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Macroeconomics is the study of the behavior of the aggregate economy. It studies the economy at the general level, and focuses on movements and changes in it. Microeconomics analyzes factors within a firm. However, it looks at all conditions that affect companies. In macroeconomics, factors, which affect economic growth, such as fluctuations in the economy and changes in interest rates, are researched. Macroeconomics entails the analysis of various independent variables in the economy that come together to form the economic system. It is crucial, because it helps to determine national income. There are various macroeconomic events, which take place throughout the year, such as determining the gross domestic product, purchasing managers’ index, hometrack housing survey, capital spending, inventories, exports and imports, among others. In this paper, the following macroeconomic event will be analyzed.
The U.S. annual gross domestic product has grown by 2% in the third quarter of 2012, according to the Bureau of Economic Analysis. The GDP refers to the monetary total value of finished goods and services that are produced in a country over a certain period of time. It can be calculated on the annual basis. It involves private and public consumption, investments and exports, and import value. The GDP is an indicator of the living standards of people in a country. The increase in it in the past quarter is a result of increased public spending in terms of personal expenditures. The government spending was on the rise too, while imports, which are usually a deduction to the GDP, decreased. There was a slight reduction in private inventory investment. Public spending on durable goods increased by 8.5%, while that on non-durable products grew by 2.4%, and the demand for services rose by 0.8%. After economists had added all these aspects, it indicated growth in the GDP.
The principles of macroeconomics include government stimulation, unemployment and the GDP. The government should step in, when troubles arise in the economy, because it has vast resources. The second principle is a problem that is constantly affecting the economy. Economists are trying to come up with ways to reduce its high rates. Finally, the GDP is a macroeconomic concept, but it is indicative of the country’s state of the economy.
Different macroeconomic concepts connected with the event mentioned above include the following: aggregate demand and supply, unemployment and inflation rate, net exports, nominal gross domestic product, real gross domestic product, gross domestic product per capita, deficits, trade restrictions and CPI to compute changes in inflation.
Inflation rates are levels, at which the costs of products and services keep rising, and it leads to lower purchasing power eventually. A small inflation rate between 1-5% is not detrimental to the economy; however, if it increases further, the purchasing power of consumers lowers to such a degree that they will be struggling to afford the basic needs. The high demand for products and services can lead to demand-pull inflation. It happens when the supply is constant, but the demand is increasing. It will make suppliers increase prices, since buyers are willing to spend more money than before. Inflation can also be caused by the increased money supply. When there is too much money in the market and a few commodities, the prices of products and services can be hiked. There are three types of inflation, namely, hyperinflation, stagflation and asset inflation. Economists measure inflation using the consumer price index (CPI), which records consumer prices every month. The CPI tells the inflation rate. Deflation comes in, when inflation is negative, though it rarely happens. The former leads to a general decrease in prices. It also slows down economic growth. It was the case in Japan in the 1990s. The inflation rate has proven to be a tough thing to forecast in macroeconomics.
Another macroeconomic concept is net exports. They are used in determining equilibrium income. It is the difference between the country’s total value of exports and that of imports. Net exports can be positive or negative depending on export and import values. Their relevance is that they can contribute to a stable balance of trade in a country. If the value of exports is higher than the one of imports, then the country has a positive trade balance. The latter can translate to other positive things such as improving country’s savings and exchange rates.
The gross national product (GNP) is the sum of domestic and foreign sources that residents of a country claim to have. It is the GDP plus the net income of residents from non-resident sources. When the GNP is divided per capita, it gives the national income per person. There has been a stable pattern in the national income since 1960s. Most African and Asian countries have less than $2 per day; however, it is much higher in industrialized nations. Economists often contrast the GNP with the GDP. The latter refers to measures of the total income within the country’s borders, whether by local or multinational companies. Both the GDP and GNP help in determining the national income, which can tell the economic state of a country. It will help in financial planning of appropriate measures for development. A good GNP/GDP rate affects the country’s currency positively. A growing economy indicates that other countries are buying and demanding goods and services from that country. A high level of the GNP also leads to a general increase in stocks, since the economy is growing, and it translates to increased profits for firms.
An interest rate is the percentage charged for the use of a certain amount of money, or a certain percentage of the total amount the lender gives. The same applies to banks; they pay their clients a certain percentage to hold their money. Holding and lending money are primary functions of a bank, though there are other institutions and individuals that offer such services. Banks get money to loan to other customers from deposits. Interest rates do not only apply to loans, but also to mortgages, credit cards, and unpaid bills. Those, which are charged by banks, depend on various factors, such as the amount a bank loans or risks associated with the loan. However, the central bank in a country determines interest rates used by banks. For example, it determines the funds rate. It is the amount of money that banks charge each other for overnight loans. Banks must have 10% of loans overnight, because this will act as a buffer for the next day withdrawal. Interest rates have positive effects on the country’s economy. If they are higher, it means that few people will afford to borrow loans. It lowers the amount of cash in circulation, which can be used to make unnecessary purchases, as well as encourages people to save. Higher interest rates also have a negative effect on the economy. Companies will have limited access to the capital required to start or expand their businesses. Besides, such rates decrease investments, lowering the GDP in turn. Low interest rates can lead to inflation; therefore, the central bank has to consider various macroeconomic factors when setting interest rates.
Aggregate demand shows the demand side of the economy. Aggregate supply represents the largest output an economy can sustain. The former is the relationship between the price level and the quantity of output. “Factors affecting AD arehousehold consumption, government spending, investment, and net exports. AD is the same in both the short run and the long run. It represents how a change in a certain price level will change expenditures on all services and goods in an economy” (Brue and Flynn 543). Aggregate supply is the measure of the volume of goods that an economy produces at a given price. It changes in the long run and the short run. Expanding labor, capital stocks and business efficiency affects aggregate supply. An increase in aggregate demand will lead to an increase in the GDP, and prices will decrease. GDP deflectors measure aggregate demand.
The aggregate demand (AD) - aggregate supply (AS) model explains macroeconomics. In the AD curve, the vertical axis represents the price level of goods and services, while the horizontal one represents their quantity. The AD curve is just like the demand curve. It is on a downward slope, because factors that affect demand, such as increase in prices, also affect it. Interest rates influence the AD curve in the way that when prices increase, a transaction consumes more money. The demand for money causes interest rates to go up. It means that spending will decrease because of their high level. It is another reason to explain the inverse relationship between price and demand in the AD curve. The downward slope in the AD curve is explained by net export effects. If prices of domestic goods increase, imported products become a little bit cheaper. It means that domestic goods are also expensive in the foreign market, hence exports will decrease. Since the latter are a crucial part of the GDP, it decreases too. The aggregate supply curve shows the quantity of the real GDP supplied by the economy at different prices. An increase in price levels will raise the amount of income, which suppliers will get for their product. It produces more output. The short term AS curve is different from the long term one. Changes in input prices and a shift in economic growth cause changes in the AS curve.
There are theories that attempt to explain various phenomena associated with macroeconomics. These include unemployment, inflation and levels of aggregate production. Macroeconomic theories attempt to explain changes in the gross domestic product. The first theory is the Keynesian theory developed by John Maynard Keynes. It was a response to massive unemployment after the recession in the 1930s. Its main principle is that aggregate demand is the main cause of business cycle instability. Keynes says that the government should be active in regulating businesses to avoid instability. The theory points out the disadvantages of free trade. Besides, ownership is not a necessary thing in capitalism, and stock investors are functionless. Keynes believed in the circular flow of money. Person’s spending goes to another person, and the system must continue that way in order for the economy to function well. He believed that the public sector should exist in order to assist the economy.
The classical economic theory developed by Adam Smith bases its principles on flexible prices. These ensure market equilibrium and full employment. The theory asserts that government involvement is not compulsory for a functional economy. The classical theory bases its principles on a self-regulating economy. Such an economy can obtain its natural level of GDP. The latter is dependent on Say’s Law, the flexibility of prices, wages and interest rates. According to Say’s Law, the economy produces a certain level of GDP. Say’s law also states that the economy generates enough income to enable it to purchase the real level of GDP. Classical theorists term unemployment as voluntary, and explain that unemployed workers choose to stay so, because they cannot accept a lower income.
The monetarism theory is a theory that says that the amount of money that circulates in an economy causes macroeconomic instability. It relates closely to the classical theory. Economists developed it in the 1960-1970s, in the period of stagflation. The quality theory of money is applied in it, whereby money velocity is equal to price levels and transactions. Therefore, the value of expenditures on goods and services ought to be the same as the value of output.
The new classical theory is the latest among macroeconomic theories. It criticizes the Keynesian theory and builds further on the classical theory. It emphasizes the market freedom. The theory uses such new approaches as public choice, free markets and market friendly strategies. As far as the free market approach is concerned, markets are independent regulating and generating enough money to keep them going. The public choice approach asserts that all types of governments are dishonest and corrupt, and will embezzle private property in the long run. The market friendly approach asserts that the government has to complement the free market, because it sometimes fails to emerge. The new classical theory supports the idea of trade liberalization because of the benefits it brings. They include economies of scale, competition, breaking down monopoly, and stimulating growth.
The aggregate market analysis theory is a combination of the classical and Keynesian theories. It combines two opposing forces in the economy, aggregate demand and aggregate supply. It is representative of the economy at its best.