Nature and Scope of Macroeconomics
Economics is the science that deals with production, exchange and consumption of various commodities in economic systems. It shows how scarce resources can be used to increase wealth and human welfare. The central focus of economics is on scarcity of resources and choices among their alternative uses. Macroeconomics is a branch of economics dealing with the performance, structure, behaviour and decision making of an economy as a whole. This include regional, national, and global economics. Macro economics is the study of aggregates or averages covering the entire economy, such as total employment, National income, national output, total investment, total consumption, total savings, aggregate supply, aggregate demand, and general a price level, wage level and cost structure. Macro economics uses aggregates which relate them to the “economy wide total”. Macroeconomics studies economic problems from the point of view of entire economy.
Nature of Macroeconomics
Macroeconomics is basically known as theory of income. It is concerned with the problems of economic fluctuations, unemployment, inflation or deflation and economic growth. It deals with the aggregates of all quantities not with individual price levels or outputs but with national output.
Scope of macro economics
The study of macro economics is crucial to understand the working of and economy. Economic Problems are mainly related to the employment, behaviour of total income and general price in the economy. Macro economics help in making the elimination process more understandable.
What is macroeconomics?
As you have already observed macroeconomics deals with aggregates. Therefore, by definition "macroeconomics is the branch of economics concerned with aggregates, such as national income, consumption, and investment". Macroeconomics examines the economy as a whole and answers questions such as: What causes the economy to grow over time? What causes short-run fluctuations in the economy?, and many such questions. Thus, macroeconomics is concerned with the behaviour of the economy as a whole. In macroeconomics we examine booms and recessions, the economys total output of goods and services and the growth of output, the rates of inflation and unemployment, the balance of payments, and exchange rates.
Macroeconomics deals with the increase in the output and employment over long periods of time that is, economic growth and with the short-run fluctuations that constitute the business cycle. Macroeconomics focuses on the economic behaviour and policies that affect consumption and investment, the money and the trade balance, the determinants of changes in wages and prices, monetary and fiscal policies, the money stock, the national budget, interest rates, as well as the national debt.
Features of macroeconomics
Study of aggregate: macro economics deals with the study of entire economy. It studies the overall conditions in the economy, such as national income, national output, total employment, general price level etc.
Main macroeconomic policy objectives
Broadly, the objective of macroeconomic policies is to maximize the level of national income, providing economic growth to raise the utility and standard of living of participants in the economy. There are also a number of secondary objectives, which are held to lead to the maximization of income over the long run. While there are variations between the objectives of different national and international entities, most economies follow the main macroeconomic policy objectives detailed below:
(1) Sustainability in economic growth this. This refers to a rate of economic growth, which allows an increase in living standards without undue structural and environmental difficulties. In development terms, sustainable economic development is the economic development that meets the needs of the present generation without compromising the ability of the future generations to meet their own needs.
(2) Full employment. As a macroeconomic policy objective, ensures that where those who are able and willing to have a job can get one, given that there will be a certain amount of frictional, seasonal and structural unemployment (referred to as the natural rate of unemployment).
(3) Price stability. Making sure that prices remain largely stable, and there is no rapid inflation or deflation. Please, note that price stability is not necessarily the same as zero inflation, but instead steady levels of low-moderate inflation is often regarded as ideal. It is also worth noting that prices of some goods and services often fall as a result of productivity improvements during periods of inflation, as inflation is only a measure of general price levels. However, inflation is a good measure of price stability. Zero inflation is often undesirable in an economy, as it tends to weaken incentives to businesses to invest and expand production.
(4) External Balance of trade. Making sure that there is equilibrium in the balance of payments without the use of artificial constraints. That is, exports should roughly be equal to imports over the long run.
(5) Equitable distribution of income and wealth. This means achieving a fair share of the national 'cake', more equitable than would be in the case of an entirely free market. It involves ensuring that no sector of society gets extremely high levels of income and wealth while others live in abject poverty.
(6) Increasing Productivity. It is every governments mandate to ensure that productivity of resources is increased over time. For example, increased productivity translates to more output per unit of labour per hour. Also, since labor is but one of many inputs to produce goods and services, it could also be described as output per unit of factor inputs per hour. As you will recall, high productivity reduces overall cost of production, which eventually leads to increased production of goods and services. When productivity-induced output growth outpaces demand for goods and services, commodity prices generally decline and more consumers manage to access the national output, leading to improvements in national welfare.
Importance of macroeconomics
The study of macroeconomics is very important for evaluating the overall performance of the economy in terms of national income. The level of fiscal activity and understanding the distribution of income among different groups of people in the economy.
Major macroeconomic issues
The major macroeconomic issues include economic growth, full employment, inflation, balance of payment (this entails managing deficits and surpluses), and exchange rate (managing exchange rate movement). Lets now examine these macroeconomic issues in detail.
Economic growth involves a change in gross national product with or without change in the structure of society. Economic growth is calculated as a percentage rate of growth of the national economy per year. The achievement of substantial levels of economic growth is an aspiration of most policy options. Economists define economic growth as either of the following:
(1) An increase in real GDP occurring over some time period. This is useful for measuring growth in military potential or political pre-eminence or superiority.
(2) An increase in real GDP per capita occurring over some time period. This definition is useful for comparing living standards and it relates to economic development.
Growth as a goal
Growth is widely held economic goal. The expansion of total output relative to population results in rising real wages and incomes and thus higher standards of living thus economic development. As you can see from explanation, an economy that is experiencing economic growth is better able to meet peoples wants and resolve socioeconomic problems. A growing economy can undertake new programs to alleviate poverty and protect the environment without impairing existing levels of consumption, investment, and public goods production. In short, growth lessens the burden of scarcity.
Positive features (benefits) of economic growth
The following are some of the notable benefits or positive features of economic growth.
- Increase in employment.
- The standard of living of the people will be improved.
- There will be an expansion and improvement in the infrastructure.
- Increased investment will be encouraged.
- Improved technology from the increased investment will stimulate production.
Negative features of economic growth
Aside from the benefits, economic growth also involves some costs or negative effects to society as listed below:
- The environment is threatened by factors such as building, chemicals and motorways.
- There may be waste of resources which are very finite
There is a probability that the increased wealth will not be equitably distributed
With urban expansion, not enough care may be taken to safeguard the community against urban problems such as intensive housing without green space and other facilities leading to crime and vandalism.
Arithmetic of Growth
Economists pay so much attention to small changes in the rate of economic growth because those changes really matter to society. For a poor country, a difference 1 percentage point, for example, from 6% to 5% in the rate of economic growth may mean the difference between starvation and mere hunger. You can estimate economic growth using a simple formula called the Rule of 70, which is illustrated below.
The Rule of 70
The mathematical approximation called the rule of 70 provides a quantitative grasp of the effect of economic growth. The Rule of 70 gives an approximate number of years that will take to double an economic indicator. For instance, you can estimate time taken for a countrys real gross domestic product (GDP) to double by dividing 70 by the countrys annual percentage. Thus, time taken to double real GDP = (70 ÷ annual percentage rate of growth). If the economy registers a 4% annual rate of growth, real GDP will double after 17.5 (= 70 ÷ 4). The rule of 70 is also used to estimate how long it will take the price level or the amount of money in your savings account to double at various percentage rates of inflation or interest rates.
Main Sources of Economic Growth
Society can increase its real output and income in two fundamental ways as follows:
(i) By increasing its inputs of resources. You will agree that, all other things equal, framers with big farms tend to produce more than those with small farms. An increase in resource package increases the production possibilities frontier.
(ii) By increasing the productivity of those inputs. Productivity is broadly measured as real output per unit of input. Higher productivity means more output per unit of input used in production. In terms of labour, productivity tends to rise when a number of factors are met; some of these factors include the following:
- Improvements in health, training, education, and motivation of workers;
- Provision of more and better machinery and natural resources to workers with which to work; and
- Labor is reallocated from less efficient industries to more efficient industries.
The Business Cycle
Sometimes growth gives way to recession and depression that is, to declines in real GDP and significant increases in unemployment. At other times rapid inflation impairs rapid economic growth. Both unemployment and inflation often are associated with business cycles. The term business cycle refers to alternating rises and declines in the level of economic activity, which sometimes extends over several years.
Phases of the Business Cycle (Explained)
There are four main phases of the business cycle and these include the peak, the recession, the trough and the recovery. As you will see, each phase has its own characteristics with regards to the status of the economy. Lets examine the phases of the business cycle in a detailed manner presented below:
(1) Peak At a peak, business activity has reached a temporary maximum. The economy is at full employment and the level of real output is at or very close to the economys production capacity. The price level is likely to rise during peak in other words there will be inflation mainly because full employment of resources, including labour means that a large number of households will have money leading to an increase in effective demand for goods and services. Therefore, if demand exceeds the economys capacity to produce, inflation will be likely outcome.
(2) Recession A peak is followed by recession a period of decline in real output, income, employment, and trade. This downturn, which lasts 6 months or more, is marked by the widespread contraction (reduction) of business activity in many sectors of the economy. But because many prices are downwardly inflexible, the price level is likely to fall only if the recession is severe and prolonged that is, only if a depression occurs. You can imagine that as business activity falls, the recession phase will be characterized by job losses leading to an increase in levels of unemployment. Thus, both increasing levels of inflation and unemployment characterize the recession phase. Inflation occurs during recession because households tend to use their assets including savings for financing their daily needs. This creates a situation in which effective aggregate demand is relatively larger than the available aggregate supply produced from the declining economic activities.
(3) Trough In the trough of the recession or depression, output and employment “bottom out” at their lowest levels. In other words, at the trough, the economys output reaches its lowest level while unemployment registers its highest level indicating greatest loss of employment opportunities by the labour force. The trough phase may be either short-lived or quite long. If the economy stays in the trough with lowest levels of output over a long period of time, prices may go down as households tend to spend all their assets which can be liquidated into cash for survival leading to a decline in the effective aggregate demand even for the little aggregate supply of goods and services on the market. During this time, the available goods tend to be those from previous production; and with declining effective aggregate demand producers are forced to reduce the selling prices just to clear the inventory in an effort to reduce storage cost.
(4) Recovery In the expansion or recovery phase, output and employment rise toward full employment. As recovery intensifies, the price level may begin to rise before full employment and full-capacity production returns. This happens because effective aggregate demand may increase faster than aggregate supply, as previously retrenched workers are re-called to get back to their jobs. You can agree that it is easier to re-call the work force to get back to work but a bit difficult for producing companies to produce to their capacity within a short time. While the producers are reorganizing their production lines to desired levels, the re-called workers will be receiving their salaries at the recommended wage rates. So, in the recovery phase of the business cycle, unemployment declines (or employment increases) while inflation rises.
Note: Although business cycles all pass through the same phases, they vary greatly in duration and intensity. Many economists prefer to talk of business fluctuations rather than cycles because cycles imply regularity of occurrence a good example of cycle is occurrence of seasons; this does not happen in the performance of the economy. Thus, the term business cycle is borrowed and used in this discussion loosely.
Causation of the Business Cycle
There are a number of factors that cause the economy to experience upward and/or downward swings over time. The following are some of the main cases of the business cycle.
- Momentous innovations such as the railroad, the automobile, synthetic fibers, and microchips, have great impact on investment and consumption spending and therefore on output, employment, and the price level. Such major innovations occur irregularly and thus contribute to the variability of economic activity.
- Major changes in productivity When productivity expands, the economy booms; when productivity falls, the economy recedes.
- Monetary phenomenon When the government creates too much money, an inflationary boom occurs. Too little money triggers a decline in output and employment and, eventually, the price level (deflation).
- Changes in the level of spending In a market economy, investment takes place only if the goods and services produced can be sold at a profit.
Cyclical Impact of the Business Cycle
The extent and severity of the impact of the business cycle may vary depending on whether the economic sector produces durable or non-durable goods. Now, lets discuss how the business cycle affects durable goods industry and then later we will examine how the non-durable goods sector get affected.
Impact of Business Cycle on Durables
Firms and industries producing capital goods (such as housing, commercial buildings, heavy equipment) and consumer durables (such as cars, personal computers, refrigerators) are affected most by the business cycle. This is so because purchase of new items tends to be postponed during economic hard times. This is true for every human being when the economy is going through hardships such as during recession, consumers change their spending behaviour and postponement of durable goods tends to be common.
Impact of Business Cycle on Non-Durables
In contrast, service industries (such as health, legal) and industries that produce nondurable consumer goods are somewhat insulated from the most severe effects of recession. Imagine, falling sick when the economy is not going well leaving you with some financial hardships in your household. Would you say you wont go to hospital to medical attention? Surely, you would dare do that. Instead, you would go the next mile looking for some money by whatever possible means for either transport to a public health facility or to pay medical bills at a private clinic. In doing so, owners of such health facilities do not suffer much when the economy is facing some challenges. People find it difficult to cut back on needed medical and legal services. Similarly, it would be very hard for you to stop or postpone the purchase of basic non-durable goods such as food and clothing during economic hardships. Of course, the quantity and quality of nondurables will decline, but not so much as will purchases of capital goods and consumer durables.
The dominant economic and social objective of government is to achieve full employment. Full employment has been defined as a situation where work is available for all those willing and able to work at the going wage rate. To achieve this objective then the problem of unemployment must be tackled.
Keeping prices under control is a major concern in any economy. Some governments consider achievement of low levels of inflation as the prime macroeconomic target. There are two main forms of Inflation (details will be discussed in Unit 3 of this module).
- Demand Pull inflation Demand Pull arises where aggregate demand is greater than aggregate supply
- Cost Push inflation Cost push inflation is a consequence of increasing costs such as wages and taxes pushing prices or cost of production up.
Balance of Payments
In an open economy where there is a high level of dependency on foreign trade the authorities must maintain vigilance or attention over their foreign trade because of the consequences in other areas. One important point for observation is the annual Balance of Payments statistics. The balance of payments is a record of a countrys financial transactions with the rest of the world. In the current account it records the movements of exports and imports of both visible and invisible goods while the capital account records movements of capital in and out of the country.
Balance of trade deficit
If a deficit on current account is recorded it is evidence that there has been an excess of imports over exports of goods and services. The prime consequence of this is that there will be a fall in demand for the national currency. If there is a decline in demand for the currency the value could fall and this could lead to increases in interest rates to protect the outflow of capital, which will follow. You will study issues of interest rates and capital flight in higher classes of your study programme especially if agricultural economics is your major field of study.
Limitations of Macro Economics
- Fallacy of composition (savings are a private virtue but a public vice)
- Dependence on individual units
- Heterogeneous units (average wage in a nation)
- Aggregate variables may not importantly necessary. (A hike in national income does not mean that individual incomes have risen)
- Different effects of aggregates (Different units Ap)
- Limited application
- It ignores the contribution of individual units
- Danger of excessive generalisation from individual experience (Ex. Bank cash withdrawal)
- Statistical and conceptual difficulties