What is Macroeconomics?
Macroeconomics is part of the economic theory that analyzes the economy as a whole and takes into account the economy, national accounts, the labor market, economic fluctuations, inflation, unemployment, deflation and growth, also called aggregate variables and similar variables.
Differs from microeconomics that analyzes individual actors such as consumers and companies.
Macroeconomics Definition (Easy explanation)
Macroeconomics refers to the large economy. The concept of macro is the Greek term for large scale, so in this economic area we do not go in and look at individual actors and groups.
In economics, macroeconomics is the part that looks at the economic whole.
With different models, macroeconomists try to explain the connection between the different parts that make up the macroeconomics.
To try to understand a country’s and the world’s economic development, macroeconomists look at the economy, the labor market, GDP, exchange rates, inflation, policy rates, and national accounts.
More about Macroeconomics
1. Macroeconomic analyzes of the national economy
Macroeconomics is about the economic whole and analyzes of factors that affect society at large. Different macroeconomic models analyze connections between different parts of the national economy.
Important societal issues such as employment and inflation are central to the macroeconomic analyzes.
The results of these analyzes then form the basis for important decisions that are made to steer the national economy where one wants, for example by regulating interest rates and exchange rates.
2. Macroeconomic decisions are made by the Riksbank, among others
It is the central bank, or the Riksbank, that makes the most important economic decisions in Sweden.
Here, economists work mainly with analyzing the national economy and implementing measures to promote economic growth and at the same time minimize risks of, for example, inflation.
Inflation is a key macroeconomic concept that can be controlled by various macroeconomic means, for example by setting the repo rate.
This type of measure has its origins in macroeconomic analyzes of society, both nationally and globally.
3. This is how a macroeconomist works
Banks and other institutions, authorities and ministries also have economists who study and analyze economic development in society with the help of macroeconomic instruments and models.
A large part of the work of a macroeconomist is to find connections between various factors in the economy that affect the central variables, such as the economy, inflation and unemployment.
The opposite of macroeconomics is microeconomics, which analyzes individual groups and actors, such as companies and consumers.
The difference between macroeconomics and microeconomics
Macro- and microeconomics are two parts of economics that affect each other and belong together. But microeconomics focuses on the finances of individual companies and groups.
Those who study macroeconomics will look at how exchange rates and interest rates affect our economy, while those who study microeconomics will instead study things such as the best possible pricing of products and services.
We can actually call the macroeconomics the total microeconomics as it includes just about everything that will affect how our resources are distributed to meet our needs.
1. What is Microeconomics?
Microeconomic theory is used to understand the factors that cause correct pricing of goods and services. By using microeconomic theory, consumer behavior can be analyzed, something that has become increasingly effective as the amount of data has increased.
By studying micro-trends, companies can produce the right amount of goods to meet consumer demand at a given price level.
Based on these insights, the company can make investment decisions and evaluate the opportunity cost for a given choice.
The alternative cost is one of the most important concepts in the field and involves the sacrifice that is made in a given choice.
Another important concept is equilibrium, when supply is as large as demand, the economy is said to be in equilibrium.
Microeconomics is thus the field of science that analyzes how markets for different goods or services work.
This is also linked to how companies make production decisions. In other words, what is to be produced and how it is produced.
2. What is Macroeconomics?
Macroeconomic theory is used to evaluate and study economics as a whole. In other words, it can be said that the macroeconomy consists of the total microeconomics.
Instead of affecting optimal pricing for goods and services, the price of money is evaluated here, ie the interest rate.
This is because the interest rate has a strong impact on other significant concepts in the macroeconomy such as GDP, unemployment and the level of indebtedness.
Business cycles in the Economy
Rising interest rates often signal that GDP has grown for many years in a row, unemployment is low and the level of indebtedness has risen.
This provides theoretical explanations for how governing central bankers and fiscal politicians can stimulate the economy in a desired direction.
Macroeconomics affects everyday life
Macroeconomic decisions are important to the public because they affect the pricing of many groceries.
Macroeconomic decisions can, among other things, affect the price of petrol and other costs for other imported goods because the exchange rate is linked to the interest rate.
Other important concepts in macroeconomics, in addition to the exchange rate and the key interest rate, are inflation.
Inflation also largely depends on the policy rate, which underlines how important the interest rate is for the economy as a whole from a macroeconomic perspective.
But what does inflation mean? Inflation is a measure of how much purchasing power is undermined per year.
At the time of writing, Sweden’s goal is for inflation to amount to 2% each year.
The 3 most important macroeconomic factors
Macroeconomic studies focus mainly on three factors: GDP, employment and inflation.
Gross domestic product (GDP) measures a country’s total economic activity over a specific period of time, usually one year.
The total economic activity consists of companies ‘and consumers’ consumption of goods and services, investments and exports minus imports.
When calculating a country’s GDP, both private and public expenditures and results are included.
The macroeconomic target is high GDP and high growth.
When it comes to the labor market, the macroeconomic analysis focuses on unemployment, ie the number of able-bodied people in a country who actually have a job.
Unemployment tends to be low when GDP is high and vice versa.
This connection is mainly due to the fact that high production of goods and services creates more jobs.
The macroeconomic goal is low unemployment.
The third main factor analyzed by macroeconomists is inflation, more specifically the price increase of the general price level.
A price increase means a decrease in the value of money because you can then buy fewer goods and services for the same amount of money.
A reverse situation, when prices fall instead, is called deflation. Persistent deflation can have devastating consequences for a country’s economy.
In Sweden, inflation is measured in the Consumer Price Index (CPI) and the Consumer Price Index with a fixed interest rate (CPIF), where the effect of changes in housing interest rates is deducted.
The macroeconomic target is low and stable inflation.
The interest rate is a key concept in macroeconomics
The interest rate is the same as the price of money and this is a major focus area in macroeconomics.
This is because the interest rate affects other main areas of macroeconomics such as the country’s indebtedness, GDP and unemployment.
The interest rate is a kind of tool used to control the macroeconomy. Our central bank tries to stimulate our economy in the right direction by adjusting the repo rate.
With the repo rate, the central bank sets a minimum price for money.
Low repo rates are considered to stimulate our economy while a higher interest rate is considered to slow it down.
Inflation and the labor market
Two other main components of macroeconomics are inflation and the labor market. Inflation is a measure of how money loses its value.
With inflation, the motivation for consumption and investment increases as money becomes less valuable in the future.
Inflation is created as wages increase and people get more for consumption. This is a natural effect of an economy that is growing rapidly and that does not have enough manpower for production.
When it becomes more expensive to hire, the prices of goods and services also go up and this is something that accelerates inflation even more.
The concept of deflation also occurs in macroeconomics, and simply put, it is the opposite of inflation.
This means that money increases in value and that many stop consuming because their money will have a higher value in the future.
Inflation and macroeconomics
Inflation is a term in macroeconomics that describes how much money loses value over time.
If inflation in 2021 was 2%, this means that $10 in 2022 has decreased 2% in value compared to its value in 2018.
In other words, inflation undermines the purchasing power of a currency.
By having inflation in an economy, the actors involved are given incentives to increase their consumption and to invest money in businesses and other assets that are expected to increase in value.
This is as a result of the fact that it is irrational to save money at an interest rate that is lower than inflation as inflation “eats away at the savings”.
Interest rates and inflation
Now we return to the interest rate because it is really central in macroeconomics. The interest rate can in fact affect what happens to inflation.
If interest rates rise, inflation will fall. If, on the contrary, interest rates fall, inflation will rise.
It is because of this that our central bank uses the interest rate to try to steer inflation and the labor market in the right direction for the country’s common economy.
This is done with an inflation target. It is a measure of where the central bank wants inflation to be in order for our country’s economy to remain stable and healthy.
When inflation appears to exceed the target set for it, the central bank will raise the repo rate to slow growth.
When it is the other way around and our economic growth seems to stand still, the central bank will lower the repo rate to get the economy going again.
What creates inflation?
Inflation arises when the labor force receives higher wages and thus has more money to spend on consumption.
This occurs when the economy grows strongly and there is a shortage of labor, which means that wages are pushed upwards, which pulls up the prices of consumer goods and services.
In addition, the now more expensive labor force means that the production cost of goods and services increases, which further stimulates inflation.
The effect of interest rates on inflation
The historical and theoretical correlation between interest rates and inflation is negative. That is, when interest rates rise, we have historically seen inflation fall and vice versa, just as macroeconomic models such as ISLM, to name one example, predict.
The method is thus in practice that the central bank uses the repo rate to steer the economy in the desired direction.
If the economy grows too fast and inflation exceeds the inflation target, they raise interest rates, all other things being equal, in order to slow down economic growth.
Conversely, the interest rate is lowered if economic growth has stagnated, inflation has fallen below the inflation target and thus needs to be stimulated.
What does a macroeconomist do?
The majority of the work carried out by a macroeconomist is to investigate and identify connections between various factors that affect socio-economic development.
This is done by applying various instruments and models that enable a comprehensive macroeconomic analysis.
Where I live macroeconomists, or economists, are often employed by banks, authorities, ministries and investigative institutes, such as the Ministry of Finance or the National Institute of Economic Research in Sweden.
Examples of questions that a macroeconomist answers through analysis:
- What causes unemployment?
- How are GDP and growth affected by economic policy?
- What creates and / or stimulates economic growth?
- What causes inflation?
The key point to take with you after reading this text is that macroeconomics studies the entire economy as opposed to microeconomics which focuses on individual companies and industries.
Depending on where in the economy an actor is located, interest in the different areas varies. A business leader is more interested in microeconomics to find the profit-maximizing pricing.
On the other hand, politicians look more at the macro side, which provides guidance for the economy as a whole.
Macroeconomics is an area in economics where the major economic issues are addressed. Examples of these are interest rates, inflation and exchange rates.
Several different models are used to try to explain relationships between different macroeconomic variables, for example the ISLM model.