Figure 1. Macroeconomists might look at the larger ecosystem in this image, while a microeconomist would focus on specific features. Whether you are looking at lakes or economics, the micro and the macro insights should illuminate each other.
In economics, the micro decisions of individual businesses are influenced by the health of the macroeconomy—for example, firms will be more likely to hire workers if the overall economy is growing. In turn, the performance of the macroeconomy ultimately depends on the microeconomic decisions made by individual households and businesses.
What determines how households and individuals spend their budgets? What combination of goods and services will best fit their needs and wants, given the budget they have to spend? How do people decide whether to work, and if so, whether to work full time or part time?
How do people decide how much to save for the future, or whether they should borrow to spend beyond their current means? What determines the products, and how many of each, a firm will produce and sell? What determines what prices a firm will charge? How do people decide how much to save for the future, or whether they should borrow to spend beyond their current means?
What determines the products, and how many of each, a firm will produce and sell? What determines what prices a firm will charge? What determines how a firm will produce its products?
What determines how many workers it will hire? How will a firm finance its business? When will a firm decide to expand, downsize, or even close?
In the microeconomic part of this book, we will learn about the theory of consumer behavior and the theory of the firm. What determines the level of economic activity in a society? In other words, what determines how many goods and services a nation actually produces? What determines how many jobs are available in an economy?
What causes the economy to speed up or slow down? What causes firms to hire more workers or to lay workers off? Finally, what causes the economy to grow over the long term? How can macroeconomic policy be used to pursue these goals? It is also important to understand the limitations of economic theory.
Theories are often created in a vacuum and lack certain real-world details like taxation, regulation, and transaction costs. The real world is also decidedly complicated and includes matters of social preference and conscience that do not lend themselves to mathematical analysis. Even with the limits of economic theory, it is important and worthwhile to follow the major macroeconomic indicators like GDP, inflation, and unemployment.
The performance of companies, and by extension their stocks, is significantly influenced by the economic conditions in which the companies operate and the study of macroeconomic statistics can help an investor make better decisions and spot turning points.
Likewise, it can be invaluable to understand which theories are in favor and influencing a particular government administration. The underlying economic principles of a government will say much about how that government will approach taxation, regulation, government spending, and similar policies. By better understanding economics and the ramifications of economic decisions, investors can get at least a glimpse of the probable future and act accordingly with confidence.
Macroeconomics is a rather broad field, but two specific areas of research are representative of this discipline. The first area is the factors that determine long-term economic growth , or increases in the national income.
The other involves the causes and consequences of short-term fluctuations in national income and employment, also known as the business cycle. Economic growth refers to an increase in aggregate production in an economy. Macroeconomists try to understand the factors that either promote or retard economic growth in order to support economic policies that will support development, progress, and rising living standards. Adam Smith's classic 18th-century work, An Inquiry into the Nature and Causes of the Wealth of Nations, which advocated free trade, laissez-faire economic policy, and expanding the division of labor , was arguably the first, and certainly one of the seminal works in this body of research.
By the 20th century, macroeconomists began to study growth with more formal mathematical models. Growth is commonly modeled as a function of physical capital, human capital, labor force, and technology.
Superimposed over long term macroeconomic growth trends, the levels and rates-of-change of major macroeconomic variables such as employment and national output go through occasional fluctuations up or down, expansions and recessions, in a phenomenon known as the business cycle.
The financial crisis is a clear recent example, and the Great Depression of the s was actually the impetus for the development of most modern macroeconomic theory. While the term "macroeconomics" is not all that old going back to the s , many of the core concepts in macroeconomics have been the focus of study for much longer.
Topics like unemployment, prices, growth, and trade have concerned economists almost from the very beginning of the discipline, though their study has become much more focused and specialized through the 20th and 21st centuries. Elements of earlier work from the likes of Adam Smith and John Stuart Mill clearly addressed issues that would now be recognized as the domain of macroeconomics. Macroeconomics, as it is in its modern form, is often defined as starting with John Maynard Keynes and the publication of his book The General Theory of Employment, Interest, and Money in Keynes offered an explanation for the fallout from the Great Depression , when goods remained unsold and workers unemployed.
Keynes's theory attempted to explain why markets may not clear. Prior to the popularization of Keynes' theories, economists did not generally differentiate between micro- and macroeconomics.
The same microeconomic laws of supply and demand that operate in individual goods markets were understood to interact between individuals markets to bring the economy into a general equilibrium , as described by Leon Walras.
The link between goods markets and large-scale financial variables such as price levels and interest rates was explained through the unique role that money plays in the economy as a medium of exchange by economists such as Knut Wicksell, Irving Fisher, and Ludwig von Mises.
Throughout the 20th century, Keynesian economics, as Keynes' theories became known, diverged into several other schools of thought. The field of macroeconomics is organized into many different schools of thought, with differing views on how the markets and their participants operate.
Classical economists held that prices, wages, and rates are flexible and markets tend to clear unless prevented from doing so by government policy, building on Adam Smith's original theories. Keynesian economics was largely founded on the basis of the works of John Maynard Keynes, and was the beginning of macroeconomics as a separate area of study from microeconomics.
Keynesians focus on aggregate demand as the principal factor in issues like unemployment and the business cycle.
Keynesian economists believe that the business cycle can be managed by active government intervention through fiscal policy spending more in recessions to stimulate demand and monetary policy stimulating demand with lower rates.
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