Understanding Macroeconomics: Key Concepts and Objectives

Posted on Jan 4, 2025 in Economy

Macroeconomics

Macroeconomics is a sub-science of economics that studies the interrelation among economic agents, generating economic indicators.

Economic Agents

  1. Households (families) → Consumption
  2. Firms (producers) → Investment to produce goods and services
  3. Public sector → Provides services (Consumption + Investment)
  4. External sector → Rest of the world (Consumption + Investment)

Markets

Markets are physical or virtual places or institutions where goods and services are exchanged for money.

  1. Goods and services markets → Price
  2. Financial market → The price is the interest rate
  3. Labor market → Wage
  4. External market → Contains all of the above and interacts according to the exchange rate

Macroeconomic Objectives

  1. Economic Growth: The main objective of a country. Necessary to escape poverty and avoid economic problems like unemployment, which causes public deficit and increased crime. Economic growth is defined by the GDP. When prices rise, economic growth decreases.
  2. Price Stability: Avoid inflation.
  3. Full Employment: Rate of unemployment, people who desire to work but cannot.
  4. Balanced Public Accounts: Public deficit and public debt.
  5. Balanced External Account: Main relation among countries. International trade, exports, and imports.

Consumption and Investment

Consumption has only one use and is used in the short run. Investment is used in the long run to generate goods, services, and then money.

The Economic Cycle

The succession of different phases of GDP growth, measured by the rate of growth or GDP.

The Four Phases of a Business Cycle

  1. Peak: Business activity reaches a temporary maximum, unemployment is low, and inflation is high.
  2. Recession: A decline in total output, unemployment rises, and inflation falls.
  3. Trough: The bottom of the recession period, unemployment is at its highest, and inflation is low.
  4. Expansion (Recovery): Output is increasing, unemployment begins to fall, and later inflation begins to rise.

Reasons for a Recession

  1. Overcapitalization: A supply reason (Investment decreases) where money doesn’t get its highest value, so it searches for more beneficial sources.
  2. Underconsumption: A demand reason (Consumption decreases) where people don’t consume as much as they can.
  3. Psychological: People consume less due to worry, for example, in Spain, if the country is doing poorly.
  4. Exogenous Reasons: External events, such as a sun storm that disrupts stock exchange communication.

Is the GDP a Good Measurement?

Yes, it is the only one we have, but it has inconveniences. The quality of goods doesn’t appear in the GDP. Some activities aren’t reflected because they aren’t traded in the market, such as work at home, volunteer work, self-consumption, and cultivating tomatoes. These are alegal activities because they are not included in the circular flow. There are also illegal activities (prostitution). Spillover (pollution) detracts from the GDP.

Inflation

The rate of change in prices within an economy. Prices no longer show the real value of things because they are inflated. Inflation is bad because we can’t detect real situations.

Measurement of Inflation

  1. GDP Deflator: The ratio of nominal GDP (GDP measured at current prices) in a given year to the real GDP of the year. Problems: difficult to measure all goods and services on time.
  2. Consumer Price Index (CPI): Measures the cost of buying a fixed basket of goods and services representative of urban consumer purchases, counted in order of importance.
  3. Producers Price Index (PPI): Measures the inflation of raw materials and semi-finished goods acquired by firms in their production processes. CPI is related to the demand side of GDP, and PPI is related to the supply side.

Problems of Inflation

  1. We can’t calculate the real value of things.
  2. We lose purchasing power because money loses value with rising prices.
  3. In international terms, we lose competitiveness because if our prices rise, our exports decrease.
  4. Inflation generates inequalities between social groups: public administration and employees, creditors and debtors, and taxpayers and public administration.

NDP

Net Domestic Product: An annual measure of a nation’s economic output adjusted for depreciation, calculated by subtracting depreciation from the GDP.

GNP

Gross National Product: Measures the production of our nation, no matter where they are producing. We subtract the production generated by foreigners.