Microeconomics and Macroeconomics: Understanding the Difference
Most people understand how physics is classified as a science, however, there might be some confusion when including economics in the same category. In fact, economics is a social science, as it shares the same qualitative and quantitative elements common to all social sciences.1 Economics focuses on the manufacturing, distribution, and consumption of goods and services, and how people, organisations, governments, and nations choose to allocate resources in order to gain these goods and services.2 As with the studies of all sciences, establishing different sections makes it easier to understand. Economics can be broken into two sections: microeconomics and macroeconomics.3 Here we delve into these sections; their differences, how they affect each other, and their impact on business.
What is microeconomics?
Microeconomics can be defined as the study of decision-making behaviour of individuals, companies, and households with regards to the allocation of their resources.4
Microeconomics strives to discover what factors contribute to peoples’ decisions, and what impact these choices have on the general market as far as price, demand, and supply of goods and services is concerned. It’s a ‘bottom-up’ approach with a focus on the basic elements that make up the economy’s three sectors (agriculture, manufacturing, and services/tertiary), such as land, entrepreneurship, and capital.5 It aims to understand the pattern of wages, employment, and income,6 as well as consumer behaviour, spending trends, wage-price behaviour, corporate policies, and how regulations impact on companies.7 Microeconomics tries to determine decisions and resource allocation at an individual level, as well as explain what happens when certain conditions change.
To summarise, microeconomics determines to understand the following:8
- How people and households spend their budgets
- What combination of products and services are the best fit for their needs and wants, in the context of their available budget
- How individuals decide whether or not to work, and if they choose to work, whether or not it will be full time or part time
- How people decide to save for the future, how much they choose to save, or whether they decide to go into debt
- How a business decides to produce and sell certain products, how it will produce it, how many of each it will sell, and for how much
- What causes them to decide how many workers it will hire
- How a firm will finance its business
- At what time a business will decide to expand, downsize, or even close
For example, microeconomics could use information from a company’s financial reports in order to determine how an organisation could maximise its production and output capacity, in order to lower prices and become more competitive.
What is macroeconomics?
Macroeconomics is the holistic study of the structure, performance, behaviour, and decision-making processes of an economy, at a national level.9 Essentially, macroeconomics is a ‘top-down’ approach.10 It seeks to understand changes in the nation’s Gross Domestic Product (GPD), inflation and inflation expectations, spending, receipts and borrowings at a governmental level (fiscal policies), unemployment, and monetary policy. This is done to interpret and know the state of the economy, so that policies can be formulated at a higher level, and macro research can be carried out for academic purposes.
Macroeconomics analyses entire industries and economies, rather than singular companies or individuals.11 It seeks to answer questions such as, “What should the inflation rate be?” and, “What stimulates economic growth?”.
To summarise, macroeconomics strives to answer the following:12
- Which factors determine how many goods and services a country can produce
- What determines the number of jobs available in an economy
- What determines a country’s standard of living
- What factors cause the economy to speed up or slow down
- What causes organisations to hire or fire more labour on a national scale
- What causes the economy to grow over the long term
- What the state of the nation’s economic health is, based on improvement in the standard of living, low unemployment, and low inflation
Macroeconomics vs microeconomics: the key differences
Microeconomics and macroeconomics both explore the same elements, but from different points of view.13 The main differences between them are:
- Macroeconomics seeks to find a general perspective, at a national level, while microeconomics focuses on the individual’s perspective, at a consumer level.14
- Even though supply and demand applies to both fields of economics, microeconomics is based on the trends of buyers and sellers, where macroeconomics focuses on the various cycles of an economy, such as short and long term debt cycle, and business cycles.15
Macroeconomics vs microeconomics: the overlap
It is clear that macroeconomics does not exist in isolation, but rather is entwined with microeconomics, and works in tandem in order to be efficient.15 Choices based on microeconomic factors, whether from individuals or businesses, can impact macroeconomics in the long run. Similarly, a national policy that involves microeconomics could affect how households and enterprises interact with their economy. For example, if the government raises the tax on a certain product (macroeconomics), an individual shop owner will have to increase the price, which will impact on the consumer and their decision for or against the product at that price (microeconomics).
How macroeconomics and microeconomics affect each other
Macro’s effects on micro17
Should a national policy be passed, such as when the nation’s central bank cuts the interest rate (a macro impact) by 100 basis points (100 bps = 1%), this will lower the borrowing costs of commercial banks. This, in turn, helps their deposit rate to drop, which gives room to lower the interest rate on credit, and to individuals and business. This causes a rise in borrowings and creates a climate of greater investment, which helps businesses invest in new assets, projects, and expansion plans (a micro impact).
Micro’s effect on macro18
The condition of the microeconomy is one of the many factors that determine macroeconomic policies. To continue the example, the central bank observes the lending and investment trends of businesses, individuals and households, now that the interest rate has been lowered, in order to determine whether or not they should make additional cuts. If the outlook is weak, keep rates as is, or increase them if the outlook is picking up.
How micro- and macroeconomics affect business
- The law of supply and demand19
Businesses use microeconomic principles to better understand the behavioural patterns of their consumers, in order to be successful and generate a profit.
Large-scale external factors that are uncontrollable, such as competitors, changes in interest rates, changes in cultural preferences, weather phenomena, and changes in governmental regulations, all play a role in influencing and affecting a company’s decisions, performance, and business strategies. Other macroeconomic factors such as legal, political, and social climates, technological advancements, and climate changes all impact on the individual’s, household’s and organisation’s decisions on resources.
When starting a business, it is important to do extensive research into the industry you are interested in. Know where customer demand is, to better provide and develop the products and services that would best match the needs of your target market. Investing in this microeconomic research can help you reach a competitive advantage to attract customers.
- Economic cycles22
Macroeconomics is cyclic; just as positive influences and changes promote prosperity, higher demand levels may trigger price increases, which may, in turn, dampen the economy, as households adopt leaner budgets. Then, when supply starts to outweigh demand, prices may go down again, leading to further prosperity, until the next cycle of economic supply and demand.
- The cost of goods and services23
Regardless of what a business produces, the goal is usually to keep costs down in order to improve profits. In microeconomic theory, companies run at the highest level of efficiency, with production decisions based on how the maximum output can be achieved with minimal extra costs. So, for example, if production is ramped up, a need for extra labour may arise, resulting in the wage costs increasing, and a potential change in sales prices. In microeconomics, the cost of labour is typically the highest expense of a business.
- Pricing decisions24
In microeconomics, the price where quantity supplied meets the quantity demanded is known as the ‘equilibrium price’. The decided price of the product or service will impact on the number of people willing to buy it. For example, setting a price above the equilibrium doesn’t always mean greater profits, as fewer people may opt to buy your product, therefore, the price of the product should match your target market’s budget.
In order to make balanced, informed business decisions, it is important to take local and global economic trends into account, as well as relevant data and interactions with your customers. Look for opportunities that arise from economic trends, both on a micro- as well as a macroeconomic levels.
Learn more about the impact of economic forces on business with the MIT Sloan Economics for Business online program.
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