Economics is also divided into macroeconomics and microeconomics. (Micro and macro derive from Greek words for “large” and “small,” respectively.) Macroeconomics (the big picture) involves study of the entire society— sums of sets of micro variables (e.g., numbers of workers employed by various firms) yield aggregate (macro) variables (e.g., national employment). Microeconomics focuses on the detailed behavior of specific households, firms, or industries. By analogy, microeconomic tools are microscopes, while macroeconomic tools are telescopes.
Modern macroeconomics increasingly relies on foundations from microeconomics. Thus, microeconomics addresses interactions among households, firms, and government agencies in much finer detail than macro.
Microeconomics is the study of individual decision making, resource allocation, and how relative prices, outputs, and the distribution of income are determined.
Three major goals dominate micro policy:
Efficiency. An inefficient economy wastes resources and fails to provide the highest possible standard of living for consumers.
Equity. Huge gaps between the “haves” and “have-nots” may leave most people impoverished while a privileged few live luxuriously.
Freedom. Maximum freedom requires people to have a wide range of choices available.
As with equity, however, more freedom for some may leave less for others. Freedom for muggers to practice their professions, for example, imposes high costs and reduces freedom for the rest of us. Thus, society limits the freedom of thugs by putting them in jail at times. Efficiency is a generally accepted normative goal, but equity and freedom hinge on more controversial value judgments.
All goals involve trade-offs. For example, efficient policies may be seen as inequitable. Granting patents for an AIDS vaccine might be efficient if potential profits stimulated successful research, but it might seem unfair not to immunize all those unable to afford the vaccine after its discovery. Alternatively, freedom and efficiency conflict if, for example, one person exercises freedom to declare bankruptcy, hindering another's production—the ability to make loans.
Such trade-offs are among reasons why legal systems are implemented to govern people's relationships. Acceptably balancing freedom, efficiency, and equity is among society's major challenges. Unfortunately, equity is almost always a bit nebulous and subject to widely different normative interpretations. Efficiency is the micro goal most susceptible to economic reasoning.
Our ability to achieve macro goals depends on micro policy, and vice versa. For example, excessive unemployment is a macro symptom of micro inefficiency—output is lost when resources are idle. Similarly, inefficient regulations may both squelch production in key industries at the micro level, and inhibit growth at the macro level. Efficiency facilitates achieving all other goals. Inefficiency wastes resources that could be used to enhance stability, growth, freedom, and equity.
Most early economists stressed microeconomics, believing that macro merely entailed summing micro variables and tacking on changes in the money supply to account for inflation. Inadequate analysis of macro phenomena may have contributed to boom-bust cycles that culminated in the world-wide Great Depression of the 1930s. That slump forced us to realize that one decisionmaker’s acts may yield far different results than if all decisionmakers act simultaneously. For example, one person in the bleachers may see a ball game better by standing up, but when others also stand (as they will) this advantage is lost. It is now clear that reaching our micro goals depends on achieving our macro goals, and vice versa. Understanding both is essential for understanding how any economy operates.
You will repeatedly encounter the building blocks from this chapter when we investigate more advanced topics later in this book. If graphs make you at all queasy, you should study the optional material at the end of this chapter before you move on to Chapter 2. In Chapter 2, we explore comparative advantage, a concept that uses opportunity costs to help explain why different people and countries specialize in some types of production and exchange their outputs for goods produced by others. We also develop graphical devices called production possibilities frontiers to illustrate how scarcity limits our available choices, and examine some mechanisms people use in trying to cope with scarcity.