Microeconomics and macroeconomics. To help understand how microeconomics affects everyday life, let’s study the process of renting an apartment. In a city like New York, there is a limited. Microeconomics and macroeconomics are two different perspectives on the economy. The microeconomic perspective focuses on parts of the economy: individuals, firms, and industries. The macroeconomic perspective looks at the economy as a whole, focusing on goals like growth in the standard of living, unemployment, and inflation.
- Microeconomics And Macroeconomics Examples
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- Real World Example Of Microeconomics
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- Definition Of Microeconomics And Macroeconomics With Examples
Microeconomics is the study of how individuals and businesses make choices on how to best use limited resources. The field interests investors as individual consumer spending accounts for about two-thirds of the U.S. economy. Microeconomics and macroeconomics (the study of the larger aggregate economy) together make up the two main branches of economics.
So how do the principles of microeconomics affect everyday life? Most people have a limited amount of time and money. They cannot buy or do everything they want, so they make calculated microeconomic decisions on how to use limited resources to maximize personal satisfaction. Similarly, a business also has limited time and money. Businesses also make decisions that result in the best outcome for the business which may be to maximize profit.
Microeconomics Principles
Microeconomics uses certain principles to explain how individuals and businesses make decisions. One of the basic principles of microeconomics is that individuals make decisions to maximize their satisfaction. In microeconomics, this is called maximizing utility.
Another economic principle that comes into play as consumers make decisions is an opportunity cost. When an individual makes a decision, she also calculates the cost of forgoing the next best alternative. For instance, if you use your frequent flier miles to take a trip to the Bahamas, you will no longer be able to redeem the miles for cash. The missed cash is an opportunity cost.
Diminishing marginal utility, another economic input, describes the general consumer experience that the more you consume of something, the lower the satisfaction you get. For instance, when you eat one burger you may feel very satisfied. But if you eat a second burger, you may feel a lesser amount of satisfaction than with the first burger.
Two other important economic principles are supply and demand. Market supply refers to the total amount of a certain good or service available on the market to consumers, while market demand refers to the total demand for the good or service. The interplay of supply and demand helps determine prices for a product or service, with higher demand and limited supply typically making for higher prices.
Renting an Apartment
To help understand how microeconomics affects everyday life, let’s study the process of renting an apartment. In a city like New York, there is a limited supply of housing and high demand. Going by the principles of microeconomics, that’s why housing costs in New York are high.
To rent an apartment, first, you must determine a budget. For this, you will have to take into account your income and how much money you are looking to spend on housing, in such a way as to maximize your utility or satisfaction. If you allocate too much of your income to rent, you will not have a lot of money left for other expenses. Thus, you will have to decide what is the most amount of money you are willing to part with, what amenities you must have in your apartment and acceptable neighborhoods. It’s about maximizing utility.
Based on all the above factors, you set a budget to get the most satisfaction for the least possible rent. You will not pay more than you have to in order to get what you want. Considering that in this supply-constrained market there are others also interested in renting the apartments that are more in demand, you might find that you will have to increase your budget. To do this, you will have to cut down on spending in another area, like entertainment, travel, or eating out. That is the opportunity cost of finding the right apartment.
Similarly, a landlord will seek to rent an apartment at the highest price possible, since her motivation generally is to get the best return by renting out the apartment. In setting the rent, she would have to take into account the demand for the apartment and the neighborhood. If there are enough potential renters interested in the apartment, she would set a higher rent. If she were to set the rent too high, compared to what other landlords in the neighborhood are charging for comparable apartments, she would find that renters are not interested. The business owner, in this case, the landlord, also makes decisions based on supply and demand.
And while she would attract a larger pool of prospective renters by setting a rent that is lower than what other neighborhood landlords are charging for comparable apartments, she would be missing out on some rental income which will not maximize her utility. Thus, both you and the landlord will make decisions to get the best outcome for yourselves given the constraints you face.
Bottom Line
In a capitalist economy, both consumers and businesses make thousands of big and small decisions each year guided by the principles of microeconomics. Consumers seek to maximize their satisfaction when they go out and shop for anything from paper towels to apartments, houses, and cars. Businesses set prices and make other decisions based on microeconomics. The prices that consumers will pay depends on the supply of a good, as well as how much others are willing to pay for it.
Microeconomics vs. Macroeconomics: An Overview
Economics is divided into two different categories: microeconomics and macroeconomics. Microeconomics is the study of individuals and business decisions, while macroeconomics looks at the decisions of countries and governments.
While these two branches of economics appear to be different, they are actually interdependent and complement one another since there are many overlapping issues between the two fields.
Microeconomics
Microeconomics is the study of decisions made by people and businesses regarding the allocation of resources and prices of goods and services. It also takes into account taxes and regulations created by governments.
Microeconomics focuses on supply and demand and other forces that determine the price levels in the economy. It takes what is referred to as a bottom-up approach to analyzing the economy. In other words, microeconomics tries to understand human choices and resource allocation.
Having said that, microeconomics does not try to answer or explain what forces should take place in a market. Rather, it tries to explain what happens when there are changes in certain conditions.
For example, microeconomics examines how a company could maximize its production and capacity so that it could lower prices and better compete in its industry. A lot of microeconomic information can be gleaned from the financial statements.
Microeconomics involves several key principles including (but not limited to):
- Demand, Supply, and Equilibrium: Prices are determined by the theory of supply and demand. Under this theory, suppliers offer the same price demanded by consumers in a perfectly competitive market. This creates economic equilibrium.
- Production Theory: This is the study of production.
- Costs of Production: According to this theory, the price of goods or services is determined by the cost of the resources used during production.
- Labor Economics: This principle looks at workers and employers, and tries to understand the pattern of wages, employment, and income.
The rules in microeconomics flow from a set of compatible laws and theorems, rather than beginning with empirical study.
Microeconomics Vs. Macroeconomics
Macroeconomics
Macroeconomics, on the other hand, studies the behavior of a country and how its policies affect the economy as a whole. It analyzes entire industries and economies, rather than individuals or specific companies, which is why it's a top-down approach. It tries to answer questions like 'What should the rate of inflation be?' or 'What stimulates economic growth?'
Macroeconomics examines economy-wide phenomena such as gross domestic product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, and price levels.
Macroeconomics analyzes how an increase or decrease in net exports affects a nation's capital account, or how GDP would be affected by the unemployment rate.
Macroeconomics focuses on aggregates and econometric correlations, which is why it is used by governments and their agencies to construct economic and fiscal policy. Investors of mutual funds or interest rate-sensitive securities should keep an eye on monetary and fiscal policy. Outside of a few meaningful and measurable impacts, macroeconomics doesn't offer much for specific investments.
John Maynard Keynes is often credited as the founder of macroeconomics, as he initiated the use of monetary aggregates to study broad phenomena. Some economists dispute his theory, while many of those who use it disagree on how to interpret it.
Microeconomics And Macroeconomics Examples
Investors and Microeconomics vs. Macroeconomics
Microeconomics And Macroeconomics Examples For Students
Individual investors may be better off focusing on microeconomics than macroeconomics. There may be some disagreement between fundamental (particularly value) and technical investors about the proper role of economic analysis, but it is more likely that microeconomics will affect an individual investment proposal.
Real World Example Of Microeconomics
Warren Buffettfamously stated that macroeconomic forecasts don't influence his investing decisions. When asked about how he and business partner Charlie Munger choose investments, Buffett responded, 'Charlie and I don't pay attention to macro forecasts. We've worked together for 50+ years, and I can't think of a time when they influenced a decision about stock or a company.' Buffett also referred to macroeconomic literature as 'the funny papers.'
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John Templeton, another famously successful value investor who died in 2008 at the age of 95, shared a similar sentiment. 'I never ask if the market is going to go up or down because I don't know. It doesn't matter. I search nation after nation for stocks, asking: 'where is the one that is lowest priced in relation to what I believe it's worth?' said Templeton.
Key Takeaways
Definition Of Microeconomics And Macroeconomics With Examples
- Microeconomics studies individuals and business decisions, while macroeconomics analyzes the decisions made by countries and governments.
- Microeconomics focuses on supply and demand, and other forces that determine price levels, making it a bottom-up approach.
- Macroeconomics takes a top-down approach and looks at the economy as a whole, trying to determine what the economy should look like.
- Investors can use microeconomics in their investment decisions, while macroeconomics is an analytical tool mainly used to craft economic and fiscal policy.