Unit 1 introduction to macroeconomics (2).docx

Unit 1 Introduction to macroeconomics The word economy comes from the Greek word oikonomos, which means "one who manages a household." At first, this origin might seem peculiar. But in fact, households and economies have much in common. A household faces many decisions. It must decide which member...

Unit 1 Introduction to macroeconomics The word economy comes from the Greek word oikonomos, which means "one who manages a household." At first, this origin might seem peculiar. But in fact, households and economies have much in common. A household faces many decisions. It must decide which members of the household do which tasks and what each member gets in return: Who cooks dinner? Who does the laundry? Who gets the extra dessert at dinner? Who gets to choose what TV show to watch? In short, the household must allocate its scarce resources among its various members, taking into account each member's abilities, efforts, and desires. Like a household, a society faces many decisions. A society must find some way to decide what jobs will be done and who will do them. It needs some people to grow food, other people to make clothing, and still others to design computer software. Once society has allocated people (as well as land, buildings, and machines) to various jobs, it must also allocate the output of goods and services they produce. It must decide who will eat caviar and who will eat potatoes. It must decide who will drive a Ferrari and who will take the bus. The management of society's resources is important because resources are scarce. **Scarcity** means that society has limited resources and therefore cannot produce all the goods and services people wish to have. Just as each member of a household cannot get everything he or she wants, each individual in a society cannot attain the highest standard of living to which he or she might aspire. **Economics** is the study of how society manages its scarce resources. In most societies, resources are allocated not by an all-powerful dictator but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. For instance, they examine how the multitude of buyers and sellers of a good together determine the price at which the good is sold and the quantity that is sold. Finally, economists analyze forces and trends that affect the economy as a whole, including the growth in average income, the fraction of the population that cannot find work, and the rate at which prices are rising. [What is Macroeconomics?] Economics is traditionally divided into two parts: **microeconomics and macroeconomics**. The main purpose of this unit is to introduce you to the principles of macroeconomics. Macroeconomics is the study of how a country\'s economy works while trying to discern among good, better, and best choices for improving and/or maintaining a nation\'s standard of living and level of economic and societal well-being. Historical and contemporary perspectives on the roles and policies of government are part of the mix of interpretations and alternatives that surround questions of who or what gains and loses the most or least within a relatively small set of key interdependent players. In the broadest view, that set consists of households, consumers, savers, firm owners, investors, agency and elected officials, and global trading partners in which some wear many hats and face price considerations at two levels. Consider one distinction between macroeconomics and microeconomics through the way prices are taken into account in both divisions. On one hand, microeconomics focuses on how supply and demand within a given market determine prices. On the other hand, macroeconomics focuses on changes in the price level across all markets. Another distinction resides within goals. A study of microeconomics orients itself toward firm profit maximization and output optimization as well as consumer utility maximization and consumption optimization. In contrast, a study of macroeconomics situates itself around a number of goals including economic growth, price stability, and full employment. Macroeconomic performance relies on measures of economic activity, focusing on variables and data at the national level within a specific period of time. Macroeconomics entails analyses of aggregate measures such as national income, national output, unemployment and inflation rates, and business cycle fluctuations. [Objectives of Macroeconomics] There are four major objectives of macroeconomics which are: - Full employment - Price stability - A high, but sustainable, rate of economic growth - Keeping the balance of payments in equilibrium. [Full Employment or low unemployment] When economists talk about full employment, they don't mean everybody has a job. And they don't mean that even the rosiest economic health can cut unemployment to zero. If unemployment falls too much, inflation will rise as employers compete to hire workers and push up wages too fast. To economists, full employment means that unemployment has fallen to the lowest possible level that won't cause inflation.  **Full employment refers to a situation in which every able bodied person who is willing to work at the prevailing rate of wages is, in fact, employed. Alternatively, it is a situation when there is no involuntary unemployment.** That is why full employment is also defined as a situation where there is no involuntary unemployment. Classical economists and Keynes view full employment in different ways. According to Classical, full employment is a situation where there is no involuntary unemployment. But according to Keynes, full employment indicates that level of employment where increase in aggregate demand does not lead to increase in level of output and employment. [Price Stability] Price level stability denotes that consumer spending is not affected by inflation because consumers do not worry that the value of money will change anytime soon. It is important to separate the increase in the prices of individual goods or services from the increase in the general price level. In market economies, it is expected that individual prices will change following the changes in demand and supply, but this doesn't mean that the general price level will change as well. Governments and central banks set a target inflation rate up to 2% because such a low inflation cannot affect the economic activity and the financial stability. Furthermore, price level stability contributes to employment because the increased demand for goods and services forces business to hire more workers. **Price level stability is an economic theory that when the prices of goods and services aren't regularly volatile, consumers are more likely to make buying and selling decisions without thinking about inflation or the consequences of it**. [A high, but sustainable, rate of economic growth] Economic growth occurs when real output increases over time. Real output is measured by Gross Domestic Product (GDP) at constant prices, so that the effect of price rises on the *value* of national output is removed. **Sustainable economic growth means a rate of growth which can be maintained without creating other significant economic problems, especially for future generations**. There is clearly a *trade-off* between rapid economic growth today, and growth in the future. Rapid growth today may exhaust resources and create environmental problems for future generations, including the depletion of oil and fish stocks, and global warming. Periods of growth are often triggered by increases in aggregate demand, such as a rise in consumer spending, but sustained growth must involve an increase in output. If output does not increase, any extra demand will push up the price level. [Keeping the balance of payments in equilibrium] Maintaining a balance of payments with the rest of the world is a macro-economic objective. In simple terms, if the balance of payments balances, then the combined receipts from selling goods and services abroad, and from the return on investments abroad, equals the combined expenditure on imports of goods and services, and investment income going abroad. As an official record, the balance of payments is broken down into two basic accounts - the current account, and the capital and financial account. **\"The equilibrium of balance of international payment is a statement that takes into accounts the debits and credits of a country on international account during a calendar year\".** When a country has unfavourable or adverse balance of payments, it is regarded as herald of disaster because the country by having deficit in her balance of payments either decreases her balances abroad or increases her foreign debits. When it has favourable credit balance, it is considered that the country is heading towards prosperity because by having surpluses, it either increases her foreign credits or reduces her foreign debits. Retrieved from Mankiw, N. Gregory. (2011). **Essentials of Economics.** 6^th^ Ed. Pearson Publishers Mankiw, N. Gregory. (2009). **Principles of Macroeconomics.** South-Western Cengage Learning, Mason OH.