What is Macroeconomics?

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.

On the other hand, microeconomics looks at the behavior of individual actors in an economy (like people, households, industries, etc). We'll look at the differences a bit more later.

Key Takeaways

  • 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.
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Macroeconomics

Understanding Macroeconomics

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.

Likewise, it can be invaluable to understand which theories are in favor and influencing a particular government administration. The underlying economic principles of a government will say much about how that government will approach taxation, regulation, government spending and similar policies. By better understanding economics and the ramifications of economic decisions, investors can get at least a glimpse of the probable future and act accordingly with confidence. (For more information, check out Explaining The World Through Macroeconomic Analysis.)

Specific Areas of Research

Macroeconomics is a rather broad field, but two specific areas of research are representative of this discipline. The first area is the factors that determine long-term economic growth, or increases in the national income. The other involves the causes and consequences of short-term fluctuations in national income and employment, also known as the business cycle.

Economic Growth

Economic growth refers to an increase in aggregate production in an economy. Macroeconomists study economic growth with an eye toward understanding the factors that either promote or retard economic growth in order to support economic policies that will support growth, development, and rising living standards. Adam Smith's classic book, An Inquiry into the Nature and Causes of the Wealth of Nations, which argues for free trade, laissez-faire economic policy, and expanding the division of labor is arguably one of the seminal works in this body of research. By the 20th century, macroeconomists began to study growth with more formal mathematical models. Growth is commonly modeled as a function of physical capital, human capital, labor force, and technology.

Business Cycles

Superimposed over long term macroeconomic growth trends, the levels and rates-of-change of major macroeconomic variables such as employment and national output go through occasional fluctuations up or down, expansions and recessions, in a phenomenon known as the business cycle. The 2008 financial crisis is a clear recent example, and the Great Depression of the 1930s was actually the impetus for the development of most modern macroeconomic theory. Popular theories of the causes and cures for these sometimes painful swings in the macroeconomy include Keynesian economics, Monetarism (a variant of Keynesian economics), Real Business Cycle Theory, Austrian Business Cycle Theory, and others.

Macroeconomics vs. Microeconomics

Macroeconomics differs from microeconomics, which focuses on smaller factors that affect choices made by individuals and companies. Factors studied in both microeconomics and macroeconomics typically have an influence on one another. For example, the unemployment level in the economy as a whole has an effect on the supply of workers from which a company can hire.

A key distinction between micro and macroeconomics is that macroeconomic aggregates can sometimes behave in ways that are very different or even the opposite of the way that analogous microeconomic variables do. For example the so-called Paradox of Thrift popularized by Keynes, who argued that while savings for an individual may be the key building wealth, when everyone in the economy tries to increase their savings at once it can contribute to a slowdown in the economy and less wealth in the aggregate.

Meanwhile, microeconomics looks at economic tendencies, or what can happen when individuals make certain choices. Individuals are typically classified into subgroups, such as buyers, sellers, and business owners. These actors interact with each other according to the laws of supply and demand for resources, using money and interest rates as pricing mechanisms for coordination.

History of Macroeconomics

Macroeconomics, as it is in its modern form, started with John Maynard Keynes and the publication of his book The General Theory of Employment, Interest and Money in 1936. Keynes offered an explanation for the fallout from the Great Depression, when goods remained unsold and workers unemployed. Keynes's theory attempted to explain why markets may not clear. This theory evolved throughout the 20th century, known as Keynesian economics, and diverged into several macroeconomic schools of thought including Post Keynesians, New Keynesians, Monetarists, and others.

Prior to the popularization of Keynes's theories, economists did not generally differentiate between micro and macroeconomics. The same microeconomic laws of supply and demand that operate in individual goods markets were understood to interact between individuals markets to bring the economy into a general equilibrium as described by Leon Walras. The link between goods markets and large scale financial variables such as price levels and interest rates was explained through the unique role that money plays in the economy as a medium of exchange by economists such as Knut Wicksell, Irving Fisher, and Ludwig von Mises.