Nature and Scope of Macroeconomics (Part - 1) - Macro Economics | Macro Economics - B Com PDF Download

Introduction:

The term ‘macro’ was first used in economics by Ragner Frisch in 1933. But as a methodological approach to economic problems, it originated with the Mercantilists in the 16th and 17th centuries. They were concerned with the economic system as a whole.

In the 18th century, the Physiocrats adopted it in their Table Economies to show the ‘circulation of wealth’ (i.e., the net product) among the three classes represented by farmers, landowners and the sterile class. Malthus, Sismondi and Marx in the 19th century dealt with macroeconomic problems. Walras, Wicksell and Fisher were the modern contributors to the development of macroeconomic analysis before Keynes.

Certain economists, like Cassel, Marshall, Pigou, Robertson, Hayek and Hawtrey, developed a theory of money and general prices in the decade following the First World War. But credit goes to Keynes who finally developed a general theory of income, output and employment in the wake of the Great Depression.

Contents:

1. Nature of Macroeconomics
2. Difference between Microeconomics and Macroeconomics
3. Dependence of Microeconomic Theory on Macroeconomics
4. Dependence of Macroeconomics on Microeconomic Theory
5. Macro Statics, Macro Dynamics and Comparative Statics
6. Transition from Microeconomics to Macroeconomics
7. Stock and Flow Concepts

1. Nature of Macroeconomics:

Macroeconomics is the study of aggregates or averages covering the entire economy, such as total employment, national income, national output, total investment, total consumption, total savings, aggregate supply, aggregate demand, and general price level, wage level, and cost structure.

In other words, it is aggregative economics which examines the interrelations among the various aggregates, their determination and causes of fluctuations in them. Thus in the words of Professor Ackley, “Macroeconomics deals with economic affairs in the large, it concerns the overall dimensions of economic life. It looks at the total size and shape and functioning of the “elephant” of economic experience, rather than working of articulation or dimensions of the individual parts. It studies the character of the forest, independently of the trees which compose it.”

Macroeconomics is also known as the theory of income and employment, or simply income analysis. It is concerned with the problems of unemployment, economic fluctuations, inflation or deflation, international trade and economic growth. It is the study of the causes of unemployment, and the various determinants of employment.

In the field of business cycles, it concerns itself with the effect of investment on total output, total income, and aggregate employment. In the monetary sphere, it studies the effect of the total quantity of money on the general price level.

In international trade, the problems of balance of payments and foreign aid fall within the purview of macroeconomic analysis. Above all, macroeconomic theory discusses the problems of determination of the total income of a country and causes of its fluctuations. Finally, it studies the factors that retard growth and those which bring the economy on the path of economic development.

The obverse of macroeconomics is microeconomics. Microeconomics is the study of the economic actions of individuals and small groups of individuals. The “study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular commodities.” But macroeconomics “deals with aggregates of these quantities; not with individual incomes but with the national income, not with individual prices but with the price levels, not with individual output but with the national output.”

Microeconomics, according to Ackley, “deals with the division of total output among industries, products, and firms, and the allocation of resources among competing uses. It considers problems of income distribution. Its interest is in relative prices of particular goods and services.”

Macroeconomics, on the other hand, “concerns itself with such variables as the aggregate volume of the output of an economy, with the extent to which its resources are employed, with the size of the national income, with the ‘general price level’.”

Both microeconomics and macroeconomics involve the study of aggregates. But aggregation in microeconomics is different from that in macroeconomics. In microeconomics the interrelationships of individual households, individual firms and individual industries to each other deal with aggregation.

“The concept of ‘industry’, for example, aggregates numerous firms or even products. Consumer demand for shoes is an aggregate of the demands of many households, and the supply of shoes is an aggregate of the production of many firms.

The demand and supply of labour in a locality are clearly aggregate concepts.” “However, the aggregates of microeconomic theory,” according to Professor Bilas, “do not deal with the behaviour of the billions of dollars of consumer expenditures, business investments, and government expenditures. These are in the realm of microeconomics.”

Thus the scope of microeconomics to aggregates relates to the economy as a whole, “together with sub-aggregates which (a) cross product and industry lines (such as the total production of consumer goods, or total production of capital goods), and which (b) add up to an aggregate for the whole economy (as total production of consumer goods and of capital goods add up to total production of the economy; or as total wage income and property income add up to national income).” Thus microeconomics uses aggregates relating to individual households, firms and industries, while macroeconomics uses aggregates which relate them to the “economy wide total”.

Scope and Importance of Macroeconomics:

As a method of economic analysis macroeconomics is of much theoretical and practical importance.

(1) To Understand the Working of the Economy:

The study of macroeconomic variables is indispensable for understanding the working of the economy. Our main economic problems are related to the behaviour of total income, output, employment and the general price level in the economy.

These variables are statistically measurable, thereby facilitating the possibilities of analysing the effects on the functioning of the economy. As Tinbergen observes, macroeconomic concepts help in “making the elimination process understandable and transparent”. For instance, one may not agree on the best method of measuring different prices, but the general price level is helpful in understanding the nature of the economy.

(2) In Economic Policies:

Macroeconomics is extremely useful from the point of view of economic policy. Modern governments, especially of the underdeveloped economies, are confronted with innumerable national problems. They are the problems of overpopulation, inflation, balance of payments, general underproduction, etc.

The main responsibility of these governments rests in the regulation and control of overpopulation, general prices, general volume of trade, general outputs, etc. Tinbergen says: “Working with macroeconomic concepts is a bare necessity in order to contribute to the solutions of the great problems of our times.” No government can solve these problems in terms of individual behaviour. Let us analyse the use of macroeconomic study in the solution of certain complex economic problems.

(i) In General Unemployment:

The Keynesian theory of employment is an exercise in macroeconomics. The general level of employment in an economy depends upon effective demand which in turn depends on aggregate demand and aggregate supply functions.

Unemployment is thus caused by deficiency of effective demand. In order to eliminate it, effective demand should be raised by increasing total investment, total output, total income and total consumption. Thus, macroeconomics has special significance in studying the causes, effects and remedies of general unemployment.

(ii) In National Income:

The study of macroeconomics is very important for evaluating the overall performance of the economy in terms of national income. With the advent of the Great Depression of the 1930s, it became necessary to analyse the causes of general overproduction and general unemployment.

This led to the construction of the data on national income. National income data help in forecasting the level of economic activity and to understand the distribution of income among different groups of people in the economy.

(iii) In Economic Growth:

The economics of growth is also a study in macroeconomics. It is on the basis of macroeconomics that the resources and capabilities of an economy are evaluated. Plans for the overall increase in national income, output, and employment are framed and implemented so as to raise the level of economic development of the economy as a whole.

(iv) In Monetary Problems:

It is in terms of macroeconomics that monetary problems can be analysed and understood properly. Frequent changes in the value of money, inflation or deflation, affect the economy adversely. They can be counteracted by adopting monetary, fiscal and direct control measures for the economy as a whole.

(v) In Business Cycles:

Further macroeconomics as an approach to economic problems started after the Great Depression. Thus its importance lies in analysing the causes of economic fluctuations and in providing remedies.

(3) For Understanding the Behaviour of Individual Units:

For understanding the behaviour of individual units, the study of macroeconomics is imperative. Demand for individual products depends upon aggregate demand in the economy. Unless the causes of deficiency in aggregate demand are analysed, it is not possible to understand fully the reasons for a fall in the demand of individual products.

The reasons for increase in costs of a particular firm or industry cannot be analysed without knowing the average cost conditions of the whole economy. Thus, the study of individual units is not possible without macroeconomics.

Conclusion:

We may conclude that macroeconomics enriches our knowledge of the functioning of an economy by studying the behaviour of national income, output, investment, saving and consumption. Moreover, it throws much light in solving the problems of unemployment, inflation, economic instability and economic growth.

Limitations of Macroeconomics:

There are, however, certain limitations of macroeconomic analysis. Mostly, these stem from attempts to yield macroeconomic generalisations from individual experiences.

(1) Fallacy of Composition:

In Macroeconomic analysis the “fallacy of composition” is involved, i.e., aggregate economic behaviour is the sum total of individual activities. But what is true of individuals is not necessarily true of the economy as a whole.

For instance, savings are a private virtue but a public vice. If total savings in the economy increase, they may initiate a depression unless they are invested. Again, if an individual depositor withdraws his money from the bank there is no ganger. But if all depositors do this simultaneously, there will be a run on the banks and the banking system will be adversely affected.

(2) To Regard the Aggregates as Homogeneous:

The main defect in macro analysis is that it regards the aggregates as homogeneous without caring about their internal composition and structure. The average wage in a country is the sum total of wages in all occupations, i.e., wages of clerks, typists, teachers, nurses, etc.

But the volume of aggregate employment depends on the relative structure of wages rather than on the average wage. If, for instance, wages of nurses increase but of typists fall, the average may remain unchanged. But if the employment of nurses falls a little and of typists rises much, aggregate employment would increase.

(3) Aggregate Variables may not be Important Necessarily:

The aggregate variables which form the economic system may not be of much significance. For instance, the national income of a country is the total of all individual incomes. A rise in national income does not mean that individual incomes have risen.

The increase in national income might be the result of the increase in the incomes of a few rich people in the country. Thus a rise in the national income of this type has little significance from the point of view of the community.

Prof. Boulding calls these three difficulties as “macroeconomic paradoxes” which are true when applied to a single individual but which are untrue when applied to the economic system as a whole.

(4) Indiscriminate Use of Macroeconomics Misleading:

An indiscriminate and uncritical use of macroeconomics in analysing the problems of the real world can often be misleading. For instance, if the policy measures needed to achieve and maintain full employment in the economy are applied to structural unemployment in individual firms and industries, they become irrelevant. Similarly, measures aimed at controlling general prices cannot be applied with much advantage for controlling prices of individual products.

(5) Statistical and Conceptual Difficulties:

The measurement of macroeconomic concepts involves a number of statistical and conceptual difficulties. These problems relate to the aggregation of microeconomic variables. If individual units are almost similar, aggregation does not present much difficulty. But if microeconomic variables relate to dissimilar individual units, their aggregation into one macroeconomic variable may be wrong and dangerous.

2. Difference between Microeconomics and Macroeconomics:

The difference between microeconomics and macroeconomics can be made on the following counts. The word micro has been derived from the Greek word mikros which means small. Microeconomics is the study of economic actions of individuals and small groups of individuals. It includes particular households, particular firms, particular industries, particular commodities and individual prices.

Macroeconomics is also derived from the Greek word makros which means large. It “deals with aggregates of these quantities, not with individual incomes but with the national income, not with individual prices but with the price levels, not with individual output but with the national output.”

The objective of microeconomics on demand side is to maximize utility whereas on the supply side is to minimize profits at minimum cost. On the other hand, the main objectives of macroeconomics are full employment, price stability, economic growth and favourable balance of payments.

The basis of microeconomics is the price mechanism which operates with the help of demand and supply forces. These forces help to determine the equilibrium price in the market. On the other hand, the basis of macroeconomics is national income, output and employment which are determined by aggregate demand and aggregate supply.

Microeconomics is based on different assumptions concerned with rational behaviour of individuals. Moreover the phrase ceteris paribus is used to explain the economic laws. On the other hand, macroeconomics bases its assumptions on such variables as the aggregate volume of output of an economy, with the extent to which its resources are employed, with the size of the national income and with the general price level.

Microeconomics is based on partial equilibrium analysis which helps to explain the equilibrium conditions of an individual, a firm, an industry and a factor. On the other hand, macroeconomics is based on general equilibrium analysis which is an extensive study of a number of economic variables, their interrelations and interdependences for understanding the working of the economic system as a whole.

In microeconomics, the study of equilibrium conditions are analysed at a particular period. But it does not explain the time element. Therefore, microeconomics is considered as a static analysis. On the other hand, macroeconomics is based on time-lags, rates of change, and past and expected values of the variables. This rough division between micro and macroeconomics is not rigid, for the parts affect the whole and the whole affects the parts.

3. Dependence of Microeconomic Theory on Macroeconomics:

Take for instance, when aggregate demand rises during a period of prosperity, the demand for individual products also rises. If this increase in demand is due to a reduction in the rate of interest, the demand for ‘ different types of capital goods will go up. This will lead to an increase in the demand for the particular types of labour needed for the capital goods industry. If the supply of such labour is less elastic, its wage rate will rise.

The rise in wage rate is made possible by increase in profits as a consequence of increased demand for capital goods. Thus, a macroeconomic change brings about changes in the values of microeconomic variables in the demands for particular goods, in the wage rates of particular industries, in the profits of particular firms and industries, and in the employment position of different groups of workers.

Similarly, the overall size of income, output, employment, costs, etc. in the economy affects the composition of individual incomes, outputs, employment, and costs of individual firms and industries. To take another instance, when total output falls in a period of depression, the output of capital goods falls more than that of consumer goods. Profits, wages employment decline more rapidly in capital goods industries than in the consumer goods industrie

4. Dependence of Macroeconomics on Microeconomic Theory:

On the other hand, macroeconomic theory is also dependent on microeconomic analysis. The total is made up of the parts. National income is the sum of the incomes of individuals, households, firms and industries. Total savings, total investment and total consumption are the result of the saving, investment and consumption decisions of individual industries, firms, households and persons.

The general price level is the average of all prices of individual goods and services. Similarly, the output of the economy is the sum of the output of all the individual producing units. Thus, “the aggregates and averages that are studied in macroeconomics are nothing but aggregates and averages of the individual quantities which are studied in microeconomics.”

Let us take a few concrete examples of this macro dependence on microeconomics. If the economy concentrates all its resources in producing only agricultural commodities, the total output of the economy will decline because the other sectors of the economy will be neglected.

The total level of output, income and employment in the economy also depends upon income distribution. If there is unequal distribution of income so that income is concentrated in the hands of a few rich, it will tend to reduce the demand for consumer goods.

Profits, investment and output will decline, unemployment will spread and ultimately the economy will be faced with depression. Thus, both macro and micro approaches to economic problems are interrelated and interdependent.