Macroeconomics


Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study aggregate measures of the economy, such as output or gross domestic product, national income, unemployment, inflation, consumption, saving, investment, or trade. Macroeconomics is primarily focused on questions which help to understand aggregate variables in relation to long run economic growth.
Macroeconomics and microeconomics are the two most general fields in economics. Given macroeconomists focus on large-scale phenomena, or aggregate variables, they differ significantly from microeconomists who study markets and decision making at a smaller level of analysis, such as firms or consumers. This divide is institutionalized in the field of economics given difference in both methods and outcomes of interest.
Macroeconomics is further divided into topics depending on the time frame of analysis: short-term fluctuations over the business cycle, medium-term determinants of aggregate variables like unemployment, unaffected by short term shocks, and long-term economic growth. The field also includes analysis of monetary and fiscal policies, particularly where they target stabilization of certain indicators or the rate of economic growth.
Macroeconomics as a separate field of research and study is generally recognized to start in 1936, when John Maynard Keynes published his The General Theory of Employment, Interest and Money, but intellectual predecessors are much older. Swedish economist Knut Wicksell wrote the book Interest and Prices, translated into English in 1936, is considered to be the pioneer of macroeconomics, while Keynes who introduced national income accounting and various related concepts can be said to be the founding father of macroeconomics as a formal discipline. Since World War II, various macroeconomic schools of thought like Keynesians, monetarists, new classical and new Keynesian economists have made contributions to the development of the mainstream research.

Basic concepts

Macroeconomics encompasses a variety of concepts and variables, but above all the three central macroeconomic variables are output, unemployment, and inflation. Besides, the time horizon varies for different types of macroeconomic topics, and this distinction is crucial for many research and policy debates. A further important dimension is that of an economy's openness, economic theory distinguishing sharply between closed economies and open economies.
It is usual to distinguish between three time horizons in macroeconomics, each having its own focus on e.g. the determination of output:
  • the short run : Focus is on business cycle fluctuations and changes in aggregate demand which often drive them. Stabilization policies like monetary policy or fiscal policy are relevant in this time frame
  • the medium run : Over the medium run, the economy tends to an output level determined by supply factors like the capital stock, the technology level and the labor force, and unemployment tends to revert to its structural level. These factors move slowly, so that it is a reasonable approximation to take them as given in a medium-term time scale, though labour market policies and competition policy are instruments that may influence the economy's structures and hence also the medium-run equilibrium
  • the long run : On this time scale, emphasis is on the determinants of long-run economic growth like accumulation of human and physical capital, technological innovations and demographic changes. Potential policies to influence these developments are education reforms, incentives to change saving rates or to increase R&D activities.

    Output and income

National output is the total amount of everything a country produces in a given period of time. Everything that is produced and sold generates an equal amount of income. The total net output of the economy is usually measured as GDP. Adding net factor incomes from abroad to GDP produces gross national income, which measures total income of all residents in the economy. In most countries, the difference between GDP and GNI are modest so that GDP can approximately be treated as total income of all the inhabitants as well, but in some countries, e.g. countries with very large net foreign assets, the difference may be considerable.
Advances in technology, accumulation of machinery and other capital, and better education and human capital, are all factors that lead to increased economic output over time. However, output does not always increase consistently over time. Business cycles can cause short-term drops in output called recessions. Economists look for macroeconomic policies that prevent economies from slipping into either recessions or overheating and that lead to higher productivity levels and standards of living.

Unemployment

The amount of unemployment in an economy is measured by the unemployment rate, i.e. the percentage of persons in the labor force who do not have a job, but who are actively looking for one. People who are retired, pursuing education, or discouraged from seeking work by a lack of job prospects are not part of the labor force and consequently not counted as unemployed, either.
Unemployment has a short-run cyclical component which depends on the business cycle, and a more permanent structural component, which can be loosely thought of as the average unemployment rate in an economy over extended periods, and which is often termed the natural or structural rate of unemployment.
Cyclical unemployment occurs when growth stagnates. Okun's law represents the empirical relationship between unemployment and short-run GDP growth. The original version of Okun's law states that a 3% increase in output would lead to a 1% decrease in unemployment.
The structural or natural rate of unemployment is the level of unemployment that will occur in a medium-run equilibrium, i.e. a situation with a cyclical unemployment rate of zero. There may be several reasons why there is some positive unemployment level even in a cyclically neutral situation, which all have their foundation in some kind of market failure:
  • Search unemployment occurs when workers and firms are heterogeneous and there is imperfect information, generally causing a time-consuming search and matching process when filling a job vacancy in a firm, during which the prospective worker will often be unemployed. Sectoral shifts and other reasons for a changed demand from firms for workers with particular skills and characteristics, which occur continually in a changing economy, may also cause more search unemployment because of increased mismatch.
  • Efficiency wage models are labor market models in which firms choose not to lower wages to the level where supply equals demand because the lower wages would lower employees' efficiency levels
  • Trade unions, which are important actors in the labor market in some countries, may exercise market power in order to keep wages over the market-clearing level for the benefice of their members even at the cost of some unemployment
  • Legal minimum wages may prevent the wage from falling to a market-clearing level, causing unemployment among low-skilled workers. In the case of employers having some monopsony power, however, employment effects may have the opposite sign.

    Inflation and deflation

A general price increase across the entire economy is called inflation. When prices decrease, there is deflation. Economists measure these changes in prices with price indexes. Inflation will increase when an economy becomes overheated and grows too quickly. Similarly, a declining economy can lead to decreasing inflation and even in some cases deflation.
Changes in the inflation level may be the result of several factors. Too much aggregate demand in the economy will cause an overheating, raising inflation rates via the Phillips curve because of a tight labor market leading to large wage increases which will be transmitted to increases in the price of the products of employers. Too little aggregate demand will have the opposite effect of creating more unemployment and lower wages, thereby decreasing inflation. Aggregate supply shocks will also affect inflation, e.g. the oil crises of the 1970s and the 2021–2023 global energy crisis. Changes in inflation may also impact the formation of inflation expectations, creating a self-fulfilling inflationary or deflationary spiral.
The monetarist quantity theory of money holds that changes in the price level are directly caused by changes in the money supply. Central bankers conducting monetary policy usually have as a main priority to avoid too high inflation, typically by adjusting interest rates. High inflation as well as deflation can lead to increased uncertainty and other negative consequences, in particular when the inflation is unexpected. Consequently, most central banks aim for a positive, but stable and not very high inflation level.
Whereas there is empirical evidence that there is a long-run positive correlation between the growth rate of the money stock and the rate of inflation, the quantity theory has proved unreliable in the short- and medium-run time horizon relevant to monetary policy and is abandoned as a practical guideline by most central banks today.

GDP Measurement

Equation Using Expenditure Approach

One way to capture GDP, or total net output, is the expenditure method. The expenditure approach requires aggregating four main components of spending: consumer spending government spending, investment, and net exports. CS is composed of household purchases of goods and services, including investments in residential housing. GS is spending by the government on goods and services, particularly things like education, military and other public infrastructure. While transfer payments, which includes things like welfare or social security payments are paid by the government, it is not included in the final calculation of the expenditure approach because it is not a final good or service. IS is all spending by businesses on physical capital or equipment as well as labor, in service of goods and service production. Finally net exports captures a country's balance of trade, such that the total exports are goods and services that a country sells abroad and imports are goods and services purchased by consumers domestically from abroad.
Represented as an equation, GDP is: