Introduction to the Study of Macroeconomics

Macroeconomics focuses on the behavior of the economy as a whole i.e. the aggregate of economic activities. In order to study the overall performance of the economy, macroeconomics focuses on economic policies and policy variables which affect the performances. To understand the complexity of the aggregate economic activities, economists use economic models which reduce the complexity of the real economy.

Macroeconomics, like the microeconomics uses the concept of demand and supply to analyze output and price level. It studies the possible existence of equilibrium and disequilibrium and their effects and corrections.

The nature of macroeconomics: Concepts and scope.

Macroeconomics is the study of the behavior of the economy as a whole. It deals with aggregates covering the entire economy such as:

• An economy’s total output of goods and services.

• National income

• Total Employment

• General Price level

• Aggregate Demand and Supply.

It also examines the interrelations among these various aggregates, their determination and causes of disequilibrium (fluctuation) in them. In summary, macroeconomics deals with the major economic issues and problems that affect the whole system. It can be said to deal with the essential. However, in dealing with the essentials it disregards details of the behavior of individual economic units such as households and firms. These are taken care of by micro-economics which studies the behavior of individuals in the economy, (households and firms). Despite this contrast between macroeconomics and microeconomics there is no basic conflict between them. After all the economy in the aggregate is nothing but the sum of its subsectors or smaller units. The difference between macroeconomics and microeconomics is therefore primarily one of the difference between the behavior of the aggregate or entire nation and individual units in the economy or nation.

Since the main economic problems are related to the behavior of the above listed aggregates, the study of macroeconomic variables is indispensable for understanding the working of the economy. These aggregates are statistically measurable, and therefore the analysis of their interrelations, determinations, causes of fluctuation and their effects on the functioning of the economy are made possible and relatively easy.

The variables that macroeconomics deals with include; National income, total employment, general price level, aggregate demand and supply, e.t.c.

Economic Policies: Monetary and Fiscal

Macroeconomics seeks not only to understand macroeconomic phenomena, but to find policies which will promote maximum output of the aggregate and minimize fluctuations (price stability) overtime. Therefore, in order to study the overall performance of the economy, macroeconomics focuses on economic policies and policy variables which affect performance.

Almost all governments, especially of the underdeveloped economies are faced with innumerable national problems. The problems include; population growth and distribution, general price levels, general volume of trade, and aggregate output of goods and services. No government can solve these problems in terms of individual behavior. So, macroeconomics is extremely useful, from the point of view of economic policies. The two major macroeconomics policies are; monetary and fiscal policies

Monetary policy

Monetary policy refers to the combination of measures designed by the government through the Reserve or Central Bank to control the supply of money and credit conditions in a nation for the purpose of achieving macroeconomic goals such as;

Full-Employment: A high level of human and physical resource utilization

Price Stability: Prevention of upward movement of prices (inflation) and instability in foreign exchange rate.

Economic Growth: Expansion of the production capacity of economy to generate increased flow of goods and services

External Balance: Promotion of a debt free and self-reliance economy.

Equitable Distribution of resources or wealth: equitable distribution of nation’s resources among the factors of production and the population

Instruments of Monetary Policy

Some of the available instruments of monetary policy for controlling money supply are;

Reserve Requirements: This refers to the proportion of total deposit liabilities which the Commercial bank and Merchant banks are expected to keep as reserve ratio and liquidity ratio. The main aim of reserve requirements is to limit the level of the reserve balances available to the banks and hence, the volume of credit that banks could extend to their customers and thus control the ability of the banks to create money, as well as protect banks against distress due to shortage of cash.

Open Market Operation: This involves the sales or purchases of securities and bills in the financial market by the CBN. With open market operation, the CBN is able to influence the volume of liquid assets and the levels of interest rates which will ultimately affect the money supply.

Discount Rate: This is the rate at which the CBN is prepared to lend to the commercial and merchant banks in the performance of its function as a lender of last resort for the banks. This instrument will regulate credit conditions and availability in the economy because other rates (such as those charged by banks and discount houses) depend on it. To reduce credit expansion, the CBN may increase discount rate and this will in turn forces banks and discount houses to increase their lending rate, and thus make borrowing less attractive.

Credit Ceilings: This involves the fixing of the commercial and merchant banks total credit to the domestic economy by the CBN. If the CBN raises the ceilings, increased lending operations will be undertaken and the money supply will increase.

Selective credit control: This involves issuance of directives to the commercial and merchant banks on the proportion of total credit to be allocated to various sectors of the national economy.

Moral Suasion: This is simply a process by which the intentions and motivations of the CBN are clarified to the commercial and merchant banks with a view to keeping them informed of the current monetary policy implementation and to seek and secure their co-operation on all aspects of the policy.

Special Deposit: The CBN may call for special deposits so as to influence the level of money supply into the economy. In order for the banks to raise the special deposits, they will in turn have to call in some of their loans. This will reduce the level of money in circulation.

• Identify five macro economics objectives.

• Full employment, Price stability, External Balance, Economic Growth, Equitable Distribution of Income and Access to Credit.

• Identify and discuss five instruments of monetary policy.

• Open market operation, discount rate, selective credit control, special deposit, credit ceiling, moral suasion etc.

Fiscal policy

Fiscal policy is one of the means through which the government intervenes to control or regulate the country’s economic activities. It is basically the use of taxation and government expenditure to regulate or control economic activities. Hence, like monetary policy, fiscal policy can also be employed to achieve macroeconomic goals of;

• Full employment

• Price stability

• External Balance

• Economic Growth

• Equitable Distribution of Income.

In dealing with the above, the government can use expansionary fiscal policy or restrictive fiscal policy as shown below.

Fiscal Policy and Unemployment: A period of economic slack with rising unemployment would call for the following expansionary fiscal policies.

• An increase in the level of government spending awards of contracts to improve socioeconomic infrastructure

• A reduction in tax rates, especially income tax and company tax to boost aggregate demand of private individuals and business.

• Tax reliefs and concessions, and fiscal incentives to stimulate domestic private enterprises and to induce foreign private investors to invest in the economy with a view to enhancing the creation of employment.

Fiscal Policy and Inflation: A country that is experiencing persistent increase in its general price level can employ the following restrictive fiscal policies.

• Curtailing the growth of government expenditure

• Raising taxes for the middle and upper income groups to reduce their disposable income.

• Lowering tariffs on essential imported inputs as a means of checking imported inflations.

Fiscal Policy and External Balance: The following fiscal policies can be taken to achieve external balance by eliminating balance of payments deficit.

• Increase tariffs on non essential goods and goods that can be competitively locally produced as a means of reducing foreign exchange payments for imports

• Give tax reliefs and concessions, to local entrepreneurs so as to stimulate and promote greater exports to pay for increased imports as required.

Fiscal policy and Economic Growth: For economic growth, the following fiscal policies will enhance expansion of the production capacity of the economy and its utilization.

• Increase in government capital expenditure which will have productivity effect on production and multiplier effect on real income of the people.

• Increase in tariffs’ on goods which can be produced locally as a means of switching expenditure in favour of the competitive local industries, thereby leading to a greater domestic industrial production

Fiscal Policy and Equitable Distribution of Income: This can be achieved by using progressive taxation which will make the richer pay a greater percentage of their income in tax. The government will then use the tax to provide public goods and services.

• What are the objectives of fiscal policy?

• Full employment, Price stability, External Balance, Economic Growth, Equitable Distribution of Income.

• What are the policy tools of the fiscal policy?

• The government can use expansionary fiscal policy or restrictive fiscal policy.

Economic Model

In order to understand the complexity of macroeconomic phenomenon, economists use economic model which reduce the complexity of the real economy. Models allow economists to link a phenomenon which they wish to study (the dependent variable) to one or more variables (the independent variables) which are believed to be largely responsible for the behavior of the phenomenon under study. In a simple two-variable model, the variable to be explained is linked to one believed to be largely responsible for its behavior. For example, economists generally link the consumption to current disposable income. Such behavior is stated as C=f(Yd). The notation (f) is just shorthand for “depends on” or “is a function of”. The above specified behavior [C=f(Yd)] then states that consumption (C) is a function of current disposable income (Ya) or that consumption depends systematically upon current disposable income.

As noted above, most often, the dependent variable (the variable to be explained) is influenced by more than one independent variable. For example, consumption may not only depend upon current disposable income, but also upon the rate of interest and expected disposable income. When we have to present consumption as a function of only disposable income, then the values of other independent variables are held constant. Then the observations on consumption and current disposable income can be presented in a table which may be plotted in a graph.

Using statistical analysis, regression is the most important tool that economists use to understand the relationship among two or more variables. It is particularly useful for the common case where there are many variables and the interactions between them are complex. As a way of understanding regression, we begin with two variables (C and

Yd). We refer to this case as simple regression while cases involving many independent variables are referred to as multiple regressions.

Through statistical analysis, a function (equation) for the relationship of consumption and current disposable income can be estimated. In the absence of statistical analysis one can specify the expected form of the relationship. For instance one could hypothesize that:-

C = a + bYd, where ‘a’ and ‘b’ are expected to have values greater than zero.

C is consumption, a positive linear function of current disposable income (Yd). The behavioral coefficient (b) measures the influence of current disposable income upon consumption. The parameter (a) represents the influence of other independent variables that are held constant (or the value of consumption when current disposable income is zero).

Numerical Example

C = 20 + 0.90Yd

Ya: 0 200 250 350 400

C: 20 200 245 290 380

Variables in a model are either endogenous or exogenous. A variable is endogenous when its value is determined within the model and exogenous when its value is determined by forces external to the model. Also, a change in the value of an exogenous variable is known as autonomous change, while a change in the endogenous variable is known as induced change. In principle, models allow one to see how a change in an exogenous variable affects the value of the endogenous variable. In a simple model of domestic product, output and current disposable income (Yd) are endogenous variable since their values are determined within the model. On the other hand, investment (I) is not determined within the model, hence it is an exogenous variable.

Y=C+ I (equilibrium condition)

C = a + bYd (behavioral equation)

I = lo (exogenous variable)

Consumption (C) is an endogenous variable.

Investment (ilo) is an exogenous variable.

Equilibrium and Disequilibrium

Macroeconomics, like the microeconomics uses the concept of demand and supply to analyze output and price level. Here, demand represents aggregate demand or aggregate expenditure; and supply aggregate supply and price, the economy general price level.

Aggregate expenditure is the sum of spending by individuals, businesses, and government and net exports at each price level,

Aggregate Demand or Expenditure AE = C + I + G + (X-M)

C is Total Consumption Expenditure by the households on goods and services which yield current satisfaction.

I is Aggregate Investment Expenditure which constitutes the flow of expenditures devoted to projects producing goods and services which are not intended for immediate consumption.

G is the expenditures of the three tiers of government in an economy.

X and M are exports and imports respectively, while (X-M) is the net export.

Aggregate supply is the amount that businesses can produce and thereby supply at each price level. It is measured by the national income (Y).

The equilibrium level will be achieved at a point where aggregate supply (Y) is equal to aggregate expenditure (C+I+G+X-M), and is given as:

Y = C + I + G + (X-M)

When we have an equilibrium position, there is supposed to be stability and there will be no further tendency to change. Macro-static analysis is the technique used to explain the static equilibrium position of the economy. It is one of the techniques of investigating the relations between macro-variables in the final position of equilibrium without reference to the process of adjustment implicit in that final position.

In a simple model such a final position of equilibrium may be shown by the equation:

Y = C + I in a closed model with government being distinguished

Y = C + I + G + (X-M) in an open governed economy

This simply shows a timeless identity equation without adjustment process and can be illustrated graphic.

Summary

Macroeconomics is concerned with the study of whole economy; each time we speak of macroeconomics we talk of aggregate economy. Macroeconomics is the study of the behavior of the economy as a whole. It deals with aggregates covering the entire economy such as: economy’s total output of goods and services, national income, total employment, general price level, aggregate demand and supply. Macroeconomics also examines the interrelations among these various aggregates, their determination and causes of disequilibrium (fluctuations) in them. In summary, macroeconomics deals with the major economic issues and problems that affect the whole system. It can be said to deal with the essential and in dealing with the essential it disregards details of the behavior of individual economic units such as households and firms. Macroeconomic objectives include: economic growth, healthy balance of payments, political and economic stability, price stability, level of employment. Macroeconomic policy tools include: monetary policy, fiscal policy, debt management policy, etc.

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