Microeconomics and macroeconomics | IGCSE Class 10 Economics Notes

This note covers microeconomics and macroeconomics: what each branch of economics studies, how they differ in their level of analysis, the decision makers involved in each, and how the two branches relate to one another.

What is microeconomics?

Microeconomics is the branch of economics that studies the behaviour of individual economic agents, such as a single consumer, a single household or a single firm, in the markets for particular goods and services.

It looks at how prices and quantities of individual goods and services are determined through the interaction of buyers and sellers in a single market, for example the market for corn or the market for cotton.

Definition: Microeconomics. The study of the behaviour of individual economic agents in the markets for different goods and services, and how prices and quantities are determined through the interaction of individuals in those markets.

Because microeconomics looks closely at one market, one firm or one household at a time, it is sometimes described as a "bottom up" view of the economy.

A microeconomic question asks about one specific part of the economy: why did the price of a particular good rise, or why did one firm decide to produce more or less this year.

What is macroeconomics?

Macroeconomics studies the economy as a whole rather than any single market. Instead of focusing on the price of one good, macroeconomics looks at aggregate measures such as total output, total employment and the aggregate price level for the whole economy, and tries to understand how these aggregate measures are determined and how they change over time.

Definition: Macroeconomics. The study of the economy as a whole, focusing on aggregate measures such as total output, employment and the aggregate price level, and on how these change over time.

Typical macroeconomic questions include: what is the level of total output in the economy, how does total output grow over time, are the resources of the economy such as labour fully employed, what are the reasons behind the unemployment of resources, and why do prices rise.

These questions are about the economy as a single system, not about any one market.

How do microeconomics and macroeconomics differ?

The central difference between the two branches is the level at which each one studies the economy. Microeconomics studies individual markets, individual households and individual firms.

Macroeconomics studies aggregate variables that summarise the whole economy, such as total output, total employment and the general price level, rather than the output, employment or price of any one good.

Both branches rely on the same underlying idea of scarce resources having to be allocated between competing uses, but microeconomics asks how this allocation happens within a single market, while macroeconomics asks how the allocation decisions of millions of individual markets add up to determine the performance of the economy as a whole.

Who are the decision makers in microeconomics?

Microeconomics is built around the decisions of individual economic agents. The two main types of decision maker studied are the household, which decides how much of each good or service to buy given its income and the prices it faces, and the firm, which decides how much of a good or service to produce and what price to charge or accept.

Workers are also microeconomic decision makers, deciding whether to work, which job to take and how many hours of labour to offer, and groups of workers may act together through a trade union to bargain over pay and working conditions.

A family farm deciding how much corn to grow, a weaver deciding how much cloth to produce, or a single consumer deciding how to spend a limited budget are all microeconomic decision makers.

These agents interact with one another through the market for a particular good, which is the set of arrangements that allows buyers and sellers to exchange that good freely, whether or not they meet in a physical place.

Microeconomics studies how the choices of many individual households and firms in a single market lead to a price and a quantity for that good.

Who are the decision makers in macroeconomics?

Macroeconomics is concerned with decision makers whose choices affect the economy as a whole rather than a single market.

The principal such decision makers are the government, which can influence total output, employment and prices through its taxation, spending and borrowing decisions, and the central bank, which influences borrowing and spending in the whole economy through its decisions on interest rates and the supply of money.

Governments use fiscal policy, meaning decisions about government spending and taxation, and central banks use monetary policy, meaning decisions about interest rates and the money supply, to try to influence macroeconomic outcomes such as inflation, a sustained rise in the general price level, unemployment, and the rate of economic growth, the rate at which total output increases over time.

Unlike the decision makers of microeconomics, who each decide about one good or service, these authorities aim their decisions at the economy as a whole, trying to influence total output, employment and the general price level for the economy taken together.

The extent to which government takes on this role varies between economies.

How are microeconomics and macroeconomics related?

Although microeconomics and macroeconomics study the economy at different levels, they are closely connected. The aggregate output of the whole economy that macroeconomics studies is, in the end, the sum of the output decisions made by individual firms in individual markets, which is the subject matter of microeconomics.

Equally, a macroeconomic change, such as a rise in the general price level or a government decision to raise taxes, affects the decisions that individual households and firms make in their own markets.

For this reason, many economists see the two branches as two different lenses for looking at the same economy: microeconomics zooms in on one market or one decision maker at a time, while macroeconomics stands back and looks at how all those markets and decision makers together determine the performance of the economy as a whole.

Going beyond the syllabus

These ideas extend the unit and are not needed for the questions on it.

What are the central problems every economy must solve?

Every economy, whatever the balance between microeconomic and macroeconomic decision making, ultimately has to decide what is produced, how it is produced and for whom it is produced, because its scarce resources are limited in comparison with what people collectively want.

How do market, planned and mixed economies differ?

In a market economy, these decisions are left largely to the free interaction of individual households and firms, the subject matter of microeconomics, with prices coordinating the choices of millions of separate buyers and sellers. In a centrally planned economy, by contrast, a central authority such as the government makes the main decisions on production and distribution for the economy as a whole, which is closer to a macroeconomic view of the system.

In practice, most economies are mixed economies, combining market-based microeconomic decision making with government and central bank macroeconomic management of total output, employment and prices. This blend of approaches shows why the microeconomic and macroeconomic branches of economics are best seen as complementary rather than separate: even in an economy with a strong government role, individual households and firms, the subject of microeconomics, still make the day-to-day production and consumption decisions that, added together, determine the aggregate outcomes that macroeconomics studies.

Glossary

• Microeconomics: the study of individual economic agents, such as a household or a firm, and how prices and quantities are determined in individual markets.
• Macroeconomics: the study of the economy as a whole through aggregate measures such as total output, employment and the price level.
• Economic agent: an individual decision-making unit, such as a person, household or firm, that makes economic choices.
• Household: a decision-making unit, usually a family, that buys goods and services and may also supply resources such as labour.
• Firm: a decision-making unit that produces goods or services for sale, deciding how much to produce and at what price.
• Market: a set of arrangements that allows buyers and sellers of a good or service to exchange freely, whether or not they meet in person.
• Aggregate output: the total quantity of goods and services produced by an economy over a period of time.
• Aggregate price level: the general level of prices across the whole economy, rather than the price of any single good.
• Employment: the use of available resources, particularly labour, in productive activity.
• Unemployment: a situation in which resources, particularly labour, that are available and willing to work are not being used in production.
• Inflation: a sustained rise in the general price level of an economy over time.
• Economic growth: an increase in the total output of an economy over time.
• Government: the central authority of a country, which can make decisions affecting the whole economy, such as taxation and spending.
• Central bank: the national authority responsible for decisions on interest rates and the money supply in an economy.
• Fiscal policy: government decisions about spending and taxation used to influence the economy as a whole.

Common errors and misconceptions

• Misconception: Microeconomics only deals with small countries and macroeconomics with large ones. Correct: the distinction is about the level of study, individual markets versus the whole economy, not the size of the country.
• Misconception: A question about one firm's price can never be relevant to macroeconomics. Correct: individual firms' decisions add up to determine aggregate output, so microeconomic behaviour underlies macroeconomic outcomes.
• Misconception: Only the government is a decision maker in economics. Correct: households and firms are the key decision makers in microeconomics; government and the central bank are the key decision makers studied in macroeconomics.
• Misconception: Inflation and unemployment are microeconomic topics because they affect individual people. Correct: inflation and unemployment are measured and studied as aggregate, economy-wide variables, so they belong to macroeconomics.
• Misconception: Microeconomics and macroeconomics are unrelated subjects. Correct: aggregate macroeconomic variables are built up from the microeconomic decisions of individual households and firms.
• Misconception: The price of a single good, such as cotton, is a macroeconomic matter because prices affect everyone. Correct: the price of one specific good is determined in its own market and is studied in microeconomics; the general price level for all goods is the macroeconomic concept.

Exam-style questions with model answers

Q1. Define 'microeconomics'. [2 marks]

1. Microeconomics is the study of the behaviour of individual economic agents.
2. It examines how prices and quantities of particular goods and services are determined through the interaction of buyers and sellers in individual markets.

Q2. Identify two decision makers studied in microeconomics. [2 marks]

1. Households, which decide how much of each good or service to buy given their income and the prices they face.
2. Firms, which decide how much of a good or service to produce and what price to charge or accept.

Q3. Identify two decision makers studied in macroeconomics. [2 marks]

1. The government, through its decisions on taxation, spending and borrowing.
2. The central bank, through its decisions on interest rates and the money supply.

Q4. Explain two ways in which microeconomics and macroeconomics differ. [4 marks]

1. They differ in the level of study: microeconomics studies individual economic agents such as a single household, firm or market, while macroeconomics studies the economy as a whole.
2. They differ in the variables examined: microeconomics looks at the price and quantity of one good or service, while macroeconomics looks at aggregate measures such as total output, employment and the aggregate price level.
3. They differ in the decision makers studied: households and firms are the main decision makers in microeconomics, while government and the central bank are the main decision makers in macroeconomics.
4. They differ in the questions asked: a microeconomic question is why the price of cotton rose, while a macroeconomic question is why unemployment in the whole economy increased.

Q5. Explain why a rise in the general price level is studied in macroeconomics rather than microeconomics. [4 marks]

1. A rise in the general price level, or inflation, affects the prices of goods and services across the whole economy at once, not just one market.
2. It is therefore an aggregate measure rather than the price of a single good determined in its own market.
3. Studying inflation requires looking at how total spending and total output in the economy interact, which is the subject matter of macroeconomics.
4. Microeconomics, by contrast, looks only at the price and quantity of one good determined in its own market.

Q6. Analyse how the decisions of individual firms are linked to the aggregate output of the whole economy. [6 marks]

1. Each individual firm decides how much of its good or service to produce, which is a microeconomic decision made in its own market.
2. The firm responds to the price it can get and the costs it faces in that market.
3. The aggregate output of the economy is the sum of the output decisions made by all individual firms in all markets.
4. When many firms increase their output at the same time, the combined effect shows up as a rise in the economy's total output, which is a macroeconomic measure.
5. Equally, a macroeconomic change such as a rise in the general price level or a tax increase affects the demand and costs that each individual firm faces.
6. Microeconomics and macroeconomics are therefore two lenses on the same economy: one zooms in on a single market, the other stands back to view the total.

Q7. Discuss whether the decision of a single bakery about how much bread to produce is a microeconomic issue or a macroeconomic issue. [8 marks]

1. The bakery's own decision about how much bread to produce, and at what price to sell it, is a microeconomic issue because it concerns a single firm operating in a single market.
2. Microeconomics studies exactly this kind of decision: how an individual firm responds to the price it can get and the costs it faces in its own market.
3. The decision is made by one of the individual economic agents, a firm, whose behaviour is the subject matter of microeconomics.
4. However, the bakery's decision is also linked to macroeconomic conditions, because the demand it faces and the prices of the inputs it buys are influenced by aggregate factors such as the general level of economic activity and the aggregate price level.
5. A government decision to raise taxes or a central bank decision to change interest rates would also affect the bakery's costs and its customers' spending.
6. If every bakery and every other firm in the economy increased or reduced output at the same time, the combined effect would show up as a change in the economy's aggregate output, which is a macroeconomic measure.
7. Overall, the bakery's own output decision is best classified as a microeconomic issue, because it is the behaviour of one individual firm in one market.
8. The combined effect of many such decisions across the economy is what macroeconomics studies, so the two levels are connected rather than separate.

Key takeaways

• Microeconomics studies individual economic agents and how prices and quantities are determined in individual markets.
• Macroeconomics studies the economy as a whole through aggregate measures such as total output, employment and the price level.
• The main decision makers in microeconomics are individual households and firms.
• The main decision makers studied in macroeconomics are the government and the central bank.
• Microeconomic questions concern a single market; macroeconomic questions concern the whole economy.
• Government uses fiscal policy and the central bank uses monetary policy to try to influence macroeconomic outcomes.
• Aggregate output is, in effect, the sum of the output decisions of many individual firms, linking microeconomics and macroeconomics.
• Inflation, unemployment and economic growth are macroeconomic variables because they describe the whole economy, not one market.

Test yourself

What does microeconomics study?

Microeconomics studies individual economic agents, such as a household or a firm, and how prices and quantities of particular goods and services are determined in individual markets.

What does macroeconomics study?

Macroeconomics studies the economy as a whole, focusing on aggregate measures such as total output, employment and the aggregate price level.

Name the two main decision makers studied in microeconomics.

Households, which buy goods and services, and firms, which produce goods and services, are the two main decision makers in microeconomics.

Name two authorities whose decisions are studied in macroeconomics.

The government, through fiscal policy, and the central bank, through monetary policy, are studied in macroeconomics.

Is a question about the price of cotton a microeconomic or a macroeconomic question?

It is a microeconomic question, because it concerns the price and quantity in a single market rather than the whole economy.

Is unemployment studied in microeconomics or macroeconomics?

Unemployment is studied in macroeconomics, because it is an aggregate measure describing how fully the resources of the whole economy are employed.

How are microeconomics and macroeconomics linked?

Aggregate output studied in macroeconomics is built up from the output decisions of individual firms in individual markets, which is the subject of microeconomics.