Microeconomics is the social science that studies the implications of human action, specifically about how those decisions affect the utilization and distribution of scarce resources. Microeconomics shows how and why different goods have different values, how individuals make more efficient or more productive decisions, and how individuals best coordinate and cooperate with one another. Generally speaking, microeconomics is considered a more complete, advanced, and settled science than macroeconomics.
Microeconomics is the study of economic tendencies, or what is likely to happen when individuals make certain choices or when the factors of production change. Individual actors are often grouped into microeconomic subgroups, such as buyers, sellers, and business owners. These groups create the supply and demand for resources, using money and interest rates as a pricing mechanism for coordination.
The Uses of Microeconomics
As a purely normative science, microeconomics does not try to explain what should happen in a market. Instead, microeconomics only explains what to expect if certain conditions change. If a manufacturer raises the prices of cars, microeconomics says consumers will tend to buy fewer than before. If a major copper mine collapses in South America, the price of copper will tend to increase, because supply is restricted. Microeconomics could help an investor see why Apple Inc. stock prices might fall if consumers buy fewer iPhones. Microeconomics could also explain why a higher minimum wage might force The Wendy’s Company to hire fewer workers. Microeconomics can address questions like these that might have very broad implications for the economy; however, questions about aggregate economic numbers remain the purview of macroeconomics, such as what might happen to the gross domestic product (GDP) of China in 2020.
Method of Microeconomics
Most modern microeconomic study is performed according to general equilibrium theory, developed by Léon Walras in Elements of Pure Economics (1874) and partial equilibrium theory, introduced by Alfred Marshall in Principles of Economics (1890). The Marshallian and Walrasian methods fall under the larger umbrella of neoclassical microeconomics. Neoclassical economics focuses on how consumers and producers make rational choices to maximize their economic well being, subject to the constraints of how much income and resources they have available. Neoclassical economists make simplifying assumptions about markets – such as perfect knowledge, infinite numbers of buyers and sellers, homogeneous goods, or static variable relationships – in order to construct mathematical models of economic behavior.
These methods attempt to represent human behavior in functional mathematical language, which allows economists to develop mathematically testable models of individual markets. As logical positivists, neoclassicals believe in constructing measurable hypotheses about economic events, then using empirical evidence to see which hypotheses work best. Unlike physicists or biologists, economists cannot run repeatable tests, so their empirical research depends on the collection and observation of economic data from real world markets. The economic efficiency of markets is then determined by how well real markets adhere to the rules of the model.
Basic Concepts of Microeconomics
The study of microeconomics involves several key concepts, including (but not limited to):
(i) Production theory
This is the study of production — or the process of converting inputs into outputs. Producers seek to choose the combination of inputs and method of combining them that will minimize cost in order to maximize their profits.
(ii) Utility theory
Analogous to production theory, consumers will choose to purchase and consume a combination of goods that will maximize their happiness or “utility”, subject to the constraint of how much income they have available to spend.
(iii) Price theory
Production theory and utility theory interact to produce the theory of supply and demand, which determine prices in a competitive market. In a perfectly competitive market, it concludes that the price demanded by consumers is the same supplied by producers. That results in economic equilibrium.
(iv) Industrial organization and market structure
Microeconomists study the many ways that markets can be structured, from perfect competition to monopolies, and the ways that production and prices will develop in these different types of markets.
- Microeconomics studies the decisions of individuals and firms to allocate resources of production, exchange, and consumption.
- Microeconomics deals with prices and production in single markets and the interaction between different markets, but leaves the study of economy-wide aggregates to macroeconomics.
- Microeconomists use mathematics as a language to formulate theories and observational studies to test their theories against the real world performance of market.
Macroeconomics is a branch of economics that studies how the aggregate economy behaves. In macroeconomics, economy-wide phenomena are examined such as inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment.
There are two sides to the study of economics: macroeconomics and microeconomics. As the term implies, macroeconomics looks at the overall, big picture scenario of the economy. Put simply, it focuses on the way the economy performs as a whole, and then analyzes how different sectors of the economy relate to one another to understand how the economy functions. This includes looking at variables like unemployment, GDP, and inflation. Macroeconomists develop models explaining relationships between these factors. Such macroeconomic models, and the forecasts they produce, are used by government entities to aid in the construction and evaluation of economic policy, by businesses to set strategy in domestic and global markets, and by investors to predict and plan for movements in various asset markets.
Given the enormous scale of government budgets and the impact of economic policy on consumers and businesses, macroeconomics clearly concerns itself with significant issues. Properly applied, economic theories can offer illuminating insights on how economies function and the long-term consequences of particular policies and decisions. Macroeconomic theory can also help individual businesses and investors make better decisions through a more thorough understanding of what motivates other parties and how to best maximize utility and scarce resources.
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 their 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.
- Macroeconomics is the branch of economics that deals with the structure, performance, behavior, and decision-making of the whole, or aggregate, economy, instead of focusing on individual markets.
- The two main areas of macroeconomic study are long term economic growth and shorter term business cycles.
- Macroeconomics first came to be distinguished from microeconomics with the work of John Maynard Keynes and his arguments that macroeconomic aggregates can behave in ways quite different from analogous microeconomic phenomena.