Although the distinction did not officially take place until 1930s, when simple classical models failed to explain the Great Depression’s persistent high unemployment, micro- and macroeconomics root back much earlier and originate from the first attempts of economists to explain market phenomena.
Microeconomics and macroeconomics (“micro” – small, and “macro” – big) are different aspects of the same subject – “economics” (the word originates from the Greek words οἶκος [oikos], meaning “family, household, estate,” and νόμος [nomos], or “custom, law,” and hence literally means “management of the state” (clearly the macroeconomic approach) or “household management” – sort of a microeconomic approach). Therefore, the micro- and macroeconomic theories are considering the same problems from different sides: the former – from the point of view of individual industries and the behavior of individual decision-making units (business firms and households), while the latter examines the economic behavior of aggregates (income, output, employment, production and prices, etc.) on a national scale.
Economics is based on the principle of scarce resources, which is why it uses terms like “opportunity cost” (what we give up or forgo, when we make a choice) and “sunk cost” (that cannot be avoided because they have already taken place).
Macroeconomics’ major fields of study are: national production/output (which includes total industrial output, gross domestic product, growth of output, etc.), aggregate price level (producer and consumer prices, rate of inflation), national income (total wages and salaries, corporate profits), total employment and unemployment in the economy (total number of jobs, unemployment rate), etc.
The basic decision-making units in the economical analysis are entrepreneurs, firms, and households. The economic activity is a circular everlasting process of supply and demand correlation in input (product markets where goods and services are exchanged) and output markets (where the resources — labor, capital, and land — are used for production and exchanged). At the core of the system, supply, demand, and prices in input and output markets determine the allocation of resources and the combinations of things produced for the market.
Effective economic activity is only possible at the market equilibrium – when supply and demand coincide at a certain level. Excess demand or excess supply – are the market disequilibria. According to the law of demand, there is inverse relationship between the price and the quantity goods demanded by the market players. There is a positive relationship between price and quantity of a good supplied, according to the law of supply. Market equilibrium is therefore an intersection point of the supply and demand curves.
In macroeconomics, equilibrium in the goods market is the point at which the aggregate output equals to the planned aggregate expenditure.
Macroeconomic theory was first based on findings of pilot economical theorists, such as Adam Smith’s theory of absolute advantage and David Ricardo’s theory of comparative advantage. Further economic research led to creation of numerous schools and trends that used different analytical approaches to study the subject of macroeconomics – monetarism, Keynesian economies, neoclassical, Post-Keynesian approach, etc. All theories stated above added significantly to the general knowledge of the subject of microeconomics, although at the same time neither of them was “ideal”.
Any market aims at the efficiency and profitability, equity, growth and stability, the national scale of analysis takes into consideration the overall national results of economic activity and therefore gives a more generalized insight into economic principles and results. Such an insight provides knowledge and thus possibility to manage and improve the state’s efficiency and stability.
The three types of economic systems (command economies, “laissez-faire” economies and mixed systems), the one that balances both command and free market principles proved to be the most efficient. Certainly, it is difficult to determine the extent of necessary control imposed by the higher institutions – e.g. government – upon the free market system. Markets themselves are imperfect, and governments influence the economic systems in order to minimize market inefficiencies, provide public goods, redistribute income, stabilize the economy, and promote low levels of unemployment and inflation.
Thus, there are three major macroeconomic points of concern: inflation (an overall price level increase), output growth (or recession – any change – positive or negative – in the aggregate output) and the unemployment (percentage (rate) of the labor force unemployed).
To influence the macroeconomics government uses either of the following policies or a combination of them:
- Fiscal policy (taxes and expenditures)
- Monetary policy (Federal Reserve control of money supply)
- Growth or supply-side policies (stimulating aggregate supply, not aggregate demand)
Fiscal policy (the manipulation of government spending and taxation) includes contraction fiscal policy (decrease in government spending or an increase in net taxes aimed at decreasing aggregate output) and expansionary fiscal policy (vice versa).
Monetary policy deals with the nation’s money supply. When it is “tight”, it restrains the economy. “Easy” monetary policy, in turn, stimulates the economy. Expansionary monetary policy is aimed at increasing aggregate output through an increase in the money supply.
Stabilization policy is both monetary and fiscal policy that aims at keeping prices as stable as possible and smoothing out fluctuations in output and employment.
The price rationing and proper resource allocation become two main points of great concern for the macroeconomic theorists. To determine the level of efficiency and analyze the current economic situation, economists consider the following terms and concepts of macroeconomic analysis: gross domestic product (GDP), the GDP price index, unemployment rates, inflation, gross input and output, investments, government expenditures, net export, etc. Providing recommendations is an even more difficult process. Because there is no ‘ideal’ formula for solving macroeconomic problems, any combination of fiscal or monetary tools would lead to a certain result that is often hard to predict due to additional factors. The known effects of different policies are intended to regulate the market, which is in fact very active and demanding. Any macroeconomic activities also take into consideration the time lags (the delays in response to stabilization policies of any given economy).
Neither situation is clearly positive or negative. For example, such a seemingly negative situation as recession might be helpful at reducing inflation. It also improves a nation’s balance of payments because it results in the demand for imports decrease. And although it is only a theory supported by the few, it is possible that recessions may increase market efficiency by driving the weakest (least efficient) firms out of business and forcing the “survivors” manage their resources better.
As it can be seen from the “recession” example, in macroeconomics all issues are interconnected. It is important not to solve the problems completely (which is hardly possible), but to balance them, in order to stabilize the economy and provide efficient economic activities.
Case, Karl E., Fair Ray C. Principles of Macroeconomics. Prentice Hall: 6th edition, 2002.
Economics. The Wikipedia article. 2006. Wikipedia, the free encyclopedia. 29 Sept, 2006. http://en.wikipedia.org/wiki/Economics
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