Understanding Macroeconomics: Key Concepts & Policies
Interest Rates
When companies or individuals request a loan, it’s returned with an additional percentage of the original amount. This percentage is called interest, representing the cost of financing. Interest rates are set freely in the market. A high interest rate typically leads to a decrease in investment, as companies will be less inclined to borrow, and fewer loans and projects will be undertaken.
Income Distribution
Income distribution is not perfectly equal; not everyone receives the same wages and benefits. This inequality reduces opportunities for people with lower incomes. To mitigate the negative effects of inequality, the state strives to provide equal opportunities through taxes, public spending, healthcare, and education.
Macroeconomic Indicators and Welfare
Macroeconomic indicators help us understand a country’s economic state. Growth in Gross Domestic Product (GDP) and per capita income often reflect increased material well-being. For example, GDP growth might be associated with better infrastructure (roads, machinery, etc.). Conversely, high unemployment can lead to family difficulties. Moderate inflation can indicate positive future economic prospects.
Limitations of Macroeconomic Indicators
These variables alone aren’t sufficient to fully understand public welfare. It’s crucial to analyze income distribution alongside per capita income. Other factors like literacy, life expectancy, and working conditions are also important.
Government Revenue
The government’s primary function regarding revenue is to finance public spending. The budget is the document outlining state expenditures and revenues. Ideally, the budget should be balanced. If the state’s revenue isn’t sufficient to cover its expenditures, it must either decrease spending or increase debt.
Expenditure
In a closed economy, all income earned becomes expenditure. This can be represented as: Output = Income = Expenditure.
Types of Expenditure
- Final consumption expenditure (public and private)
- Expenditure on capital goods (investment)
Therefore, Production = Private Consumption + Public Expenditure + Investment (by businesses).
Expenditure and the External Sector
When considering the external sector, national production doesn’t necessarily equal national expenditure. The equation becomes: GDP = Private Consumption + Private Investment + Public Spending + Exports – Imports.
Consumer Price Index (CPI)
The CPI is calculated using a weighted average. Each product included in the CPI’s composition is assigned an index value of 100.
Debt and Deficit
A balanced budget occurs when costs and revenues are equal. A public deficit arises when the state spends more than it collects in revenue. A public surplus occurs when the state collects more than it spends. To finance a public deficit, the state issues debt. Public debt consists of loans the state takes from households and businesses. There are also automatic stabilizers, such as certain taxes, that help stabilize the economy.
Demand-Side vs. Supply-Side Policies
If demand is weak, demand-side policies are implemented. If there’s a problem with aggregate supply, policies to increase supply are used.
- Keynesian economists believe that economic problems often stem from insufficient demand. When aggregate demand is weak, they advocate for the state to collect fewer taxes and increase public spending.
- Classical economists generally don’t assume that demand is scarce. If demand decreases, they believe companies will lower prices to sell their production. Therefore, they don’t see a need for policies to stimulate demand, focusing instead on supply-side concerns.