What is Macroeconomics? | Top Terms in Macroeconomics
This is probably the more fascinating subject among the two branches of economics – micro and macroeconomics. This contains the global picture, a bird’s eye view and to me, has a lot more interesting aspects to think about. I would choose macro over microeconomics any day. So what’s with macroeconomics?
- What is Macroeconomics?
- Grossly Important – GDP and GNI
- Schools of Economic Thought
- Consumption (C); Investment (I); Government Spending (G) and; Net Exports (X-M)
- The Nation’s Accounts – Balance of Payments (BoP)
- Conclusion
What is Macroeconomics?
Macroeconomics is a ‘top-down’ approach and is in a way, a helicopter view of the economy as a whole. It aims at studying those aspects and phenomena which are important to the national economy and world economy at large. To mention a few of them are the country’s GDP (Gross Domestic Product) growth; inflation and inflation expectations; the government’s spending, receipts, and borrowings (fiscal policies); unemployment rates; monetary policy, etc. (also have a look at Fiscal vs Monetary Policy)
These can help understand the state of the economy, formulate policies at an influential level and conduct macroeconomic research.
John Maynard Keynes is widely regarded as a pioneer in macroeconomics. In fact, it is almost as if macroeconomics owes a lot to him. His understanding of macroeconomics so to speak was influenced by the Great Depression of the late 1920s. In the late 1930s when the Great Depression was nearing its end, Keynes came up with a piece of seminal research, ‘The General Theory of Employment, Interest and Money’ which focused on observing the depression and formulating the field of macroeconomics – the work and its offshoots are considered as Keynesian economics.
Another great macroeconomist and a Nobel Laureate, Milton Friedman also did a study on the Great Depression and debated the earlier premise Keynes – this piece and its offshoots form part of Monetary economics,
While Keynes explained the Great Depression through aggregate demand, expenditure, levels of income, government financing and rates of unemployment, Friedman explained the event through monetary stances – higher interest rates, contractionary monetary policy, a banking crisis and disinflation to deflation.
When we study macroeconomics, we must familiarize ourselves with certain ubiquitous terms and more importantly, what they mean. Once we appreciate the theory, we get a sound understanding of the global events that affect everyday life. So let’s get to it!
Top Terms in Macroeconomics
#1 – Gross Domestic Product (GDP)
This is the value in terms of money, of all the goods and services that are produced domestically (within the nation). Why is this important? The country’s actual worth is determined by its ability to produce domestically – that it makes use of the resources available within it to make widgets that people are willing to spend for. Thus it measures the level of economic activity in the country.
#2 – Gross National Product (GNP) aka Gross National Income (GNI)
This too measures the level of economic activity in a country and is very similar to GDP. The difference is that another component known as ‘Net Factor Income from Abroad’ (NFIA) is added to the value of GDP.
Factor Income is the income received from the four factors of production namely: Land, Labour, Capital, and Entrepreneurship. This factor income can be received from abroad by utilizing the factors of production and remitting incomes, paid abroad by having foreign companies utilizing the factors of production in your country or both. Netting both of them (factor income received minus factor income paid) we get NFIA.
Thus GNP is also a measure of a nation’s economic activity but GDP is more often used for different reasons.
GNP = GDP + NFIA
Demand and Supply in Macroeconomics
Where beauty lies in the eyes of the beholder
In general, there are considered to be two schools of economic thought: ‘demand-side’ and ‘supply-side’. This is very widely debated and economists generally fall into one of these categories. This is even more visible when it comes to macroeconomics than microeconomics. Here, demand and supply mean a broad range of things since both of them are aggregate by nature.
Demand-side economics which Keynes advocates try to impact real GDP by increasing aggregate demand. Measures like improving income/wage levels, stable unemployment, government spending to boost the spending abilities of the people, industry and corporate investment in capital goods and other factors.
Supply-side economics tries to impact real GDP by increasing aggregate supply. Measures like adjusting tax rates, deregulation, infrastructure support, benefitting educational levels, privatization and a number of others form part of supply-side economics.
Broadly speaking, GDP and thus GNP can be said to comprise the following four fundamental components of the aggregate demand side of economics.
Consumption (C); Investment (I); Government Spending (G) and; Net Exports (X-M)
Private consumption of goods and services forms part of Consumption (C) which is how much households expend to purchase final goods and services and not intermediate ones. Examples of final goods and services are cars, refrigerators, milk purchased by households and they’re like. Intermediate goods are those which can be used for further production or can be resold. Examples include the milk shop purchasing the milk which we consider as a final good etc. The curd we buy from the shop is a final good unless the milk made by us using the curd is meant to be sold. Thus they are distinguished based on their use and not based on the product itself.
Investments (I) include purchases of machinery, equipment, capital-intensive purchases, households’ spending on homes, etc. Buying shares of companies doesn’t form part of the above mentioned ‘investment’ nor do change hands of assets which we already have with us.
Government Spending (G) as the name suggests talks about public spending which shows itself in different forms like expenditures on the defence sector; building roads, public schools, and hospitals, etc. Although the government does spend on unemployment benefits etc. in some countries like the US these don’t count in the calculation of aggregate demand for GDP.
Net Exports (X-M) is Exports (X) minus imports (M). There’s no need for an explanation for that! Net Exports are similar to Balance of Trade (BoT) but a subtle point to note is that balance of trade includes exports and imports only of goods (goods are also known as ‘visible items’ in macroeconomics while services are known as ‘invisible items’). In the modern age, services are increasingly forming a major part of one’s economy. Have a look at how many IT companies are already there, the apps you use and whatnot.
Thus, GDP consists of all the above components. I am sure you would allow me to write it as:
GDP (Y) = C + I + G + (X-M)
Macroeconomic – Balance of Payments (BoP)
We looked at the Balance of Trade a while ago. A country also maintains its Balance of Payments (BoP). BoP is simply an overall record of the receipts and payments of a country with the other countries. Typically transactions made by consumers, corporates and the governments of one country with the others’ are recorded.
There are two types of accounts that every nation has. The ‘Current Account’ and ‘Capital Account.’ Let’s have a look at what they are:
Current Account
The Current Account (CA) of a country is a record of the monetary value of its exports and imports (goods, services, and unilateral transfers) and forms part of the BoT. When the exports are greater than its imports, its current account records a surplus and when exports are lesser than its imports, it records a deficit – quite obvious! These are generally short-term transactions. The US, UK, India and a majority of the countries in the world run a current account deficit. Japan and Germany are a few examples of nations running a current account surplus.
Just to put this in an equation’s perspective,
CA = Net Exports of goods and services + Net unilateral transfers + NFIA
Capital Account
This is a record of the monetary value of purchases of foreign assets and liabilities like sovereign debt, investments made by and into the country, corporate debt from abroad, etc. although I wouldn’t like to elaborate too much on this, the talk about Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) into countries and the building up of FX Reserves (like buying US government debt and thus, dollars) to stabilize a country’s currency falls into the capital account.
Cap A/C = Net FDI + Net FPI + Net of other Portfolio flows (debt flows etc.) + change in reserves
If you are familiar with accounts, this is like a company’s balance sheet which has an assets and liabilities side where both should tally and the difference be zero.
BoP = CA + Cap A/C
- The above should be equal to zero.
- If CA > Cap A/C the country faces a Current Account Surplus or a Capital Account Deficit
- If CA < Cap A/C the country faces a Current Account Deficit or a Capital Account Surplus
No comments:
Post a Comment