Why Should We Study Macroeconomics Separately?

Now, an important question which arises is why a separate study of the economic system as a whole or its large aggregates is necessary.

Can’t we generalise about the behaviour of the economic system as a whole or about the behaviour of large aggregates such as aggregate consumption, aggregate saving, aggregate investment from the economic laws governing the behaviour patterns of the individual units found by microeconomics.

In other words, can’t we obtain the laws governing the macroeconomic variables such as total national product, total employment and total income, general price level etc. by simply adding up, multiplying or averaging the results obtained from the behaviour of the individual firms and industries.

The answer to this question is that the behaviour of the economic system as a whole or the macroeconomic aggregates is not merely a matter of addition or multiplication or averaging of what happens in the various individual parts of the whole. As a matter of fact, in the economic system what is true of parts is not necessarily true of the whole.

Therefore, the application of micro-approach to generalise about the behaviour of the economic system as a whole or macroeconomic aggregate is incorrect and may lead to misleading conclusions. Therefore, a separate macro-analysis is needed to study the behaviour of the economic system as a whole as well as in respect of various macroeconomic aggregates.

When laws or generalisations are true of constituent individual parts but untrue and invalid in case of the whole economy, paradoxes seem to exist. K.E. Boulding has called these paradoxes as macroeconomic paradoxes. It is because of the existence of these macroeconomic paradoxes that there is a justification for making macro-analysis of the behaviour of the whole economic system or its large economic aggregates.

Thus, Professor Boulding rightly remarks, “It is these paradoxes more than any other factor, which justify the separate study of the system as whole, not merely as an inventory or list of particular items, but as a complex of aggregates.”

Professor Boulding further elaborates his point by comparing the economic system with a forest and the individual firms or industries with the trees in the forest. Forest, he says, is the aggregation of trees but it does not reveal the same properties and behaviour patterns as the individual trees. It will be misleading to apply the rules governing the individual trees to generalise about the behaviour of the forest.

Various examples of macroeconomic paradoxes (that is, what is true of parts is not true of the whole) can be given from the economic field. We shall give two such examples which are concerned with savings and wages, on the basis of which Keynes laid stress on using and applying macroeconomic analysis as a separate and distinct approach from microeconomic analysis.

Take savings first. Savings are always good for an individual since they save with some purpose in view, for old age, for education of their children, for purchasing durable things like houses and cars etc. in the future, accumulation of money to start or expand business, for lending money to others including banks to earn interest.

But savings are not always good for the society as a whole. If an economy is in the grip of depression and unemployment caused by the deficiency of aggregate effective demand, the increase in savings by individuals will lead to a fall in aggregate consumption demand of the society which will cause aggregate demand to fall.

As a result, national income will decline. Given the propensity to save, at the lower level of national income, the aggregate saving will fall to the original level of aggregate saving. The paradox of thrift arises because the act of all the people to save more does not actually lead to the increase in national saving. Besides, as their decision to save more causes fall in national income, consumption of the people is less than before which implies they will become worse off than before. Therefore, this has been called a paradox of thrift.

Another common example to prove that what is true for the individual may not be true for the society as a whole is the wage-employment relationship. As pointed out above, classical and neo-classical economists, especially A. C. Pigou, contended that the cut in money wages at times of depression and unemployment would lead to the increase in employment and thereby eliminate unemployment and depression.

Now, whereas it is true that a cut in money wages in an individual industry will lead to more employment in that industry but it is not a valid proposition for the economy as a whole. It is quite common-place conclusion of microeconomic theory that, given the demand curve for labour, at a lower wage rate more men will be employed. But for the society or economy as a whole this is highly misleading.

If the wages are cut all round in the economy, as was suggested by Pigou and others on the basis of wage-employment relationship in an individual industry, the aggregate demand for goods and services in the society will decline, since wages are incomes of the workers which constitute majority in the society.

The decline in aggregate demand will mean the decrease in demand for goods of many industries. Because the demand for labour is a derived demand, i.e. derived from the demand for goods, the fall in aggregate demand of goods will result in the decline in demand for labour which will create more unemployment rather than reduce it.

We thus see that the laws or generalisations which hold good for the behaviour of an individual consumer, firm or industry may be quite invalid and misleading when applied to the behaviour of the economic system as a whole. There is thus a fallacy of composition. This is so because what is true of individual components is not true of their collective whole.As mentioned  these are called macroeconomic paradoxes and it is because of these paradoxes that a separate study of the economic system as a whole is essential. above,

Macroeconomic analysis takes account of many relationships which are not applicable to individual parts at all. For instance, an individual may save more than that he invests or he may invest more than he saves, but for the economy as a whole it is one of the important principles of Keynesian macroeconomics that actual savings are always equal to actual investment.

Likewise, for an individual, expenditure may be more or less than his income but the national expenditure of the economy must be equal to the national income. In fact, the national expenditure and national income are two identical things.

Similarly, in the case of full employment, an individual industry may increase its output and employment by bidding away the workers from other industries, but the economy cannot increase its output and employment in this way. Thus, what applies to an individual industry does not do so in case of the economic system as a whole.

We therefore conclude that a separate and distinct macroeconomic analysis is essential if we want to understand the true working of the economic system as a whole. From this it should not be understood that microeconomic theory is worthless and should be abandoned. As a matter of fact, microeconomics and macroeconomics are complementary to each other rather than being competitive.

The two types of theories deal with different subjects, one deals mainly with the explanation of relative prices of goods and factors and the other with the short-run determination of income and employment of the society as well as its long- run growth. The study of both micro and macroeconomics is therefore necessary. Professor Samuelson rightly says, “There is really no opposition between micro and macroeconomics. Both are absolutely vital. And you are only half-educated if you understand the one while being ignorant of the other.