What Is Macroeconomics - Essay Example

University

Introduction: what is macroeconomics?

Macroeconomics is a branch of economics that is concerned about the economy as a whole. To understand it better, it would be necessary to understand first how the free market economy works and where macroeconomics fit and plays it role.

The law of supply and demand

In general, the economy is dictated by the law of supply and demand. This means that distribution of resources and prices of goods are allocated based on the interplay of demand and the available supply at a price where the market could agree on. Demand is simply the total quantity of products and services needed or wanted by the consumers while supply is the total goods and services that the firms could provide. The exchange of demand with goods and services is facilitated through a price. The level of the price where the demand and supply curves met or intersected is called equilibrium price or the price that is agreeable both to the seller (supply side) and buyer (demand side). When the general price of goods and services rises over a sustained period of time, inflation occurs and this is the time when government applies its macroeconomic policies to control inflation and in effect, mitigate the rise of price. When price declines over a sustained period of time, a deflation occurs.

Gross Domestic Product

The total amount of supply, aggregate output or simply the total goods and services available in a certain economy is called Gross Domestic Product or GDP. When GDP grows over a certain period of time, it is called expansions while a declining GDP growth over a certain period of time is called recession. An expansionary period is good for the economy for this is the time that businesses grows and expands where they hire more employees. This is also a good time for employees because they have more discretionary income and more money to spend creating a ripple effect in the economy causing the growth to be sustained.

Unemployment

One important aspect in macroeconomics that it is concern about is unemployment rate. Unemployment rate is the percentage of the population who would like to work but are unable to find work. Governments and economic managers always find ways to bring unemployment down as high unemployment rate would be disastrous to a given economy. When unemployment rate is high, productivity is low as fewer people will be paying taxes. It would also increase the number of people that the government has to subsidize. High unemployment rate would also bring other social problems such as high crime rate.

One of the ways to bring down if not totally eliminate unemployment rate is to have a sustained positive GDP growth where the economy is expanding. It is said that when an economy is robust, it would need more people to work in its factories, offices, or laboratories effectively staving off unemployment. When full employment is achieved, it can be said that government and its economic managers are doing its job well.

Fiscal and monetary system

As previously stated, a sustained increased in price level can be troublesome to a certain economy and that growth must be sustained. Such, economic managers of a certain economy strive to control inflation and the growth of economy through its central bank which in turn, exercises its monetary and fiscal tools to combat inflation and to stir growth in the economy or to save an economy from going into depression. Fiscal policy is the tool used by central bank to control the amount of money circulating in a given economy. Fiscal policy is often used by central banks to control inflation or when there is too much liquidity or money in circulation that causes prices to increase. Central banks exercise their fiscal control over inflation by increasing their interest rates. When interest rates are increased, cost of borrowing also increases and this has the effect of easing the quantity of money circulating in a given economy effectively controlling inflation. On the other hand, if government wants the economy to expand, it would “ease up” its interest rates to encourage borrowing as cost of money would become cheap. The regular FOMC meeting where it announces whether to increase the interest rates of banks is the classic example of how central banks exercises their fiscal control in a given economy.

Monetary policy on the other hand are the methods that government would stir growth in the economy through ripple effect. The traditional way of government’s exercising its monetary tool is to embark on ambitious infrastructure projects where the government will spend enormous amount of money creating a ripple effect in the economy. This ripple effect would create jobs and encourage local expenditure causing the economy to expand. There are also other ways of exercising monetary policy such as the bailout made by President Obama to various banks during the previous financial crisis. The President infused billions of dollars into the banks to prevent them from collapsing. While this act of the President is questioned by many, it cannot however, be denied that if the banks collapsed, the financial system would lose its credibility and also effectively collapsing.

Trade

Trade is another important aspect of an economy where macroeconomics concern itself about. Trade is exchange of goods and service between countries. Trade has existed since time immemorial and macroeconomics seeks to make trade beneficial to all parties. At present, world trade is animated by the principles of comparative advantage as espoused by David Ricardo. The principles of comparative advantage states that countries that has the natural resources and/or makes a certain product or deliver particular services in a most efficient and highest quality possible should trade its products and services where it has a comparative advantage over other countries. Since all countries have particular products and services that they are very good at, it is thought that this system would be beneficial for all.

A trade organization called World Trade Organization or WTO was created to facilitate a mutually beneficial trading for all countries. WTO is a byproduct of GATT or General Agreement on Trade and Tariff which was initiated after World War II. The idea behind the creation of WTO is to prevent the eruption of conflict brought by unfair trade. Such, when WTO was created, its member countries agreed to lower or remove trade and non-trade tariffs to facilitate a freer exchange of goods and services. Thus, globalization is born as goods and services can now freely transfer between countries as facilitated by the advances in communication technologies. Countries who do not abide by the regulations of WTO are sanctioned. Its sanction is effective as being out of WTO meant without a country to trade with which makes it very difficult if not impossible for any country to survive.

Foreign exchange

To facilitate trade, foreign exchange is established. Foreign exchange is just the dynamics of various currencies that countries use where its values is denominated in its exchange rates. And the value of money is also subject to the law of supply and demand and various dynamics in the markets and thus its price fluctuates. Macroeconomics concern itself with foreign exchange rate because it is an important component of trade. If one’s currency is highly appreciated and its economy is highly dependent on export, it would be advantageous to its economy and such, economic managers has to find ways to lower it. An export oriented economy with a highly valuated currency would mean that their products and services abroad would become expensive. And if it becomes expensive, it would not be competitive with similar products from other countries. A classic example of a country which is export oriented but with a relatively highly valuated currency is Japan. Such, Japan’s economic managers devalue their yen through deflation where cost of money is almost free to deliberately devalue the yen.

Conclusion

Macroeconomics deals with the economy as a whole. And as it deals with the economy as a whole, it has to consider a lot of variables ranging from GDP, employment, interest rates, to exchange rates. Economic managers have to do a meticulous act of balancing various macroeconomic variables to ensure that the economy remains robust where its citizens can live prosperous lives.