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Micro and Macro The Economic Divide Back To Basics Finance Development
Micro and Macro The Economic Divide Back To Basics Finance Development
Micro and Macro The Economic Divide Back To Basics Finance Development
Micro and Macro: The Economic Divide - Back to Basics: Finance & Development
MicroandMacro:TheEconomicDivide
FINANCE & DEVELOPMENT
G.ChrisRodrigo
Economicsissplitbetweenanalysisofhowtheoveralleconomyworksandhowsinglemarkets
function
Physicistslookatthebigworldofplanets,stars,galaxies,
andgravity.Buttheyalsostudytheminuteworldofatoms
andthetinyparticlesthatcomprisethoseatoms.
Economistsalsolookattworealms.Thereisbigpicture
macroeconomics,whichisconcernedwithhowthe
overalleconomyworks.Itstudiessuchthingsas
employment,grossdomesticproduct,andinflationthe
stuffofnewsstoriesandgovernmentpolicydebates.Little
picturemicroeconomicsisconcernedwithhowsupply
anddemandinteractinindividualmarketsforgoodsand
services.
Aquestionofscale(photo:Zack
Seckler/Corbis)
Inmacroeconomics,thesubjectistypicallyanationhow
allmarketsinteracttogeneratebigphenomenathateconomistscallaggregatevariables.Inthe
realmofmicroeconomics,theobjectofanalysisisasinglemarketforexample,whetherprice
risesintheautomobileoroilindustriesaredrivenbysupplyordemandchanges.The
governmentisamajorobjectofanalysisinmacroeconomicsforexample,studyingtheroleit
playsincontributingtooveralleconomicgrowthorfightinginflation.Macroeconomicsoften
extendstotheinternationalspherebecausedomesticmarketsarelinkedtoforeignmarkets
throughtrade,investment,andcapitalflows.Butmicroeconomicscanhaveaninternational
componentaswell.Singlemarketsoftenarenotconfinedtosinglecountriestheglobalmarket
forpetroleumisanobviousexample.
Themacro/microsplitisinstitutionalizedineconomics,frombeginningcoursesinprinciplesof
economicsthroughtopostgraduatestudies.Economistscommonlyconsiderthemselves
microeconomistsormacroeconomists.TheAmericanEconomicAssociationrecentlyintroduced
severalnewacademicjournals.OneiscalledMicroeconomics.Another,appropriately,istitled
Macroeconomics.
Whythedivide?
Itwasnotalwaysthisway.Infact,fromthelate18thcenturyuntiltheGreatDepressionofthe
1930s,economicswaseconomicsthestudyofhowhumansocietiesorganizetheproduction,
distribution,andconsumptionofgoodsandservices.Thefieldbeganwiththeobservationsofthe
earliesteconomists,suchasAdamSmith,theScottishphilosopherpopularlycreditedwithbeing
thefatherofeconomicsalthoughscholarsweremakingeconomicobservationslongbefore
SmithauthoredTheWealthofNationsin1776.Smithsnotionofaninvisiblehandthatguides
someoneseekingtomaximizehisorherownwellbeingtoprovidethebestoverallresultfor
societyasawholeisoneofthemostcompellingnotionsinthesocialsciences.Smithandother
earlyeconomicthinkerssuchasDavidHumegavebirthtothefieldattheonsetoftheIndustrial
Revolution.
EconomictheorydevelopedconsiderablybetweentheappearanceofSmithsTheWealthof
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NationsandtheGreatDepression,buttherewasnoseparationintomicroeconomicsand
macroeconomics.Economistsimplicitlyassumedthateithermarketswereinequilibriumsuch
thatpriceswouldadjusttoequalizesupplyanddemandorthatintheeventofatransient
shock,suchasafinancialcrisisorafamine,marketswouldquicklyreturntoequilibrium.Inother
words,economistsbelievedthatthestudyofindividualmarketswouldadequatelyexplainthe
behaviorofwhatwenowcallaggregatevariables,suchasunemploymentandoutput.
ThesevereandprolongedglobalcollapseineconomicactivitythatoccurredduringtheGreat
Depressionchangedthat.Itwasnotthateconomistswereunawarethataggregatevariables
couldbeunstable.Theystudiedbusinesscyclesaseconomiesregularlychangedfroma
conditionofrisingoutputandemploymenttoreducedorfallinggrowthandrisingunemployment,
frequentlypunctuatedbyseverechangesoreconomiccrises.Economistsalsostudiedmoneyand
itsroleintheeconomy.ButtheeconomicsofthetimecouldnotexplaintheGreatDepression.
Economistsoperatingwithintheclassicalparadigmofmarketsalwaysbeinginequilibriumhadno
plausibleexplanationfortheextrememarketfailureofthe1930s.
IfAdamSmithisthefatherofeconomics,JohnMaynardKeynesisthefoundingfatherof
macroeconomics.Althoughsomeofthenotionsofmodernmacroeconomicsarerootedinthe
workofscholarssuchasIrvingFisherandKnutWicksellinthelate19thandearly20thcenturies,
macroeconomicsasadistinctdisciplinebeganwithKeynessmasterpiece,TheGeneralTheoryof
Employment,InterestandMoney,in1936.Itsmainconcernistheinstabilityofaggregate
variables.Whereasearlyeconomicsconcentratedonequilibriuminindividualmarkets,Keynes
introducedthesimultaneousconsiderationofequilibriuminthreeinterrelatedsetsofmarkets
forgoods,labor,andfinance.Healsointroduceddisequilibriumeconomics,whichistheexplicit
studyofdeparturesfromgeneralequilibrium.Hisapproachwastakenupbyotherleading
economistsanddevelopedrapidlyintowhatisnowknownasmacroeconomics.
Coexistenceandcomplementarity
Microeconomicsisbasedonmodelsofconsumersorfirms(whicheconomistscallagents)that
makedecisionsaboutwhattobuy,sell,orproducewiththeassumptionthatthosedecisions
resultinperfectmarketclearing(demandequalssupply)andotheridealconditions.
Macroeconomics,ontheotherhand,beganfromobserveddivergencesfromwhatwouldhave
beenanticipatedresultsundertheclassicaltradition.
Todaythetwofieldscoexistandcomplementeachother.
Microeconomics,initsexaminationofthebehaviorofindividualconsumersandfirms,isdivided
intoconsumerdemandtheory,productiontheory(alsocalledthetheoryofthefirm),andrelated
topicssuchasthenatureofmarketcompetition,economicwelfare,theroleofimperfect
informationineconomicoutcomes,andatthemostabstract,generalequilibrium,whichdeals
simultaneouslywithmanymarkets.Mucheconomicanalysisismicroeconomicinnature.It
concernssuchissuesastheeffectsofminimumwages,taxes,pricesupports,ormonopolyon
individualmarketsandisfilledwithconceptsthatarerecognizableintherealworld.Ithas
applicationsintrade,industrialorganizationandmarketstructure,laboreconomics,public
finance,andwelfareeconomics.Microeconomicanalysisoffersinsightsintosuchdisparateefforts
asmakingbusinessdecisionsorformulatingpublicpolicies.
Macroeconomicsismoreabstruse.Itdescribesrelationshipsamongaggregatessobigastobe
hardtoapprehendsuchasnationalincome,savings,andtheoverallpricelevel.Thefieldis
conventionallydividedintothestudyofnationaleconomicgrowthinthelongrun,theanalysisof
shortrundeparturesfromequilibrium,andtheformulationofpoliciestostabilizethenational
economythatis,tominimizefluctuationsingrowthandprices.Thosepoliciescaninclude
spendingandtaxingactionsbythegovernmentormonetarypolicyactionsbythecentralbank.
Bridgingthemicro/macrodivide
Likephysicalscientists,economistsdeveloptheorytoorganizeandsimplifyknowledgeabouta
fieldandtodevelopaconceptualframeworkforaddingnewknowledge.Sciencebeginswiththe
accretionofinformalinsights,particularlywithobservedregularrelationshipsbetweenvariables
thataresostabletheycanbecodifiedintolaws.Theoryisdevelopedbypinningdownthose
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invariantrelationshipsthroughbothexperimentationandformallogicaldeductionscalled
models.
SincetheKeynesianrevolution,theeconomicsprofessionhashadessentiallytwotheoretical
systems,onetoexplainthesmallpicture,theothertoexplainthebigpicture(microandmacro
aretheGreekwords,respectively,forsmallandbig).Followingtheapproachofphysics,for
thepastquartercenturyorso,anumberofeconomistshavemadesustainedeffortstomerge
microeconomicsandmacroeconomics.Theyhavetriedtodevelopmicroeconomicfoundationsfor
macroeconomicmodelsonthegroundsthatvalideconomicanalysismustbeginwiththebehavior
oftheelementsofmicroeconomicanalysis:individualhouseholdsandfirmsthatseektooptimize
theirconditions.
Therehavealsobeenattemptstouseveryfastcomputerstosimulatethebehaviorofeconomic
aggregatesbysummingthebehavioroflargenumbersofhouseholdsandfirms.Itistooearlyto
sayanythingaboutthelikelyoutcomeofthiseffort.Butwithinthefieldofmacroeconomicsthere
iscontinuingprogressinimprovingmodels,whosedeficiencieswereexposedbytheinstabilities
thatoccurredinworldmarketsduringtheglobalfinancialcrisisthatbeganin2008.
Howtheydiffer
Contemporarymicroeconomictheoryevolvedsteadilywithoutfanfarefromtheearliesttheories
ofhowpricesaredetermined.Macroeconomics,ontheotherhand,isrootedinempirical
observationsthatexistingtheorycouldnotexplain.Howtointerpretthoseanomalieshasalways
beencontroversial.Therearenocompetingschoolsofthoughtinmicroeconomicswhichis
unifiedandhasacommoncoreamongalleconomists.Thesamecannotbesaidof
macroeconomicswherethereare,andhavebeen,competingschoolsofthoughtabouthowto
explainthebehaviorofeconomicaggregates.ThoseschoolsgobysuchnamesasNewKeynesian
orNewClassical.Butthesedivisionshavebeennarrowingoverthepastfewdecades(Blanchard,
DellAriccia,andMauro,2010).
Microeconomicsandmacroeconomicsarenottheonlydistinctsubfieldsineconomics.
Econometrics,whichseekstoapplystatisticalandmathematicalmethodstoeconomicanalysis,is
widelyconsideredthethirdcoreareaofeconomics.Withoutthemajoradvancesineconometrics
madeoverthepastcenturyorso,muchofthesophisticatedanalysisachievedinmicroeconomics
andmacroeconomicswouldnothavebeenpossible.
G.ChrisRodrigoisaVisitingScholarintheIMFsResearchDepartment.
Reference
Blanchard,Olivier,GiovanniDellAriccia,andPaoloMauro,2010,RethinkingMacroeconomicPolicy,
IMFStaffPositionNote10/03(Washington:InternationalMonetaryFund).
Updated:March28,2012
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