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INTRODUCTION TO MACROECONOMICS
Chapter Overview
INTRODUCTION TO MACROECONOMICS

Introduction Macroeconomics Vs Microeconomics

Macroeconomics Vs Microeconomics

LEARNING OBJECTIVES:
After studying this chapter, you should be able to:

1. To differentiate between microeconomics and macroeconomics. 2. To understand the objectives of macroeconomics 3. To explain how the macroeconomic objectives may conflict with each other.

1.0

Introduction

In the previous semester, as a student of microeconomics you learnt the definition of economics and the divisions of economics. As you are aware economics is a social science which studies the behavior of man in a society. It is a study of how society chooses to allocate scares resources which have alternative uses to satisfy their needs. Economics is a study of how man produce, distribute and consume goods and services.

Economics: The study of how man produce, distribute and consume goods and services.

Economics is divided into two broad categories that is, microeconomics and macroeconomics. Adam Smith, known as a father in economics believed that man will act on their own- self interest to produce goods and services that will eventually benefit the society. However, during the great depression in the 1930 with the collapse of wall street, the unemployment level increased, prices fall and the economy was slipping into a deep recession. The classical model could not explain this phenomena, it was John Maynard Keynes in 1936, who propose to examine the economy as a whole to find the solution. He suggested government intervention in the economy was necessary to revive the economy. Macroeconomics emerged as separate subject after 1930. Macroeconomics studies the economy as a whole with specific focus on unemployment, inflation, international trade and business cycle.

Macroeconomics: studies the economy as a whole with specific

focus on unemployment, inflation, international trade and business cycle.

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In microeconomics we study how individuals make decision, where as in macroeconomics we study the sum of these individual decisions. Instead of focusing on the factors that influence the production of particular products and behaviour of individual firms, macroeconomics focuses on the determinants of total national output Macroeconomics studies not household income but national income, not individual prices but the overall price level in the society and of the nation. It does not analyse the demand for labour in the automobile industry but rather total employment in the economy of the nation. If you are unemployed, it is a microeconomic problem of finding the right wage or developing the right skills. If 10 million people are unemployed, it is a macroeconomic problem. If the price of eggs rises, it is a microeconomic problem. If the aver-age price of everything rises, it is a macroeconomic problem.

Aggregate: The sum of all sectors or the whole economic system 2

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Macroeconomics Vs Microeconomics To have an understanding of macroeconomics it is important to be able to differentiate between microeconomics and macroeconomics. Microeconomics that you have studied deals with interaction at individual level that is among and between producers and consumer in individual market. The microeconomics topic basically covers demand, supply, production, cost and type of market structures. Some of the issues you learnt are: the effect of an increase in price of a product on demand and supply, how producers determine efficient combination of resources and how prices of products are determine in different types of market structures. Some examples of microeconomics relationships are if the price of rice increase what will happen to the demand and supply, how many Excellent school bags should a firm produce and what price to sell to maximize profit, what is the combination of resources should the firm use to produce at the lowest possible cost. Macroeconomics studies the economy as a whole that is the total production of a country and how it allocates its limited resources to maximize production, promote growth and trade. It comprises broad economic activities such as unemployment level in the economy, national debt, general price level and growth rate. The performance of an economy is measured by national output, unemployment, inflation, saving and investment. These key economic indicators are monitored by the government, businesses and consumers. In macroeconomics the issues are more dynamic and complex. It is concern with variable such as factors influencing aggregate demand, how to reduce inflation rate and unemployment level, and promote economic growth. Table 1.0 compares some issues to show the differences between microeconomics and macroeconomics. Microeconomics analyses individual behavior of consumers and producers in the economy. In contrast macroeconomics sums individual behavior and analyses it on aggregate level or as a whole. Table 1.0: Comparison between Microeconomics and Macroeconomics. Microeconomics 1. The study the individual basis. economy Macroeconomics on 1. The study the economy on aggregate basis.

2.

2. It focuses on the factors that influence national production It focuses on the factors that influence firms production of a in an economy (aggregate particular product (supply of a supply) product) 3. It deals with the national income.

3. It deals with household income only. 4.

It analyses individual prices of 4. It analyses the overall general

goods and services.

price level.

6.

It studies factors that influence 5. It studies factors that influence aggregate demand demand of a particular product (price, income, price of related (consumption, investment, product and preference) government expenditure and net exports) It examine the optimum amount of resources (labour) employed 6. It examines the fullemployment level in an in a firm economy

Macroeconomics (forest)

Microeconomics (trees) Self Assessed Questions 1. State which of the following issues are macroeconomics or microeconomics a) b) c) d) The electronic goods firm employs more labour in Malaysia than in Singapore. The price of chicken fluctuates more often during festive season than off-season The rate of economic growth this year may be lower than last year The economic crisis has caused many workers to be unemployed.

Answer a) Microeconomics b) microeconomics c) macroeconomics d) macroeconomics

CHECKLIST
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At this point you should be able to:

Differentiate microeconomics and macroeconomics. Explain macroeconomics with real-life examples,

1.2

Macroeconomic Objectives There are four macroeconomic objectives. They are to maintain price stability, achieve full-employment, economic growth and balance of payment stability. You may have heard of this objectives mentioned by media or individuals. Every economy will pursue these same objectives. (i) Price stability

Price stability means that the general price level in the economy should be kept as low as possible. When the general price level increases inflation occurs. Inflation is undesirable in an economy when it cannot be controlled. During inflation the value of money falls and people lose confidence in the countrys currency. These will bring about harmful effect on households and business firms as demand for goods and services will increase and investment will decrease rapidly. Inflation redistributes income and resources in the economy, leading to greater inequality in income distribution. Low and stable inflation rate is crucial to achieve business investment, full employment and economic growth.

Inflation : An increase in the general price level.

(ii) Full employment

Achieving full employment or reducing unemployment is another objective of macroeconomics. Full employment is defined as almost everyone who wants to work is able to find a job. However there is a certain percentage of unemployment which is made up of voluntary unemployment. Voluntary unemployment refers to those who are not willing to work at the existing wage rate. From the viewpoint of the economy, unemployed workers represent lost potential output. From the viewpoint of the worker, unemployment means loss of income, and as unemployed workers cut back on their spending, production will fall and other workers soon find themselves jobless. Prolong unemployment increases crime rates, poverty and security expenditure. Unemployment is a key indicator of an economys health Full employment is defined as almost everyone who wants to work is able to find a job. (iii) Economic growth

Economic growth is a rate of increase in gross domestic product (GDP). GDP is total value of goods and services produced in a country in a given year. Economic growth t is measured by finding the current GDP and comparing it to the GDP of the previous year. Economic growth means that incomes are rising, job opportunities, economic development and rising standard of living. The key to prosperity in an economy is steady growth in national output. Economic growth is characterized by upswing and downswing in the level of real output is called a business cycle. There are 4 phases of a business cycle: Peak: occurs when GDP spending in the economy is the highest. It is between expansion and recession. Recession (downturn): is a period during which real GDP decreases. The economy begins to slowdown and key economic indicators are not showing favorable figures for example unemployment rate rises, business activities and income falls Trough: is also known as slump or depression. It is when the economy declines by more 10%. It is period when recession ends expansion begin Expansion (upturn): occurs when the economy begins to recover from a depression. The GDP begins to increase and unemployment decreases.

Economic growth is a rate of increase in total value of goods and services produced in a country in a given year (gross domestic product GDP).

Figure 1: Business cycle GDP Peak Recession Expansion GDP Potential GDP

Trough

Year

(iv)

Balance of Payment stability

Balance of Payments is a record of all monetary transactions taking place between a country and other countries. Basically all countries will try to create an environment in which exports are greater the imports. In an open economy, stability in the balance of trade is important as a balance of payment deficit ( the payment paid abroad is greater than payments received) will result in sharp depreciations in the international value of the currency necessary which will effect investment flow into a country and ultimately economic development.

Balance of payment is a record all monetary the transaction carried by a country and other countries.

1.2.1

Conflicting objectives. In the process of achieving the above objectives, there is a cost. The cost is the conflict between the main objectives. To achieve one objective another objective will be affected.. Full Employment and Inflation During a recession to reduce unemployment the government will create job opportunities by increasing aggregate demand through government expenditure. The government will increase the expenditure on building hospital, infrastructure and schools. This will not only increase income to increase aggregate demand but also put pressure on the price level and inflation occurs. Economic Growth and Balance of Payment. Policies promoting economic growth will increase the national income and aggregate demand. To meet the increase in demand for goods and service, the country will have increase imports and decrease exports, leading to deficit in the balance of payment. Economic Growth and Inflation Rapid economic growth will increase the aggregate demand and put pressure on the prices of raw material and wages which will eventually lead to inflation. A persistent inflation can have negative effect on international trade, profits and economic growth. On the other hand controlling inflation rate by increasing interest rates, may appreciate the exchange rate. This will reduce the countries competitiveness as prices of exports increases and affect the balance of payment.

When economic goals of the government conflicts, the government must choose which objective is the more important and prepare to accept the consequences, at least for the time being. The choice of which macroeconomic objective to pursue may differ from one country to another or according to time period.

1.3

Islamic Economics

Islam as Ad-deen is a complete way of life aims to construct and guide human life and culture according to the values and principles revealed by Allah for mans guidance. In Islamic economics we do not attempt to build our society on economic foundation alone but also focuses on ethical and moral values. Every human being must bear in mind that they are merely custodians over their property and not real masters and the wealth must be acquired by lawful means and not through dishonesty and treachery. We are the Khalifa of Allah on earth based on the principle of Tauhid which form two relationships. 1. 2. Hablul-minAllah Hablul-minannas

Thus the scope of Islamic is wider than conventional economics because it encompases mans whole existence, the two types relationship mentioned above. In Islamic economic, the time frame under consideration is the life in this world and the life the world here after. Thus the approach to Islamic economics is more global and holistic.

Hablul-minAllah : The relationship between man and God (Allah). Hablul-minannas : The relationship between man and man.

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Macroeconomic Objectives from Islamic Perspective In an Islamic system, the basic policy objectives are : 1. 2. 3. 4. Social justice Universal education Optimal rate of economic growth Maximization of employment generation

The above objectives are additions to the conventional macroeconomic objectives. Though there is nothing new or distinctive about these objectives, what makes the difference between the Islamic Economic system with that of other systems is that the pursuit of these objectives in an Islamic economic system must be guided and constrained by Islams own ethical philosophy.

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Social Justice

Social justice, an aspect of the universal law of Equilibrium, forms the cornerstone of the Islamic economic system : Say : May Lord enjoineth justice In other works, man is guaranteed of his freedom and will not be abuse by those who have economic, political or physical power. Four basic points must be noted about Islams distinctive conception of social justice. a. Islamic point of view on social justice is based on the principle that all that exists in the Universe belongs to Allah. Allah is the heritage of the heavens and the earth Man, because of his being Gods vicegerent on earth has been granted the ownership of this bounties. Since man is only as a trustee to Allahs bounties, he must therefore use whatever given to him as a trustee not an absolute owner. Institutions must be created to ensure that man performs all his duties voluntarily. b. Even though, Islam insists on a powerful build-in income-redistributive mechanism, some income inequality is allowed since this promotes individual initiative. In particular, differences in earnings resulting from unequal intellectual endowments are allowed for : He, it is Who hath placed you as viceroys of the earth and hath exalted some of you in rank above others, that may try you by (the rest of) that which hath given you. c. Social Justice in Islam is rooted in mans faith. A man of faith authomatically has a duty to do justice. Income redistribution, voluntarily or compulsory is not only an economic necessity but also a means to spiritual salvation. d. At the philosophical level, the Islamic concept of social justice rests on its value about that maximizes human hapiness. In the Islamic perception, human hapiness rest on mans knowledge of the absolute: Happiness is whatever that makes man happy and in Islam, human happiness comes not so much from the possession of material goods as from contentment and gratitude. Wealth and children are an ornment of life of the world. But the good deals which endure are better in the Lords sight fir reward, and better in respect of hope. 2. Universal Education

The acquisition of knowledge has been made obligatory. In fact, mans title to superiority over all creation is based on his superior knowledge.

Allah will exalt those who believe among you, and those who have knowledge, to high ranks Therefore an Islamic society must distinguish itself by the quality and excellence of its educated class. Thus, every child, irrespective of his birth, must receive an equal opportunity to education. In an Islamic society, universal education has to be subsidized (or free of change) so that education can equalized man who are endowed differently in terms of wealth and property. 3. Optimal rate of economic growth

Economics growth in an Islamic economy is qualitatively different from the growth paths of all other economic systems, in terms of its consumption, production and distribution contents. Accordingly, the very concept of growth in an Islamic economy will change in that it will be more comprehensive including moral, spiritual and material aspects of mans life. In terms of capital formation, it will include explicitly human-capital as well as material capital. However, there will be greater emphasis on human capital formation for the simple reason that, in the Islamic perspective, man is the centre of all economic activity. This consideration should influence the composition of investment because the expenditure on education will now be considered as investment. 4. Maximizing Employment Generation

It should be obvious that an Islamic economy, in its quest for social justice, must ensure that economic growth makes a maximum contribution to the creation of new employment opportunities. However, it must be noted that the objective in an Islamic society is not to increase employment (i.e. to attain full-employment at the cost of economic efficiency. Additional employment must, in the long run, be generated in a technically efficient fashion. This can be achieved through technological progress focused on evolving a suitable technology in line with resource endowment. Technological breakthrough can only be achieved in countries with education largely geared to the acquisition of technical and scientific knowledge. Social justice, universal education, economic growth and maximum employment are the basic policy objectives of an Islamic economy. Social justice requires an elimination of uneconomic and immoral inequalities in income and wealth. This process will be greatly strengthened by the creation of new employment opportunities in the lower income groups. Furthermore, there is absolute necessity of universal education, which, in general, will determined the quality of social justice. However, social justice must be maintained not only at a given point of time but dynamically as well.

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1.4 Key Terms Economics Microeconomics Classical Economist Macroeconomic Objectives Unemployment Full Employment Monetary Policy Islamic Economic Hablul-minAllah Unversal Educaton Social Justice 1.5 Summary 1. The study of microeconomics involve only individual decision making while in macroeconomics involve the whole economic system. Macroeconomics studies involve the aggregate demand, aggregate supply and the general price level. The macroeconomics issues / problem are inflation, unemployment, economic growth and international trade. Government plays an important role to achieve the macroeconomic objectives by imposing fiscal policy, monetary policy and income policy. Islamic economic is based on Tauhid which form to relationships i.e. Hablul - minaAllah and Hablulminanaas. The objectives of Islamic Economics are to achieve social justice, universal education, optimal rate of economic growth and maximization of employment generator. Scarcity Macroeconomics Keynesian Economist Inflation Economic growth Balance of Payment Fiscal Policy Income Policy Hablul-minannas Optimal Rate of Economic Growth

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Practice Questions Multiple- choice Questions 1. Macroeconomics is A. B. C. D. the study of market regulations. the study of economy-wide phenomena. the study of how households and firms make decisions and how they interact. the study of money and financial markets.

2.

The goal of macroeconomics is A. B. C. D. to explain the economic changes that affect a particular household, firm, or market. to explain the economic changes that affect many households, firms, and markets simultaneously. to devise policies to deal with market failures, such as monopoly, externalities, common resources, and public goods. all of the above.

3.

Which of the following macroeconomics? A.

topics

are more likely

to be studied in

B. C. D.

The effect of taxes on the prices of airline tickets, the profitability of automobile-manufacturing firms, and employment trends in the foodservice industry. The price of beef, wage differences between genders, and antitrust laws. How consumers maximize utility, and how prices are established in markets for agricultural products. The percentage of the labor force that is out of work, and differences in average income from country to country.

4.

Macroeconomics is concerned about all of the following except: A. B. C. D. the level of output. the general level of prices. production methods and costs. the growth of real output.

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5.

The study of how one business firm sets its prices would fall under the study of: A. Macroeconomics. B. Microeconomics. C. Income distribution. D. Economic Growth. The production of more goods and services to increase a nations standard of Living would be associated with which economic goal? A. B. C. D. Economic efficiency Economic security Economic Growth Balance of Payment

6.

7.

If the country is concerned about the general price level it means that the Country is targeting to achieve A. B. C. D. Economic growth Full-employment Price stability Inflation.

8.

Which pair of macroeconomic objectives tend to be conflicting? A. B. C. D. Economic growth and equitable income distribution. Full employment and economic growth. Full employment and favourable balance of payment. Full employment and equitable income distribution.

9.

Which of the following is not considered as a macroeconomic goal? A. B. C. D. Full employment price stability Pure competition Economic Growth

10.

Which of the following issue is related to microeconomic A. B. C. D. What should the Federal Government to reduce the trade deficit with? Will merger of two airlines likely lead to higher airline ticket price? What factors are contributing to the rise of unemployment in the? Will the inflation rate remain relatively stable this year?

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Essay Questions

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Discuss the differences between microeconomics and macroeconomics. Explain briefly the main objectives of macroeconomics objectives in the perspective of conventional and Islamic economics. With the aid of diagram explain the components of the macroeconomics. Discuss with related examples the role of government in the macroeconomics.

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