Microeconomics vs. Macroeconomics: An Overview
Economics is divided into two different categories: microeconomics and macroeconomics. Microeconomics is the study of individuals and business decisions, while macroeconomics looks at the decisions of countries and governments.
While these two branches of economics appear to be different, they are actually interdependent and complement one another. Many overlapping issues exist between the two fields.
- Microeconomics studies individuals and business decisions, while macroeconomics analyzes the decisions made by countries and governments.
- Microeconomics focuses on supply and demand, and other forces that determine price levels, making it a bottom-up approach.
- Macroeconomics takes a top-down approach and looks at the economy as a whole, trying to determine its course and nature.
- Investors can use microeconomics in their investment decisions, while macroeconomics is an analytical tool mainly used to craft economic and fiscal policy.
Microeconomics is the study of decisions made by people and businesses regarding the allocation of resources and prices of goods and services. It also takes into account taxes, regulations, and government legislation.
Microeconomics focuses on supply and demand and other forces that determine the price levels in the economy. It takes what is referred to as a bottom-up approach to analyzing the economy. In other words, microeconomics tries to understand human choices, decisions, and the allocation of resources.
Having said that, microeconomics does not try to answer or explain what forces should take place in a market. Rather, it tries to explain what happens when there are changes in certain conditions.
For example, microeconomics examines how a company could maximize its production and capacity so that it could lower prices and better compete in its industry. A lot of microeconomic information can be gleaned from the financial statements.
Microeconomics involves several key principles including (but not limited to):
- Demand, Supply, and Equilibrium: Prices are determined by the theory of supply and demand. Under this theory, suppliers offer the same price demanded by consumers in a perfectly competitive market. This creates economic equilibrium.
- Production Theory: This principle is the study of how goods and services are created or manufactured.
- Costs of Production: According to this theory, the price of goods or services is determined by the cost of the resources used during production.
- Labor Economics: This principle looks at workers and employers, and tries to understand the pattern of wages, employment, and income.
The rules in microeconomics flow from a set of compatible laws and theorems, rather than beginning with empirical study.
Microeconomics Vs. Macroeconomics
Macroeconomics, on the other hand, studies the behavior of a country and how its policies affect the economy as a whole. It analyzes entire industries and economies, rather than individuals or specific companies, which is why it's a top-down approach. It tries to answer questions like "What should the rate of inflation be?" or "What stimulates economic growth?"
Macroeconomics examines economy-wide phenomena such as gross domestic product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, and price levels.
Macroeconomics analyzes how an increase or decrease in net exports affects a nation's capital account, or how GDP would be affected by the unemployment rate.
Macroeconomics focuses on aggregates and econometric correlations, which is why it is used by governments and their agencies to construct economic and fiscal policy. Investors of mutual funds or interest-rate-sensitive securities should keep an eye on monetary and fiscal policy. Outside of a few meaningful and measurable impacts, macroeconomics doesn't offer much for specific investments.
John Maynard Keynes is often credited as the founder of macroeconomics, as he initiated the use of monetary aggregates to study broad phenomena. Some economists dispute his theory, while many of those who use it disagree on how to interpret it.
Investors and Microeconomics vs. Macroeconomics
Individual investors may be better off focusing on microeconomics than macroeconomics. There may be some disagreement between fundamental (particularly value) and technical investors about the proper role of economic analysis, but it is more likely that microeconomics will affect an individual investment proposal.
Warren Buffett famously stated that macroeconomic forecasts don't influence his investing decisions. When asked about how he and business partner Charlie Munger choose investments, Buffett responded, "Charlie and I don’t pay attention to macro forecasts. We have worked together now for 50 years and can’t think of a time we made a decision on a company where we’ve talked about macro." Buffett also has referred to macroeconomic literature as "the funny papers."
John Templeton, another famously successful value investor who died in 2008 at the age of 95, shared a similar sentiment. "I never ask if the market is going to go up or down because I don't know. It doesn't matter. I search nation after nation for stocks, asking: 'where is the one that is lowest priced in relation to what I believe it's worth?'" he once said.