Thursday, January 8, 2015


The study of economics has two major branches: macro and micro. Macroeconomics deal with "national, regional, and global economies." Microeconomics on the other hand include individual and household decisions to engage in voluntary exchange. In this article, we will present an overview of macroeconomics touching the basic concepts, models, policies, and historical development. 

1. Basic Concepts 

Output. The basic concepts of macroeconomics include output, unemployment, and inflation. Output is the total production of a specific country in a given period of time. Since products that are sold generate income, typically output and income are terms used interchangeably. 

Another important term related to output is Gross Domestic Product (GDP). It is the price tag on total output of a nation in a specific period of time. It covers private consumption, government spending, investments, and total net exports. This formula helps us understand GDP:

GDP = C + G + I + NX


C - private consumption

G - government spending

I - investments

NX - total net exports (exports minus imports)


In order to increase output, economists study the factors for economic growth. This study serves as a reference for governments' economic policies. Three main factors of economic growth include technological innovation, capital accumulation, and human capital. However, macroeconomists think that continuous increase of output is usually arrested by seasonal business cycles. Again, it is the task of these economists to come up with proposals for government policies to prevent economic recessions. 

Unemployment. Another important macroeconomic concept is unemployment. For macroeconomists, there are at least four types of unemployment related to their causes: 

  • Classical unemployment. This type of unemployment "suggests that unemployment occurs when wages are too high for employers to be willing to hire more workers." Two theories are raised to qualify this view on classical unemployment. One theory suggests "that increased wages actually decrease unemployment by creating more consumer demand." Another theory suggests "that unemployment results from reduced demand for the goods and services produced through labor and suggests that only in markets where profit margins are very low and the market will not bear a price increase of product or service, will higher wages result in unemployment."
  • Frictional unemployment. This type of unemployment "occurs when appropriate job vacancies exist for a worker, but the length of time needed to search for and find the job leads to a period of unemployment."
  • Structural unemployment. This type of unemployment has diverse causes: skills mismatch, economic transition, and skills acquisition. 
  • Cyclical unemployment. This type of unemployment is an outcome of economic stagnation. 

Inflation. The third and last macroeconomic concept is inflation. This term refers to a general increase of prices of products and services. Various theories are attempted to explain the root causes of inflation. Two popular explanations are the overheating of economy (the economy "grows too quickly") and the "changes in aggregate demand and supply." 

On the other hand, the Austrian explanation, which is considered unpopular in the past is now gaining increasing attention. Austrian economists claim that price increase is an inevitable result of the increase in money supply. It is therefore not true that central banks prevent price increase through monetary policy such as raising interest rates and reducing the money supply. In reality, the printing of paper money by the central banks is the source of inflation. 

The opposite of inflation is deflation. Again, for macroeconomists, "deflation can lower economic output," and is a sign of economic decline.

2. Models

We will not discuss the four macroeconomic models found in Wikipedia. It is sufficient for our purpose to simply identify them. The student is advised to study these models as either part of classroom discussion or in his personal research. 

The four models are aggregate demand-aggregrate supply (AD-AS), equilibrium in savings and investments in the goods market and equilibrium between the money supply and liquidity preference in the money market (IS-LM), and the two growth models. These latter models originate from the "neoclassical growth theory" and the "endogenous growth theory."

3. Policies

Monetary policy. "Central banks implement monetary policy by controlling the money supply through several mechanisms. Typically, central banks take action by issuing money to buy bonds (or other assets), which boosts the supply of money and lowers interest rates, or, in the case of contractionary monetary policy, banks sell bonds and take money out of circulation."

As a result of 2008 economic crisis, a monetary policy designated as "quantitative easing" became popular. Wikipedia describes it as "unconventional." The aim of this policy is "to help increase output." Austrian economists see this as economically disastrous for instead of allowing the market to follow its natural course, quantitative easing artificially stimulates economic output. 

Fiscal policy. "Fiscal policy is the use of government’s revenue and expenditure as instruments to influence the economy. Examples of such tools are expenditure, taxes, debt."

It is commendable that the Wikipedia article identifies the setback of fiscal policy. "When government takes on spending projects, it limits the amount of resources available for the private sector to use." 

4. Historical Development

Macroeconomics were claimed to be the offshoots of business cycle theory and monetary theory. At this point, we will give a historical overview of five stages in the development of macroeconomics: the Austrian School, the Keynesian School, monetarism, the new classical macroeconomics, and the new Keynesian economics.

The Austrian School. Ludwig von Mises book, The Theory of Money and Credit remains one of the most important book in monetary theory. The Wikipedia article claims this "was one of the first books from the Austrian School to deal with macroeconomic topics."

The Keynesian School. The publication of John Maynard Keynes' General Theory of Employment, Interest and Money inaugurated macroeconomics in its modern form.

Monetarism. Another reputable economist, Milton Friedman is considered as the father of monetarism. He "updated the quantity theory of money." He also "argued that the role of money in the economy was sufficient to explain the Great Depression and aggregate demand oriented explanations were not necessary." Furthermore, he "doubted the government has ability to 'finetune' the economy with monetary policy. He generally favored a policy of steady growth in money supply instead of frequent intervention."

New classical macroeconomics. "New classical macroeconomics challenged the Keynesian school." Robert Lucas is considered the prominent economist of this school. 

New Keynesian economics. "New Keynesian economists responded to the new classical school by adopting rational expectations and focusing on developing micro-founded models that are immune to the critique of the new classical school. In short, new Keynesianism "which developed partly in response to new classical economics, strives to provide microeconomic foundations to Keynesian economics by showing how imperfect markets can justify demand management." The models, which resulted from this school "are now used by many central banks and are a core part of contemporary macroeconomics." 


No wonder, nations' economies are in bad shape. The typical economic course taught in colleges remains Keynesian in its outlook despite the havoc it created since 2008. The market is blamed for the crisis and macroeconomic models are created to justify further government intervention. Unless the voice of the Austrian economists is given serious attention and their ideas are implemented, nations cannot expect a recovery from economic crisis. 

Guide Questions:

1. What are the two major branches in the study of economics?

2. What are the four topics covered in this article?

3. What are the three basic macroeconomic concepts? 

4. Explain the meaning of output and GDP.

5. What are the four types of unemployment? Briefly explain each.

6. Enumerate the four macroeconomic models.

7. What are the two primary macroeconomic policies? Briefly explain each. 

8. How do Austrian economists see quantitative easing?

9. According to Wikipedia, what's the setback of fiscal policy?

10. Give an overview of the historical development of macroeconomics.

11. Considering the present status of economic education in colleges, what do you think will be the future of global economy? Why?