Introduction to Macro Economics.
Macro Economics: Meaning and Definition The words, micro economics and macro economics were coined by the economist, Ragner Frisch in 1933. Micro means small; macro means large. Macro economics studies the large aggregates of the economy. Micro economics studies the small units of the economy. Macro economics deals with aggregates like GNP, total employment, total savings and investment, general price level, etc. K.E. Boulding defines macro economics in the following words,
Scope of Macro Economics The scope of macro economics is summarised below:
1. National income: Here we study various concepts of national income, methods of measurement of national income, national income composition, etc.
2. Employment: Theory of employment and determinants of employment and unemployment are important issues in macro economics.
3. Price level: Inflation, deflation, stagnation, variations in general price level, its causes and impact form an integral part of macro economics.
4. Trade cycles: Trade cycles are fluctuations in the level of economic activity seen in the level of aggregate output, employment and price level. The study of trade cycles is an important topic in macro economics.
5. Monetary and Fiscal policies: Trade cycles, inflation and deflation can be controlled with monetary and fiscal policies. Therefore, the study of these policies forms an important part of macro economics.
6. Economic growth: Theories of economic growth and development come under the scope of macro economics.
7. International trade: International trade is trade among nations. Naturally, it is macro economic in character.
Importance of Macro Economics
- Helps to understand the functioning of the economy
- Helpful in comparisons
- Useful in planning
- Helpful in studying growth and development
- Helpful in studying economic fluctuations
- Helpful in the formulation of economic policies
Emergence of Macro Economics Emergence and popularity of macro economics can be traced back to the eminent economist, John Maynard Keynes and his famous book, ‘The General Theory of Employment, Interest and Money’ (1936). Even though the macro approach of looking at and analysing the economy as a whole existed before Keynes, it was Keynes who revolutionised macro economics. His macro approach is referred to as the Keynesian Revolution.
Before Keynes, economic thinking was dominated by classical economics. Classical economists believed in and argued for laissez-faire, which means least intervention. Economic activities should be left to market forces. The ‘invisible hand’ of market forces will ensure equilibrium and full employment. ‘Supply creates its own demand’ (J.B. Say), Therefore, the question of over production and deficiency of demand does not arise.
Classical ideas of full employment and automatic functioning of the economy were proved wrong by the Great Depression of 1930s. The Great Depression was the worst economic crisis in modern economic history. It started in the USA in 1929 and then spread to other countries. Many banks went bankrupt, leading to credit crisis and economic contraction. Unemployment shot up from 3% in 1929 to 25% in 1933. The U.S. economy contracted by 33% during this period. This Great Depression disproved most of the economic ideas of classical economists. This necessitated a new interpretation and analysis in macroeconomics. Keynes filled this gap with his great work, ‘The General Theory’. Thus, Macro Economics emerged and became popular.
Macroeconomics in Capitalist Economies It is important to note that we are dealing with macroeconomic subjects in the pattern of a capitalist economy. Vast majority of the economies of the world are capitalist. But, we cannot say that all of these will exhibit all the features of a capitalist economy.
Generally, capitalist economies are based on institutions of private property, markets, private initiative and enterprise, competition and profit motive. In capitalist economies, the Government will not play an active role in eéonomic activities. Government’s role will be regulatory in nature.
Sectors of the Economy In typical capitalist economies, bulk of goods and services are produced by private entrepreneurs or firms. They hire labour from the market and pay wages as compensation. Capital for investment is either raised by the entrepreneurs themselves or borrowed from financial institutions like banks. Capital is also raised from the capital market. The reward for using capital is interest. Land /natural resources are necessary for production. The reward for land is called rent. When the entrepreneur sells his products in the market at a price higher than his cost of production, he makes a surplus. This surplus or profit is the reward for entrepreneurship. Entrepreneurs and firms engage in economic activities motivated by profit.
Firms Entrepreneurs or firms form an important sector of the capitalist system. Entrepreneurs are catalysts of economic growth. They generate wealth, create employment, Pay taxes to the Government and thereby play a crucial role in economic growth and development.
Households The second major sector in an economy is the household sector or families. Households refer to an individual or a group of individuals whose consumption decisions are taken jointly. The major component in aggregate demand in an economy is household consumption demand. Households earn income, pay taxes, save and spend money on consumption. Households receive income as wages or salaries.
Government The other important sector in capitalist economies is the State or the Government. The State does not actively involve in economic activities, but plays a regulatory role. The Government makes laws and enforces them. Another important role of the State is the development of social and economic infrastructure.
External Sector All modern economies are open economies. Open economies have economic relations with the rest of the world. They engage in trade. Therefore, the external sector is the fourth important sector of an economy.
All these four sectors of the economy are important from the macroeconomic perspective.
A Closed Economy
A closed economy is an economy which has no economic relations with other countries of the world. In such an economy imports, exports, foreign investment, foreign borrowings and lendings do not happen.
An Open Economy
An economy which has economic relations with other countries of the world is called an open economy. In such an economy imports, exports, foreign investment, foreign borrowings and lendings will happen.