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Macroeconomics

As the term suggests, macroeconomics is the counterpart of microeconomics, addressing the large-scale, nation-wide and global economies, rather than the small business and individual level.

Macroeconomics forms the basis for national policies, administered by governments and bodies such as federal banks, as well as informing the policies of international organisations, such as the World Bank and IMF. It studies the sum total of microeconomic activities, which are summarily reduced to individual choices related to buying and selling.

Macroeconomic theory, it should be emphasised, cannot be treated independently of the microfoundations, or the set of assumptions explaining microeconomic behaviour. Taxation and relative pricing are areas of national policy which straddle both macro and micro level economics.

The indices often employed in macroeconomics include GDP/GNI, unemployment, purchasing price parity, trade balance and others. Models are developed and evolve to explain growth and the business cycle. These invlove how national income, production output, consumption, inflation, money allocation (investment and savings), trade and global finance, interdepend.

Throughout history, primarily since the advent of the industrial revolution, there have been many attempts at theorising the complexities of macroeconomics:

Keynes

John Maynard Keynes, 1883 - 1946, was an English economist, whose macroeconomics theories influenced governments' economic policies and laid the foundation for international economic cooperation. The term Keynesian economics is used to refer to the school of thought he inspired.

John Maynard Keynes
John Maynard Keynes, 1883 - 1946, English economist, and founder of the monetary policies used by capitalist governments today

Keynes rebelled against the prevailing economic ideas of the 1930s. He proposed that aggregate demand and overall economic activity, and therefore unemployment, were mutually determinant. One of his radical proposals was for the necessity of state intervention, rather than relying solely on free market forces, as a means to provide stability, and avoid cyclical boom and bust scenarios.

His response to the depression and ever-present dangers of recession were his famous fiscal and monetary policies. These were adopted by most western capitalist economy planners in the decades following the Second World War.

Keynesian Economics

General Theory of Employment, Interest and Money, 1936

John Maynard Keynes

Keynes expounds his theory of aggregate demand, and it causal association with economic activity and unemployment. The theory defines the total income of a nation as the sum of consumption and investment. to combat recession and depression, in which unemployment is high and production capacity unexploited, it is necessary to increase spending, in consumption or investment, rather than the neoclassical thinking response of austerity.

Say's Law and the ideas of David Ricardo represent the general economic thinking prior to Keynes. They state that an economy is in natural equilibrium, since consumer demand would outstrip production if the price were affordable. Keynes' General Theory tackles the underlying assumption that where a surplus of goods and services exists, the price will drop till they are all consumed.

Keynes introduced a complexer analysis of an economy. Employment was the result of imbalances in demand, and reflected the growth of the economy. Since employment was never at 100%, governments had the obligation to act, and never more so than during periods of recession and contraction of markets. Non-utilisation of savings will result in under-performance, such as in potential output and growth.

Keynes replaced the concept of general glut in supply of the classical economic model with an interpretation of aggregate demand for goods and services reflecting production levels and loss of demand due to increased unemployment as a response to falling demand. Keynes proposes a reduction in the amplitude in the business cycle by government spending, to increase economic activity and reduce unemployment and deflation.

The theory has two primary factors: monetary policy and fiscal policy.

By reducing interest rates, the cost of borrowing money is lowered, making investments more affordable. Central banks instigate steps to influence the interest rate by mechanisms which are generally referred to as monetary policy.

Fiscal policy, on the other hand, attempts to regulate net public spending through taxation levels and government investment. Government bonds (borrowing from capital markets) are an instrument which helps balance inequalities between spending and revenue. This is referred to as deficit spending.

Edmund Phelps

The American Nobel Peize-winning economist, Edmund Phelps, born 1933, is famous for his Golden Rule Savings Rate paper, published in 1961.

Edmund Phelps
Edmund Phelps, Nobel Prize winning economist

Together with Milton Friedman, Phelps challenged the Phillips Curve, which presents a relationship between inflation and unemployment, introducing the non-viability of long-term balance between inflation and unemployment. They foresaw that in certain economic conditions, such as were present during the oil crises of the 1970s, there could be both high inflation and high unemployment.

Golden Rule savings rate

The rate of savings at which ideally consumption grows at a maximum steady state level.

$sf(k) = (n + d)k$, where the per capita output is $y = f(k)$, $s$ is the savings rate, $k$ is the capital/labour ratio, $n$ is the constant exogenous population growth rate, and $d$ the constant exogenous rate of depreciation of capital.

The equation can be used to derive a relationship between $c$, the level of consumption, and the unique level of steady state per capita consumption: $c = (1 - s)f(k)$, in answer to the question of how the capital per worker, k, varies with the maximum level of consumpton in the steady state.

Content © Andrew Bone. All rights reserved. Created : October 20, 2015 Last updated :January 25, 2016

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