Microeconomics and Macroeconomics

1. Different Perspectives on the Economy

As long as people have lived in communities and traded items, skills, and labor with one another, there have been economies. Civilizations as far back as The Bronze Age (4000-2500 BCE) are known to have written documents accounting for land, labor, and livestock, recorded debts, and interest payments. But while there have always been economies, the foundation of economics as a field of study arose in Europe. In the 16th century, two leading members of the Protestant Reformation, Martin Luther and John Calvin, examined economic practices of the day—such as usury, monopolistic practices, financial speculation, and importation of luxury goods—through a religious lens. Literature and dialogue about economics emerged in the field of philosophy in the early 1700s, as thinkers began considering the source of a nation’s wealth. The ideas of this foundational work and that of many prominent thinkers of 18th century Europe were unified by Adam Smith in his treatise, The Wealth of Nations, which serves as the foundation of the Classical School of economic thought.

1a. Adam Smith and Classical Economics

Scottish economist and philosopher Adam Smith is considered by experts in the field of economics to be the “Father of Economics.” His publication, An Inquiry into the Nature and Causes of the Wealth of Nations, drew together the thoughts of many contemporary thinkers like David Hume, Robert Malthus, and David Ricardo. It was a written response to claims by merchants that the government should stay out of their business interests. Smith’s book serves as the foundation of the classical view of how the economy works.

Classical economics is centered around markets and the importance of the production side of the economy as a source of stability. Classical economists are the followers of the Classical School of thought. Classical economists take a long-view of market ups and downs, considering what is likely to happen over a long period of time rather than focusing on things that are happening now or going to happen soon. Classical economists believe that if a good is produced, then sufficient income will have been paid to owners of resources to purchase the good; in essence “supply creates its own demand” and, therefore, markets are a source of stability for the economy. We’ll cover this in more detail in the challenge about demand and supply.

EXAMPLE

From a classical perspective, if a business produces a shirt costing five dollars, then five dollars of income has been earned by the worker(s), which was exactly sufficient to buy the shirt. The supply of the shirt creates its own demand in the form of the payment of income.

In the classical view, markets are viewed as self-regulating. If a market produces too much of a product, a fall in price would clear away the surplus. Alternatively, if a market was short of a product, a rise in price would trigger the production of additional products. In this way, markets are seen as self-regulating and, therefore, government involvement was unnecessary.

EXAMPLE

The following scenario shows how markets self-regulate. If there is a surplus of refrigerators priced at $200, then the price of refrigerators should go down, which would incentivize people to buy new refrigerators and clear the surplus. But if there were a shortage of refrigerators, then the price of refrigerators would go up, which would encourage refrigerator makers to increase the number of refrigerators they were producing.

Economics that is concerned with the study of markets that make up the broad economy is called microeconomics. In this view, markets are considered the foundation of an economy. Markets are any arrangement that brings buyers and sellers together to exchange goods and services for other goods and services or for money. For example, a market could be an online store or the car for sale in your driveway. The rest of this course will be about microeconomics, the type of economics that focuses on markets.

terms to know

Classical Economics

A view of the economy that believes in the self-regulating of markets and encourages minimal government intervention to achieve growth and wealth.

Microeconomics

A study of the markets that make up the broad economy.

Markets

Any arrangement that brings buyers and sellers together to exchange goods and services for money.

1b. John M. Keynes and Keynesian Economics

The Great Depression was a period of sustained economic downturn that lasted through most of the 1930s around the world. The severity, worldwide scale, and length of the Great Depression upended the classical view of the economy. In light of these new economic situations, in 1936 the British economist John M. Keynes published The General Theory of Employment, Interest and Money, offering an alternative perspective on how the economy works. This perspective became known as “Keynesian” economics.

Keynes challenged the classical notion that the supply (production) of a good creates sufficient demand for the good. Keynes pointed out that even during the depth of the Depression, farmers were bringing produce to the market but could not sell it because people had insufficient income to pay for the produce, even though it was desired. He argued that during times of economic instability, demand for products was too low. Keynes asserted that it was a responsibility of the government to jump-start the economy by spending its tax revenue in order to create demand. Keynes' ideas provided support for many of the policies President Franklin Delano Roosevelt implemented in response to the Great Depression.

The collection of Keynes’ ideas about how the economy works is known as Keynesian economics. A central tenet of Keynesian economics is that governments should not wait to intervene and should solve problems in the short run.

Keynes’ demand-side focus on the economy challenged the supply-side thinking of classical economists. As a result, the field of economics became divided with microeconomics studying markets and how well markets work and macroeconomics studying the broad economy, such as how an economy grows and how growth is maintained. Both classical and Keynesian perspectives are respected, plausible explanations of how the economy works.

terms to know

Keynesian Economics

A view of the economy that believes that during periods of economic instability it is the responsibility of the government to intervene replacing individual demand with government demand for products.

Macroeconomics

The study of the broad economy, such as how an economy grows and how growth is maintained.

1c. Complementary Perspectives

In truth, microeconomics and macroeconomics are not separate subjects but rather complementary perspectives on the overall subject of the economy.

did you know

The words micro and macro look similar, but their meanings are very different. Micro means small and macro means large. In economics, markets represent the small scale of the economy–the micro view–while the collection of markets represents the large scale of the economy as a whole, or the macro view.

To understand why both microeconomic and macroeconomic perspectives are useful, consider the example of studying a biological ecosystem like a lake. One person who sets out to study the lake might focus on specific topics: certain kinds of algae or plant life, the characteristics of particular fish or snails, or the trees surrounding the lake. Another person might take an overall view and instead consider the lake's ecosystem from top to bottom: what eats what, how the system stays in a rough balance, and what environmental stresses affect this balance. Both approaches are useful, and both examine the same lake, but the viewpoints are different. In a similar way, both microeconomics and macroeconomics study the same economy, but each has a different viewpoint.

Whether you are scrutinizing lakes or economics, the micro and the macro insights should blend with each other. In studying a lake, the micro insights about particular plants and animals help to understand the overall food chain, while the macro insights about the overall food chain help to explain the environment in which individual plants and animals live.

In economics, the micro decisions of individual businesses are influenced by whether the macroeconomy is healthy. For example, firms will be more likely to hire workers if the overall economy is growing. In turn, the macroeconomy's performance ultimately depends on the microeconomic decisions that individual households and businesses make.

Classical Economics	Keynesian Economics
The focus is on markets.	The focus is on the entire economy.
Believes that supply creates its own demand and because of that markets should be self-regulating.	Believes that demand affects how much supply producers provide and because of that the government should intervene as needed to stabilize the economy.
Presumes that markets are stable.	Presumes that markets are unstable.
The role of government is limited. Does not support government intervention in markets	The role of government is active. Supports government use of fiscal and monetary policy to stimulate demand and nurture economic stability.
Takes the long run view of economic ups and downs.	Takes the short run view of economic ups and downs.

terms to know

Micro

Small.

Macro

Large.

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2. Microeconomics

While studying microeconomics, you will learn about how buyers and sellers interact in the market and how markets sometimes fail to work properly. Microeconomics involves asking questions like the following:

Questions about buyers’ role in the market:

• What determines how individuals and households spend their income?
• What combination of goods and services will best fit people's needs and wants, given the income they have to spend?
• How do people decide how much to save for the future or whether they should borrow to spend beyond their current means?

Questions about the behavior of sellers in the market:

• What determines the products, and how many of each, a firm will produce and sell?
• What determines the prices a firm will charge?
• What determines how a firm will produce its products?
• What determines how many workers it will hire?
• How will a firm finance its business?
• When will a firm decide to expand, downsize, or even close
• How do people decide whether to work full time or part time?

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3. Macroeconomics

While studying macroeconomics, you will learn about what determines the employment and price levels in the economy and why the economy sometimes seems like a roller-coaster, going up and coming down. Macroeconomics involves asking questions like the following: Questions about the overall performance of the economy:

• What determines the level of economic activity in a society? In other words, what determines how many goods and services a nation actually produces?
• What determines how many jobs are available in an economy?
• What determines a nation’s standard of living?
• What causes the economy to speed up or slow down?
• What causes firms to hire more workers or to lay them off?
• What causes the economy to grow over the long term?

We can determine an economy's macroeconomic health by examining the policy goals of the government. The most important policy goals include:

• Maintaining as high a level of employment as feasible.
• Keeping the average price of all goods and services across the economy as stable as possible.
• Growing the economy to enable a rising standard of living for people.

You might ask yourself, how does the government plan and pursue achieving macroeconomic goals? The government attempts to achieve economic goals through monetary policy and fiscal policy. A nation's central bank conducts monetary policy, which involves policies that affect money and credit conditions to stabilize the economy. For the United States, the central bank is the Federal Reserve. A nation's executive and legislative bodies determine fiscal policy, which involves government spending and taxes. For the United States, this is the Congress and the Executive branch, which originates and agrees upon the federal budget.

Monetary policy and fiscal policy are the government's main tools to control and stabilize the economy. Americans tend to expect the government to fix whatever economic problems we encounter, but to what extent is that expectation realistic? These are just some of the issues that are explored in macroeconomics.

Congratulations you have now reached the end of the first challenge in microeconomics! We have covered a lot of ground. You have learned that an understanding that economics can add value to your life by helping you become a more well-rounded thinker, using a logical and objective approach to finding solutions to social problems. You are also now acquainted with the fundamental principles of the economic way of thinking. As you progress through this course, you will see further applications of these principles.

While this course covers the micro-side of the economy, there is another course that will develop your understanding of the macro-side of the economy. Both courses are needed to have a complete understanding of economics.

terms to know

Fiscal Policy

The use of government spending and taxing powers to stabilize the economy.

Monetary Policy

The use of money and credit to stabilize the economy.

REFERENCES

Adam Smith, 1723-1790. The History of Economic Thought. (n.d.). Retrieved April 19, 2022, from hetwebsite.net/het/profiles/smith.htm

John Maynard Keynes, 1883-1946. The History of Economic Thought. (n.d.). Retrieved April 19, 2022, from hetwebsite.net/het/profiles/keynes.htm

The First Economists. The History of Economic Thought. (n.d.). Retrieved May 25, 2022, from www.hetwebsite.net/het/schools/first.htm