Macroeconomics differs from microeconomics by focusing on the behavior of the economy as a whole.

Table 12-1 lists some typical economic questions from the perspective of microeconomics and from macroeconomics. By comparing the questions, you can begin to get a sense of the difference between microeconomics and macroeconomics.

As these questions illustrate, microeconomics focuses on how decisions are made by individuals and firms and the consequences of those decisions. For example, we use microeconomics to determine how much it would cost a university or college to offer a new course, which includes the instructor’s salary, the cost of class materials, and so on. The school can then decide whether to offer the course by weighing the costs and benefits.

Macroeconomics, in contrast, examines the overall behavior of the economy—how the actions of all the individuals and firms in the economy interact to produce a particular economy-wide level of economic performance. For example, macroeconomics is concerned with the general level of prices in the economy and how high or how low it is relative to the general level of prices last year, rather than with the price of one particular good or service.

You might imagine that macroeconomic questions can be answered simply by adding up microeconomic answers. For example, the model of supply and demand introduced in Chapter 3 tells us how the equilibrium price of an individual good or service is determined in a competitive market. So you might think that applying supply and demand analysis to every good and service in the economy, then summing the results, is the way to understand the overall level of prices in the economy as a whole.

But that is incorrect: although basic concepts such as supply and demand are essential to macroeconomics, answering macroeconomic questions requires an additional set of tools and an expanded frame of reference.

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If you drive on a highway, you probably know what a rubber-necking traffic jam is and why it is so annoying. Someone pulls over to the side of the road, perhaps to fix a flat tire, and, pretty soon, a long traffic jam occurs as drivers slow down to take a look.

What makes it so annoying is that the length of the traffic jam is greatly out of proportion to the minor event that precipitated it. Because some drivers hit their brakes in order to rubber-neck, the drivers behind them must also hit their brakes, those behind them must do the same, and so on. The accumulation of all the individual hitting of brakes eventually leads to a long, wasteful traffic jam as each driver slows down a little bit more than the driver in front of him or her. In other words, each person’s response leads to an amplified response by the next person.

Understanding a rubber-necking traffic jam gives us some insight into one very important way in which macroeconomics differs from microeconomics: many thousands or millions of individual actions compound upon one another to produce an outcome that isn’t simply the sum of those individual actions.

Consider, for example, what macroeconomists call the paradox of thrift: when families and businesses are worried about the possibility of economic hard times, they prepare by cutting their spending. This reduction in spending depresses the economy as consumers spend less and businesses react by laying off workers. As a result, families and businesses may end up worse off than if they hadn’t tried to act responsibly by cutting their spending.

This is a paradox because seemingly virtuous behavior—preparing for hard times by saving more—ends up harming everyone. And there is a flip-side to this story: when families and businesses are feeling optimistic about the future, they spend more today. This stimulates the economy, leading businesses to hire more workers, which further expands the economy. Seemingly profligate behavior leads to good times for all.

A key insight of macroeconomics, then, is that the combined effect of individual decisions can have results that are very different from what any one individual intended, results that are sometimes perverse. The behavior of the macroeconomy is, indeed, greater than the sum of individual actions and market outcomes.

To a much greater extent than microeconomists, macroeconomists are concerned with questions about policy, about what the government can do to make macroeconomic performance better. This policy focus was strongly shaped by history, in particular by the Great Depression of the 1930s.

Before the 1930s, economists tended to regard the economy as self-regulating: they believed that problems such as unemployment would be corrected through the working of the invisible hand and that government attempts to improve the economy’s performance would be ineffective at best—and would probably make things worse.

The Great Depression changed all that. The sheer scale of the catastrophe, which left a quarter of the U.S. workforce without jobs and threatened the political stability of many countries created a demand for action. It also led to a major effort on the part of economists to understand economic slumps and find ways to prevent them.

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In 1936 the British economist John Maynard Keynes (pronounced “canes”) published The General Theory of Employment, Interest, and Money, a book that transformed macroeconomics. According to Keynesian economics, a depressed economy is the result of inadequate spending. In addition, Keynes argued that government intervention can help a depressed economy through monetary policy and fiscal policy. Monetary policy uses changes in the quantity of money to alter interest rates, which in turn affect the level of overall spending. Fiscal policy uses changes in taxes and government spending to affect overall spending.

In general, Keynes established the idea that managing the economy is a government responsibility. Keynesian ideas continue to have a strong influence on both economic theory and public policy: in 2008 and 2009, Congress, the White House, and the Federal Reserve (a quasi-governmental agency that manages U.S. monetary policy) took steps to fend off an economic slump that were clearly Keynesian in spirit, as described in the following Economics in Action.