Economics studies the consumption, distribution, and allocation of our planet’s finite resources. Resources might include land (e.g, water and crops), labour (e.g., workers and staff), capital (e.g. machines) and entrepreneurship (e.g. business know-hows). By analysing the decisions that individuals, businesses, governments and nations take on how to use these resources, economics assesses how these may optimally be assigned and distributed in order  to maximise productivity and, hopefully, human well being.

Economics is divided into two distinct fields of study: microeconomics and macroeconomics. Microeconomics focuses on the resource allocation decisions of individuals and businesses, whilst macroeconomics looks at the decision making process of governments and countries. 

 

What is Microeconomics?

As the name might suggest, microeconomics is the smaller scale analysis of economics. It looks at how individuals, households and businesses make decisions when choosing what to do with the resources that they have at hand. The economics professor Gregory Mankiw, author of Principles of Microeconomics, describes this discipline in a nutshell: 

‘Microeconomics is the study of how households and firms make decisions and how they interact in specific markets.’

Microeconomics may look at how an individual who has inherited a hectare of land may use it to improve their well being. This could be by growing crops or building a new house. Microeconomics can help individuals find the best way to allocate the twenty four hours available in a day to maximise their income. Companies can also benefit from the findings of microeconomics by, for instance, understanding how to use their machines and staff to maximise production, or offer lower market prices. 

The choices that individuals and businesses make with regards to their resources will have a direct impact on the demand and supply of goods and services in a specific market; the two driving forces behind microeconomic analysis. In his book The Principles of Economics, Alfred Marshall, also known as the father of microeconomics, famously conceives the forces of supply and demand, and compares these to the upper and lower blades of a pair of scissors. Both blades are equally important when cutting paper, just like supply and demand are equally important in determining market equilibrium. Market equilibrium is important in microeconomics because it is the point where all households (i.e., market demand) and firms (i.e., market supply) have interacted and are satisfied with their microeconomic decisions. 

According to Marshall, it is when supply and demand meet that markets achieve that state of equilibrium, where there is no shortage or surplus of goods in a specific market. For every equilibrium point, there is an equilibrium price. Pricing is the common language spoken by households and firms, and it is when both parties have agreed on an equilibrium price for a good or service, that resources can be deemed to be optimally allocated. In Marshall’s own words, 

 

Principles of Economics by Alfred Marshall

 

 

‘When the demand price is equal to the supply price, the amount produced has no tendency either to be increased or to be diminished; it is in equilibrium.’

 

 

 

 

Microeconomics explores, analyses and draws conclusions on the decision making process of individuals, households and firms. We’ve detailed some of these microeconomic decision making processes below.

 

Individuals & Households:

  • Choice and demand. How do individuals spend their budgets? How do people define their preferences? How much utility do people obtain from certain goods and services? What combination of products and services are the best fit for their needs and wants, in the context of their available budget? How much are people willing to pay for goods and services?
  • Production and supply. How do individuals decide whether or not to work, and if they choose to work, whether or not it will be full time or part time? How many resources should go into the production of a good or service? How much should us individuals produce to meet market demand?

 

Firms:

  • Pricing of inputs. How much should businesses pay for land, labour, capital and enterprise? How does time depreciate these factors of production?
  • Competition. How do firms interact in different market compositions? What are the best strategies firms can follow to drive their competitive advantage?
  • Market failure. Are goods efficiently and optimally distributed in the market? If not, why? Is it because individuals and households have more information than firms, or vice versa?

 

What is Macroeconomics? 

Intuitively, macroeconomics is the antithesis of microeconomics. It is the study of economics on a broader and larger scale.  Macroeconomists will try to understand the decisions taken by entire economies. This implies thinking about the aggregate behaviour of large numbers of individuals, households and firms. When the latter are grouped together, you get industries, countries and economies as a result. And this is what macroeconomics essentially looks at; how industries, countries and economies make decisions when choosing what to do with the resources that they have at hand. 

The word ‘aggregate’ is key to understanding macroeconomics. The variables that feature in the study of microeconomics such as supply or demand, reappear in macroeconomics as “aggregate” variables. For instance, supply becomes “aggregate supply” and demand becomes “aggregate demand”. Now, the word aggregate means to collect and add many elements of the same type into one single mass or unit. Therefore, aggregate demand and supply are the sum of all market demands and supplies in an economy. Equally, prices become a single “aggregate price level”; the average total price across the entire spectrum of goods and services produced in an economy

Macroeconomists will look at the changes in these aggregate variables to understand how the economy behaves. When these variables change, the following three indicators and building blocks of macroeconomic analysis are born: 

 

  • Economic growth: An increase in the goods and services consumed and produced in a country over a period of time.

 

  • Inflation: The rise in the aggregate price level.

 

  • Unemployment: The percentage of the labour force (people between the ages of 16 and 64) that doesn’t have a job, and is looking for one. 

 

Macroeconomists analyse these indicators separately and in combination to answer questions such as “How is economic growth affected by unemployment?” or “What happens to inflation when economies are growing?” or “What is the optimal price level given the rate of unemployment?”.

Once the analysis on how the economy behaves has been carried out, macroeconomists delegate the resource allocation task to governments through policy making. Policy making is the mechanism that governments use to bring economies back to their equilibrium and distribute resources effectively across nations. Often, these mechanisms involve changing tax levels, spending in public goods, or altering interest rates in the economy. An example of this would be the recent increase in taxes in the UK to raise government revenue and compensate for the budget deficit incurred after a period of spending and recovery from the COVID-19 pandemic.  

It is in examples and situations like these where macroeconomics becomes extremely relevant to our everyday lives. Macroeconomics will allow you to understand why your monthly tax bill has gone up, or why individuals are finding it easier to open bank accounts and take out mortgages. In broader terms, macroeconomics provides individuals with the tools to evaluate the positive or negative effect of a given economic policy, and what impact it may have in their day-to-day life. Citing David Moss, the renowned Harvard Business School professor, in his book A Concise Guide to Macroeconomics

A Concise Guide to Macroeconomics, Second Edition by David A. Moss

 

 

‘A basic understanding of the subject [macroeconomics] is important to us as consumers, as workers, as investors, and even as voters. Whether our elected officials manage the macro economy well or poorly obviously has great significance for our quality of life, both now and in the future.’ 

 

 

 

What’s the Difference Between Micro and Macroeconomics?

The answer to this question a century ago would have been that there is no difference between micro and macroeconomics. As explained in the book Back to Basics: Economic Concepts Explained, there was not always a divide in this social science and “economics was economics”. Before the Great Depression in 1930, individual markets and the overall economy were believed to be so closely intertwined that there was no need to look at these separately.

But with the prolonged instability of the Great Depression, economists of the time conjectured that their existing economic theory was not enough to explain such abnormalities, and thereafter, economists began to take sides to mould the difference between microeconomics and macroeconomics. It was John Maynard Keynes, the father of macroeconomics, who kick started this division between disciplines in 1936 with his book The General Theory of Employment, Interest and Money, focusing on the instability of aggregate variables only. 

Essentially, the main difference between these two disciplines is the perspective and methodology followed when approaching a resource allocation issue. Macroeconomists will follow a top-down approach, analysing the bigger picture first, and using their findings to explain its impact on individuals, households and firms. On the other hand, microeconomists will follow a bottom-up approach, analysing the behaviours and decisions of individuals first to explain the impact of the latter on the overall economy. Because their approaches are different, the tools and theories they look at when carrying out their analyses are different too. 

 

How do Micro and Macroeconomics Overlap? 

Prominent economists such as Adam Smith, who built economic theory prior to Keynes and made no distinction between disciplines were not wrong in their beliefs. As a matter of fact, microeconomics and macroeconomics were and still are highly overlapping to the point where it may seem pointless to study them in isolation. 

These two disciplines overlap because they are constantly impacting each other. For instance, if governments decide to increase their spending on public goods (a macroeconomic decision), individuals may have easier and possibly cheaper access to public transportation and decide not to buy a new car (a microeconomic decision), affecting thus the supply and demand of the car market. 

This correlation works the other way round too. Individuals and firms might be spending less and less because the goods and services in the economy are too expensive to afford (microeconomic decision). Macroeconomists will identify this to be an event of increasing inflation. In turn, governments might decide to decrease taxes to increase the disposable income of individuals and firms (macroeconomics decision), encouraging them to spend. 

 

Final Thoughts & Examples 

Overall, the study of microeconomics and macroeconomics aids the decision making process at an individual and nationwide level. 

Understanding how to best budget your weekly income, or setting the prices for your newborn entrepreneurial products are both examples of how microeconomics can assist individuals and firms to make decisions on a daily basis. Equally, macroeconomics can help governments and nations establish the optimal interest rate to keep inflation stable, or figure out the acceptable levels of unemployment to achieve the target economic growth in a nation.

Even though the approach and tools to decision-making are different for microeconomists and macroeconomists, all decisions should make sense in the context of the mirror discipline. That is, a decision will have implications on the microeconomy and the macroeconomy. Therefore, a clear understanding of both branches of knowledge is essential to make sensible decisions that maximise the welfare of all, so that no individual or larger systems are mistreated by a given policy. 

 

Further Reading and Resources: 

Microeconomics for Dummies

Macroeconomics for Dummies

The Principles of Microeconomics

The Principles of Macroeconomics

Thinking Fast and Slow

Intermediate Microeconomics: A Modern Approach

 

Micro/Macroeconomics FAQs

  • What is microeconomics in simple terms?

    As the name might suggest, microeconomics is the smaller scale analysis of economics. It looks at how individuals, households and businesses make decisions when choosing what to do with the resources that they have at hand. The economics professor Gregory Mankiw, author of Principles of Microeconomics, describes this discipline in simple terms:

    ‘Microeconomics is the study of how households and firms make decisions and how they interact in specific markets.’

  • What is macroeconomics in simple terms?

    Intuitively, macroeconomics is the antithesis of microeconomics. It is the study of economics on a broader and larger scale.  Macroeconomists will try to understand the decisions taken by entire economies. This implies thinking about the aggregate behaviour of large numbers of individuals, households and firms. Macroeconomics essentially looks at how industries, countries and economies make decisions when choosing what to do with the resources that they have at hand.

  • What is the key difference between micro and macroeconomics?

    Essentially, the main difference between these two disciplines is the perspective and methodology followed when approaching a resource allocation issue. Macroeconomists will follow a top-down approach, analysing the bigger picture first, and using their findings to explain its impact on individuals, households and firms. On the other hand, microeconomists will follow a bottom-up approach, analysing the behaviours and decisions of individuals first to explain the impact of the latter on the overall economy. Because their approaches are different, the tools and theories they look at when carrying out their analyses are different too.

  • Who coined the terms 'microeconomics' and 'macroeconomics'?

    Professor Ragnar Frisch coined the term microeconomics & macroeconomics in 1933.

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    Bibliography:

    Mankiw, G. (2021) Principles of Microeconomics. Boston, MA. Cengage Learning.

    Marshall, A. (2021) Principles of Economics. Illustrated. Strelbytskyy Multimedia Publishing. Available at: https://www.perlego.com/book/3041868/principles-of-economics-illustrated-pdf

    Moss, D. (2014) A Concise Guide to Macroeconomics, Second Edition. Harvard Business Review Press. Available at: https://www.perlego.com/book/837335/a-concise-guide-to-macroeconomics-second-edition-pdf

    Fund, I. M. (2017) Back to Basics : Economic Concepts Explained. INTERNATIONAL MONETARY FUND. Available at: https://www.perlego.com/book/1667503/back-to-basics-economic-concepts-explained-pdf

     

    Written by: Inés Luque 

    Inés LuqueInés Luque is a Management Science final year master student at University College London. During high school, she developed a strong interest in Economics, leading her to win the national Economics prize in her country of nationality, Spain. Her expertise is in the areas of microeconomics, game theory and design of incentives.