Macro & Micro economics
It is customary to divide the main body of economic analysis into two components: macroeconomics and microeconomics. In a nutshell, macroeconomics deals with the aggregate (country wide) level of the economy – aggregate output (real GDP) and income – total employment, level of unemployment or the average price level of all goods and services. Microeconomics is concerned with the behavior of single consumers, the individual producer or firm, the individual industry or the sectoral composition of the national output. This column and the next one will explore the transition from macro to micro.
In its first eight months, August 2015 through March 2016, this column dealt with fiscal and monetary policy. Together, they are known as macroeconomic policy measures because they are designed to affect the entire economy. That does not mean that all sectors of the economy are equally affected because not all sectors are equally sensitive to these policies. For example, the housing sector is ultra-sensitive to interest rate variations, so it would be first affected by monetary policy. But the policies themselves are aimed at the aggregate economy: stimulating it in times of recession and slowing it down in times of inflation.
For the purpose of recollection, monetary policy is concerned with the quantity of money and interest rates. It is conducted by the central bank which, in the U.S., is the Federal Reserve System; and fiscal policy is conducted by the congress. Similar arrangements exist in other countries. In the euro-zone of the European continent, the European Central Bank (ECB) conduct monetary policy for the entire 19-country zone, while each country’s parliament conducts fiscal policy for its own country. Similarly in the U.K., (which in 2016 exited the EU) it is the Bank of England and the British parliament respectively. In Japan, it is the Bank of Japan and the Japanese parliament, respectively.
There are 30 advanced industrial countries, including the U.S., Canada, Europe, Australia, South Korea and Israel, which form an organization known as the Organization of Economic Cooperation and Development (OECD), headquartered in Paris and sometimes dubbed, “the rich man club.” In the fall of 2016, the U.S. economy is doing well in terms of aggregate output and employment, while Europe and Japan suffer from high unemployment and very low inflation. Interest rates hover around zero in all these countries because of expansionary monetary policy conducted in 2008 to combat the last “great recession.” The question is sometimes raised; what if another recession occurs (as some observers expect)? How can it be combatted given 2016 circumstances? Here are some ways:
Near zero interest rates, even for long term loans, which means:
- Nearly exhausted monetary policy tools
- Ability to borrow very cheaply even for the long run
- Crying needs for infrastructural construction, such as roads, airports, hospitals etc., especially in the U.S.
Under these conditions, all that remains is fiscal policy. The federal government can borrow (float long term bonds) at very low interest rate, thereby locking this debt for, say, 30 years at low rates. That money can be distributed to the states for infrastructure spending. In the U.S. it may amount to, say, $500 billion, and similarly in other countries. That can jar the global economy out of current or future doldrums. In the U.S. it would increase the national debt from 18 to 18.5 trillion dollars, but this would remain reasonable as a percent of GDP. Varying conditions exist in other countries, but such fiscal spending is more urgently needed than concern over the debt.
Microeconomics: The Consumer
By contrast, microeconomics concerns itself with the economics of the individual consumer, business or industry. But that definition requires elaboration. The individual consumer selects a bundle of goods and services to consume, subject to a budget constraint, so as to maximize his/her satisfaction (which economists call “utility”). Why does it follow that the consumer would purchase a bundle of goods and services? If a refrigerator yields more satisfaction than a washing machine, why not proceed to buy only refrigerators? Because while the first refrigerator yields more satisfaction than the first washing machine, it does not follow that the second refrigerator would yield more satisfaction than the first washing machine. Indeed, the more unit of a product a consumer has, the less the added satisfaction from an extra unit.
Suppose we could measure satisfaction in units called “utils,” and take a product called a car. The first car may yield 1000 utils, but the second car (once the consumer owns one car) might yield only 600 utils, for a total of 1600 utils, while the third car may yield no additional satisfaction, as it may only cause accidents in the driveway. The numbers are not important, only the principle is a matter of common sense: The more units one has of a product, the less the additional satisfaction derived from an extra unit. Total satisfaction might still rise as the number of units rises, but at a declining rate. This principle applies to all products, and it explains why the average would must buy a bundle of goods and services to maximize his/her satisfaction.