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What Is Macroeconomics?
Macroeconomics is the study of economies as a whole. This means interrelatedness of multiple industries, markets, the unemployment rate, inflation, and general economic output of an entire economy, such as that of a country or of the globe as a whole. (“Macro” comes from the Greek prefix meaning “large.”)
The History of Macroeconomics
The study of macroeconomics is not new, but most modern interpretations are heavily influenced by the British economist John Maynard Keynes and his book The General Theory of Employment, Interest, and Money (1936).
During the 1930s, the Great Depression hit the United States. Many economists believed that the market would provide full employment if workers were desperate to work and therefore flexible in their wages; the same economists also believed that goods would sell—as long as the market drove down the down the price. None of this was indeed happening and it left many economists perplexed by the situation.
Keynes explained that the prosperity of whole economies could decline even if their capacity to produce was undiminished. Even productive economies could get caught in a trap where a lack of spending could cause businesses to cut back on production. The cuts in production would then lead businesses to reduce the number of workers they employed. The reduction in employment opportunities would then lead families to cut back on spending, worsening the original problem.
Keynes postured that aggregate demand, which is the overall total demand for goods and services in an economy, would dictate overall economic activity, and if an economy did not create enough demand it would lead to high levels of unemployment and inflation. Keynes argued that during times of recession or depression, certain governmental measures could increase demand and help fuel the overall economy. This came to be known as Keynesian economics.
Macroeconomics vs. Microeconomics
Macroeconomics focuses on the overall quilt of an economy—how various industries, markets, and businesses are affected and shaped by overarching economic, fiscal, and monetary policies. On the other side of the spectrum is microeconomics, which focuses on the behaviours of businesses and individuals within a specific market. Microeconomics are often affected by governmental policies, which are influenced by macroeconomics.
The 4 Main Principles of Macroeconomics
Macroeconomists—the people who study macroeconomics—look at a variety of broad economic factors in order to determine how the economy is performing as a whole. Four of these factors stick out as the most important:
1) Unemployment
The unemployment rate is the percentage of people who are willing and able to work but who cannot find gainful employment. People who are unemployed are not actively contributing to the economy and, if the unemployment rate is high enough, this can cause an economic slowdown.
Some macroeconomists include people who have given up looking for work or people who are unable to work in their unemployment rates; the official United States unemployment rate does not include this group (often leading to misrepresented numbers).
2) Inflation
Inflation rate refers to the rising cost of goods and services over time, and is one of the more complex fields macroeconomists study. Generally, macroeconomists agree that inflation should stay low, which is one way to help mitigate the possible negative effects of a recession.
3) National Income
This is the study of how much wealth a nation or economy is creating. Macroeconomists look at figures such as Gross Domestic Product (GDP), Real Gross Domestic Product, Gross National Product, and Net National Income, all of which are ways of analysing the value of the services and goods a nation produces over the course of year or specific business cycle.
Of these figures, GDP is one of the most important statistics in economics. It represents three separate conceptions of the strength of an economy:
- The value of everything that is produced within the country.
- The value of everything that is purchased within the country plus that country’s net exports to other countries, in other words the country’s international trade.
- The income of all the individuals and businesses within the country.
4) Economic Output
Economic output studies the amount goods and services an economy produces. If more people are buying an economy’s goods and services, the economic output remains high and the country is able to keep people employed and collect more tax revenue.
Macroeconomists develop models based on these factors that can predict broad movements in the economy, such as the relationship between interest rates and consumer confidence; their models can also help predict economic growth or stagnation.
The IS-LM Graph and Macroeconomics
Macroeconomic models are helpful in illustrating how various factors impact the economy. The four main principles of macroeconomics can be distilled using an IS-LM graph, which stands for “investment and savings, liquidity and money.”
This type of graph is commonly used by macroeconomists and shows how economic goods and services interact with interest rates and money markets. As interest rates fall, the GDP expands. A contracting GDP can cause interest rates to rise. Macroeconomists try to keep this in balance.
Macroeconomics, Governmental Policy, and Understanding the World
Macroeconomists work with government policy makers to keep the economy stable. A stable economy is one with no inflation and low unemployment.
In the United States, it’s the job of the Federal Reserve, or Fed, to keep the economy healthy. Technically the Fed’s mandate from Congress is to achieve full employment and price stability. Economists have long debated what the terms “full employment” and “price stability” mean in practice.
Price stability: The understanding today is that price stability means keeping the inflation rate around 2% per year.
Full employment: Full employment means getting unemployment as low as it can go without driving up inflation.
An economy that produces too little will suffer from high unemployment, since the low rate of employment opportunities will be inversely proportional to the high number of able-bodied workers. An economy that produces too much will see widespread increases in the prices of nearly all goods and services as the demand for them outpaces production capabilities. This general increase in prices is known as inflation.
The next time you find yourself wondering why a certain fiscal policy was enacted or why stocks are behaving a certain way, pause and consider the underlying macroeconomics. Any time you turn on the news and hear a politician talking about economic policy, unemployment rates, national spending, or consumer confidence, you are hearing macroeconomic policy in action.
From creating a national budget to raising or lowering taxes, imposing trade tariffs or signing trade agreements, these actions are all part of overall macroeconomic monetary policy of a country. Now that you have the foundational basis, you’ll start noticing that nearly every aspect of contemporary society is—in one way or another—impacted by macroeconomics.
