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Micro and Macro: The Economic Divide

Economics is split between analysis of how the overall economy works and how single markets functioA

Physicists look at the big world of planets, stars, galaxies, and gravity. But they also study the minute world of atoms and the tiny particles that comprise those atoms.

Economists also look at two realms. There is big-picture macroeconomics, which is concerned with how the overall economy works. It studies such things as employment, gross domestic product, and inflation—the stuff of news stories and government policy debates. Little-picture microeconomics is concerned with how supply and demand interact in individual markets for goods and services.

In macroeconomics, the subject is typically a nation—how all markets interact to generate big phenomena that economists call aggregate variables. In the realm of microeconomics, the object of analysis is a single market—for example, whether price rises in the automobile or oil industries are driven by supply or demandchanges. The government is a major object of analysis in macroeconomics—for example, studying the role it plays in contributing to overall economic growth or fighting inflation. Macroeconomics often extends to the international sphere because domestic markets are linked to foreign markets through trade, investment, and capital flows. But microeconomics can have an international component as well. Single markets often are not confined to single countries; the global market for petroleum is an obvious example.

The macro/micro split is institutionalized in economics, from beginning courses in “principles of economics” through to postgraduate studies. Economists commonly consider themselves microeconomists or macroeconomists. The American Economic Association recently introduced several new academic journals. One is called Microeconomics. Another, appropriately, is titled Macroeconomics.

Why the divide?

It was not always this way. In fact, from the late 18th century until the Great Depression of the 1930s, economics was economics—the study of how human societies organize the production, distribution, and consumption of goods and services. The field began with the observations of the earliest economists, such as Adam Smith, the Scottish philosopher popularly credited with being the father of economics—although scholars were making economic observations long before Smith authored The Wealth of Nations in 1776. Smith’s notion of an invisible hand that guides someone seeking to maximize his or her own well-being to provide the best overall result for society as a whole is one of the most compelling notions in the social sciences. Smith and other early economic thinkers such as David Hume gave birth to the field at the onset of the Industrial Revolution.

Economic theory developed considerably between the appearance of Smith’s The Wealth of Nations and the Great Depression, but there was no separation into microeconomics and macroeconomics. Economists implicitly assumed that either markets were in equilibrium—such that prices would adjust to equalize supply and demand—or that in the event of a transient shock, such as a financial crisis or a famine, markets would quickly return to equilibrium. In other words, economists believed that the study of individual markets would adequately explain the behavior of what we now call aggregate variables, such as unemployment and output.