Macroeconomics and Microeconomics: Part I

Macroeconomics (the study of aggregate economic activity), in most expositions of it that I have seen, fails on two counts. First, macroeconomics usually ignores or accounts inadequately for microeconomic behavior, that is, the behavior of individual persons and firms. Second, it aggregates that which cannot be aggregated, namely, disparate forms of economic activity performed by disparate actors.

Regarding the first point, macro without micro is meaningless. Macroeconomic aggregates have no independent existence.

Secondly, an aggregate is meaningless if it represents disparate phenomena. A foot (measure of distance) is a meaningful measure only if it represents a collection of inches (or fractions thereof); a pound (measure of weight) is meaningful only if it represents a collection of ounces (or fractions thereof); and so on. But a foot is a foot, and a pound is a pound; the two cannot be aggregated because they measure different things. (Yes, there is in physics a measure of force known as the foot-pound, which “is the amount of energy expended when a force of one pound acts through a distance of one foot along the direction of the force.” But “foot-pound” is something distinct from “foot” and “pound”; it is a measure of force, not a way of making length and weight commensurate.)

This post illustrates both points. Consider A and B, who have discovered, through trial and error, that each can have more clothing and more food if they specialize: A in the manufacture of clothing, B in the production of food.

Our primitive pair also has discovered a “just right” balance in the amount and allocation of clothing and food that they make and consume. Through voluntary exchange (bargaining), they have found a jointly satisfactory balance of production and consumption. A makes “just enough” clothing so that he can cover himself adequately, keep some clothing on hand for emergencies, trade the balance to B for “just enough” food, and enjoy “just enough” leisure. B does likewise with food. Both A and B might like to have more clothing and/or food, but both are doing as well as they can do in a voluntary relationship.

A and B’s respective decisions and actions are microeconomic; the sum of their decisions, macroeconomic. The microeconomic picture might look like this:

  • A produces 10 units of clothing a week, 5 of which he trades to B for 5 units of food a week, 4 of which he uses each week, and 1 of which he saves for an emergency.
  • B, like A, uses 4 units of clothing each week and saves 1 for an emergency.
  • B produces 10 units of food a week, 5 of which she trades to A for 5 units of clothing a week, 4 of which she consumes each week, and 1 of which she saves for an emergency.
  • A, like B, consumes 4 units of food each week and saves 1 for an emergency.

Given the microeconomic picture, it is trivial to depict the macroeconomic situation:

  • Gross weekly output = 10 units of clothing and 10 units of food
  • Weekly consumption = 8 units of clothing and 8 units of food
  • Weekly saving = 2 units of clothing and 2 units of food

You will note that the macroeconomic metrics add no useful information; they merely summarize the salient facts of A and B’s economic lives — though not the essential facts of their lives, which include (but are far from limited to) the degree of satisfaction that A and B derive from their economic activities.

The customary way of getting around the aggregation problem is to sum the dollar value of microeconomic activity. But this method simply masks the aggregation problem by assuming that it is possible to add the marginal valuations (i.e., prices) of disparate products and services being bought and sold at disparate moments in time by disparate individuals and firms for disparate purposes. One might as well add two bananas to two apples and call the result four bapples. The essential problem is that A, B, and everyone else will derive different types and levels of enjoyment from clothing and food (both of which come in many forms), not to mention the vast array of other kinds of goods and services that are bought and sold. (For a long disquisition on this point, go here.)

In sum, macroeconomic concepts (e.g., aggregate demand) are not exogenous entities that exist independently of microeconomic activity. At best, they are ambiguous, qualitative proxies for a host of disparate microeconomic activities.

In future installments I will cover such topics as recession and fiscal policy.