Saturday, 11 March 2017

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What is Macro Economics? Definition, Evolution and Concept of Circular Flow of Income


Our last article gave a glimpse of one of the major branches of economics i.e. micro economics. In this article we shall get discuss the meaning and scope of the important branch of economics – MACRO ECONOMICS! Macroeconomics is derived from the words “MAKROS”. Literally, the word macro means large or whole. The branch of economics that studies the economy as a whole is called macroeconomics.

What is Macro Economics?

Unlike micro economics, which studies the decision making of small economic variables or units (like consumer, industry or firms), macroeconomics deals with the large economic variables of an economy or an economy as a whole. It studies the economic behavior of aggregate or total units. Here, study of total units or large economic variable means study of national income of a country, its total investment, total savings, unemployment, inflation, international trade, balance of payments etc. phew.. :P too much to talk about!
Macroeconomics teaches us how these units of an economy are determined, say calculation of national income, and how they are affected by different units of an economy like unemployment, total savings etc.

Evolution of Macro Economics over the Ages

In earlier times, around 1930, macroeconomics was referred as “classical economics. It delivered the concept that an economy functions at full level of employment since market forces (demand & supply) are free i.e. both are uncontrolled or negligibly controlled by government.
However, this meaning of macroeconomics was highly criticized & it was so damn obvious. An economy never functions at full level of employment. For example: United States of America (USA), the beholder of advanced technologies, abundantly rich infrastructure , well optimised usage of natural and man-made resources, is the biggest economy in the world. It reflects highest GDP i.e. gross domestic product (indicator of national growth) but even then, it doesn’t ensure full employment. People still suffer from unemployment there.

Number two, market forces does work in free economy, which means that demand and supply are never left uncontrolled. Such demand and supply of products are always controlled by government in the form of taxes, price barriers (maximum or minimum price of goods) and certain restrictions imposed to prevent new business players entering into market and thereby increasing competition.
For example: government imposes licensing policy for certain businesses so that such businesses do not grow unnecessarily and lead to increasing competition. It restricts new players to enter into market. This is why classical economics was criticized due to its obvious reasons.

The Recent changes in Macro Economics Definition and now here it is-

Therefore, in 1936, a well-known British economists Sir John Maynard Keynes (J.M. Keynes), evolved a new concept of macroeconomics in his book “The General Theory of Employment, Interest and Money”.

The modern economics argues that competitive economies never guarantees full employment or full investment. That’s why macroeconomics is also called as theory of income and employment. His theory is concerned with the problems of unemployment, economic fluctuations, inflation or deflation etc. macroeconomics is the study of the causes of unemployment and its various factors.
This theory basically focused on four important units of an economy-
1.     The concept of circular flow of income.
2.     National income accounting
3.     Money and banking
4.     International trade
5.     Economic growth

Let’s have a brief explanation of these terms.

What is the concept of circular flow of income?

In the field of business cycles, macroeconomics concerns itself with the effect of investment on the total output, total income and total employment. The total output means the total amount of every goods and services produced in a country in a given period of time. Since the total value of goods and services includes its cost and added profit of the sellers therefore, total output is equal to the total income of the country.  That’s why the term total output and total income can be used interchangeably.

National Income accounting explained with Example?

In the sphere of national income accounting, it establishes a platform which addresses as to how the national income is accounted for and what causes the fluctuations in the national income of the country. It clearly bifurcates between the income which is to be included in the assessment of national income and which is not to be included in the determination of national income.
For example: salary income is included in the national income. But, illegal income (income from smuggling, robbery) or windfall gains i.e. unexpected income (income from winning a lottery or a game show say KBC) are not included in national income ; even if tax is paid on it.

Macro Economics in Monitory means and Employment

In terms of employment, macroeconomics deals with issues related to employment & unemployment. Employment means percentage of workers in the labour force (i.e. people eligible to work: generally above 18 years to 60 years) engaged in an economic activity. Economic activity means any activity by which a person earns his or her livelihood and which adds to the national income of the country. For example: a teacher working in a school or a college, earning monthly salary to sustain his or her living, is said to be engaged in an economic activity. Whereas a girl taking coaching classes in her spare time & earning monthly income shall not be considered to be engaged in an economic activity.
On the other hand, unemployment means percentage of workers in labour force who are willing to do jobs but are job less. Macroeconomics covers the factors affecting unemployment.

Now, considering monetary sphere i.e. money and banking, macroeconomics studies the effects of total quantity of money on the general price level. It explains how money flows in an economy, what causes inflation (rise in prices of goods and services) and deflation (fall in prices of goods and services) and their impact on the general price level.

In international trade, it focuses on the problems of imports and exports, balance of payments and foreign aid. It answers questions as to how exports are increased, how the foreign exchange is earned. Foreign exchange means conversion of one currency into another currency. And, earning of foreign exchange means how a country earns through such conversion of currency.

Economics Growth as a factor in studying Macro Economics

And, lastly economic growth, macroeconomics attempts to explain the factors affecting the development or growth of the nation. It provides a guidelines for formation of economic policies of a country that leads to growth and development of a nation. Here, we concluded that macroeconomics provides the broader scope of understanding the economies of the world than the microeconomics.

Microeconomics studies the economic actions of individual & small group of individuals- study of particular industry, individual prices, wages, incomes & commodities etc. but macroeconomics deals with aggregates of these quantities, not with individual prices but with the total price levels, not with the individual incomes but the national income. , not with the individual output but the total output of the nation. We can say that micro economics is the study of a tree but macroeconomics is the study of the forest.
We shall have deeper analysis of the macroeconomic theories in our later articles!


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