Every time there is trouble looming for the economy, my schedule of presentations and interviews explode. It happened during my 40-plus years on the NCSU faculty, and it still happens in my retirement, as I continue to interact with groups and the media.
I’m seeing the same reactions today with worries about inflation and recession. Certainly, I understand people being concerned when the economy is gloomy, especially if their livelihoods and incomes are threatened. Some psychologists say humans are naturally wired to focus more on potentially bad outcomes than on good ones.
But for some, I think the focus on negatives like recession and inflation make many believe these are the only topics of importance to economists. They couldn’t be more wrong.
There are two broad categories of economics — macroeconomics and microeconomics. Macroeconomics is “big picture” economics, concentrating on the economy as a whole rather than on the individual pieces. Macroeconomics looks at topics such as economic growth, productivity, interest rates, the stock market, and the financial system, as well as inflation and recession.
Macroeconomics captures our attention because its components impact everyone. Anyone who borrows or invests money is influenced by economic growth, interest rates, the stock market, and the financial system. So too are people who run a business or work for a business. They know that even if they are perfect at their job, they can be hurt if the macroeconomy deteriorates.
In contrast, microeconomics is “small picture” economics because it looks at the individual components of the macroeconomy. Why a specific job pays what it does, evaluating the opening a new business, deciding whether to go to college, and planning for your retirement are all examples of microeconomics.
Since microeconomics often is overshadowed by macroeconomics, let me delve into the “small picture” world by highlighting some of the concepts that makes microeconomics valuable.
The first is incentives. One of the elementary principles of microeconomics is that decision-makers — workers, managers, investors, parents, children, etc. — respond to incentives. If incentives to do more of something are increased, decision-makers will do more of it. Conversely, if incentives to do something are decreased, decision-makers will do less of it.
We see incentives at work all around us. Lower prices of products and services we like cause us to buy more of them, while when faced with higher prices, we cut back. Businesses will increase wages to fill vacant positions. If the government wants us to do something, they will often cut taxes on that activity.
A key concept of microeconomics is the idea we can’t have it all. It’s the nature of most people to want many things. But at any point in time we have limited resources to achieve our goals. This means we have to make choices. A big part of microeconomics is helping people evaluate their choices, so they make the selection that gives them the most satisfaction.
The last microeconomic concept I’ll discuss is competition. Competition is important because if several companies are vying for your business, not only will they have to deliver a quality product or service, but they will also need to offer a reasonable price. This keeps profits relatively low. Indeed, companies in highly competitive markets have profit rates (profits as a percentage of revenues) in the low single digits.
If starting a business is relatively easy and without any legal barriers, then competition is robust, sellers respond to consumers’ needs, and prices reflect costs plus a modest profit rate.
Yet notice the two qualifiers to my last statement. Sometimes it’s difficult to replicate what existing companies are doing, or it is simply too expensive to try. Or, there may be cases where there are legal impediments to competition, often imposed by government. In these situations, competition is limited and prices are higher.
I’ve just skimmed the surface on the three microeconomic principles of incentives, tradeoff, and competition. While macroeconomics often gets the headlines, microeconomics may be just as — or maybe more — important to our everyday lives.