What is Macroeconomics?
Macroeconomics is the study of an overall economy — for example, of a country, a continent, or the entire world.
Macroeconomics is a branch of the social science of economics that deals with the entire economy by examining key factors such as the unemployment rate, the inflation rate, interest rates, and the gross domestic product. Macroeconomics isn’t concerned with how an individual consumer or a lone business behaves; that is microeconomics. Instead, it looks at aggregates. Macroeconomics seeks to understand the cumulative effect of the actions performed by all the consumers and businesses within an economy. Macroeconomics attempts to explain the underlying forces influencing the economy. A macroeconomic understanding of what is driving the economy can help governments, businesses, banks, and other players make better-informed decisions.
Imagine that the morning news reports that the nation’s unemployment rate is at an all-time low. The news report is an overall look at the country’s economy. The report isn’t about specific segments of the nation’s economy, such as the double-digit unemployment rates within certain industries — Rather, it’s about the overall economy. The news report is, therefore, taking a macroeconomic look at the country’s economy.
Macroeconomics is like a national weather report…
Macroeconomics analyzes the conditions affecting an entire economy just as a national weather report looks at the meteorological developments that will impact the weather across the country. Similar to the way a national weather report looks at how conditions could result in above or below average temperatures throughout the country, macroeconomics looks at how market forces are shifting at a large scale.
Macroeconomics attempts to explain business cycles and why an economy may be experiencing growth or stagnation. Macroeconomics also seeks to understand the major forces influencing the economy. Having a sense of where the economy is heading can help government policymakers, businesses, banks, and other players make better-informed decisions.
Macroeconomics gives a big picture view of the economy, which is useful for determining what is happening in the marketplace. It simply isn’t possible to understand the large-scale economic outlook by examining isolated segments of the economy.
For example, if we want to know the condition of a neighborhood, we should take into account all the properties in the area. If we were to examine only one home, we could reach the wrong conclusion. We may find that particular house neglected, rundown, and slated for foreclosure.
That home could give us the impression that the entire area is in the same condition. But the other homes may be well-maintained, and the homeowners up-to-date on their mortgage payments. As a whole, then, the neighborhood is in excellent condition. But we would only realize that after we looked at it from a macroeconomic point of view.
Modern macroeconomics dates only to the 1930s. It arose in response to the Great Depression. The microeconomic methods that economists were previously using were ineffective in explaining why the world’s largest economies had tumbled.
Microeconomics looks at small aspects of an economy. But the Great Depression didn’t affect one or two parts of the country’s market but the entire thing. Economists needed a new way of analyzing an overall economy.
Norwegian economist Ragnar Frisch was the first to use the term macroeconomics in print in 1933. But it’s British economist John Maynard Keynes whose work and ideas in the 1930s popularized the use of macroeconomics to explain what happens on a large scale. Keynes rose to prominence — his book The General Theory of Employment, Interest and Money was published in 1936 — as the first of the great macroeconomists, with his theories on what caused the Great Depression and what could end it.
Macroeconomics studies an entire economy while microeconomics looks at only a portion of that economy. For example, macroeconomists track the amount of products produced by all of the industries within a national economy. In contrast, microeconomists might examine only the output of a particular company or industry.
Macroeconomics is valuable for investigating any number of significant aggregates that influence an economy. A few of the areas of macroeconomic research include the following:
The flow of goods and services between nations can contribute to the prosperity or decline of a national economy.
Macroeconomics can shed light on whether regulation of specific industries hampers economic growth or strengthens the economy by promoting safer working conditions and healthier environments.
Macroeconomics can track the progress and struggles of groups of people historically subjected to discrimination in the workplace. As these groups achieve more active roles in the economy, the overall economy tends to improve.
The condition of the labor market is a crucial determinant of the state of the economy.
How and where a government chooses to spend its money can affect the state of the economy. For example, the United States spent a fortune on public works programs in the 1930s to attempt to steer the country out of the Great Depression.
Renewable energy and climatic change are now household topics. Macroeconomics can show the impact that environmentally-friendly policies and investments are having throughout the economy.
There has never been a consensus among the world’s economists concerning how best to run an economy. Opinions vary widely across time, space, and the political spectrum. But here are a few of the better-known schools of macroeconomic theory that you’re likely to encounter:
Keynesian economics receives its name from British economist John Maynard Keynes. It proved to be an accurate way to explain the Great Depression and its lingering effects. In part, according to the theory, countries were to blame for not introducing economic policies that would jumpstart their economies.
Keynes promoted the idea that in a free market, government spending is necessary to stabilize a faltering economy. He taught that a strictly hands-off approach was dangerous because markets aren’t always capable of recovering from freefalls quickly enough to prevent severe damage to workers and businesses.
Monetarism owes its existence primarily to the work of economist Milton Friedman. Monetarism places great importance on a nation’s money supply and having the proper amount of money in circulation. Monetarists believe that the government should relax or restrict the flow of currency to regulate the growth of the economy. For example, in the late 2000s, the U.S. put additional money into circulation in an attempt to energize a slow economy.
Classical thinkers agree with economist and philosopher Adam Smith, who trusted the financial market to achieve general equilibrium without help from the government. Classical economists don’t like governmental economic programs, but their macroeconomic theory does allow for occasional and limited influence.
A group of prominent economists in Austria created what became known as Austrian economic theory. Its followers believe in a laissez-faire approach. They think that the economic system should operate without any government interference even during a financial crisis.
The Marxian school of economics maintains that a financial system must be under the strict control of the government. Marxians believe that a centralized authority will better protect the rights of the working class than will capitalist business owners.
Behavioral economists don’t usually promote macroeconomic policies but rather investigate the decision-making processes of the players in an economy. Behaviorists want to know why, for example, well-informed investors can still make irrational choices.
Macroeconomics deals with the entire economy, not with individual players in the marketplace. Therefore, macroeconomics isn’t necessarily useful when trying to understand the actions of a particular consumer, investor, or business.
Macroeconomics is concerned with national income rather than individual income, so it can fail to reveal troubling aspects of financial markets such as income inequality. For example, a nation’s economy may appear to be thriving, but yet, a considerable portion of its citizenship remains in poverty. The apparent success of the country’s economy may be the result of the earnings of only a small segment of the population.
Another limitation of modern macroeconomics is its inability to foresee future economic activity consistently. Economists often rely upon digital macroeconomic models to predict the direction the economy will take. But it’s challenging to program accurate macroeconomic computer models that reflect real-world circumstances because there are too many constantly shifting variables.
It’s essential to keep in mind that macroeconomics is a social science, not a hard science such as chemistry. In chemistry, you can be confident that mixing solutions A and B will always give you the mixture C. In contrast, social sciences are not as assured. No one can say with complete assurance that the combination of economic conditions A and B will always result in C. There are too many factors in the marketplace for mathematical certainty.
As a result, noteworthy events can occur of which macroeconomics fails to predict, such as the Great Recession from 2007 to 2009.
A well-known quote by psychologist, writer, and educator Laurence J. Peter sums up the limitations of macroeconomics: “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”
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