The upcoming discussion will update you about the differences between microeconomics and macroeconomics.
It was the first Nobel Laureate economist Ranger Frisch who drew a distinction (in the year 1933) between the two major branches of economics: microeconomics and macroeconomics. These two terms have by now been adopted by all economists.
Microeconomics is the branch of economics concerned with the study of the behaviour of individual consumers and firms and the determination of market prices and quantities bought and sold of commodities and services and of factors of production.
In fact, Marshall’s Principle of Economics (1890) is usually considered as the first book on microeconomics. Microeconomic analysis “investigates how scarce economic resources are allocated between alternative ends and seeks to identify the determinants of an optimally efficient use of resources”.
In contrast, macroeconomics is the branch of economics concerned with the study of aggregate economic activity. Keynes’ General Theory (1936) is the first full-scale treatise on macroeconomics. Macroeconomic analysis investigates how the economy as a whole functions. It also seeks to identify determinants of the levels of national income and output, employment and prices.
The term microeconomics is derived from the Greek word Mikros which means ‘small’. Likewise the term macroeconomics is derived from the Greek word Makros, which means ‘large’. Thus, in microeconomics the focus is on individual economic units such as individual consumer or an individual firm or an individual factor owner. Each such micro (small) unit seeks to maximise or minimise something.
This ‘something’ is utility in case of a consumer, profit or loss in case of a business firm (private) and factor income (such as wage income) in case of a factor owner. This maximisation or minimisation goes by the name optimisation. In microeconomics we study the optimisation goal(s) of an individual consumer or a single business firm. The focus is on a particular market or a very small segment of the economy.
In the language of Gwartney and Stroup, “since individual human decision makers are the moving force behind all economic action, the foundations of economics are clearly rooted in a micro-view. Analysis that focuses on a single consumer, producer, product or productive resources is referred to as micro-economics”.
As A. P. Lerner put it, “Microeconomics consists of looking at the economy through a microscope, as it were, to see how the millions of cells in the body economic — the individuals or households as consumers, and the individuals or firms as producers — play their part in the working of the whole organisation”.
According to K. E. Boulding, “Microeconomics is the study of particular firms, particular households, individual prices, wages, incomes of individual industries, and particular commodities.”
On the other hand, macroeconomics focuses on how the aggregation of individual micro-units affects our analysis. Macroeconomics, like microeconomics, is concerned with incentives, prices, and output. In macroeconomics, however, the markets are highly aggregated. In our study of macroeconomics, millions of households will be lumped together when we consider such topics as the importance of consumption spending, savings and employment.
Similarly, a few million firms existing in the economy will be lumped together into something we call ‘the business sector’. Thus, in macroeconomics we are concerned with certain broad aggregates. In any macro-economic study we seek to analyse the behaviour of an economy in its totality. We describe, analyse and explain the behaviour of large aggregates like total output (or gross national product), national income, total consumption, aggregate investment, the level of employment.
We also study the behaviour of the general price level as also the growth of the economy. In the words of Boulding again, “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 price levels; not with individual outputs but with the national output.”
What factors determine the level of aggregate output, the rate of inflation, the amount of unemployment, and interest rates? These are all macroeconomic questions.
Microeconomics is a very important component of positive economics and has both theoretical uses and practical relevance. It is extremely useful in the formulation of economic policies that are supposed to promote social welfare.
In fact, the primary functions of economists are to formulate policies. A knowledge of microeconomics is essential for wise policy making. Policy makers who do not understand the consequences of their actions are unlikely to reach their goals.
In fact, before the publication of Keynes General Theory in 1936, the whole of economic science or body of economic units largely, if not entirely, was microeconomics. Neo-classical economics was microeconomics. The works of Alfred Marshall, W. S. Jevons, Leon Walras and others explain the basis of the market economy.
They all tried to explain how a free enterprise economy with its millions and millions of diverse consumers and business firms interact, through specialisation and exchange, to decide about the allocation of resources among various goods and services.
As early as in 1776 Adam Smith argued that a free exchange market economy would lead to an efficient allocation of society’s resources. The ‘invisible hand’ of the market forces would direct individuals and resources into the areas where they were most productive. Coordination, order and efficiency would result, despite the absence of a central authority that planned and directed the economy.
Meaning and Coverage:
The word ‘Macro’ means large and macroeconomics means economics in the large. Macroeconomics analyses the behaviour of the economic system in its totality. In other words, it is concerned with the sum total of economic activities of large entity — the whole economic organisation. This is why macroeconomics is also known as aggregative economics.
Macroeconomics seeks to establish and analyse the functional relationship among the aggregates of an economy such as total consumption, total investment, aggregate employment, the demand for money, supply for money and the general price level.
In other words, macroeconomics is that part of the subject which deals with aggregates and averages of the system rather than with particular items in it. It seeks to define these aggregates in a useful manner and to examine their relationships.
In the words of T. F. Dernburg, “The macroeconomist’s concerns are with such global issues as total production, total employment and unemployment, the overall level and the rate of change of prices, the rate of growth and so on. The questions asked by the macroeconomist deal with broad aggregates — what determines the spending of all consumers as opposed to the determinants of the spending decisions of a single household; what determines the capital spending of all firms rather than the decision to build a new plant of a single firm; what determines the overall level of employment in the economy as opposed to why some particular individual is unemployed. Macroeconomics measures overall economic activity; it analyses the determinants of such activity by the use of macroeconomic theory; it forecasts future economic activity; and it attempts to formulate policy responses designated to reconcile forecasts with target values of production, employment and prices”.
In this context the following quote from R.G. Lipsey and his co-authors is highly relevant:
“Microeconomics and Macroeconomics differ in the questions each asks and the level of aggregates each uses. Microeconomics deals with the determination of prices and quantities in individual markets and with the relationship among these markets.”
Thus, it look at the details of the market economy. It asks, for example, how many workers are employed in the construction industry and why the number is increasing every year. It seeks to identify the determinants of demand for pocket calculators, cassettes, motor cars, television sets and so on. It also asks about the prices of these things, why some prices (such as those of pocket calculators, VCRs, etc.) fall.
Microeconomics also attempts to analyse how prices and output respond to external factors — events in other markets or changes in government policy. It asks, for example, how a technical innovation, a government subsidy, or a drought will affect the price and output of sugarcane and the employment of agricultural workers.
In contrast, “macroeconomics focuses on much broader aggregates.” It looks at such things as the total number of people employed and unemployed, the average level of prices and how it changes over time, national output and aggregate consumption.
Macroeconomics asks what determines these aggregates and how they respond to changing conditions. Whereas microeconomics looks at demand and supply with regard to particular commodities, macroeconomics looks at aggregate demand and aggregate supply.
Comparison of the Two:
“Macroeconomics concerns itself with such variables as the aggregate volume of output of an economy, with the extent to which resources are employed, with the size of the national income, with the general price level.”
To quote Dernburg, “Macroeconomic analysis attempts to explain how the levels of the principal macroeconomic variables—the employment rate, growth of real output, the rate of price inflation — are determined at any moment, and it has been attempted, through the development of theories of the business cycle and of economic growth, to explain the dynamics of how these aggregates move over time”.
Microeconomics, on the other hand, deals with the division of total output among industries products and firms and the allocation of resources among competitive uses. It considers problems of income distribution. Its interest is in relative prices of particular goods and services.
Uses and Applications:
A thorough study of macroeconomics provides government policymakers with some knowledge of the conditions conducive to economic development.
Foremost among these conditions seem to be the following:
(a) Protection of private property,
(b) Freedom of exchange,
(c) Stable prices and
(d) Low marginal tax rates.
Governments that protect property rights of individuals and permit freedom of exchange and follow monetary (and fiscal) policies consistent with relatively stable prices establish the foundation for economic growth.
Thus, a background knowledge of macroeconomics helps governments to formulate policies to achieve steady growth of per capita income and full employment of resources (particularly manpower) in the absence of demand-pull inflation.
Similarly, a knowledge of macroeconomics provides the basis for plan formulation in developing countries like India. National economic plans are largely based on certain broad aggregates such as national income, total consumption, total investment, the level of employment, the general price level, the volume of exports and imports, and so on.
The goals or objectives of planning are based on the current and future needs of a country.
Interdependence between the Two:
Therefore, there is a strong interdependence between the two branches of economics. In fact, tools and analyses of microeconomics provides a common ground, and even a language for economists in a wide range of problems relating to the whole economy. For example, our study of the aggregate consumption function is based on our study of the consumption behaviour of a single individual.
In fact, by adding up the consumption schedules of different individuals we arrive at the aggregate consumption schedule. Similarly, the investment function of different firms provides the microeconomic foundation of the social (aggregate) investment function. By adding up the investment functions of different firms (micro-units) we arrive at the aggregate investment function.
Thus, we derive several important theories regarding the behaviour of some macroeconomic aggregates from the theories of individual behaviour. Yet the fact remains that we are able to arrive at aggregate consumption and investment functions simply because the behaviour of aggregates in most cases is not fundamentally different from those of the individual components.
This enables us to treat national output or GNP as the sum total of the value added in different sectors of the economy. However, it is possible to arrive at the behaviour of these aggregates under certain restrictive conditions, e.g., if either the composition of aggregates remains constant or if the composition changes in some regular or systematic way.
For example, we can derive the aggregate consumption function if there is no change in the age composition of the population.
To conclude with Fritz Machlup, “Ever since the beginning of economics, macro and micro theory existed side by side they will continue to do so in the future. Each is needed, neither is expendable.” The conclusion is that, if we want to properly understand and gain a clear insight into the actual working of an economy, a separate and distinct macroeconomic analysis is absolutely essential.
But, this does not imply that microeconomics is totally useless and should not be studied at all.
The truth is that, the two branches of economic analysis — micro and macro — are not opposed to each other. Instead, they are complementary inasmuch as they deal with different subjects.
Whereas microeconomics deals with the behaviour of individual economic units such as consumers and business firms and is concerned with determination of relative prices of commodities and factors of production, macroeconomics deals with short-run fluctuations in the level of employment and national income and long-term growth of the economy. So, it is absolutely essential to study both.
As Paul Samuelson has rightly commented, “There is really no opposition between micro and macroeconomics. Both are absolutely vital. And you are only half- educated if you understand the one while being ignorant of the other”.