1. Explain the distinction between macro and microeconomics?
2. Using a diagram, explain why an economy’s income must be equal to its expenditure?
3. Should policy-makers care about GDP? Explain your answer.?
Economics is the social science of choice. It deals with how people choose the scarce resources efficiently in order to produce various commodities and also how the central authority of a country produce and distribute different good and service to the people such that their utility will be maximized. This subject is concerned with the money, interest rate, capital and scarce resources. Now, the three main questions that arise frequently will be discussed below. These three main questions are -1) the key difference between the micro and the macroeconomic theory, 2) why the income of a country should be equal to the expenditure of the country and 3) Why do the policy makers give importance to the GDP of a country (Sheffield, 2015).
Economic theory can be classified into two parts- 1) Microeconomic Theory and 2) Macroeconomic Theory. Micro and Macro-these two terms were first used by Ragnar Frisch. The term “micro” means small. The other term “macro” means large. Macroeconomics deals with the analysis of individual economics units such as consumers, firms and small aggregates or groups of individual units such as industries and markets. However, macroeconomics deals with the analysis of the economy as a whole and its large aggregate such as total national output, national income, total consumption, aggregate investment, etc. The microeconomic theory makes a microscopic study of the economics. This theory tries to determine the mechanism through which different economic units attain equilibrium. This theory does not consider the totality of behavior of all units in the economy. It takes into account the total resources of the economy as given and tries to analyze how these resources are allocated efficiently among different economic units such that their utility will be maximized. On the other hand, macroeconomics is concerned with the behavior of the economy as a whole. This theory deals with the total amount of goods and services of an economy, the growth of the output, inflation rate, unemployment rate, the balance of payment, exchange rate, etc. The main focus of this macroeconomic theory is on the economic behavior and the policies that can affect total consumption, investment, monetary stock in an economy, the budget, amount of debt, etc. In brief, this theory deals with the major economic issues arises in an economy(Bishop, 2013).
In an economy, total income must be equal to the total expenditure so that the economy will be in the equilibrium. Every economic transaction has a buyer on one side and a seller on the other side. Therefore, each expenditure by the buyer will be the each income of the seller. Thus, it can be said after considering the total economy as a whole the total income of an economy will be equal to the total expenditure of the same economy. The total expenditure of an economy can be measured using the GDP of that economy. It is the total expenditure done by the economy on its currently produced goods and services. On the other hand, the total income of an economy in a given period is the total earnings of the economy from the current production of goods and services. Any imbalance in the income and expenditure will take the economy in a disequilibrium position from where the economy always tries to return its equilibrium point. The amount of inventories plays a significant role in this adjustment process. The firms in an economy experience unplanned changes in the inventories. This induces the firms to change their production level immediately. This change in the production level in turn influences the total income and total expenditure of the economy. As a result of this, the economy move towards the equilibrium point. This adjustment process has been shown in the following figure.
In the below figure, initially the economy is operating at point A. The 45-degree line in the below diagram shows all the point where income equals expenditure. Let us assume that for some reasons, the GDP is greater than the income. This has been shown by the income level Y1. In this situation, the firms are selling less than they are producing. The unsold goods are then added to the inventory stock. This unplanned increase in inventory induces the firms to reduce their production. The process of this inventory accumulation and the continuous fall in income continues until the economy reaches its equilibrium position(Sheffield, 2015).
Again let us assume that the GDP is lower than the total income. This is indicated in the following figure by the income level Y2. In this situation, the firms have to meet the demand for goods and services by drawing down their total stock of inventories. But when the firms see their stock of inventory is decreasing continuously, they have to increase their production level. As a result, the economy again approaches to the equilibrium point (Bishop, 2012).
Therefore from the above analysis it can be concluded that any imbalance in the income and expenditure induces the economy to move from the disequilibrium position to the equilibrium position. Therefore, to keep the economy in a stable position the income of the economy must be equal to the expenditure of the economy.
Gross Domestic Product (GDP) is the value of all final goods and services produced in the country within a given period. This includes the value of goods such as house and electronic goods, and the value of services, such as train, airplane rides, the lecture by the teacher, etc. The value of each and every good and service is calculated at the current market price. This is a very esoteric concept from the common man’s view but the very useful concept at the time of policy making by the economists.GDP is the well-being indicator of the residents of a country. This measure can be used easily to understand the current state of an economy as well as how the economy is changing over time. This measure is also useful to compare the economic conditions between different countries. Now different uses of GDP estimate will be discussed below to understand why policymakers give so much importance both on the value of GDP and also the GDP growth rate (Klein, Bauman and Ramos, 2013).
1) GDP is calculated by adding together total consumer’s expenditure, investment expenditure, government expenditure and the amount of net export (GDP=C+I+G+NX). These four components describe the present inclusive scenario of an economy. Hence, this GDP can give insight into the current trend of the economy. This also helps the policymaker to understand the relative position of the country compared to another country in the world economy. The policymaker then adopts various fiscal and monetary policies to reach the targeted GDP growth rate and narrow the gap between two countries (Krugman, Wells and Baechler, 2013).
2) GDP is also a useful indicator used by the policymaker of a country for the internal development to make various economic planning and formulate effective policy. Government of a country often shows interest in the study of demographic change, overall health condition of the population, supply of skillful labor, overall literacy state of the country along with the country’s GDP. This helps them to allocate scarce resources efficiently such that the sectors having an urgent need for money will get the capital first. This efficient allocation is very useful especially for the rapid economic development of both developing countries and less developed countries (Library.ulster.ac.uk, 2015).
3) GDP growth rate is also important for the policymakers of the central monetary authority of a country. This rate helps the policy makers to set appropriate interest rate and other tools they used to control the money liquidity in the economy. It is known that interest rate is negatively linked with the money supply in an economy. A decrease in the interest rate leads to the increase of investment by investors and also the consumption spending by the consumers. As a result, the money supply in the economy increases so much. This increment in the money supply also influences on the overall price level of the economy and leads to the rise in inflation rate. A high inflation rate can hamper the economic growth of a country in the long run. Very high or too low inflation rate both can impede the growth rate. Therefore, the level of inflation rate should be at the moderate level. To keep the inflation rate at a desired level for sustainable development the policy maker has to implement effective monetary policy and for that it needs to observe first the country’s GDP (Library.ulster.ac.uk, 2015).
At the end, from the above analysis it can be said that although both micro and macro economics deal with the efficient allocation, there is a little difference between them. Microeconomics does the analysis on the individual economic unit whereas macroeconomics takes the whole economy as its analysis subject. It is also discussed in this essay that the income and expenditure of an economy must be equal to keep the economy in a stable condition as the volatile economic condition is not helpful to sustain economic development. The third analysis shows why policymakers pay much attention to the GDP growth rate of the economy at the time of policy formulation.
Bishop, S. (2012). AP macroeconomics/microeconomics 2013-2014. New York: Kaplan Pub.
Bishop, S. (2013). AP macroeconomics/microeconomics 2014. New York, NY: Kaplan Pub.
Klein, G., Bauman, Y. and Ramos, F. (2013). IntroduccioÌn a la macroeconomiÌa en vinÌƒetas. [Barcelona]: Debate.
Krugman, P., Wells, R. and Baechler, L. (2013). MicroeÌconomie. Bruxelles: De Boeck.
Library.ulster.ac.uk, (2015). University of Ulster Library - Electronic Resources. [online] Available at: https://library.ulster.ac.uk/electronic/eresources.php [Accessed 25 Jul. 2015].
Library.ulster.ac.uk, (2015). University of Ulster Library - Library Databases - ABI Global Package. [online] Available at: https://library.ulster.ac.uk/electronic/check/eiscard.php?eisno=1 [Accessed 25 Jul. 2015].
Sheffield, U. (2015). FAME - Databases - The University Library - The University of Sheffield. [online] Sheffield.ac.uk. Available at: https://www.sheffield.ac.uk/library/cdfiles/fame [Accessed 25 Jul. 2015].
Sheffield, U. (2015). Nexis - Databases - The University Library - The University of Sheffield. [online] Sheffield.ac.uk. Available at: https://www.sheffield.ac.uk/library/cdfiles/nexis [Accessed 25 Jul. 2015].
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