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What Is Macroeconomics?
- Macro vs. Microeconomics
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Macroeconomics Definition, History, and Schools of Thought
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Macroeconomics is a branch of economics that studies how an overall economy—the markets, businesses, consumers, and governments—behave. Macroeconomics examines economy-wide phenomena such as inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment.
Some of the key questions addressed by macroeconomics include: What causes unemployment? What causes inflation? What creates or stimulates economic growth? Macroeconomics attempts to measure how well an economy is performing, understand what forces drive it, and project how performance can improve.
- Macroeconomics is the branch of economics that deals with the structure, performance, behavior, and decision-making of the whole, or aggregate, economy.
- The two main areas of macroeconomic research are long-term economic growth and shorter-term business cycles.
- Macroeconomics in its modern form is often defined as starting with John Maynard Keynes and his theories about market behavior and governmental policies in the 1930s; several schools of thought have developed since.
- In contrast to macroeconomics, microeconomics is more focused on the influences on and choices made by individual actors in the economy (people, companies, industries, etc.).
Investopedia / Julie Bang
As the term implies, macroeconomics is a field of study that analyzes an economy through a wide lens. This includes looking at variables like unemployment, GDP, and inflation . In addition, macroeconomists develop models explaining the relationships between these factors.
These models, and the forecasts they produce, are used by government entities to aid in constructing and evaluating economic, monetary, and fiscal policy. Businesses use the models to set strategies in domestic and global markets, and investors use them to predict and plan for movements in various asset classes.
Properly applied, economic theories can illuminate how economies function and the long-term consequences of particular policies and decisions. Macroeconomic theory can also help individual businesses and investors make better decisions through a more thorough understanding of the effects of broad economic trends and policies on their own industries.
History of Macroeconomics
While the term "macroeconomics" is not all that old (going back to the 1940s), many of macroeconomics's core concepts have been the study focus for much longer. Topics like unemployment, prices, growth, and trade have concerned economists since the beginning of the discipline in the 1700s. Elements of earlier work from Adam Smith and John Stuart Mill addressed issues that would now be recognized as the domain of macroeconomics.
In its modern form, macroeconomics is often defined as starting with John Maynard Keynes and his book The General Theory of Employment, Interest, and Money in 1936. Keynes explained the fallout from the Great Depression when goods remained unsold, and workers were unemployed.
Throughout the 20th century, Keynesian economics, as Keynes' theories became known, diverged into several other schools of thought.
Before the popularization of Keynes' theories, economists did not generally differentiate between micro- and macroeconomics. The same microeconomic laws of supply and demand that operate in individual goods markets were understood to interact between individual markets to bring the economy into a general equilibrium , as described by Leon Walras .
The link between goods markets and large-scale financial variables such as price levels and interest rates was explained through the unique role that money plays in the economy as a medium of exchange by economists such as Knut Wicksell, Irving Fisher, and Ludwig von Mises.
Macroeconomics vs. Microeconomics
Macroeconomics differs from microeconomics , which focuses on smaller factors that affect choices made by individuals and companies. Factors studied in both microeconomics and macroeconomics typically influence one another.
A key distinction between micro- and macroeconomics is that macroeconomic aggregates can sometimes behave in very different ways or even the opposite of similar microeconomic variables. For example, Keynes referenced the so-called Paradox of Thrift, which argues that individuals save money to build wealth (micro). However, when everyone tries to increase their savings at once, it can contribute to a slowdown in the economy and less wealth in the aggregate (macro). This is because there would be a reduction in spending, affecting business revenues and lowering worker pay.
Meanwhile, microeconomics looks at economic tendencies, or what can happen when individuals make certain choices. Individuals are typically classified into subgroups, such as buyers, sellers , and business owners. These actors interact with each other according to the laws of supply and demand for resources, using money and interest rates as pricing mechanisms for coordination.
Limits of Macroeconomics
It is also important to understand the limitations of economic theory. Theories are often created in a vacuum and lack specific real-world details like taxation, regulation, and transaction costs. The real world is also decidedly complicated and includes matters of social preference and conscience that do not lend themselves to mathematical analysis.
It is common in economics to find the phrase ceterus paribus , loosely translated as "all else being equal," in economic theories and discussions. This is because there are so many variables that economists use this phrase as an assumption to focus on the relationships between the variables being discussed.
Even with the limits of economic theory, it is important and worthwhile to follow significant macroeconomic indicators like GDP, inflation, and unemployment. This is because the performance of companies, and by extension their stocks, is significantly influenced by the economic conditions in which the companies operate.
Likewise, it can be invaluable to understand which theories are in favor and influencing a particular government administration. The underlying economic principles of a government will say much about how that government will approach taxation, regulation, government spending, and similar policies. By better understanding economics and the ramifications of economic decisions, investors can get at least a glimpse of the probable future and act accordingly with confidence.
Macroeconomic Schools of Thought
The field of macroeconomics is organized into many different schools of thought, with differing views on how the markets and their participants operate.
Classical economists held that prices, wages, and rates are flexible and markets tend to clear unless prevented from doing so by government policy, building on Adam Smith's original theories. The term “classical economists” is not actually a school of macroeconomic thought but a label applied first by Karl Marx and later by Keynes to denote previous economic thinkers with whom they respectively disagreed.
Keynesian economics was founded mainly based on the works of John Maynard Keynes and was the beginning of macroeconomics as a separate area of study from microeconomics. Keynesians focus on aggregate demand as the principal factor in issues like unemployment and the business cycle.
Keynesian economists believe that the business cycle can be managed by active government intervention through fiscal policy, where governments spend more in recessions to stimulate demand or spend less in expansions to decrease it. They also believe in monetary policy, where a central bank stimulates lending with lower rates or restricts it with higher ones.
Keynesian economists also believe that certain rigidities in the system, particularly sticky prices , prevent the proper clearing of supply and demand.
The Monetarist school is a branch of Keynesian economics credited mainly to the works of Milton Friedman. Working within and extending Keynesian models, Monetarists argue that monetary policy is generally a more effective and desirable policy tool to manage aggregate demand than fiscal policy. However, monetarists also acknowledge limits to monetary policy that make fine-tuning the economy ill-advised and instead tend to prefer adherence to policy rules that promote stable inflation rates.
The New Classical school, along with the New Keynesians, is mainly built on integrating microeconomic foundations into macroeconomics to resolve the glaring theoretical contradictions between the two subjects.
The New Classical school emphasizes the importance of microeconomics and models based on that behavior. New Classical economists assume that all agents try to maximize their utility and have rational expectations , which they incorporate into macroeconomic models. New Classical economists believe that unemployment is largely voluntary and that discretionary fiscal policy destabilizes, while inflation can be controlled with monetary policy.
The New Keynesian school also attempts to add microeconomic foundations to traditional Keynesian economic theories. While New Keynesians accept that households and firms operate based on rational expectations, they still maintain that there are a variety of market failures, including sticky prices and wages. Because of this "stickiness," the government can improve macroeconomic conditions through fiscal and monetary policy.
The Austrian Schoo l is an older school of economics that is seeing some resurgence in popularity. Austrian economic theories mainly apply to microeconomic phenomena. However, they, like the so-called classical economists, never strictly separated micro- and macroeconomics.
Austrian theories also have important implications for what is otherwise considered macroeconomic subjects. In particular, the Austrian business cycle theory explains broadly synchronized (macroeconomic) swings in economic activity across markets due to monetary policy and the role that money and banking play in linking (microeconomic) markets to each other and across time.
Macroeconomics is a rather broad field, but two specific research areas represent this discipline. The first area is the factors that determine long-term economic growth , or increases in the national income. The other involves the causes and consequences of short-term fluctuations in national income and employment, also known as the business cycle .
Economic growth refers to an increase in aggregate production in an economy. Macroeconomists try to understand the factors that either promote or retard economic growth to support economic policies that will support development, progress, and rising living standards.
Economists can use many indicators to measure economic performance. These indicators fall into 10 categories:
- Gross Domestic Product indicators : Measure how much the economy produces
- Consumer Spending indicators : Measure how much capital consumers feed back into the economy
- Income and Savings indicators : Measures how much consumers make and save
- Industry Performance indicators : Measures GDP by industry
- International Trade and Investment indicators : Indicates the balance of payments between trade partners, how much is traded, and how much is invested internationally
- Prices and Inflation indicators : Indicate fluctuations in prices paid for goods and services and changes in currency purchasing power
- Investment in Fixed Assets indicators : Indicate how much capital is tied up in fixed assets
- Employment indicators : Shows employment by industry, state, county, and other areas
- Government indicators : Shows how much the government spends and receives
- Special indicators : All other economic indicators, such as distribution of personal income, global value chains, healthcare spending, small business well-being, and more
The Business Cycle
Superimposed over long-term macroeconomic growth trends, the levels and rates of change of significant macroeconomic variables such as employment and national output go through fluctuations. These fluctuations are called expansions, peaks, recessions, and troughs—they also occur in that order. When charted on a graph, these fluctuations show that businesses perform in cycles; thus, it is called the business cycle.
The National Bureau of Economic Research (NBER) measures the business cycle, which uses GDP and Gross National Income to date the cycle. The NBER is also the agency that declares the beginning and end of recessions and expansions.
Because macroeconomics is such a broad area, positively influencing the economy is challenging and takes much longer than changing the individual behaviors within microeconomics. Therefore, economies need to have an entity dedicated to researching and identifying techniques that can influence large-scale changes.
In the U.S., the Federal Reserve is the central bank with a mandate of promoting maximum employment and price stability. These two factors have been identified as essential to positively influencing change at the macroeconomic level.
To influence change, the Fed implements monetary policy through tools it has developed over the years, which work to affect its dual mandates. It has the following tools it can use:
- Federal Funds Rate Range : A target range set by the Fed that guides interest rates on overnight lending between depository institutions to boost short-term borrowing
- Open Market Operations : Purchase and sell securities on the open market to change the supply of reserves
- Discount Window and Rate : Lending to depository institutions to help banks manage liquidity
- Reserve Requirements : Maintaining a reserve to help banks maintain liquidity—reduced to 0% in 2020
- Interest on Reserve Balances : Encourages banks to hold reserves for liquidity and pays them interest for doing so
- Overnight Repurchase Agreement Facility : A supplementary tool used to help control the federal funds rate by selling securities and repurchasing them the next day at a more favorable rate
- Term Deposit Facility : Reserve deposits with a term, used to drain reserves from the banking system
- Central Bank Liquidity Swaps : Established swap lines for central banks from select countries to improve liquidity conditions in the U.S. and participating countries' central banks
- Foreign and International Monetary Authorities Repo Facility : A facility for institutions to enter repurchase agreements with the Fed to act as a backstop for liquidity
- Standing Overnight Repurchase Agreement Facility : A facility to encourage or discourage borrowing above a set rate, which helps to control the effective federal funds rate.
The Fed continuously updates the tools it uses to influence the economy, so it has a list of 14 other previously used tools it can implement again if needed.
What Is Macroeconomics in Economics?
Macroeconomics is the field of study of the way a overall economy behaves.
What are the 3 Major Concerns of Macroeconomics?
Three major macroeconomic concerns are the unemployment level, inflation, and economic growth.
Why Is Macroeconics Important?
Macroeconomics helps a government evaluate how an economy is performing and decide on actions it can take to increase or slow growth.
Macroeconomics is a field of study used to evaluate performance and develop actions that can positively affect an economy. Economists work to understand how specific factors and actions affect output, input, spending, consumption, inflation, and employment.
The study of economics began long ago, but the field didn't start evolving into its current form until the 1700s. Macroeconomics now plays a large part in government and business decision-making.
Bureau of Economic Analysis. " Data by Topic ."
National Bureau of Economic Research. " US Business Cycle Expansions and Contractions ."
Board of Governors of the Federal Reserve. " Policy Tools ."
Board of Governors of the Federal Reserve System. " Policy Tools | Expired Tools ."
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Macroeconomics – Notes and Essays
Main topics in macroeconomics
- Policies to reduce current account deficit
- Policies to reduce budget deficit
- Causes of Boom and Bust Cycles
- Policies to increase economic growth
- Theories of economic growth
- Environmental economics
- Fiscal policy
- Effect of an appreciation
- Effect of devaluation
- European Union
- Monetary policy
- Policies to reduce inflation
- International trade
- Supply-side policies
- Policies to reduce unemployment
- Saving Ratio
- Macroeconomic objectives and conflicts
- Classical vs Keynesian
- Real Business Cycle
- Austrian economics
Macro Graphs and data
- Economic growth
- Current account b of p
UK economic periods
- 1940s and 1950s – Austerity, rationing, war debt, but full employment, the new welfare state and rising living standards.
- 1960s – The ‘You’ve never had it so good era’ starts to unwind .
- 1970s – The Era of Discontent . Strikes, 3 day weeks, inflation, boom and bust. The 70s had everything except stability
- 1980s – Boom and Bust economy – The UK economy in the 1980s
- Late 1980s – The Lawson Boom . Rapid growth, inflation and recession
- 1990s – Recession and great stability – Recovering from the recession and leaving ERM
- The economics of the 2000s – from stability to financial crisis
- 1992-2007 – The great moderation – a period of economic growth between 1992 and 2007
- 2010-16 – The austerity years – The economic record of Cameron and Osborne.
- Great Depression of 1929-37
- UK recession of 1981
- UK recession of 1991-92
- UK recession of 2008-2013
- UK devaluation of 1967
- Leaving the ERM in 1992
- Brexit devaluation 2016
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Macro Economic Essays
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- Discuss whether the primary macroeconomic target of the govt should be low inflation? “The govt has given the MPC an inflation target of CPI 2.% +/-1. Therefore Monetary policy will be designed in order to achieve this goal…”
- inflation “Inflation occurs when there is a continuous increase in the general price level as measured by the RPIX. There are various explanations for this..”
- What determines the Natural Rate of Unemployment “The natural or (equilibrium) level of unemployment is determined by calculating the level of unemployment when the labour market is in equilibrium.”
- What Changes the Natural Rate of Unemployment “The Natural rate is mainly composed of frictional and structural unemployment, therefore, factors that affect these types of unemployment will alter the natural rate.”
- Should Government Seek to Increase the Rate of Economic Growth? Arguments for and against increasing the rate of economic growth
- Government Intervention in the Macro Economy
- AS Macro Economic Essays
Essays on Inequality / Poverty
- Minimum Wage in the UK
- Distribution of Income in the UK
- Policies to Reduce Inequality
- Causes of Poverty
- Tax System in the UK
- Definitions of Investment
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Critical Essay on Modern Macroeconomic Theory
by Frank Hahn and Robert M. Solow
208 pp. , 6 x 9 in ,
- Published: August 21, 1997
- Publisher: The MIT Press
- Rights: not for sale in Europe or the UK Commonwealth, except Canada
- Published: December 8, 1995
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Macroeconomics began as the study of large-scale economic pathologies such as prolonged depression, mass unemployment, and persistent inflation. In the early 1980s, rational expectations and new classical economics dominated macroeconomic theory, with the result that such pathologies can hardly be discussed within the vocabulary of the theory. This essay evolved from the authors' profound disagreement with that trend. It demonstrates not only how the new classical view got macroeconomics wrong, but alsohow to go about doing macroeconomics the right way. Hahn and Solow argue that what was originally offered as a normative model based on perfect foresight and universal perfect competition—useful for predicting what an ideal, omniscient planner should do—has been almost casually transformed into a model for interpreting real macroeconomic behavior, leading to Panglossian economics that does not reflect actual experience. Following an explanation of microeconomic foundations, chapters introduce the basic elements for a better macro model. The model is simple, but combined with the appropriate model of the labor market it can say useful things about the fluctuation of employment, the correlation between wages and employment, and the role for corrective monetary policy.
Frank Hahn, one of Britain's most eminent economists, is Professor of Economics at Cambridge University and author of Equilibrium and Macroeconomics (MIT Press 1985).
Robert M. Solow is Institute Professor of Economics.
Like the great debate between Einstein and Bohr on quantum physics,the debate between Hahn-Solow and Lucas's rational expectationismis a must for all serious students of macro. This is how scientificprogress should be done—by sober analysis rather than cleverrhetoric or frenzied ideology. Paul A. Samuelson, Professor of Economics, M.I.T.
Professors Hahn and Solow pick up the simple general equilibrium models of new classical macroeconomics and run with them. Of course, they head off in directions that are theirs alone. Critics of these models, and enthusiasts, will want to read this book and see how far they get. Paul M. Romer, Professor of Economics, University of Californiaat Berkeley
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2014 Theses Doctoral
Essays on Macroeconomics
This dissertation is a collection of three essays on macroeconomics, examining the sources of business cycles. In particular, we are interested in understanding how shocks propagate over the business cycle in both closed economy and open economy settings. The common approach we take in these chapters is to use both theory and data in a structural estimation based on a dynamic stochastic general equilibrium model. In the first chapter, motivated by the correlation of business cycles across countries, we provide a new empirical evidence about the role of common shocks in business cycles for small open economies. Specifically, we conduct a structural estimation of a small open economy real business cycle model featuring a realistic debt adjustment cost and common shocks. Using a novel dataset for 17 small developed and developing countries between 1900 and 2006, we find that common shocks are a primary source of business cycles, explaining nearly 50% of the output fluctuations over the last 100 years in small open economies. The estimated common shocks capture important historical episodes such as the Great depression, the two World Wars and the two oil price shocks. Moreover, these common shocks are important for not only small developed countries but also developing countries. We point out the importance of our structural approach in identifying the sizable role of both productivity and other common shocks such as interest rate premium shocks. The reduced form dynamic factor model approach in the previous literature, which often assumes one type of common component, would predict only a third of the contribution estimated in the structural model. In the second chapter, we focus on the transmission from one country to another through international trade. First, we argue that while we observe substantial business cycle correlation across countries, especially among developed economies, most existing models are not able to generate strong transmission of shocks endogenously through international trade. In the framework of structural model, we show that the nature of such transmission depends fundamentally on the features determining the responsiveness of labor supply and labor demand to international relative prices. We augment a standard international macroeconomic model to incorporate three key features: a weak short run wealth effect on labor supply, variable capital utilization, and imported intermediate inputs for production. This model can generate large and significant endogenous transmission of technology shocks through international trade. We demonstrate this by estimating the model using data for Canada and the United States with quasi-Bayesian methods. We find that this model can account for the substantial transmission of permanent U.S. technology shocks to Canadian aggregate variables such as output and hours documented in a structural vector autoregression. Transmission through international trade is found to explain the majority of the business cycle comovement between the United States and Canada while exogenous correlation of technology shocks is not important. In the third chapter, we turn to the sources of business cycles in a closed economy setting and analyzes the effects of news shocks, which are found to be an important driver of business cycles in the U.S. in the recent literature. The innovation of this chapter is that we use data on expectations to inform us about the role of news shocks. This approach exploits the fact that news shocks cause agents to adjust their expectations about the future even when current fundamentals are not affected, therefore, data on expectations are particularly informative about the role of news shocks. Using data on expectations, we estimate a dynamic, stochastic, general equilibrium model that incorporates news shocks for the U.S. between 1955Q1 and 2006Q4. We find that the contribution of news shocks to output is about half of that estimated without data on expectations. The precision of the estimated role of news shocks also greatly improves when data on expectations are used. Moreover, the contribution of news shocks to explaining short run fluctuations is negligible. These results arise because data on expectations show that changes in expectations are not large and do not resemble actual movements of output. Therefore, news shocks cannot be the main driver of business cycles.
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Macroeconomics Essay Guide: Writing Tips and Topic Ideas
Best topics for your macroeconomics essay.
In today's world, macroeconomics is a rather interesting field to study. If it's one of your majors, you are probably required to write macroeconomics essays quite often. But even if you truly like this subject and are genuinely motivated to research it, you won't be able to write a paper in one night.
Economies of different countries are complicated and quite unstable, which means you always need much time to research a particular issue. Another thing you always need is the ability to analyze and think critically. Your professors will expect you to submit a clearly organized essay that depending on its type, uncovers all the sides of the topic, gives answers to all questions or suggests solutions to common problems.
When it's time to write your essay and earn a high grade, you will want to demonstrate the best of you - your understanding of the topic and the whole course, your analytical skills, and your personal opinions. Your professors may expect to see not only that you have absorbed all the information you were given in class but also that you are able to apply the knowledge in an individual assignment and later - in real life. If that's what you want to show them, you will need a good topic for a start.
What Does a Good Topic Mean?
First of all, good means interesting; not only for you but also for your professor. You may doubt that he or she actually cares, but the fact is there's really a great number of papers professors have to grade, especially by the end of a term. You may choose a simple topic, which doesn't spark much interest, do a great job researching it, and even organize the piece of writing properly. But the impression will be poor because the topic is too boring or have been already discussed multiple times. So, keep your professor's interest in mind, as he or she is your first (and maybe the only) reader.
Furthermore, if you aim at getting a high grade, you need to check if there is enough information about the issue you are going to discuss before you actually start doing it. Don't go for a minor problem or a question that already has an answer. To tell the truth, if you really want to write about a common subject that has been resolved, you can do that, but you'd better try to look at the problem from a new perspective. Who knows, you may find a new solution.
There are some good sources of inspiration you can easily find: Wall Street Journal, online periodical issues on economics, the news, etc. Phdify.com has also gathered some good macroeconomics topic ideas for you to get inspired. These are more general, but you can always add a real personal angle to the one you choose.
Interesting Macroeconomics Essay Topics
- Why and how have credit cards become so popular?
- What is the reason Walmart offers low wages and how does it influence the country's economy?
- How does the war affect the economy?
- How does franchising affect the economy?
- What makes the rich so influential for the economy?
- What does economic growth mean? Analyze how the economic situation in the country would look in times of economic growth.
- What does contribute to economic growth in the long run?
- Define inflation and its effects on a country.
- Exchange rates: What are the effects and consequences of a falling Dollar in the world, especially in the third world countries?
- Should the US government aim at ensuring all citizens are employed?
- What were the causes and effects of Wall Street Crash in 1929?
- Should the USA consider China as a threat?
- The effects of marijuana legalization on both local and overall US economies.
- Is freelancing good for the economy? Does the country need to create better conditions for freelancers?
- Why do some countries remain poor, while others develop fast?
If you still haven't found a topic you like, you can address our experts at phdify.com for advice on a macroeconomics essay. We can help you with the whole paper or only some part of it; we can help you find a topic basing on your individual requirements; we can help you with formatting and grammar. Also, you are welcome to check out our sample essays on macroeconomics and on a huge variety of other disciplines.
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Essay on Microeconomics and Macroeconomics
In this essay we will discuss about Microeconomics and Macroeconomics. After reading this essay you will learn about: 1. Meaning of Microeconomics 2. Scope of Microeconomics 3. Limitations of Microeconomics 4. Importance of Microeconomics 5. Problems of Interrelation and Integration of Micro and Macroeconomics 6. Meaning of Macroeconomics 7. Scope and Importance of Macroeconomics 8. Limitations of Macroeconomics.
- Essay on the Limitations of Macroeconomics
Essay # 1. Meaning of Microeconomics:
Microeconomics is the study of the economic actions of individuals and small groups of individuals. This includes “the study of particular firms, particular households, individual prices, wages, income, individual industries, and particular commodities.”
It concerns itself with the analysis of price determination and the allocation of resources to specific uses. The determination of equilibrium output of the firm or industry, the wage of a particular type of labour, the price of a particular commodity like rice, tea, or car are some of the fields of microeconomic theory.
In the words of Ackley:
“Microeconomics deals with the division of total output among industries, products and firms and the allocations of resources among competing groups. It considers problems of income distribution. Its interest is in relative prices of particular goods and services.”
Microeconomics is, in fact, a microscopic study of the economy, according to Maurice Dobb. It is like looking at the economy through a microscope to find out the working of markets for individual commodities and the behaviour of individual consumers and producers.
In other words, in microeconomics we study the interrelationships of individual households and individual firms, and individual firms and individual industries to each other. In this sense, microeconomics involves the study of aggregates.
Essay # 2. Scope of Microeconomics :
“Price and value theory, the theory of the household, the firm and the industry, most production and welfare theory are of the microeconomic variety,”
Thus, microeconomics studies:
(i) How resources are allocated to the production of particular goods and services,
(ii) How the goods and services are distributed among the people, and
(iii) How efficiently they are distributed.
While studying the conditions in which the price of a particular good is determined, microeconomics assumes the total quantity of resources as given and seeks to explain their allocation to the production of that commodity.
The allocation of resources to a particular good depends upon the prices of other goods and the prices of factors producing them. It is, therefore, the relative prices of goods and services that determine the allocation of resources.
In other words, other things being equal, it is the allocation of resources that determines what to produce, how to produce, and how much to produce. This decision, in turn, depends upon the relative prices of goods and services. Thus, microeconomics is the study of price theory: how the price of a particular commodity like rice, tea, milk, fans, scooters, etc. is determined; how the wages of a particular type of labour, interest on a particular type of capital asset, rent on a particular land and profits of a particular entrepreneur are determined; and how efficiently the various resources are allocated to individual consumers and producers.
We briefly study these problems below.
In microeconomics the analysis of price determination and allocation of resources is studied in three different stages:
(i) The equilibrium of individual consumers and producers,
(ii) The equilibrium of a single market, and
(iii) The simultaneous equilibrium of all markets. Individual consumers and producers are unable to influence the prices of goods they buy and sell. A consumer is faced with given prices and he buys that much of the commodity which maximises his utility.
For an individual producer, input and output prices are given and he produces that much of the product which maximises his profits. In the market, the price and quantity bought and sold are determined by the actions of buyers and sellers. The aggregate demand and supply curves are derived from individual demand and supply curves.
The equality of aggregate demand and supply curves determines the price and the quantity bought and sold in the market. It applies both to product and factor markets. By relaxing some of the assumptions of the perfectly competitive market, this analysis is extended to monopoly, oligopoly and monopolistic, competition markets.
Finally, in microeconomics, the interrelations between the different markets are taken so as to determine all prices simultaneously.
Though, it is generally said that microeconomics is related to partial equilibrium analysis which is the study of the equilibrium position of an individual, a firm, an industry or group of industries, yet it is also a study of their interrelationships and interdependences within the economy which falls under the general equilibrium analysis.
First, there is the consumers market in which the quantity of each commodity demanded depends not only on its own price but also on the price of every other commodity available in the market. In this market, consumers meet producers to buy commodities which the former demand and the latter sell.
The demand of consumers for the various commodities depends upon their prices and the prices of the services which they offer. In other words, a consumer earns by selling the productive services he owns and creates demands for commodities.
The price at which a commodity sells depends upon its costs of production. The costs of production, in turn, depend on the quantities of the various productive services employed and the prices paid for them. Thus the supply of commodities in the market depends on the costs of the firms, and the prices and quantities of the various productive services used by them.
Secondly, there is the producers market or factor market. In this market, the demand for productive services (factors of production) comes from the producers, and supply from the consumers. The quantity of a service (factor) used in producing a commodity depends on the relationship between the prices of that service and other services, and on the prices of commodities.
Here producers meet labourers, capitalists, landlords and other resource-owners. In this market, money incomes are earned by resource-owners who own and sell their resources, the majority of whom are consumers. Thus microeconomics is a study of interacting units of consumers, producers, and resource-owners.
In this system, all prices are relative to one another. A change in any one price establishes a ripple which touches both product and factor markets. The interrelation between product and factor markets through prices is shown in Figure 1.
In this system, consumers and firms are linked through the product market where goods and services are bought and sold. They are also linked through the factor market where the factors of production are bought and sold. In the inner circle that consumers who are resource-owners sell productive resources in the factor market which are used by firms.
Great Depression Vs. Great Recession
Both the Great Depression and the Great Recession were major events that have occurred in the United States economy that have had lasting effects on the country and other countries around the world. But these events were necessarily good ones. They were two of the greatest crises in American economic history. The Great Depression was first, occurring from 1929 to1939. The Great Recession happened many decades in the future, starting in late 2007 and ending in early 2010. Comparison of […]
Great Depression: what Happened, Causes, how it Ended
During the 1930s. America went through one of the worst economic declines in world history, The Great Depression. Many believe it was sole because of the stock market crash, however other factors played a huge role in causing the Great Depression to occur. Bank failures, the Smoot-Hawley Tariff in the 1930s, and weather conditions from the Dust Bowl all played a critical factor in influencing this economic depression within America. Throughout America's history, much examination has been placed in the […]
Why was Herbert Hoover Blamed for the Great Depression?
President Herbert Hoover is often blamed for the great depression for many reasons, he had ideas put into place that were meant to aid the problems in the economy but hurt it instead. Pro-labour policies made by President Hoover after the stock market crash of 1929 caused the majority of the nation's gross domestic product to decline over the next two years. This made what could have been a bad recession turn into the Great Depression. There were many reasons […]
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The gross domestic product (GDP) is the measure of goods and services produced in a country during a year (Boone 2016). When GDP is increasing, the economy is in expansion mode. When GDP is decreasing, the economy is in a recession. Economic growth occurs when the GDP increases over time. When economists use the term "economic growth," they are normally referring to sustained increases that occur over a substantial time period, rather than the quarterly changes often discussed in the […]
What was the Great Depression and why did it Start in the USA
There are many significant events that have shaped America’s history. Some were infamous, some scandalous and some we choose to overlook..According to the PBS film “The Great Depression”, The Great Depression was one of the most traumatic and gut wrenching event throughout history. This film outline the events leading up to the great depression and highlights some of the significant events during this time period. The Great Depression was an economic downturn that began in 1929 while president Herbert Hoover […]
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Impact of Foreign Direct Investment on Economic Growth in Afghanistan
Our study includes four variables GDP which is the dependant variable, whilst the independent variables are FDI, export (EX) and official development assistance (ODA). The following table (4.1) unfolds the descriptive statistics for all those variables; it shows the Mean, Median, Maximum, Minimum and Standard Deviation. We can note that the mean of the GDP is equal 8.7512 USD with the standard deviation equal 1.1753 USD therefore the mean of FDI is equal 18.8318 USD with standard deviation 1.6227 USD […]
How could the Great Depression been Pre Tive
The Great Depression started in 1929 and lasted through 1939, where over a short period of time drastic changes occurred not just to the United States but also other countries that were involved in the United Nations. Even though the economy suffered, unemployment increased and the stock market fell this could have been prevented looking back at it now. The start of the Depression was caused by the engagement of the government decision over the nation's economy and also the […]
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Overview In the U.S., there approximately eleven million undocumented immigrants and more are to come. Illegal immigration has become a serious problem in the cause of many social, economic, security, and legal issues within the country. Although illegal immigrants have helped the economy, humbled, and developed the overall image of America, members of the House find that the U.S. should not allow anyone to enter the country illegally to be a “citizen” in the country. With this thought going around, […]
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The rate of unemployment is more than a percentage of unemployed people, it is used as key a macroeconomic indicator when determining the health of an economy. The unemployment rate is found by taking the labor force and dividing it by the number of people who are currently searching for a job, also know as the number of unemployed people. The unemployment rate is composed from three types of unemployment: frictional, cyclical, and structural. This could create a potentially serious […]
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Research over the years has shown that unemployment rates and Gross Domestic Product (GDP) figures go hand in hand. This paper aims to define and discuss GDP, and its relation to economic growth. Additionally, the paper will discuss how the use of fiscal or monetary policies can effectively battle recession and aid in the growth of the economy, and how losing a battle to a recession can severely impact unemployment and the unemployment rate, along with other factors leading to […]
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Essays on Macroeconomics
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The Issue of Fiscal and Monetary Policy in USA
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The Issue of Income Inequality in Europe
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Review of Various Economic Reasoning
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Basics of Microeconomics and Macroeconomics Essay
Microeconomics can be defined as a subdivision of economics that deals with the routine, structure, and behavior of a national or regional economy. It puts more emphasis on the overall output of a nation and how the nation allocates its limited resources, i.e., land, labor, and capital, so as to maximize production and uphold trade and economic growth of that nation for future generations (Case & Fair 46-89). Additionally, macroeconomics tries to predict the economic conditions of a country/nation so as to assist consumers, firms, and governments make informed decisions. For instance, consumers may want to know the best time to find work, prices of goods and services in the market, and the cost of borrowing money; businesses will make a decision on the best time to expand production, and the government will use macroeconomics when budgeting, spending, creating taxes, deciding on interest rates and making policy decisions (Gordon & Solow 219-230).
Macroeconomic pointers such as Gross Domestic Product (GDP), unemployment rates, and price indices are employed to appreciate how the economy of a nation works. Moreover, relationships between national income, production output, consumption, unemployment, inflation, savings, and international trade and finance dynamics are pointed out by macroeconomics functions. However, macroeconomics is a broad field and cannot be studied as a whole. Therefore, it is divided into two areas; one that tries to explain the causes and consequences of short-run variation in the national income (business cycle), and the other tries to explain the determinants of long-run economic growth, i.e., national income growth (Case & Fair 110-119).
Fundamentals of Macroeconomics
Macroeconomics has three major fundamentals, which include: National output (measured by the gross domestic product), unemployment, and inflation.
National output/ Gross Domestic Product
Gross Domestic Product (GDP), as a basis of macroeconomics, refers to the full amount of goods and services that a nation creates. Moreover, the GDP being the fundamental gauge of the economy’s fiscal routine, it can be defined as the market value of all the goods and services produced in a country within the country’s financial year (Case & Fair 120-145). GDP is equal to all expenses of all goods and services produced in a country, equal to the total of value-added during the production of the goods and services by all industries within a country plus taxes and minus subsidies on the products, and finally, GDP is equal to a total of all the income created by the production of the goods and services in a particular country within a specific span of time.
Gross Domestic Product has three components which include: Consumption in the market and includes personal expenditure of the citizens of that particular country in their households (food, rent, medical, clothing) excluding the cost incurred when relocating to a new house; Investment which refers to the acquisition of new assets by businesses and household. For instance, the purchase of new machinery, software, and pieces of equipment. In investment expenses incurred by the household on new houses is included. However, buying of financial products like bonds and share is not considered as an investment but as savings; Government Spending which is referred to as the amount of money the government spends on final goods and services. These expenses include all the payments to the public servants, purchase of military weapons and all ventures by the government; Export of goods and services produced by the country and include all goods and services produced by the particular country for another country’s consumption; Imports which include all goods and services that a country import from another country for use in their country. However, all imports to a country are subtracted (Gordon & Solow 250- 273). Therefore, Gross Domestic Product to the sum of consumption, investment, government expenditure, and export minus imports
That is; GDP= Consumption + investment +Government expenditure + (Export –imports).
Unemployment as a fundamental of macroeconomics refers to a situation where people lose their jobs unwillingly while there are other workers in the country looking for work. Unemployment in a country means that the country does not fully utilize its resources, leading to some people who are willing to work jobless. Unemployed people exclude all those people who are not looking for a job or are unwilling to work (Case & Fair 300-390).
Unemployment is divided into four categories, namely: frictional unemployment, which occurs due to the time required to match the employment seeker requirements with the job opening on hand. This kind of unemployment is voluntary as the jobseeker fights back and forth between the available job choices and thus ends up being unemployed. Structured unemployment occurs when a large number of job seekers do not qualify for a large amount of labor force required, for instance, when a group of job seekers does not have the skills required by the employer. Structured unemployment is caused by a shift in consumer preference, technological changes, tax, and geographical location, among others; Seasonal unemployment occurs when demand and supply of goods and services fluctuate, thus affecting the amount of labor required. For instance, during summer, the demand for harvesting workers increases, and cyclical unemployment is caused by the business cycle where during low production, a firm lays off some workers only to reemploy them when production rises (Gordon & Solow 305 -307).
Unemployment is measured as a percentage of the total labor force available in a particular country. Unemployment /labor force *100 Where labor force refers to both unemployed people and the employed people of that particular country
According to Fair and Case (420-440), unemployment in a country affects the Gross Domestic product in that it affects the consumption of a household. This is so because, with less income, a household will reduce its consumption. Moreover, unemployment lowers the total yield of a country in terms of goods and services as the unemployed are not engaged in production.
Inflation as an essential of macroeconomics refers to a state where there is a continued increase in the general price level leading to a reduction in purchasing power and monetary value. The rate of inflation is measured by the yearly percentage variation in the level of prices against the consumer index, which measures the cost of living of a typical household. Inflation is caused by increased domestic inflation where the government may increase the VAT leading to high prices of commodities and thus domestic inflation, fluctuation in the exchange rate where a currency of a certain country fluctuates over the other currencies (Gordon & Solow 308-313). This makes the imports expensive, and the export become lowly priced. Moreover, the sudden rise of prices in crude oil and other imports may lead to inflation in a country. Inflation causes increased prices of commodities of a country, making it unaffordable to the citizens, and this affects the gross domestic product of that country.
Microeconomics which tends to look at the output of an individual and firms within an economy is a scientific strategy that emphasizes all parts that constitute a country’s economy. Both micro and macroeconomics are conjoined, and thus their understanding would help countries and firms make informed decisions (Case & Fair 110-105). The fundamentals of macroeconomics help in evaluating the national output; the gross domestic product measure the total value of country goods and services, thus the income of the country within a financial year. On the other hand, unemployment measure the rate of dependence of the citizens of a country, i.e., the dependence of the unemployed on the employed citizens. Inflation as a fundamental of macroeconomics helps to gauge whether there is a lot of money circulation in a nation or a country as this affects borrowing and the prices of a country’s commodities in the international market. When a country is allocating resources to the various sectors of the economy in a country, they must take into consideration the command economy (forces within a competitive market, i.e., invisible hand that influence the allocation of resources) and the market economy.
- Case K. & Fair R.: Principles of Macroeconomics. Pearson Prentice Hall 2006, pg. 46 – 105, 110-390, 410-500
- Gordon J. & Solow R.: Productivity Growth, Inflation, and Unemployment. Cambridge University Press. 2004, pg. 219-273, 305- 313
- Keizō Nagatani. Macroeconomic dynamics. Cambridge University Press, 1981, pg. 150-200
- Fischer, Stanley. Macroeconomics. McGraw-Hill, 1990, pg. 750- 800
- Baumol, William & Blinder, Alan. Macroeconomics: principles and policy. 7th Edition. Dryden Press, 1997, pg. 350-400
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107 Macroeconomics Essay Topics
🏆 best essay topics on macroeconomics, ✍️ macroeconomics essay topics for college, 🎓 most interesting macroeconomics research titles, 💡 simple macroeconomics essay ideas, ❓ macroeconomics essay questions.
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- Macroeconomic Situation in the US The macroeconomic situation in the US is currently faced with high inflation rates, which paint a gloomy picture to many US citizens.
- Germany’s Macroeconomic Performance in 2015 It is imperative to note that macroeconomic performance is a fascinating topic that is actively discussed by many scholars. The situation in Germany is especially interesting.
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Wars and the Labor Market Outcomes of Minorities in the U.S.
This chapter reviews key literature studying the effects of wars on minority and underrepresented groups in U.S. labor markets in the 20th century. These labor markets, characterized by historically pervasive barriers to entry into certain occupations and industries, promotions, and fair pay for underrepresented workers, experienced severe challenges during times of war. These challenges served to break down some of the barriers faced by underrepresented workers. Recent years have shown that sudden labor shortages, similar to those induced by large-scale wars, are not a feature of the past. Hence, a better understanding of such shortages and their effects on different groups continues to be important. The focus here is on the labor market outcomes of Black and white women, as well as Black men, during and after the two World Wars. Their labor inputs compensated for the lack of white male workers during the war years; however, only WWII generated significant and more prolonged socioeconomic progress for both groups. This chapter summarizes theoretical considerations that can explain why some war-induced labor market shocks are persistent while others are not, and the empirical literature related to the labor market experiences of women and Black workers during and after the World Wars.
I am grateful to Madison Arnsbarger, Price Fishback, Taylor Jaworski, Maggie Jones, Thomas Maloney, Patrick Szurkowksi, Pat Testa, and Sarah Walker for valuable comments and discussions. All remaining errors are my own. This paper was prepared as chapter for the Routledge Handbook on the Economic History of War. There were no sources of funding or financial relationships involved in the writing of this paper. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
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Research paper on macroeconomics, thesis statement for macroeconomics.
There are expectations for global macroeconomic development. As there is a global financial crisis that is declining, there are policymakers that can achieve longer issues that are holding back development. In the last decades, there has been an increase in economic crises happening that include negative circumstances. The World Economic Situation Prospects discusses the global financial crisis happening in 2008 through 2009, which was then followed by a debt crisis called the European sovereign.
Since then, these crises have subsided, and our economy has slowly been increasing since then. The advantage of our economy strengthening is we will be offered a better way of changing policy that includes social dimensions and also environmental that will be good for sustainable development.
Argumentative Essay Examples on Macroeconomics
There is an investment control that is improving, but the negative side to this is there are elevated policy uncertainty and increasing levels of debt that will prevent a more global investment issue. These conditions will eventually improve, reduce banking sectors, and recovery in commodity sectors. With that being said, the financial cost will be decreased with the support of rising capital flows that involve cross-border lending and credit growth that is efficient that is focused on developing economies.
Having improved quality has also helped with production investment in larger economies. When looking at the gross fixed capital formation, it accounted for 60 percent of the rate of change in global activity in 2017. These changes are close to a low point. Because of weak investment growth, a firm and also a rebound investment is needed for the involvement of supporting strong productivity growth and a rate of change progress. There are also uncertain regards to the balance sheet adjustment that is in important central banks. These uncertainties are also in rising debt.
Ideas: Environmental Sustainability and Economic Growth
As a rate change in economic growth goes up, there needs to be an awareness of environmental sustainability. As there is an acceleration that is happening in economic growth, it also comes with an environmental cost. As there are weather shocks that are continuing to increase, there is also a need to build a way to recover quickly from climate change. From this, it helps to control the pace of environmental wearing down. Their carbon emissions seemed to have remained flat between 2013- 2016, and the result of this has resulted in a higher emission level.
As aviation emissions and international shipping have not fallen under the Paris Agreement, these sectors are growing at a fast rate than road transport within the past 25 years. This has also continued to increase since 2013. Because of the air pollution measures happening and are strengthened in international shipping and aviation companies, it is still unsure if current policies will lower emission levels related to the Paris Agreement.
Uncertain Risks and Geopolitical Tensions
There are uncertain risks of future events occurring, which involves changes in trade policy. There is a problem surrounding global conditions and tensions with geopolitical actions. As elevated policy uncertainty continues, it is affecting world trade, aid development, and migration targets. The rise in geopolitical tensions could lead to unilateral and also isolationist policies. Due to global liquidity and low borrowing cost, this has resulted in a rise in global debt measures and an increase in financial imbalances.
Developing economies with open capital markets will be vulnerable because of risk aversion and global liquidity conditions. Because of monetary policy normalization, this could trigger a sort of spike. There are central banks that are in developed economies that are operating in unchartered territory. Lastly, it is less predictable with the change in financial markets. The risk with policy errors then throughout recoveries.
Policy Challenges and Reorienting for Long-Term Growth
Policy challenges are a big problem and reflect the negative shocks of reorienting policy. It is still seen that there are risks and uncertainties remaining. What stands out the most when discussing the economic environment is the positioning of the economic cycle. These cycles are among major economies and control financial market conditions. While there is a focus on policy actions on this crisis, improving investments will create scope in order to reorient policy for long-term issues. This includes being able to strengthen environmental quality related to economic growth. This makes things more inclusive and targets institutional issues that block development.
Finding a way to reorient policy in addressing challenges and making the best use of co-benefits and development objectives can be an outcome of stronger investment, an increase in higher job creation, and economic growth. There are present investments in areas including education, expanding healthcare, a recovery from climate change, and improving and building financial inclusion. This will also cause a change in the progress of environmental goals.
Global Investments and Productivity Growth
Global investments are now marking a significant step in the direction of a broad recovery in global activities and an increase in the long-term world economy. This is sometimes geared up towards productive investment in equipment. The ending result will weigh on the productivity of growth. As global labor productivity increased in 2018. There is an improvement in the world economy. This has been a pickup in productivity growth. As there is a growth of 1.3 percent, global labor productivity is likely to increase by 1.9 percent.
Developed economies such as Japan, the United States, and Western Europe all have similarities which include productivity growth that has happened over the years. There is productivity growth that is in developed economies that is estimated to have changed from 0.5 percent in the year 2016, now to 1 percent in 2018.
It is still unclear if there will be any improvements in productivity growth that can be continued going forward. It is significant to understand the past of these growth developments. Ever since the global financial crisis that has taken place, it has resulted in slow labor productivity growth in developed economies.
Labor Productivity and its Weaknesses
The many reasons why there is a weakness in labor productivity is because of slow private investments due to the global financial crisis affecting this. Also, the euro area debt crisis plays a part and the fall of commodity prices. The developed stocks have developed in economies and have stayed stagnant, over time depreciating value because of existing capital stock. Investments that are weak have slowed capital deepening. Not only this, but it has a weight on TFP growth. This involves delaying the adoption of capital technologies.
Commodities, International Trade, and Growth Momentum
Commodities and international trade play a part in emerging Asia international trade flows. With world trade rebounding, this is the result of weak trade flows. The following of this is weak trade flows. As global trade flows, there is an amount of expansion post-crisis of growth that is low, which is a growth rate of 2.2 percent. Trade elasticity is calculated by the ratio of growth of global trade, which rose from 0.9 in 2016 to an increased number of 1.2 in 2017. This number still remains low compared to other ratios that were once seen in the years 1990 and the early 2000s. From this, it suggests that there are structural factors taken into account and continue to have an impact on the growth momentum related to global trade.
There is rising tension due to geopolitical and natural disasters that have increased the tension between the Korean Peninsula and the Middle East. The tension between one another is posing global growth. As there are increased incidents of weather-related disasters happening, they are posing a risk during the outlook period of the world economy. Looking at this from a global perspective, escalations between the Democratic Republic of Korea crisis and also tension in the Middle East are of concern to this issue. This problem became worse in 2017. There is a probability that military escalation appears low, but there are also fears that escalation can affect investor sentiment throughout the world and cause financial volatility. The increase in risk aversion related to investors could also have consequences worldwide.
Policy Issues for Sustainable Growth
There are policy issues that are raising sustainable growth. Policymakers have a scope to change the focus of policy towards more long-term growth. As there is growth happening in 2017, a number of situations are holding back quick global progress from social dimensions and sustainable development. Issues are becoming less intense, and this is creating a strong economy that will be able to offer policymakers a better scope to get rid of long-term problems. There are a number of challenges that are happening that are continuing to hold back development which involves governance structure, higher levels of exposure to weather-related disasters, and going through challenges such as security and also political uncertainty. Still, wage growth and higher levels of unemployment are causing a burden across the globe. The quality of economic growth is increasing and is continuing to raise issues of inequality, degradation, and the increase of poverty. As a result and consequence, policymakers should address important key areas, which include: a supportive environment for investment, minimizing inequality, and finding a way to change and improve institutions.
Among these problems, a concern in economic diversification is the development in countries that remain that are at times remaining dependent on some commodities. As commodity exporters deal with busting investment cycles, these cycles pass through conditions such as macroeconomics. Because of this, it is seen by the heavy and increased economic costs that are facing commodity exporters. There are current commodity price realignments that are the result of this.
Sustainable Finance and SDGs
There is a need for sustainable finance that will be able to help with social investments. A financial system is important to have because it is a way of having efficient international flows from developed economies. The lingering risk that could potentially affect global growth will also stop progress toward the SDGs. In addition, there is a need for more resources and a need for mobilizing finance investments that are required for SDG.
Meanwhile, developing countries, as well as emerging economies that have financing needs, should find ways to prepare for low capital flows, liquidity that has secure conditions, and a tighter monetary policy space. Big emerging economies have seemed to have a better position to find global financial issues than in the past. Exchange rate flexibility is the result of this and an improvement in macroeconomic management.
Strengthening the Financial System
The problem with tackling the global financial crisis is making the financial system more stable. There have been efforts, such as regulatory and supervisory measures, to find ways to strengthen the banking sector. These global systemically banks are located in Japan, the United States, China, and Europe. The objective is to build a strong balance sheet for larger banks and improve their capital and risk management positions. Economists are believed to agree that balance sheets strengthened ever since the global financial crisis has happened. Over the years, banks have made improvements in addressing overhanging problems. An example of this would be writing off bad loans. Even though there are visible improvements, it is unknown how balance sheets are vulnerable. The progress through this has been uneven, and there are many European banks that are having issues reducing the amount of loans that are non-performing. Because of the “too big to fail” situation, this circumstance has been slow, revealing the need to further build national resolution mechanisms, not only but also developing cross-border resolution planning.
All in all, modest economic growth will continue to build in fiscal revenue growth. There are efforts to try to get rid of growth that is constrained. Even though there is a decline in inflation and poor economic activity, there is still improved financial stability. The South American banks that are located in Colombia, Brazil, and Peru have progressed and eased monetary policy in the year 2017. Brazil cut its policy rate from 14.25 percent in October 2016 to a current 8.25 percent, the lowest level it has now been low since the year 2013. While South America is gaining, recovery and economic slack are diminishing. Eventually, the monetary cycle is expected to result to an end. Negative shocks and policy rates are also seen to remain and stay stagnant over the next year. In the future economy, there should be a control of monetary policy that will be possible in the near forecast period to come.
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Essay On Macroeconomics
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The IS LM model or the Hicks –Hansen model is the macroeconomic tool that shows the relationship between the interest rates and the real output of goods and services and the money market. The intersection of the investment - saving curve or the IS curve and liquidity preference curve or the money supply curve is the general equilibrium in both the markets .This model explains the changes in the national income when the price level is fixed in the short run and also shows the reason for the shift in the aggregate demand curve. It was first developed by Hicks and then by Hansen as a mathematical representation if the Keynesian macroeconomic theory. The Keynesian income expenditure analysis developed in the General Theory of Employment Interest and money offered an alternative approach to the interpretation of changes in the money income that emphasized the relation between money income and investment are autonomous expenditure rather than the relation between money, income and the stock of money. According to Keynes whether an increase in the quantity of money will lead to an increase in the price level does not depend what happens to the aggregate demand curve but depends on the shape of the aggregate supply curve. In the Keynesian system the equilibrium price level is determined at the intersection of aggregate demand and aggregate supply curves. When the supply of money increases the aggregate demand curve shifts to the right. Now the effect of an increase in the quantity of money on the equilibrium price levels depends on two things. Firstly it depends on the extent by which aggregate demand curve shifts to the right. Secondly it depends on the shape of the aggregate supply curve. If the productive capacity of the economy is employed the supply of output will be completely inelastic and any increase in demand will lead only o an increase in the price level . On the other hand if there is unused capacity at levels of production a rise in effective demand leads to an increase in production and supply keeping prices unchanged. Again, when the economy approaches full utilization of capacity (i.e. when firms operate in a region of rising the marginal cost) a rise in effective demand leads to rise in output and a simultaneous increase in prices. Thus the effect of an increase in the effective demand on prices depends entirely on the initial position of the economy. In other words, in case of full employment the aggregate supply curve is a vertical straight line. The unused capacity of the aggregate supply curve is a horizontal straight line. Lastly, when the economy approaches full utilization of capacity the aggregate supply curve is upward rising(Dornbusch,334). Let us see how a change in the quantity of money leads a change in the effective demand. In the Keynesian theory of income and employment we know that when there is an increase in the quantity of money this will lead to the lowering of the interest rate. A fall in the inertest rate will lead to the increase in the rate of investment. The increase in the rate of investment will increase the effective demand through the multiplier process. Thus the effect of the change in quantity demand depend on three factors: First, the extent by which the rate of interest falls as the quantity of money is increased which in turn depends on the slope of liquidity preference schedule. Second, the extent by which investment rate will be stimulated due to a fall in the rate of interest. i.e. interest elasticity of investment. Third, the extent by which the effective demand will increase as the rate of investment increases i.e. the size of investment multiplier which again depend on the propensity to consume. There are two special cases when an increase in the money supply will not lead to increase in effective demand. The first case is the case of liquidity trap or the absolute liquidity preference where the preference schedule becomes absolutely elastic. The second is the complete inelasticity of investment. According to Keynesian model the price level changes in these situations even if there is an increase in the quantity of money but only in the case of full employment. In case of full employment an increase in aggregate demand leads to an increase in the quantity of money which will again lead to an increase in price level The IS curve slopes downward because a decrease in the interest rates increases the investment spending thereby increasing the aggregate demand and the level of output at which the goods market is in equilibrium. The fiscal expansion shifts the IS curve to the right. Both government spending and the tax rate affect the IS schedule (Dornbusch, 261). The figure shows that an expansionary fiscal policy raises the income and the interest rate. At The figure shows that an expansion fiscal policy raises the income and the interest rate. At unchanged interest rates the higher levels of government spending increases the level of aggregate demand that causes shift in the IS schedule. At each level of interest rate the equilibrium income is raised by increase in government spending. The rising national income follows the increased aggregate demand which also increases the transaction demand for money. But with money supply fixed and rising interest rates will motivate people to hold less cash. This is because the opportunity cost of holding wealth in the form of cash rises when interest rises. The increase in interest rate causes reduction on private investment which offsets some of the rise in government spending . This is known as financial crowding effect. The increase in interest rate that follow the rise in government spending crowd out other interest sensitive components of aggregate demand. The investment is the sum of purchase of newly produced capital goods , changes in inventories known as inventory investments and purchases of new residential building. The increase in interest rate which will offset private investment will choke off the residential spending. That means that the real estate market will incur loss (Dornbusch, 263). Monetary policies operate by stimulating the interest responsive components of aggregate demand , primarily investment spending. When the central bank like Federal reserve pays for the bonds it buys with money then it reduces the quantity of bond available in the market thereby increasing their prices or lowering their yield only. But at lower interest rate the public buy the wealth in the form of bonds or holds larger fraction in the form of money. In open market purchase the LM curve shifts below. The increase in the nominal quantity of money given the price level shits the LM curve and a new equilibrium is reached with a lower interest rate and higher level of income. The steeper the LM curve the larger is the change in income. If money demand is very sensitive to interest rate then a given change in the money stock can be absorbed in the asset market with only a small change in the interest market.
According to Keynes theory of saving and investment in equilibrium planned saving is equal to planned investment. This applies to the economy where there is no government or no foreign trade. So from national income accounting equation, Y= C+S .
It means income is either spent or saved. Without government and foreign trade aggregate demand equals consumption plus investment
Y= C+I. S putting together C+S = C+I or S = I. If the economy moves from the state of equilibrium then what will happen .Inventory investment takes place when firms increase their inventories. The increase in inventory happens in two situations. First, when the sales of firms are unexpectedly low and it is found that unsold inventories are accumulating on the shelves. This is unanticipated inventory. In some cases the inventory investment can be high when firms plan to build up inventories and this is anticipated investment. Unanticipated inventory investment is a result of unexpected low aggregate demand. But planned inventory investment adds to aggregate demand. Thus rapid accumulation of inventories are associated with either rapidly declining aggregate demand or rapidly increasing aggregate demand (Dornbush,324). In the simple Keynesian model of income determination the equilibrium level of income is determined by the equality of intended saving and intended investment. The equilibrium level of income thus determined may be of full employment or one of less than full employment. Keynes produced an aggregate general equilibrium model where money influence real variables. He also explained that the horizontal LM curve is due to liquidity trap. The other reason is the inadequate interest elasticity in the savings and investment functions even when the interest fell to zero i.e. inelastic IS curve or such that the highest attainable level of income is below full employment. The Pigou effect reintroduced the cash balance mechanics and argued that the slope of the IS curve depend on the people's real wealth. A falling price level shifts the IS cure rightward so that the economy goes back to full employment. Pigou argued that the rate of interest can either be zero or negative .In that case saving and investment would always be at a positive rate of interest. When people save even at negative interest rate then they save for other reasons. The dependence of the saving function on the real value of cash balances is the "Pigou" or wealth effect. It states that the consumption expenditure of the economy is related to the volume of wealth such that as total wealth increases total consumption expenditure also increase. In case of full employment as consumption expenditure increases, saving decrease. So saving in inversely related to the volume of wealth (Dornbusch, 336).
Dornbusch, Rudiger. Macro economics. New Delhi: Tata McGraw-Hill, 2005 .
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