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Have you ever wondered how macroeconomic phenomena affect our daily life? Macroeconomics is the study of the economy as a whole. For example, the UK government recently raised interest rates in order to combat creeping inflation. This is a macroeconomic decision. Read on to read more examples of macroeconomics in real life.
Macroeconomics studies the economy as a whole. In macroeconomics, we study different sectors of the economy and their interdependency. This is what makes it different from microeconomics.
Macroeconomists usually try to answer big questions that citizens ask about their country’s economy. Are things going to be expensive? Are there many jobs available in the country? What is the best parameter to know the health of a country’s economy? What should the government do to make the economy better?
If you give these questions a thought, you will notice that now you can no longer think of a particular sector but you have to think about the economy of the whole country.
Adam Smith, the founder of modern economics, said that if buyers and sellers in each market thought of their self-interest, economists wouldn’t have to think about the wealth and welfare of the country.
But soon economists realized that they had to study further. To control the market, a government must intervene via policies and regulations. This would mean that many have to put aside their self-interest and work for the welfare of society as a whole.
In 1929 and 1933, the unemployment rate of the USA rose from 3% to 25% and aggregate output fell by almost 33%. That period was the period of the ‘Great depression’. Some years after this crisis, in 1936, John Keynes published his renowned book The general theory of employment, interest, and money.
In his book Keynes tried to identify the interdependence between different sectors of the economy. Thus, we could argue that it was the beginning of the study of ‘Macroeconomics.’
The four sectors that make up the macroeconomy are households, firms, the government, and external factors (import, export). The households provide labour input to firms and firms produce goods and services. Households get paid for their labour. Then they buy goods and services from the firms. This is a simple circular flow of income model that explains how the economy works.
The government can introduce monetary and fiscal policies to correct the economy. If external factors are involved in this cycle, the economy may gain or lose money. There is, thus, a strong interrelation between all these sectors and macroeconomics specifically studies their relations.
Macroeconomics focuses on three factors: economic output, unemployment, and inflation. Let’s see some real life examples.
Economic output is the value of all goods and services sold in a country.
Economic output doesn’t actually give added value to the economy. This is because intermediate sales are counted twice in economic output. Let’s consider an example.
A restaurant bought vegetables from a farmer for £100. The restaurant adds value by preparing some dishes with those vegetables and selling them for £500 in total.
The economic output becomes:
£100 (the value of the vegetables sold by the farmer) + £500 (the value of the dishes sold by the restaurant) = £600.
But as you can see, the price of the vegetables is being counted twice. Once when the farmer sold them and then when a restaurant sold them. Hence, while calculating national economic output, intermediate sales are subtracted from the total output. Gross domestic product (GDP) is a widely accepted measure of national economic output.
Gross domestic product is the market value of all final goods and services produced in a year in a country.
There are different methods to calculate GDP. The most common method is the expenditure method that looks at the demand side of the products. According to that method:
GDP = C + I + G + X – M
Where,
C = Final consumption expenditure of goods and services produced.
I = Final investment expenditure.
G = Government expenditure.
X = Export revenues.
M = Aggregate import expenditure.
For every economy, there is an acceptable rate of unemployment. The acceptable rate of unemployment is when the economy is producing goods and services at its full capacity. This is called the Natural rate of unemployment.
But what is unemployment?
An unemployed person is someone who has been actively looking for work for some time. A person should be of working age, should be available to work, and should be looking for work to be counted as unemployed.
The unemployment rate is calculated as
Unemployment rate % = Unemployed population / (Working population + Unemployed population ) * 100
To learn more about these topics check our explanations on Unemployment and the Natural Rate of Unemployment.
The unemployment rate in the fourth quarter of 2021 came out to be 4.1%. This means that there are more than 1.3 million unemployed people in the UK. The unemployment rate in the UK is falling but it is still yet to reach the pre-pandemic rate (4%)1.
Figure 1. Unemployment rates in the UK (2006–21) - StudySmarter. Source: Office for National Statistics, ons.gov.uk.
If we observe figure 1, we see that unemployment was high in the years 2009 to 2013. It was gradually decreasing until the pandemic hit in 2020.
There was also a recession in the year 2007–08. During the recession, the growth of the economy slowed down. Firms didn’t employ people as there was no demand for their products. Many people lost their jobs and thus it reduced the purchasing power of customers. Hence, we can observe a rise in unemployment rates after 2008.
Figure 1 is evidence of how unemployment and national output are interrelated and how macroeconomics acts in real-life scenarios. The economy is cyclic. To learn more check our explanation on the Economic Cycle.
The increase in the price of goods and services over some time is called inflation.
Inflation indicates that the economy is growing, but high inflation is harmful. Inflation and unemployment rates are related to each other. If inflation increases, firms will produce more goods as their goods can be sold for more on the market. To do that, they will employ more people. Hence if inflation increases, unemployment decreases.
To find out more on the relationship between inflation and unemployment check our explanation on the Phillips curve.
The current consumer pricing index (CPI) in the UK is 4.9% in the 12 months till January 2022 in the UK. Inflation is a monetary phenomenon. When the demand for goods and services increases, prices increase. That means people are willing to pay more for the goods and services.
But if demand becomes too high or too low, the government has to intervene and correct the market. The government corrects the market by using fiscal policies while the central bank can introduce monetary policies. Monetary policy controls the money and debt in the economy while fiscal policy controls government spending and taxation.
As macroeconomics studies the economy on a large scale and how different phenomena interact with each other, it is logical that it also studies international trade and its implications. International trade, world politics, and the economic condition of one country affect the whole world. Here we provide you with some examples of world economies for your reference.
You may probably know that the US, China, Japan, Germany, and the UK are the five biggest economies according to the World Bank. Together, they contribute a 55.9% share of the world economy. There are some emerging markets like India and Brazil that are catching up with them.
Some factors that threaten world economies are natural calamities, pandemics like Covid-19, and war.
In China, pure capitalism operates with state-owned enterprises. Manufacturing, labour, and agriculture are major contributors to the Chinese economy. The economic growth rate is now moving at a slower pace due to economic imbalances, environmental issues, and social imbalances.
China can tackle this by concentrating on making the economy more reliant on the service sector, promoting the private sector, and some fiscal reforms. According to the World Bank, China should concentrate on a sustainable and carbon-neutral economy.
Sweden, Norway, Denmark, Finland, and Iceland together follow the nordic model which is a combination of capitalism and socialism in social welfare and economic system. The key points of the Nordic model are no minimum wage, low corruption, strong property rights, high tax burden, public pension system, welfare, and a high level of equality.
Some criticize the model for being unsustainable because of the aging population, immigration, the high levels of taxation, and government intervention.
The United Kingdom’s economy is a free market economy where buyers and sellers make decisions and are not controlled by government policies. The service sector contributes 72.79% to this fifth-largest economy.
The economy also relies on imports. Imports are double the exports in monetary value. The main imports are machinery, transportation equipment, food, fuel, and chemicals. The exports are cars, crude oil, and pharmaceuticals. The US and Europe are the main trading partners of the UK.
In the last few years, the growth of the UK economy has slowed down and inflation is rising as a combined effect of Brexit and the Covid-19 pandemic.
You can read more about the economic implications of Brexit in our explanation of the Consequences of Brexit.
Cuba is a socialist country with a planned mixed economy. The Cuban economy doesn’t have a free market. Cuba stands 176th in economic freedom according to The heritage foundation and the country’s economy was always reliant on foreign help first from the U.S, then from the USSR, and most recently from Venezuela.
The main product of Cuba is sugar cane and the service sector contributes 69.97%2. The Cuban economy needs strong reforms and willingness from the government to change into a sustainable, independent economy.
You can read more about Cuba in our explanation about the Cuban Economy.
Singapore's economy has benefitted from globalisation. Since establishing a free market economy, it has developed trading agreements with countries like the US, China, Malaysia, Indonesia, and Japan. Singapore Economy now blooms in many sectors such as port trading, tourism, and services, banking, biotech, and oil.
Apart from these world economies, you can also read about the German Economy which is the largest economy in the European Union, or the Indian economy which is one of the fast-growing economies. Or you may be interested in reading about South Korea Economy, which has grown thanks to innovation and technology.
A recession is a significant decline in economic activity which lasts for months or years. In the UK a recession is defined as negative economic growth for two consecutive quarters. Recession is a normal part of the economic cycle. Like night and day, a growth period comes after a decline.
A severe recession is called depression. Recessions have an adverse impact on the economy. Let’s see some examples of recessions and financial crises.
The Great Depression is the longest ever economic downfall. It began in 1929 with a stock market crash and investor panic and lasted for 10 years. According to monetarist views, the US Federal Reserve’s lack of monetary actions caused it and according to Keynesian views, it happened due to a decrease in aggregate demand.
During the time of the Great Depression unemployment increased significantly, world trade decreased, and banks failed to survive.
Argentina entered the recovery phase in 2009 after the Argentine Great Depression that happened between 1998– 2002. External crisis and implementation of bad monetary and fiscal policies pushed the Argentinian economy into depression. After 2003, Argentina started promoting exports and tourism. This contributed hugely to the recovery of the economy.
The prices for goods and services in Japan decreased from 1991 to 2001. This was the country’s first lost decade. However, according to some economists, since then Japan has been going through a deflationary spiral and thus, the lost decades continue.
Japan was caught in a cash liquidity trap after the burst of the real-estate bubble. Citizens were saving money but were not spending it. The central bank in Japan failed to take corrective actions in time. To stop deflation, Japan introduced negative interest rates, but now they are unable to increase interest rates back to positive.
In the 1970s, Arab nations of OPEC (Organization of the Petroleum Exporting Countries) put an embargo on exporting oil to the US and Europe due to a political situation between Egypt and Israel and the devaluation of the dollar. To bear with the lost export revenues, OPEC countries quadrupled the oil prices and reduced oil production. The hike of oil prices from $2 to $12 translated to other sectors quickly giving rise to high inflation3.
The Venezuelan economy is highly dependent on oil exports and the government used all the oil exports income for government spending. However, due to the high exchange rates for oil, the demand for Venezuelan oil decreased.
In 2010, it was not sustainable for the government to keep funding social projects. In 2014, Venezuela entered into a recession, and by 2016 inflation reached its highest point in the history of the country: 800%4.
Lebanon provided attractive trading rates for clients from all over the world. There was a high inflow of foreign currency in Lebanese banks and the main trading currency was the U.S. dollar. After the war in the neighbouring country, Syria, people were afraid to put their money in Lebanon. The short inflow of foreign currency was thus the main reason for the Lebanese Economic Crisis.
The 2008–09 Financial Crisis started when the housing bubble burst in the US. There were many reasons for the recession but the biggest reason was risky loans. This resulted in a drop in global trade and thus affected the whole world.
Major economies saw a sharp drop in GDP, unemployment skyrocketed, and government debt increased. The recession lasted for five quarters from Q2 of 2008 to Q2 of 2009. The UK government took some steps to come out of the recession but it took almost 5 years to do so.
You can read about the global impacts of the recent financial crisis in our explanation 2008 Financial Crisis.
References
1. Employment and labour market, ons.gov.uk
2. Cuba: Sectorwise distribution of GDP - Statista.com
3. The National Archives, World recession and the oil crisis, https://www.nationalarchives.gov.uk/cabinetpapers/themes/world-recession-oil-crisis.htm
4. Venezuela 2016 inflation hits 800 percent, GDP shrinks 19 percent, CNBC, 2017.
5. UK interest rates lowered to 0.5%, BBC News, 2009.
To tackle the recent financial crisis, the UK government introduced an expansionary fiscal policy. It included a temporary cut in VAT.
The central bank in the country can introduce monetary policy under government guidance. Monetary policy controls the money supply and interest rates in the whole economy. Hence, monetary policy is not a microeconomics example but a macroeconomics one.
The Financial Crisis (2008–09) is a real-life macroeconomics example. The UK government took some steps to come out of the recession including a cut in interest rates, expansionary fiscal policy, and bank rescues.
Yes, national income is studied under macroeconomics. The most commonly used indicator for national income is GDP.
Some Macroeconomics examples in the real world include the Chinese Economy, Nordic Model, the United Kingdom economy, the Cuban Economy, and Singapore’s economy.
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