Wednesday, 18 March 2009

Micro v. macro

Don Boudreaux over at Cafe Hayek blogs on the distinction between "microeconomics" and "macroeconomics." The distinction he makes he says is due to the Swedish economist Erik Lindahl, who spells it out in his book Studies in the Theory of Money and Capital. Boudreaux writes
The distinction, as I understand it, is this:

Microeconomics focuses on the actions of individuals; it examines how individuals respond to incentives, as well as studies the various incentives that individuals in different circumstances confront. Gary Becker is a living example of a premier microeconomist.

Macroeconomics involves tracing out the unintended consequences of various actions and sets of individual actions. It studies the logic of the spontaneous, unintended order (or disorder, as the case may be) that emerges when each of many individuals respond to the incentives identified and classified by microeconomics. On this definition, Hayek is certainly one of history's greatest macroeconomists.

So a typical microeconomic insight, for example, is the recognition that a price cap on gasoline reduces suppliers' incentives to supply and increases the quantities buyers' seek to purchase. A (confessedly simple) macroeconomic insight is the recognition that an unintended consequence of the price cap will be queues at gasoline stations and black-market dealings in gasoline.

A more elaborate macroeconomic insight is Carl Menger's explanation of how money was not the creation of a conscious mind but, instead, evolved into use.
Boudreaux goes on to add
Both "micro" and "macro" are important -- and understanding people accurately at the "micro" level is useful for doing good work at the "macro" level.
I agree with this last statement. I would also agree that micro is about what incentives people face and how individuals respond to these incentives. As Steven E. Landsburg has famous put it,
Most of economics can be summarized in four words: People respond to incentives. The rest is commentary.
I'm guessing that it is the view of macroeconomics that will be the controversial part of the above quote. But I think I agree with that as well. Any other views?

1 comment:

Richard Ebeling said...

It is unfortunate that the term "macroeconomics" came to be identified with changes in economy-wide and measurable magnitudes: total output, total employment, the general price or wage level.

Because the distinction that Don's comment highlights is more reasonable. All social and economic phenomena arise out of the actions of individuals, since they are the ultimate and elementary "components" of social processes.

The starting point of social and economic analysis, therefore, logically begins with understanding the individual and the "logic of choice and action" that guide his conduct. Thus, "Crusoe" economics is not the "unrealistic" or "irrelevant" exploration that some have claimed over the last two hundred years.

But, now, having grasped the logic and implications of the individual's choices and actions under conditions of various scarcities, constraints and trade-offs, the next step is to analysis the results and outcomes when more than one individual exists, and they interact.

Thus, the arrival of "Friday" introduces a totally new dimension to the study.

It is perhaps of note that when Carl Menger, one of the "fathers" of marginalist analysis aa well as of the Austrian School, moved his investigation to this next level, he spoke of the interactions between the "economies" of men.

That is, each individual is an "economy," i.e., a chooser of ends, an applier and allocator of means, a coordinator of his individual plans to assure an "equilibrium" among his actions and activities according to his overall personal "central plan."

What happens when these individual economies and "central plans" meet in an emergent social arena that arises when individuals "discover" each others presence, and then communicate, interact, associate and possibly trade?

It is not surprising, given this way of approaching the origin and emergence of a "social arena," that Menger also gave special attention to the resulting "spontaneous order" and the many institutions that are the "unintended" outcomes from these interactions -- language, customs, traditions, law, property rights, market rules of association, contract, etc.

This, then, is the "macroeconomic" arena: the origin, development, and evolution of the "social order" in which individual planners and their plans interact, but where there is no overarching plan above the individual plans.

The "macroeconomic" "research program" then becomes an investigation of what arises from all this, and how? Certainly, this is how Menger saw the nature and purpose of social and interpersonal economic theory.

In such a perspective, the "microeconomic" focus is on the individual's plans and their "equilibrium" and equilibrating sequence as the individual is confronted with various types of "change."

The "macroeconomic" focus is on any emerging "coordination" among these individual plans, and what forms that coordination takes on: types of markets, institutions and their associative rules and procedures, etc.

And, of course, if such macro-coordination can be demonstrated, what may bring about "discoordination" and what follows from this, including the processes by which individuals attempt to respond and reestablish interpersonal coordination, including the actions and sequence of events that this recoordinating attempt may take on.

In this approach there is a clear meaning to the idea of "micro-foundations" to macro-phenomena. And the macro phenomena is traceable to micro actions and responses.

Richard Ebeling