Every time there is trouble looming for the economy, my schedule of presentations and interviews explodes. It happened during my more than 40 years on the North Carolina State University 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 think these are the only topics economics focuses on. 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 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 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 make microeconomics valuable.
The first is incentives. One of the elementary principles of microeconomics is that decision-makers — workers, managers, investors, parents and children — 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. A good example today is the tax cuts for buying an electric vehicle.
Incentives don’t have to be all monetary. Actions that are praised by our neighbors, colleagues, friends and society at large will attract more followers, while behaviors that are scorned will have a deterrent effect. Over time, the praised and scorned actions can change as societal values and culture change.
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. I know I do. These things can be personal, or they can apply to our community or nation. But the commonality is 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.
One way of expanding what we can have at any point in time is to borrow. Borrowing gives us more resources to use today. For example, what if you wanted to buy a new vehicle, but you don’t have the cash to make the purchase? Instead, you can borrow the cash, have the vehicle now and pay off the loan over time. This is a logical process — indeed, most people borrow to buy “big ticket” items like homes and vehicles — but it can create problems. What if you can’t make the loan payments and have your home or vehicle repossessed? This is a consideration when attempting to “expand your resources” through borrowing.
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 — or 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 the government. In these situations, competition is limited, and prices are higher.
I’ve just skimmed the surface of the three microeconomic principles of incentives, tradeoffs and competition. While macroeconomics often gets the headlines, microeconomics may be just as — or maybe more — important to our everyday lives. But, you decide!
Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.