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.
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.
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, but macroeconomics cannot be ignored altogether. Fundamental and value investors may disagree with technical investors about the proper role of economic analysis. While it is more likely that microeconomics will impact individual investments, macroeconomic factors can affect entire portfolios.
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, and besides, 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?’”
Can macroeconomic factors affect my investment portfolio?
Yes, macroeconomic factors can have a significant influence on your investment portfolio. For example, the Great Recession of 2008–09 and accompanying market crash were caused by the bursting of the U.S. housing bubble and subsequent near-collapse of financial institutions that were heavily invested in U.S. subprime mortgages.
For another example of the effect of macro factors on investment portfolios, consider the response of central banks and governments to the pandemic-induced crash of spring 2020. Governments and central banks unleashed torrents of liquidity through fiscal and monetary stimulus to prop up their economies and stave off recession, which had the effect of pushing most major equity markets to record highs in the second half of 2020 and throughout much of 2021.
What is a global macro strategy?
A global macro strategy is an investment and trading strategy that centers around large macroeconomic events at a national or global level. “Global Macro” involves research and analysis of numerous macroeconomic factors, including interest rates, currency levels, political developments, and country relations.
What is the basic difference between microeconomics and macroeconomics?
Microeconomics is the study of how individuals and companies make decisions to allocate scarce resources. Macroeconomics is the study of an economy as a whole.
How do core concepts of microeconomics such as supply and demand affect stock prices?
Microeconomic concepts such as supply and demand affect stocks prices in two ways: directly and indirectly.
- The direct effect can be gauged by the impact of demand and supply disequilibrium on stock prices. When demand for a stock exceeds supply at a given point in time because there are more buyers than sellers, the stock will rise; conversely, when supply exceeds demand because there are more sellers than buyers, the stock will fall.
- The indirect effect is based on supply and demand for the underlying company’s products and services. If the company’s products are flying off the shelves because of robust demand, it may be on a probable strong earnings trajectory that would likely translate into a higher price for its stock. But if demand is sluggish and there is excess inventory (or supply) of its products, the company’s earnings may disappoint and the stock may slump.
Does my portfolio performance hinge on both microeconomic and macroeconomic factors?
Yes, the performance of your portfolio hinges on both microeconomic and macroeconomic factors. Microeconomic factors such as supply and demand, taxes and regulations, and macroeconomic factors such as gross domestic product (GDP) growth, inflation, and interest rates, have a significant influence on different sectors of the economy and hence on your investment portfolio.