Microeconomics vs. Macroeconomics: An Overview
Economics is divided into two categories: microeconomics and macroeconomics. Microeconomics is the study of individuals and business decisions, while macroeconomics looks at the decisions of countries and governments.
Though these two branches of economics appear 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 at which they trade goods and services. It considers taxes, regulations and government legislation.
Microeconomics focuses on supply and demand and other forces that determine price levels in the economy. It takes 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. A lot of microeconomic information can be gleaned from company financial statements.
Microeconomics involves several key principles, including (but not limited to):
- Demand, Supply and Equilibrium: Prices are determined by the law of supply and demand. In a perfectly competitive market, suppliers offer the same price demanded by consumers. 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 patterns 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 impact 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 such as, "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, rates of growth and price levels.
Macroeconomics focuses on aggregates and econometric correlations, which is why governments and their agencies rely on macroeconomics to formulate economic and fiscal policy. Investors who buy interest-rate sensitive securities should keep a close eye on monetary and fiscal policy. Outside 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 theories, while many Keynesians disagree on how to interpret his work.
Investors and Microeconomics vs. Macroeconomics
Individual investors may be better off focusing on microeconomics rather than macroeconomics. Fundamental and value investors may disagree with technical investors about the proper role of economic analysis. But it is more likely that microeconomics will impact an individual investment.
Warren Buffett famously stated that macroeconomic forecasts didn't influence his investing decisions. When asked how he and partner Charlie Munger choose investments, Buffett said: "Charlie and I don't pay attention to macro forecasts. We have worked together now for 54 years, and I can't think of a time we made a decision on a stock, or 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, 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," Templeton told Forbes in 1978. "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?'"