Macroeconomics is one of the major subdivisions in the study of economics. In this lesson, you’ll learn what it is, why it’s important and its major principles. You’ll also have a chance to take a short quiz after the lesson.
What is Macroeconomics?
Macroeconomics is the study of economics involving phenomena that affects an entire economy, including inflation, unemployment, price levels, economic growth, economic decline and the relationship between all of these. While microeconomics looks at how households and businesses make decisions and behave in the marketplace, macroeconomics looks at the big picture – it analyzes the entire economy.
Importance of Macroeconomics
We live in a complex and interconnected world. No one is unaffected by the economy. Most of us depend on the economy to provide job or business opportunities so we can make money to buy the goods and services we need to survive and function in modern society. The study of macroeconomics allows us to better understand what makes our economy grow and what makes it contract. A growing economy provides opportunities for better lives, while a contracting economy can be disastrous for most everyone. Macroeconomics provides the analysis for proper policy making so that we can develop and nurture the best economy possible.
Macroeconomic study focuses on three broad areas and the interrelationships between them. These three concepts affect all participants in an economy, including consumers, workers, producers and government. Let’s look at each of these concepts.
Macroeconomics studies the national output, or income, of a country. National economic output is the total value of all goods and services produced in an economy during a specific time period. Economists measure national output by calculating the gross domestic product (GDP), which is the market value of final goods and services that an economy produces during a specific period of time. Economists will use the term real GDP, which is GDP valued at a constant price level, to compare current output with past output. This comparison will tell you if the economy is growing, is stagnant, or is contracting.
The basic model used in macroeconomics to study economic fluctuations is the model of aggregate demand and aggregate supply. The model involves two variables: the economy’s output, which is measured by real GDP, and the economy’s overall price level, measured by a price index (usually the GDP deflator or CPI). You can plot the general price level in an economy on the vertical axis of a graph and the quantity of output on the horizontal axis. The aggregate supply curve is upward sloping in the short-run, but vertical in the long-run. The aggregate demand curve is downward slopping. Economic output and price level will move towards the point where aggregate supply equals aggregate demand.
Fluctuations in economic output are generally caused by one of two things. First, fluctuations can occur when the aggregate demand shifts. If the aggregate demand curve shifts to the left, output and prices will decline. If the curve shifts to the right, output and prices will rise. Second, economic fluctuations may be caused by a shift in aggregate supply. A right shift in the aggregate supply curve means that the quantity of goods and services supplied will increase at a particular price level. If the short-term aggregate supply curve shifts to the left, output will fall and prices will rise – this is called stagflation.
Macroeconomists study employment and what leads to unemployment, which is the percentage of people who are not working but want to work. Unemployment is an economic reality. There is a natural rate of unemployment that an economy normally experiences even when an economy is stable. Cyclical unemployment is a deviation from the natural unemployment rate that is usually caused by fluctuations in the business cycle. People transitioning between jobs cause frictional unemployment, and structural unemployment is unemployment that occurs when there are jobs available, but unemployed workers don’t have the skills to qualify for them.
Economists measure unemployment through calculating the unemployment rate and the labor participation rate. The unemployment rate measures the percentage of people in the labor force that are unemployed. The labor participation rate measures the percentage of people that are eligible to work but are not working.
Inflation and Deflation
Inflation and deflation are also important concepts studied in macroeconomics. Inflation is a rise in the general price level of an economy. Deflation, on the other hand, is a decline in the general price level of an economy.
Money supply is correlated to inflation and deflation. According to the quantity theory of money, the quantity of money available in an economy will determine the general price level, and the growth rate in the quantity of money will determine the rate of inflation. As the money supply increases, inflation will increase.
The study of macroeconomics is very important to make sound policy decisions that can affect the entire economy and all individuals, organizations, and governments that participate in it. Three major concepts studied in macroeconomics include economic output, unemployment and inflation and deflation. Economic output tells you how much an economy is producing, unemployment tells you how many people are working, and inflation and deflation tell you whether prices in the economy are going up or down.
Key Areas of Macroeconomics
|Economic Output||Unemployment||Inflation and Deflation|
|*The total value of all goods and services produced in an economy during a specific time period
*Studied using the model of aggregate demand and aggregate supply
| *The percentage of people not working but who want to work
*Types of unemployment include natural unemployment and cyclical unemployment
| *The rise (inflation) and decline(deflation) in the general price level of an economy
*Money supply of a country is correlated to inflation and deflation
When you are finished, you should be able to:
- Explain what macroeconomics is and why it is important
- Discuss the three major concepts studied in macroeconomics