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Microeconomics and Macroeconomics

Microeconomics and Macroeconomics

Hello there. Ready to do some learning? Today, we’re going to discuss a very interesting topic or, actually, two of them. Microeconomics and Macroeconomics are long, complicated words, but they’re really the building blocks of all modern economic theories and strategies. Don’t worry, we’re not going to overburden you with too many details, but we do intend to offer a quick explanation of what these two concepts are about.

Ready? We’re starting now.

What are microeconomics and macroeconomics?

What are microeconomics and macroeconomics?

While the purpose of economics is to analyze the production and consumption of finite resources, economics itself can be broken down into two categories: microeconomics and macroeconomics.
The difference between macroeconomics and microeconomics can be summarized as focusing on the details as opposed to focusing on the big picture as a whole.

A microeconomist will often look at individual companies and analyze how the cost of providing goods and services can be reduced. They will also consider factors like supply and demand, taxes and other expenses that companies must take into account in an effort to improve their bottom line.

A macroeconomist, on the other hand, will often analyze the economy from the statewide level. So while a microeconomist might be giving advice to a local company in Silicon Valley as to how they can boost productivity, a macroeconomist will look at the overall economy in the state of California (or the United States as a whole). Macroeconomists specialize in entire industries as well and will often track and analyze large scale economic data such as GDP, unemployment reports and interest rate decisions.

A fun sports analogy

A fun sports analogy

Let’s compare it to basketball. If you were to translate microeconomics into sports, you may only focus on a specific superstar player when watching an NBA basketball game. You study his strengths, his weaknesses and how he exploits opportunities to dunk over the defense with authority. You may take the player aside and explain what he can do to improve his performance.

If there was a ‘macroeconomist’ of sports, they would probably focus on the performance of the whole team. The player’s performance would be one aspect taken into consideration when reviewing their overall performance and what adjustments needs to be made in order for them to win a championship.

They’re not opposite, but not the same either

They’re not opposite, but not the same either

Although these two disciplines may seem to be polar opposites, they are actually quite interdependent of one another. For example, inflation, which is a macro effect, could cause the cost of everyday household items to rise (a micro effect). That’s why microeconomists need to be aware of macroeconomic indicators in order to better make recommendations and vice versa.

In short, microeconomics works from the bottom-up trying to better understand the choices people make that can improve an organization’s bottom line. Macroeconomics, on the other hand, have a more top-down approach whereby they will often discuss how a general matter has affected a specific asset. For example: how an increase or decrease in interest rates will affect society, or if an import tariff on foreign goods stimulates domestic growth, etc.

A few quick examples

Need a few examples? We figured you would. Here are several examples of hypothetical situations whereby microeconomics and macroeconomics overlap in the real world.

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Example one Suppose the Canadian government decided that all workers should be earning more money and enjoying a higher standard of living. The government goes ahead and enforces a policy to raise the minimum wage to $15 per hour. That’s an example of macroeconomics in action. But once this wage hike takes effect, Canadian business owners realize that they are unable to afford the new salary increase and so they decide to either lay off some of their employees or reduce their hours while demanding higher productivity to make it worth their while to stay open. The resulting effect would be an example of microeconomics.

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Example two If the US government decides to increase the corporate tax (macroeconomics), a corporation like Apple may find it more cost-effective to move their operations overseas to a country like Ireland (microeconomics). The loss of American jobs from this development can lead to higher unemployment, something the US government would have to contend with (bringing the saga back to macroeconomics).

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Example three (last one!) Another theoretical example can be if the Central Bank of Australia wants to stimulate growth in the Australian economy. It decides to lower interest rates by 3% (macroeconomics). This encourages businesses to open up across the continent as the cost to borrow money from the banks just got cheaper. This can also allow a business to either increase its workforce or reallocate the money they saved on interest into buying a new plant machine, office equipment or more rental space to boost productivity (microeconomics).

Academically speaking

Academically speaking

When it comes to the discipline of economics as a whole, many people assume that microeconomics and macroeconomics are two equally-weighted fields. This perception is formed by the curriculum taught to most undergraduates studying economics. But the truth is that macroeconomics is a very specific discipline while everything else is essentially microeconomics. This includes industries like healthcare, environmental regulations, trade, education and many others. That’s because individual decisions are all micro while the aggregate of those decisions are macro.

For example, if an economist studies the effects of healthcare, they may take into account the individual decisions of an employee getting health insurance or if a program like Obamacare will hurt or help their economic status. If that same economist looks at those same decisions, but from the perspective of an entire population, we would have a classic example of macroeconomics and how one affects the other.

Macroeconomics is becoming increasingly important due to the fallout from the financial crisis of 2007. Why? Because when the economy is doing well, people tend to care less about things on a macro scale. However, when the stock market crashes or - in America’s case - the sub-prime mortgage market crashes, more people begin to worry about how government and central bank decisions will help the economy recover. For example, when the Fed lowered interest rates to help the US economy recover from the bursting of the sub-prime mortgage bubble, American companies who ran export based businesses found themselves at a loss.

That’s because the value of US dollars against foreign currencies dropped. That also explains why many traders pay close attention to macroeconomic events and their resulting policies.

Role of central banks

Role of central banks

Although macroeconomics is a far more specific discipline than microeconomics, it often receives greater attention from the stock market. It’s not too difficult to assess why. Macro decisions will often affect the overall economy as a whole. This will usually help certain industries succeed while others suffer.

Rate hikes are one example. If the Fed changes interest rates, US banks will lend money at the overnight rate. A lowered interest rate could potentially be good for bank stocks like Citi, JPMorgan Chase and Goldman Sachs, since lower interest rates can encourage investment, bringing more investors to the bank. It can also be bad for more boutique banks, since they may not be able to handle a large volume of customers and could therefore make less money on future interest once those same rates are reduced.

Lower interest rates can help the construction industry and stocks like Caterpillar. If the cost of borrowing money is now cheaper, more people might want to take out mortgages and build homes. If more people build homes, they will need heavy machinery for the construction of those homes. And if a contractor needs more heavy machinery for construction, they might start buying tractors, bulldozers and parts from companies who sell them, like Caterpillar. This is one reason why some stock brokers will recommend buying shares of a company like Caterpillar if interest rates are reduced. That is just one example of how a macroeconomic development can affect a microeconomic decision to trade.

From a macro perspective, if the Fed decides to sell off bonds at a low price, it could encourage foreign and domestic investors to buy them. If this happens, the US government will have more money to spend in the short run. So, if President Trump has been talking about building the wall on the Mexican border and suddenly has extra cash received as bonds, some share traders might decide to invest in the company that’s positioned to build the wall or supply the cement to build the wall itself (assuming it’s a publicly-traded company). That’s because the money they’d hypothetically get for the contract will likely boost their overall valuation.

Macroeconomists will often focus on economic factors such as change reserve requirements, quantitative easing, buying bonds and mortgage backed securities.

A word of warning regarding theories

A word of warning regarding theories

Macroeconomics and microeconomics can sound very persuasive. They include long words and sound like they have all the answers. However, please try and remember that these are branches of economics that focus on specific factors and employ specific theories. Did you see that last word? Theories. Macroeconomics and microeconomics can be valuable to traders in the sense that they offer a specific way to look at market changes and opportunities, but they don’t give you decisive answers – at the very best they can only offer possible indications.

Conclusion

Conclusion

To summarize, macroeconomics is a top-down approach to analyzing the economy as a whole. And while it may seem to be a more ‘inclusive’ approach to economics, it’s actually a more focused study as a whole. Meanwhile, microeconomics is the study of smaller, more specific sectors that are directly or indirectly affected by the macro. Although the two disciplines are different in nature, they do rely on each other as there is a direct correlation between them.

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