Economics and the Historian

Macroeconomics: An Introduction for Historians

Macroeconomics An Introduction for Historians RICHARD SUTCH Anyone who has made the acquaintance of the science of economics knows she has; two faces. Each expresses its own personality. We call them microeconomics and macroeconomics. M/croeconomics examines economic behavior in a small part or small sector of the economy isolated from the larger whole. Describing how prices are determined in the market for rice1 or analyzing the effect of a tax on the work effort of artisans are illustrative microeconomic topics. Macroeconomics, by contrast , is the stu dy of the economy as an entity, as a complete functioning system of economic institutions. Establishing what determines the total quantity of output produced by the economy and analyzing the problems of unemployment and inflation are typical macroeconomic issues . There are two branches of economic methodology, not because economists suffer with dual personalities but becausethere have to be. To answer macroeconomic questions the economy must be analyzed as a system —not on a piecemeal basis, but as a whole. This imperative can be attributed to three facts of life. The three points are closely related, but it helps—certainly so, at the outset—to discuss them individually. Each I wish to thank all the participants in this enterprise for their critical, helpful, and attentive comments. The historians of China helped me set the tone and level of my argument and clear away muddle. Particular thanks are due to Thomas Rawski, Donald McCloskey , and Susan Carter for their constant belief in the valueof presenting an introduction to economics for historians. 159 160 Richard Sutch helps in a different way to explain why microeconomic methods, if applied to a macroeconomic problem, would fail. i. With a macroeconomic problem the microeconomic assumption of ceteris paribus isunrealistic. z. The behavior of the whole cannot reliably be deduced from the behavior of its component parts. Reasoning by analogy from the part to the whole often fails. 3. There are constraints that do not bind individual behavior but work at the aggregate level. CETERIS PARIBUS FAILS When studying a small segment of the whole economy, microeconomists assume that the influences emanating from all the other parts of the economy are known and unchanging. As a vestige of the long-lost classical heritage of economics, this simplifying assumption still bears its Latin name: ceteris paribus (other things being equal). The assumption of an unchanging context simplifies most microeconomic problems into tractability. Indeed, microeconomic methodology is based on ceteris paribus and in that branch of economics it is employed universally. When ceteris paribus can be said to hold, each economic segment of the economic system can be examined separately in isolation from the others. When supply and demand in the village market for rice is discussed , for example, we mentally freeze all other activitygoing on in the economy. Everything relevantto the market participants' behavior other than the price of rice is assumed to remain unchanged. The assumption that the outside influences are unchanging in such cases is often an excellent approximation to reality. The price of gold, recent medical advances in treating infections, the volume of river traffic on the Mississippi , and so on are very unlikely to be much influenced by the village rice market. Thus, whatever their influence on the rice market might be, that influenceis unlikelyto change as a result of what goes on there. But not every economic problem can be dealt with in this simplified way. Some phenomena are so bound up with the rest of the world that one cannot usefully separate them from the wider economy. Macroeconomics deals with economic problems where the ceteris paribus assumption is unrealistic. Dispensing with this assumption is often necessary when the economic changes under examination affect a large number of people. In such cases the collective response to the eco- Macroeconomics 161 nomic change may have a significant indirect influence on the phenomenon under study that is distinct from its direct impact. For example, suppose you are interested in the implications of a reduction in the rate of income taxation on your well-being.The direct impact on your take-home pay is obvious, but a tax cut affects many other people as well. Since a general tax reduction would put more spendable income in nearlyeveryone 's hands, you should expect an indirect influence on your welfare from the general increasein spending that would result. To assume that the rest of the economy stood still when...