they have lowered their policy rates, they observe the borrowing and investment patterns of corporates, individuals and households. These behavioural patterns can help determine whether the Central Bank should cut rates further if the outlook is weak, keep rates on hold or increase them if the outlook is picking up or shooting up. Additional examples include the following:

• The Consumer Price Index (CPI) is determined by taking surveys of individuals and retailers based on their spending patterns where the outcome results in a certain ‘percentage figure’ which is indicative of the rate of inflation. This figure is considered a key determinant for the Central Bank to set policy interest rates. The spending behaviour of individuals is a microeconomic variable.
• Taking a deep dive into the US Federal Reserve and in particular the US economy, news would tell us that a major factor influencing their policy decisions is the payroll numbers or the wage growth which is part of the micro economy.
• A key concept in Microeconomics is that of ‘Opportunity Cost’ i.e., the cost incurred by not choosing the second best alternative given the choices are mutually exclusive (one choice eliminates the others). In other words, it is the marginal benefit one could derive by choosing the second best comparable alternative to achieve the same purpose given that the choices are mutually exclusive. On a more philosophical note, this has some roots in the concept of ‘’

Example: You are a 5 year old kid and have $5 with you to choose between an ice-cream and Swiss chocolate which cost $5 and $4 respectively (would a 5 year old kid really care if it were a Swiss chocolate? I doubt he’d know its speciality. Who knows?). Let’s say that the kid chooses the chocolate over the ice-cream just to spoil our clichéd assumption that a kid would always choose the ice-cream! He relishes the chocolate until he sees his friend relishing the ice-cream. The kid then tries to weigh the costs of his decision to go for the chocolate.

Macroeconomics vs Microeconomics – Key Differences

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‘The difference’ is of course, that micro gives the picture from the smaller parts of the economy while macro looks at the economy at large.

Other Differences

• Remember the ‘Supply-Demand’ graph shown earlier? Although the supply-demand behaviour applies to both fields of economics, it is believed that Microeconomics is based on the premise of buyers and sellers achieving equilibrium before long, if disequilibrium exists. Macroeconomics focuses on different cycles of the economy like the short and long term debt cycle, business cycles, super-cycles etc. ultimately leading us to believe that the economy could stay in a state of ‘disequilibrium’ for longer than expected before everything adjusts to equilibrium. Just to introduce you to one of the harder concepts to master in economics without delving into it too much, Macroeconomics lends its roots to the ‘Theory of General Equilibrium.’
• A less significant distinction would be the different ‘Schools’ of economics. There are multiple schools of Macroeconomics like Keynesian Economics, Monetary Economics, Chicagoan Economics and Austrian Economics to name a few. Some of those in Microeconomics are Classical Economics, Neo-Classical Economics and Islamic Economics to name a few.

A Tinge of Important History

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There’s more history apart from the fact that Adam Smith and J.M. Keynes were the so called ‘fathers’ of micro and macro-economics. It is believed that Macroeconomics majorly evolved from an economic crisis, the infamous ‘Great Depression’ from 1929 to the late 1930s where J.M. Keynes and Milton Friedman played a major role in explaining and understanding the event. J.M. Keynes wrote a book titled ‘The General Theory of Employment, Interest and Money’ where he sought to explain the Great Depression through aggregate expenditures, income levels, employment levels and government spending – Keynesian Economics. Milton Friedman, a highly regarded economist explained the Great Depression by a banking crisis, deflation, higher interest rates and restrictive Monetary Policy – School of Monetary Economics.

If you understood the above paragraph and its various inter linkages, you are on the verge of becoming an upcoming economist and a good economic thinker. If you didn’t totally understand it, you are going to start thinking more about economics and the more you think about it, the more you would appreciate it.

Macroeconomics vs Microeconomics – Conclusion

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Firstly to be honest, if you have absorbed all the material above, you have possibly gone through the best crash course in Micro and Macro economics and a bit of Finance – there’s no doubt about that. You probably know much more than you may actually have to. Well…if you have not lasted till the conclusion and are directly coming to it seeking a recap, you are going to be disappointed. Why? Simply because you have to read everything above to really appreciate the subject. After all there is nothing greater than learning, understanding and appreciating the beauty of a subject, especially a subject as broad as Economics.

Secondly, you would have or atleast should have observed the particularity in the language used to explain different concepts. Often times, loose or not so precise language could either cast doubts or not explain the influencing items. For example, to explain the principle of ‘Opportunity Costs’ you would have come across the word ‘mutually exclusive.’ To help understand the importance attached to these words, they have been marked them in Italics.

The next time you bargain with a dealer or a seller, be sure to keep in mind that some fundamental economic principles are in place; that your transactions are part of the micro economy and; that a whole lot of people like you who are buying stuff (material or immaterial) are actually impacting the macro economy at large. Hope you learnt a lot of new concepts. That’s enough of economics for now!!!