Introduction to Macroeconomics

In Class 11 we studied microeconomics — the behaviour of individual units like a single consumer, firm or market. Now we turn to macroeconomics, which studies the economy as a whole. The word "macro" means large. Macroeconomics looks at the big, aggregate picture: the total output of the country, the general price level, total employment, and the overall growth of the economy.

Macroeconomics was developed mainly by the economist J. M. Keynes, especially after the Great Depression of the 1930s, when economists realised that the whole economy could behave differently from a single market — for example, the economy as a whole could suffer mass unemployment that simple market forces did not cure.

The chief subject matter (scope) of macroeconomics includes:

• National income — how to measure the total output and income of a country (GDP, GNP, etc.).
• Money and banking — the supply of money and the role of banks and the central bank.
• Determination of income and employment — what decides the level of output and jobs.
• The government budget and fiscal policy.
• The open economy — trade, the balance of payments and exchange rates.
• Inflation and economic growth.

The key difference: microeconomics studies the trees, macroeconomics studies the forest. Micro asks "what is the price of one good?"; macro asks "why is the general price level rising?". Micro asks "how much does one firm produce?"; macro asks "what is the country's total output?".

How does income move around an economy? The circular flow of income shows how money and goods flow continuously between the different sectors of the economy. In the simplest two-sector model, the economy has only households and firms, linked by two markets.

• Households own the factors of production (land, labour, capital, enterprise) and supply them to firms through the factor market. In return, firms pay them factor incomes (rent, wages, interest, profit).
• Firms use these factors to produce goods and services and sell them to households through the product market. Households pay for them — this is consumption expenditure.

So money flows in a circle: firms pay income to households (for factor services), and households spend that income back on goods (consumption), which returns to firms as revenue — round and round. The diagram below shows this:

Macroeconomics measures many variables, and it is important to know whether each is a stock or a flow.

• A stock variable is measured at a point of time — it has no time dimension. Examples: the amount of money you have right now, the capital of a firm, the population on a given date, wealth.
• A flow variable is measured over a period of time — it has a time dimension (per month, per year). Examples: income (per month), investment (per year), national income, expenditure.

A simple way to remember: a stock is like the water in a tank at a moment; a flow is like the water entering the tank per minute. Wealth is a stock; income is a flow.

An economy is run by its economic agents — the decision-makers: households (consume and supply factors), firms (produce), the government (taxes and spends), and the external sector (foreign trade). Correspondingly, the economy is divided into sectors:

• The household sector, the firm (producing) sector, the government sector, and the external (foreign) sector.
• By function, output is also grouped into the primary sector (agriculture, mining), the secondary sector (industry, manufacturing) and the tertiary sector (services).

A two-sector economy has only households and firms; adding the government makes it a three-sector economy; adding the external sector makes it a four-sector (open) economy — which is the realistic case we build up to in this course.