Thursday, February 02, 2006

The difference between micro and macro economics

Microeconomics is a coherent set of axioms and conclusions built on solid deductive reasoning. What is wanting is empirical evidence. A few simple assumptions such as people are rational and maximise some objectives given some constraints lead to a powerful prediction that people react to incentives: that is, when something becomes relatively more expensive compared with its alternatives, you do less of it. Is this prediction true? It is extremely hard to check empirically!

Macroeconomics is a lot of observations between different aggregate measures of activitities. What is wanting is a coherent set of theories. There are as many theories as there are theorists, and none of them can explain the big puzzles: why the Great Depression happened, why there was much malaise in the 1970s, and why the hell is everyone (save Americans) saving so much today.