Understanding Macroeconomics vs Microeconomics
As the name suggests, Microeconomics studies the decisions made by individual and business concerning the distribution of resources and prices of goods and services. It deals with a specific industry or a sector, the connections of firms and households in the market. While saying so we also take into consideration the taxes and other regulations that have been created by governments. It primarily focuses on the supply, demand and other forces that define the price levels of good and services in the economy.
Microeconomics would study how a company could lower its prices to increase its product demand in the market.
On the other hand Macroeconomics, studies the behavior of not only particular company or industries but whole economy. It includes understanding how unemployment, price levels, growth rate affects the economy wide aspects such as the Gross National Product (GNP).
Macroeconomics would look at how an increase/decrease in net imports would affect a nation’s capital account.
Looking at the two differences macroeconomics vs microeconomics we could say that when we study an individual paper mill manufacturing paper, it would be microeconomics but if we study the whole paper manufacturing sector of the economy it would be macroeconomics.
The following table would briefly distinguish macroeconomics vs microeconomics examples;
It deals with the decision making of single economic variables such as the demand, price, consumer, etc. It deals with averages and aggregates of the entire economy such as national income, aggregate output, aggregate savings etc.
It is narrow in scope and interprets the small constituents of the entire economy. It has a wide scope and interprets the economy of a country as a whole.
It is also known as the price theory because it explains the process of economic resources allocation on the foundation of relative prices of several goods and services. It is also known as the income theory because it explains the changing levels of national income of an economy during a period of time.
It deals with the flow of various factors of production from a single owner to a single user of those resources. It deals with the circular flow of income and expenditure between different sectors of the economy.
It helps in developing policies appropriate resource distribution at firm level. It helps in developing policies appropriate resource distribution at economy level such as inflation, unemployment level etc.
Do Macroeconomics vs Microeconomics interact with each other?
Looking at the above mentioned differences between macroeconomics vs microeconomics it appears that these two studies of economics are different but in reality they are inter-related and complement each other since the issues that they address are overlapping.
Increased inflation (a macroeconomic effect) would increase the prices of raw materials required by the companies to manufacture products which would in turn also affect the price for the final product charged to the public.
Microeconomics and Macroeconomics are both exploring the same things but from different viewpoints. When we talk about macroeconomics while studying the constituents of output in nations economy we also have to understand the demand of single households and firms, which are micro economic concepts. Similarly when we study the investment policies of businesses- a microeconomic concept we cannot do it without learning about the effect of macroeconomic trends in economic growth, taxation policies etc.
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How macreconomic vs microeconomic variables affect equity investors?
The stock market gets affected by various economic and social factors. It is important that every finance professional or investor should be aware of these factors before deciding to invest in it.
If there is increasing inflation in the economy it would have consequent effects on the stock market.
Inflation and Deflation
Inflation signifies a rise in general level of prices over a period of one year. Inflation can have contrary effects on the stock market. When inflation is at a low rate, the stock market reacts with a rush to sell shares. High inflation influences the investors to think that companies would hold back on spending; this leads to a decrease in revenue. Now, the higher cost of goods coupled with the drop in revenue pushes the stock market to drop.
There have however been exceptions, when there have been sustained decline in the price level of goods and services. This occurrence is called deflation. While deflation would sounds like it should be received well by investors, it actually is a reason for a drop in the stock market since they perceive deflation as the consequence of a weak economy.
This inflation can have significant impact on other macroeconomic variables; let’s understand where and how;
Exchange Rate: Persistent prevalence of higher inflation in a country (say Country P) comparative to the inflation in another country (say Country Q) generally leads to depreciation of a currency in country P.
Interest Rates: When the level of price rise each unit of currency can buy fewer goods and services than before, implying a reduction in the purchasing power of the currency. So, people with excess funds demand higher interest rates, as they want to protect the returns of their investment against the adverse impact of higher inflation. As a outcome, with rising inflation, interest rates tend to rise. The reverse happens when inflation declines.
Unemployment: There is an opposite relationship between the rate of unemployment and the rate of inflation in an economy. It has been perceived that there is a stable short run trade off between unemployment and inflation.
From the lender’s perspective, interest can be thought of as an “opportunity cost’ or “rent of money” and interest rate as the rate at which interest accumulates over a period of time for the amount given as loan. From a borrower’s perspective, interest rate is the cost of capital i.e. it is the cost that a borrower has to sustain to have access to funds.
Interest rates as established by the Central bank and individual banks can have an effect on the stock market. Higher interest rates indicate that money has become more expensive to borrow. In order to recompense for the increased interest costs, businesses would have to cut down on costs leading to lay off workers. Also the company cannot borrow as much as it used to, and this affects the company’s earnings adversely. All of this supplements to a drop in the stock market.
They are the government spending policies that influence macroeconomic conditions. Through fiscal policy, regulators try to improve unemployment rates, control inflation, stabilize business cycles and influence interest rates in an effort to control the economy.
The most direct influence of fiscal policies on the financial market is through taxation. The government can try to change the tax rates; it can impose new taxes or abolish existing ones or can use measures to broaden the tax base. In each of these cases, it will affect the income and consumption pattern of a large number of people. Dependent upon the tax measure, it will have a positive or a negative impact on the financial market. For example, if personal income tax rate is lowered then it is likely to see an upturn the disposable income of people and can have a positive impact on the financial markets through an enhanced level of financial savings. On the other hand, introduction of a long-term capital gains tax 10 may have the adverse impact on the market.
Foreign market is a market in which participants are able to buy, sell, exchange and speculate on currencies.
When the worldwide economy is down, goods and services cannot be sold abroad as they used to be. This eventually leads to decrease in the revenue and as a consequent effect cause the decline in the stock market. If foreign stock exchanges start weakening or experience sharp declines, a ripple effect can be anticipated. This eventually results in the overall drop in a global stock market.
After understanding all this we could definitely comprehend that both Macroeconomics vs Microeconomics provide important tools for any finance professional and should be studied together in order to completely comprehend how corporations function and make revenues and thus, how a whole economy is managed and continual.