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What is a macro economy?

A term that you may have never heard of!

Jun 6, 2019 |
5 min read

A term that you may have heard when referring to global finances is “macro economy”, but what does this mean? Here, we’ll take a closer look at what macroeconomics involves and why it’s so important.

What is macroeconomics?

The macro economy is a term to describe a wider view of the overall economy. It is used to refer to a country or the world as a whole. It involves zooming out to look at the larger picture, asking questions such as:

  • “How many people are in employment?”
  • “What kind of employment do they have?”
  • “How rapid is the speed of economic growth?”
  • “Who benefits from the economic growth?”

In a nutshell, that is macroeconomics.

The history of the macro economy

The concept of the macro economy didn’t arise until the early part of the 20th century. Until that time, the world of economics was very similar to the field of microeconomics today. Economists only studied businesses and individuals before extending their analysis to the entire economy as a whole.

This all changed in 1929 when there was a collapse in the world economy. Economists wanted to find out why this happened. They soon discovered they couldn’t explain it simply by looking at the decisions made by individuals. Every individual had been acting to improve their own lives; so how had the economy worsened so dramatically for everybody?

It was clear that a different approach was required. Thus, macroeconomics was invented. This new science of economy didn’t rely on adding up the behavior of individuals to gain an understanding of the larger picture.

This traditional way of viewing the economy was retitled “microeconomics”. It is still in use today to look at small economic areas. However, macroeconomics looks immediately at the larger picture.

Macroeconomic policies – an overview

The study of macroeconomics involves everything you usually hear on the news. It takes into account issues such as economic growth and inequality. It also looks at recessions, depressions, unemployment and international trade.

People who study the macro economy usually directly work with policy issues. It is their role to determine the ways in which government actions could affect the overall economy. This includes not only the economics of the nation itself, but the world as a whole.

Study of macro economics is a very broad field. However, there are two key research areas which characterize this discipline. One is attempting to understand the consequences and causes of the business cycle (or short-running fluctuations in the national income).

The other is attempting to understand increases in the national income, or long-term economic growth and its determinants. By gaining these greater insights, macroeconomists are able to forecast how the economy will be affected in the future.

Those forecasts, in turn, can be used by the government to help them in developing and evaluating economic policies.

A key macroeconomic policy question is, of course, how the government should respond in the event of an economic crisis. Over the years since the macro economy was created economists everywhere have disagreed about how this question should be answered.

Debates surrounding it remain a central challenge of macroeconomics.

The concepts of the macro economy

There are several variables and concepts involved in the study of the macro economy.

However, there remain three principal areas for macro economic research. These include:

Output/income

The national output refers to the entire total of everything produced by a nation over a set time period. Everything produced by the country and sold will generate income. Income and output are generally considered to be equivalent to each other since output turns into income.

GDP or gross domestic product is the measurement of macroeconomic output. Economic output can be increased by human capital, improved education, machinery and technological advances. Recessions cause short-term output drops.

Economists who study macro economics look for policies who prevent recessions and lead to more rapid long-term growth.

Unemployment

The unemployment rate measures how many people in the country are unemployed. It doesn’t take into account anyone in education, retired, or discouraged from looking for work due to limited job prospects. There are several types of unemployment which are studied by macro economists.

These include frictional, structural, cyclical and classical unemployment.

Deflation and inflation

If prices increase economy-wide, this is called inflation. The term deflation can be used when those prices universally decrease. Price indexes can be used to measure price changes and monetary policies the aim it to try to prevent price level changes.

Macroeconomic models

There are several different macroeconomic models used by economists today.

The Aggregate Demand – Aggregate Supply (AS-AD) model

This shows price levels and output levels. This model shows that when prices are low, a higher output is required. When prices fall, demand for money decreases. The result is declining interest rates and increased borrowing.

Conversely, this model shows when prices rise, exports decline since domestic goods are expensive for overseas consumers. This model can be used to show the effect of macroeconomic policies on the country as a whole.

IS-LM

This model shows the right combination of output and interest rates to ensure balance in the money and goods markets. This model demonstrates how fiscal and monetary policies affect the economy of the nation.

Growth model

this can be used to demonstrate economic growth over the long-term. It shows how output increases are only possible when capital stock increases. Or when the population increases or when technological advances result in higher productivity.

How macroeconomics are used in practice

Usually, macroeconomic policies are implemented via two types of tools – monetary policy and fiscal policy. Both are used for stabilizing a nation’s economy. This may mean improving the economy up to the GDP level which would be consistent with the country’s full employment.

Macroeconomic policies essentially focus on limiting business cycle impacts in order to achieve three primary economic goals. These are: price stability, growth and full employment.

Although the field of the macro economy is a complex one, it is an essential one. Without it, governments would be unable to make effective financial decisions. They would also lack the information they need to prevent financial crises.  

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