Macroeconomics and the Macroeconomic Goals and Objectives of the Government
While microeconomics deals with economic decisions of individual economic agents such as individuals and companies, macroeconomics deals with the economic decisions with respect to the entire economy in aggregate which results in the country’s national income. The main issues that are dealt with in macroeconomics include: unemployment, inflation, business cycle, economic growth and development and; trade.
The five main macroeconomic goals or objectives of the government are economic growth, full employment, price stability, a favourable external position and a stable exchange rate.
Economic Growth - economic growth is the increase in goods and services produced in an economy within a given period usually a year.
Full Employment or the Alleviation of Unemployment – unemployment can lead to social problems so it is critical that governments have as many resources employed as possible including human resources which is labour.
Price Stability (Containment of Inflation and Deflation) – government will want to contain inflation which is the rise in the general level of prices in the economy. When there is inflation, money loses its value.
Favourable External Position/Improvement in Trade – a country’s external position can be measured by viewing its balance of payments position. The balance of payments is the set of records which a country keeps all of its exports (the amount of goods and services which it sells to other countries) and its imports (the amount of goods and services which it buys from other countries). Ideally, governments will want a surplus in their balance of payments position.
Exchange Rate Stability – instability in the exchange rate can result in outflow of foreign reserves. Therefore, a stable exchange rate plays a key role in international trade.
Tools for Achieving the Macroeconomic Objectives
The main macroeconomic policy tools or instruments for the achievement of the five main macroeconomic goals are:
- Monetary policy – this determines the money supply as well as interest rates in order to achieve desired economic objectives. Monetary policy is really the manipulation of the money supply in order to achieve the government’s economic goals.
- Fiscal policy – is the creation of economic activity by changing expenditures and taxation to foster economic growth, price stability, the creation of employment and hence the reduction of unemployment.
- Interventionist or direct policies – are government attempts to moderate inflation by direct steps (legislated wage or price controls).
- Trade policies – consist of tariffs, quotas and other devices that restrict imports or encourage exports. Tariffs are duties (taxes) imposed on imports. When tariffs are imposed, the prices of imports will increase by the extent of the tariff. The increased prices will reduce the demand for imported goods.
- Exchange rate policy – exchange rate represents the price of one currency in terms of the currency of other nations. There are different ways or methods to regulate a foreign exchange market. One of the methods is a depreciation/devaluation of the local currency which refers to a fall in the value of a country’s currency on the foreign exchange market. This makes the value of imports more expensive and exports more feasible thereby improving the balance of payments position.
National Income and Measures of National Income
National income is the total value a country’s final output produced in one year.
The following are some measures of national income:
GDP is the market value of all final goods and services produced within a country in a given period of time;
GNP is the market value of all final goods and services produced by permanent residents of a nation within a given period of time; this is GDP plus net income earned by our citizens living abroad.
NNP is the total market value of all final goods and services produced by citizens of an economy during a given period of time; it is Gross National Product or GNP minus depreciation.
NNI is the Net National Product (NNP) minus indirect taxes.
Per capita GDP is total GDP divided by the population.
Current GDP is GDP expressed in the current prices of the period being measured.
Nominal GDP growth is GDP growth in nominal prices (unadjusted for price changes).
Real GDP growth is GDP growth adjusted for price changes.
Approaches to Measuring National Income
There are three main methods of calculating national output which are:
- The expenditure approach which aggregates demand or gross national expenditures by summing consumption (C), investment (I), government expenditures (G), and net exports (X).
- The income approach which sums all incomes and;
- The output approach which sums all outputs.
It is important to note that the values from all three of these approaches must equal because what is spent by some are the income of others.
The expenditure approach:
The GDP of a country is defined as the total market value of all final goods and services produced within a country in a given period of time (usually a calendar year). It is also considered the sum of value added at every stage of production (the intermediate stages) of all final goods and services produced within a country in a given period of time. This expenditure approach can be depicted as follows:
GDP = consumption + investment + government spending + exports − imports, or, GDP = C + I + G + (X-M)
- C is private consumption in the economy. This includes most personal expenditures of households such as food, rent and medical expenses but does not include new housing.
- I is defined as business investments in capital. Examples of investment by a business include construction of a factory, purchase of software, or purchase of machinery and equipment for a factory. Spending by households on new houses is also included in Investment. Unlike general meaning, Investment in GDP is meant very specifically as non-financial product purchases.
- G is the sum of government expenditures on final goods and services. It includes salaries of public servants and any investment expenditure by a government. It does not include any transfer payments such as social security or unemployment benefits.
- X is gross exports; GDP captures the amount a country produces, including goods and services produced, for overseas consumption, therefore exports are added.
- M is gross imports which are subtracted since imported goods represent an outflow of money from the country.
Converting GDP from Market Prices to Factor Cost
Converting gross domestic product from market prices to gross domestic product at factor cost requires subtracting indirect taxes and adding back subsidies.
Another way of measuring GDP is to measure the total income (gross domestic income - GDI) payable in the GDP income accounts. This should provide the same figure as the expenditure method described above. By definition, GDI=GDP.
The formula for GDP using the income approach
GDP = W + R + I + P, where:
W - wages
R - rents
I - interests
P - profits
The Output Approach
This method of compiling GDP leads to counting the production by sector of activity. One major drawback of this method is the difficulty to differentiate between intermediate and final goods. The problem with differentiating between final and intermediate goods can lead to double counting or the overstating of national output and income. This can be overcome be using only the added value at the intermediate stage of production.
Limitations of the Use GDP and GNP as a Measure of Economic Well-Being
The following are some of the challenges of using GDP as a measure of economic well-being:
Non-Marketable Activities – with few exceptions, GDP only counts goods and services that pass through markets. Production that is not bought or sold does not generally get counted. For example, a mother raising a child is an extremely important activity. However, this is not something that is paid for or provided on the market.
Forced Government Expenses – perhaps the most significant shortcoming of GDP as a measure of economic growth is its inclusion of government spending alongside other voluntary or forced market transactions. For example, higher crime rates may lead to increased expenditures. In other words, even though GDP or per capita GDP may be stated as being high, it may be so due to increased or forced government expenses as a result of tensions and problems in society.
Externalities – GDP also can be misleading due to the exclusion of negative externalities that can result from the production of goods. Just as there are positive externalities, there are also some negative externalities resulting from production. We may have a situation where there is growth and expansion in the manufacturing sector. However, this can also cause pollution through the emission of chemicals into the atmosphere.
Underground economy – it is also stated that the underground economy is excluded from the calculation of GDP. This category includes activities that are illegal such as drugs. Incomes in these activities are not included in GDP and therefore GDP is understated. In some countries the underground economy is rather large.
In a recession, workers are laid off and the unemployment rate increases. Factories and machinery are idled and capacity utilization falls significantly. This causes a decline in wages as workers will be willing to obtain employment at a lower wage rate. This is so due to the oversupply of workers relative to the demand for labour by firms. Recessions also result in a fall in exports and even a fall imports at times. When this happens, the revenues of the country fall and the response from countries is usually a devaluation or depreciation of the country’s currency. This can have the effect of making its exports attractive again on the global market and it may also reduce imports because imports are now more expensive.
During a recession, prices for inputs on the resource markets are low. On the product market, prices for goods and services will also be low so that people can purchase what is on the market. On the labour market, the price of labour which is wage will also be low in order for more labour to be demanded by firms and for people to get more work. On the capital market, the price of loans which is the interest rate is also low in order for investors to be encouraged to take out loans in order to invest. Therefore, inflation is low during a recession.