Microeconomics - Macroeconomics

1. Introduction: Microeconomics-Macroeconomics

The prices and quantities of goods and services emerge every day from decisions made by millions of individual consumers and firms.

Microeconomics studies the behaviour of these individual decisions making units and the primary objective of microeconomic theory is to explain how those decisions are made. How do consumers decide what products to buy and in what quantities? What does it cost business firms to produce the goods and services consumers demand?

Macroeconomics studies the overall price level, unemployment rates, recession, inflation, the so-called economic aggregates. It focuses on the performance of the entire economy rather than the behaviour of individual participants. The central concern of macroeconomics is the business cycle – recurrent bouts of expansion and contraction of the nation’s output. These cycles affect jobs, prices, economic growth, international trade and financial balances.

The distinction micro / macro is not based on the size of the industry or of the business. Microeconomic decisions may be taken just as well in astonishingly large units like AT&T, but also in small family businesses and the effects of a macroeconomic issue, like unemployment, might be felt at a national level just as in each family.

If economy is to be compared to a “pie”, a microeconomist will assume that the pie is of the right size, but frets over its ingredients and division. On the other side, a macroeconomist will analyse the determination of the size of the economic “pie”, paying no attention to what is inside or how it is divided among the dinner guests.

Therefore, both approaches are necessary as they refer, after all, to only one economy. The two approaches act according to the principle “where the telescope ends, the microscope begins” and it is hard to say which of the two fields gives a grander view or how do, the fields differ and why.

In either case, the basic forces at work that organise and construct the microeconomic and macroeconomic models are demand and supply.

From this perspective, if we consider the three graphs below, we may interpret them as follows:

- from a microeconomic perspective, figure 1.1. (a) represents, let us say, the market for milk or any other individual product or service, figure1.1. (b) shows a shift of the respective product demand curve to the right because of increased income and figure 1.1. (c) shows a shift of the respective product demand curve to the left because of reduces income.

- from a macroeconomic perspective, figure 1.1. (a) represents the market for the national product, figure 1.1. (b) is a problem of inflation, with a shift to the right of the aggregate demand curve and increased price level, figure 1.1. (c) is a problem of recession and a general fall of output.

In microeconomics, the determinants of demand and supply may shift their respective curves and we can see how Price and Quantity respond to the new conditions of demand and supply.

Similarly, in macroeconomics, the shifts of aggregate demand and supply curves are used to explain how the overall economic activity fluctuates. The horizontal axis is used to show the evolution of the overall aggregate output (the real national product) and the vertical axis shows the average level of prices.

Figure 1.1. (a, b, c): Demand And Supply From Micro And Macro Perspective

2. The Macroeconomic Model

If one takes a broad view of how macro economy works, one simply must emphasize that macroeconomic performance depends on a finite set of determinants and the primary measurements are made by some outcomes (figure 1.2.).

Figure 1.2.: The Macro Economy

The determinants of the forces that affect macro performance include:

- internal market forces: population growth, spending behaviour, invention and innovation and the like,

- external shocks: wars, natural disasters, trade disruptions a.s.o.,

- policy levers: tax policy, government spending, monetary policies a.s.o..

The basic macro outcomes include:

- output: total value of goods and services produced,

- jobs: levels of unemployment or employment,

- prices: average price of goods and services,

- growth: year-to-year expansion in production capacity,

- international balance: international value of the national currency, trade and payments balances with other countries.

These macro outcomes define the economic welfare of a nation; they measure the economic well-being in terms of the value of output produced, the number of jobs created, the price stability and the rate of economic expansion. Thus, the performance of the economy is rated by the “scores” in these five macro outcomes.

With reference to determinants, it is not compulsory that all determinants have the same share in performance of the economy; in the absence of external shocks or government policy, an economy would still function – it would still produce output, create jobs, develop prices and, maybe, even grow. In the absence of these two determinants, macro outcomes depend exclusively on internal market forces, operating in relative isolation from governments and international events.

The Classical School considers that internal market forces are self-stabilising and there is no need for policy levers while the Keynesian school emphasizes the fact that policy levers are both effective and necessary.

The two trends of thinking – the Classical and the Keynesian economics – express different views on a crucial macro controversy: whether pure, market driven economies are inherently stable or unstable.

2.1. Aggregate Demand & Aggregate Supply

A closer examination of the inner workings of macro economy, of the fundamental mechanics on which macro economy is built, points out the two forces that are at work: demand and supply.

Macro economy performance and all macro outcomes presented in figure 1.2. are the result of market transactions – interaction between supply and demand as instruments to explain concepts such as output, employment, level of prices and their fluctuations. Hence, any influence of determinants of macro outcomes must be transmitted through the mechanism of supply and demand.

By conceptualising the inner workings of the macro economy in supply and demand terms, economists have developed a remarkably simple model of how the economy works. To make the model operate, however, we need to know more about the macroeconomic dimensions of supply and demand.