Understanding Microeconomics, Trade, and Macroeconomic Objectives
Understanding Key Economic Principles
1. Microeconomics vs. Macroeconomics
Microeconomics is the study of decisions made by individuals and businesses regarding the allocation of resources and the prices of goods and services, considering taxes and government regulations. It focuses on supply and demand and other forces that determine price levels in the economy.
Macroeconomics, on the other hand, studies the behavior of the economy as a whole, including entire industries and economies. It examines Gross Domestic Product (GDP) and how it is affected by changes in unemployment, national income, growth rate, and price levels.
2. Gains from Trade
Countries can benefit from trade by specializing in producing goods in which they have a comparative advantage, meaning goods that can be produced at low opportunity costs.
Trade can generate significant benefits for firms and consumers, including promoting competition, reducing prices, increasing choice, and driving economic growth.
3. Trade Restrictions
A trade restriction is any government policy that limits the free flow of goods and services across borders.
4. Reasons for Trade Restrictions
Valid reasons for restricting trade include:
- The infant industry argument
- Addressing dumping practices
- Preventing the establishment of foreign-based monopolies
- Spreading the risks of fluctuating export prices
- Addressing concerns that free trade may affect consumer tastes and not account for externalities
5. The World Trade Organization (WTO)
The World Trade Organization (WTO) is the primary global international organization dealing with the rules of trade between nations. Its goal is to facilitate business for producers of goods and services, exporters, and importers.
Most countries are members of the WTO and, in theory, support moves toward freer trade. The WTO can impose sanctions on countries that do not respect its rules, including non-discrimination, reciprocity, no quotas, fair competition, and binding tariffs.
Trade talks, such as the Uruguay Round, have led to reductions in tariffs and other trade restrictions. The Doha Round focuses on trade liberalization and aims to spread the benefits of trade across developing countries.
6. Macroeconomic Objectives
Four key macroeconomic objectives are:
- High and stable economic growth
- Reducing unemployment
- Low and stable inflation
- Avoiding balance of payments and exchange rate problems
Additional aims include achieving a balanced budget, enabling income redistribution, and developing policies to prevent environmental damage.
7. Circular Flow of Income
The circular flow of income represents the flow of money, income, and expenditure within an economy. The inner flows show the direct flows between firms and households. Money flows to workers as wages, and money flows back to firms in exchange for products.
However, not all income flows directly from households to businesses. Some is withdrawn as savings, taxes, or expenditure on imports.
Expenditure on domestic firms’ products comes not only from domestic consumers but also from investment expenditure, government expenditure, and expenditure on a country’s exports.
8. The Business Cycle
The business cycle is the fluctuation in economic activity that an economy experiences over time. It consists of four phases: the upturn, the expansion, the peaking-out, and the slowdown or recession.
9. Defining Money
Money in its narrow sense includes cash in circulation. However, money is typically defined more broadly to include all bank deposits, not just cash (referred to as M4 in the UK).
10. Inflation
Inflation is the annual percentage increase in prices.
11. Unemployment
Unemployment occurs when a person actively searching for employment is unable to find work. Common measures include claimant unemployment (claiming unemployment benefits) and ILO/OECD standardized unemployment (people actively looking for a job or waiting to take up an appointment).