A Unified Theory of Economics?

Most people who aren’t economists probably don’t realize this, but there’s a large division in economics – that of micro and macro economics. Microeconomics usually deals with individual decisions while macroeconomics works to explain what happens at the larger level. Attempts to bridge the two are often called something like “Micro foundation of macro models.”

The Economist has a good post on one of my favorite topics – the importance of using models and the shortfalls we must be aware of when using them. At one point the writing moves into this subject:

Modern economists are often accused of “physics envy”, filling their papers with complex equations to make them look like “real” science. But in one important sense, the subjects are similar; they can be divided into two. There is sub-atomic physics which deals with the tiny particles that make up matter, and then there is classical mechanics, which deals with the effect on bodies of forces like gravity.  Marrying the two has not always been easy. Similarly, there is micro-economics which deals with how individuals and companies behave; and macroeconomics, which deals with the overall economy.

There are various ways of dividing modern economic thought, but one divide is the way they marry the micro and the macro. The Chicago/neoclassical school tends to build up from the micro level, looking at the way that rational individuals will respond to incentives. The Keynesian school sees that the aggregated response of rational individuals might have perverse outcomes, as in the paradox of thrift, so calls on the government to take action in response.

This nicely illustrates one problem of how markets can fail. What might be a good decision at the individual level might not work at the aggregate level. Restraining spending might be good for me but if everyone does it then the economy dries up reinforcing the effect of a surplus of funds in driving down rates of returns.

It’s unclear if we’ll ever have a unified theory of economics which explains the effects at both the micro and macro levels, but I’m sure that people will keep trying to uncover one. Until that day it’s important for economists to remember that not everyone understands the difference in the fields and the different level of certainty economists have in various effects. Better communication is clearly needed.

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