The Meaning and Importance of Macroeconomics

 

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Economics: The Basics

There are two major branches of economics:

• Microeconomics
• Macroeconomics

In short, microeconomics is the study of individual economic units of the economy, while macroeconomics is the study of the economy as a whole and its totality. There are two main schools of economic thought. These schools are 1. Classical economics or 2. Keynesian economics.

Macroeconomics before Keynes is sometimes called “classical” economics. According to classical economics:

1. An economy as a whole always functions at a level of full employment due to free play of market forces in a free economy.

2. Supply creates its own demand.

This classical doctrine of automatic full employment was largely accepted until the early 1930s when the Great Depression occurred. The Great Depression of 1929–1933 exploded the myth that an automatic working of market mechanisms would ensure an equilibrium level of income consistent with full employment of resources.

There was a persistent fall in the level of output, income, and employment during the Great Depression, even though the United States and other western countries were highly industrialised, with well-developed basic industries, electric power, means of transport and communication, banks, and other financial institutions. The Classicals failed to explain this situation during The Great Depression.

The Birth of Macroeconomics

In 1936, well-known British economist J. M. Keynes introduced his own theory and wrote his famous book The General Theory of Employment, Interest and Money, which birthed the Keynesian revolution, the second primary school of economic thought. Keynes criticised the Classical assumption of full employment and developed modern macroeconomics: economic theory that attempts to connect money supply, employment, business cycles, and government policy.

The incentive for the development of modern macroeconomics came from the Great Depression of the early 1930s. Macroeconomics addresses:

• the desire to control business cycles in advancing economies and
• the need to develop backward economies.

The Meaning of Macroeconomics

Macroeconomics is the study of the aggregates and averages of the entire economy. It's the part of economic theory which studies the economy in its totality or as a whole.

In microeconomics, we study the individual economic units like a household, a firm, or an industry. However, in macroeconomics we study the whole economic system like national income, total savings and investment, total employment, total demand, total supply, general price level.

We study how these aggregates and averages of economy as a whole are determined and what causes fluctuations in them. The aim of the study is to understand the reason for the fluctuations and to ensure the maximum level of employment and income in a country.

In other words: Microeconomics is the study of individual trees, whereas macroeconomics is the study of forests as a whole.

Macroeconomics is also known as the theory of income and employment, since the subject matter of macroeconomics revolves around determination of the level of employment and income.

At the time of the Great Depression, government participation through monetary and fiscal measures in the economy increased considerably. Since the study of millions of individual economic units is almost impossible, macroeconomics provided tools for the assessment of economic policy. Macro policies make it possible to control inflation and deflation and moderate violent booms and recessions.

The main functions of macroeconomics are the collection, organising, and analysis of data; determining national income, and formulating appropriate economic policies to maintain economic growth and full employment in a developing country.

The scope of macroeconomics includes the following theories:

• National income
• Money
• Economic growth
• Employment
• Price levels

The studies of problems of balance of payment, unemployment and general price level are parts of macroeconomics, as these relate to the economy as a whole.

The Importance of Macroeconomics

Why is macroeconomics important? Here are a few crucial reasons:

• It helps us understand the functioning of a complicated modern economic system. It describes how the economy as a whole functions and how the level of national income and employment is determined on the basis of aggregate demand and aggregate supply.
• It helps to achieve the goal of economic growth, a higher GDP level, and higher level of employment. It analyses the forces which determine economic growth of a country and explains how to reach the highest state of economic growth and sustain it.
• It helps to bring stability in price level and analyses fluctuations in business activities. It suggests policy measures to control inflation and deflation.
• It explains factors which determine balance of payments. At the same time, it identifies causes of deficit in balance of payments and suggests remedial measures.
• It helps to solve economic problems like poverty, unemployment, inflation, deflation, etc., whose solution is possible at the macro level only (in other words, at the level of the whole economy).
• With a detailed knowledge of the functioning of an economy at a macro level, it has been possible to formulate correct economic policies and also coordinate international economic policies.
• Last but not least, macroeconomic theory has saved us from the dangers of application of microeconomic theory to the problems that require us to look at the economy as a whole.