Macroeconomics Meaning, Scope and Importance

Recently updated on April 13th, 2023 at 06:16 pm

The term ‘macro’ was first used in economics by Ragner Frisch in 1933. But as a methodological approach to economic problems, it originated with the Mercantilists in the 16th and 17th centuries. They were concerned with the economic system as a whole.

It is that part of economic theory which studies the economy in its totality or as a whole.

It studies not individual economic units like a household, a firm or an industry but the whole economic system. Macroeconomics is the study of aggregates and averages of the entire economy.

Such aggregates are national income, total employment, aggregate savings and investment, aggregate demand, aggregate supply general price level, etc.

In the 18th century, the Physiocrats adopted it in their Table Economies to show the ‘circulation of wealth’ (i.e., the net product) among the three classes represented by farmers, landowners and the sterile class. Malthus, Sismondi and Marx in the 19th century dealt with macroeconomic problems. Walras, Wicksell and Fisher were the modern contributors to the development of macroeconomic analysis before Keynes.

Certain economists, like Cassel, Marshall, Pigou, Robertson, Hayek and Hawtrey, developed a theory of money and general prices in the decade following the First World War. But credit goes to Keynes who finally developed a general theory of income, output and employment in the wake of the Great Depression.

Microeconomics, according to Ackley, “deals with the division of total output among industries, products, and firms, and the allocation of resources among competing uses. It considers problems of income distribution. Its interest is in relative prices of particular goods and services.”

Macroeconomics, on the other hand, “concerns itself with such variables as the aggregate volume of the output of an economy, with the extent to which its resources are employed, with the size of the national income, with the ‘general price level’.”

Both microeconomics and macroeconomics involve the study of aggregates. But aggregation in microeconomics is different from that in macroeconomics. In microeconomics the interrelationships of individual households, individual firms and individual industries to each other deal with aggregation.

“The concept of ‘industry’, for example, aggregates numerous firms or even products. Consumer demand for shoes is an aggregate of the demands of many households, and the supply of shoes is an aggregate of the production of many firms.

The demand and supply of labour in a locality are clearly aggregate concepts.” “However, the aggregates of microeconomic theory,” according to Professor Bilas, “do not deal with the behaviour of the billions of dollars of consumer expenditures, business investments, and government expenditures. These are in the realm of microeconomics.”

Thus, the scope of microeconomics to aggregates relates to the economy as a whole, “together with sub-aggregates which:

(a) Cross product and industry lines (such as the total production of consumer goods, or total production of capital goods)

(b) Add up to an aggregate for the whole economy (as total production of consumer goods and of capital goods add up to total production of the economy; or as total wage income and property income add up to national income).”

Thus, microeconomics uses aggregates relating to individual households, firms and industries, while macroeconomics uses aggregates which relate them to the “economy wide total”.

The term ‘Macro’ is derived from the Greek word ‘Uakpo’ which means large. Macroeconomics looks at the economy as a whole. It examines the factors that determine national output and its growth overtime. It studies the economic aggregates such as the overall level of prices, output and employment in the economy.

According to R. G. D. Allen:

“The term macroeconomics applies to the study of relations between broad economic aggregates such as total employment, income and production”.

In the words of Edward Shapiro:

“The major task of macroeconomics is the explanation of what determines the economy’s aggregate output of goods and services. It deals with the functioning of the economy as a whole”.

Professor K. E. Boudling is of the view that:

“Macroeconomics is that part of economics which studies the overall averages and aggregates of the economic system. It does not deal with individual incomes but with the I national income, not with individual prices but with the price level, not with individual output, but with national output”.

Microeconomics looks at the individual units, household, the firm, the industry, It sees and examines the “trees”. Macroeconomics looks at the whole, the economic aggregates. It sees and analyzes the ‘forest’.

Scope of Macroeconomics

Macroeconomics is much of theoretical and practical importance. Following are the points covered under the scope of macroeconomics:

Working of the Economy

The study of macroeconomics is crucial to understand the working of an economy. Economic problems are mainly related to the employment, behavior of total income and general price in the economy. Macroeconomics help in making the elimination process more understandable.

In Economy Policies

Macroeconomics is very useful in an economic policy. Underdeveloped economies face innumerable problems related to overpopulation, inflation, balance of payments etc. The main responsibilities of government are controlling the overpopulation, prices, volume of trade etc.

Following are the economic problems where macroeconomics study are useful:

  • In national income
  • In unemployment
  • In economic growth
  • In monetary problems

Understanding the Behavior of Individual Units

The demand for individual products depends upon aggregate demand in the economy therefore understanding the behavior of individual units is very important in macroeconomics. Firstly, to solve the problem of deficiency in demand of individual products, understanding the causes of fall in aggregate demand is required. Similarly, to know the reasons for increase in costs of a particular firm or industry, it is first required to understand the average cost conditions of the whole economy. Thus, the study of individual units is not possible without macroeconomics.

Macroeconomics enhances our knowledge of the functioning of an economy by studying the behavior of national income, output, savings, and consumptions.

Importance of Macroeconomics:

(i) It helps in understanding the determination of income and employment. Late J.M. Keynes laid great stress on macro-economic analysis. He, in his revolutionary book, “General Theory, Employment interest and Money”, brought drastic changes in economic thinking. He explained the forces or factors which determine the level of aggregate employment and output in the economy.

(ii) Determination of general level of prices. Macro-economic analysis answers questions as to how the general price level is determined and what is the importance of various factors which influence general price level.

(iii) Economic growth. The macroeconomic models help us to formulate economic policies for achieving long run economic growth with stability. The new developed growth theories explain the causes of poverty in under developed countries and suggest remedies to overcome them.

(iv) Macro economics and business cycles. It is in terms of macroeconomics that causes of fluctuations in the national income are analyzed. It has also been possible now to formulate policies for controlling business cycles i.e., inflation and deflation.

(v) International trade. Another important subject of macroeconomics is to analyze the various aspects of international trade in goods, services and balance of payment problems, the effect of exchange rate on balance of payment etc.

(vi) Income shares from the national income. Mr. M. Kalecki and Nicholas Kelder, by making departure from Ricardo theory, has presented a macro theory of distribution of income. According to these economists, the relative shares of wages and profits depend upon the ratio of investment to national income.

(vii) Unemployment. Another macroeconomic issue is to explain the causes of unemployment in the economy. Stagflation is another important issue of modern economics. The Keynesian and post Keynesian economists are putting lot of efforts in explaining the causes of cyclical unemployment and high unemployment coupled with inflation and suggesting remedies to counteract them.

(viii) Macroeconomic policies. Fiscal and monetary policies affect the performance of the economy. These two major types of macroeconomic policies are central in macro-economic analysis of the economy.

(ix) Global economic system. In macro-economic analysis, it is emphasized that a nation’s economy is a part of a global economic system. A good or weak performance of a nation’s economy can affect the performance of the world economy as a whole.

Limitations of Macroeconomics:

There are, however, certain limitations of macroeconomic analysis. Mostly, these stem from attempts to yield macroeconomic generalisations from individual experiences.

(1) To Regard the Aggregates as Homogeneous:

The main defect in macro analysis is that it regards the aggregates as homogeneous without caring about their internal composition and structure. The average wage in a country is the sum total of wages in all occupations, i.e., wages of clerks, typists, teachers, nurses, etc.

But the volume of aggregate employment depends on the relative structure of wages rather than on the average wage. If, for instance, wages of nurses increase but of typists fall, the average may remain unchanged. But if the employment of nurses falls a little and of typists rises much, aggregate employment would increase.

(2) Fallacy of Composition:

In Macroeconomic analysis the “fallacy of composition” is involved, i.e., aggregate economic behaviour is the sum total of individual activities. But what is true of individuals is not necessarily true of the economy as a whole.

For instance, savings are a private virtue but a public vice. If total savings in the economy increase, they may initiate a depression unless they are invested. Again, if an individual depositor withdraws his money from the bank there is no ganger. But if all depositors do this simultaneously, there will be a run on the banks and the banking system will be adversely affected.

(3) Indiscriminate Use of Macroeconomics Misleading:

An indiscriminate and uncritical use of macroeconomics in analysing the problems of the real world can often be misleading. For instance, if the policy measures needed to achieve and maintain full employment in the economy are applied to structural unemployment in individual firms and industries, they become irrelevant. Similarly, measures aimed at controlling general prices cannot be applied with much advantage for controlling prices of individual products.

(4) Aggregate Variables may not be Important Necessarily:

The aggregate variables which form the economic system may not be of much significance. For instance, the national income of a country is the total of all individual incomes. A rise in national income does not mean that individual incomes have risen.

The increase in national income might be the result of the increase in the incomes of a few rich people in the country. Thus, a rise in the national income of this type has little significance from the point of view of the community.

Prof. Boulding calls these three difficulties as “macroeconomic paradoxes” which are true when applied to a single individual but which are untrue when applied to the economic system as a whole.

(5) Statistical and Conceptual Difficulties:

The measurement of macroeconomic concepts involves a number of statistical and conceptual difficulties. These problems relate to the aggregation of microeconomic variables. If individual units are almost similar, aggregation does not present much difficulty. But if microeconomic variables relate to dissimilar individual units, their aggregation into one macroeconomic variable may be wrong and dangerous.

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