Macroeconomics
Macroeconomics
Definition
Macroeconomics is
the study of economic
behaviour and decision
making in the whole
economy, rather than
individual markets.
Macroeconomics is the study of economic behaviour and decision making in the
whole economy, rather than individual segments of the economy. It looks at
aggregate variables, such as the demand for all goods and services in the
economy (national output) and the general level of prices in the economy
(inflation and deflation).
Topics covered in macroeconomics include:
» the role of government (Chapter 24)
» redistribution of income (Chapter 25)
» fiscal policy (Chapter 26)
» monetary policy (Chapter 27)
» supply-side policies (Chapter 28)
» economic growth (Chapter 29)
» employment and unemployment (Chapter 30)
» inflation and deflation (Chapter 31).
Macroeconomics attempts to explain what is likely to happen to the economy as a
whole if certain economic factors change. For example, a prolonged recession (see
Chapter 29) will cause unemployment in many industries, and result in negative
economic growth for the economy as a whole. Macroeconomics places greater
emphasis on using empirical data as evidence to explain changes in the economy,
such as booms and recessions (see Chapter 29).
▲ Unemployment is a fundamental macroeconomic topic
Decision makers in microeconomics
Microeconomics is concerned with decision making by individuals, households and
firms, such as:
» an entrepreneur considering which type of business to start
» a farmer deciding how best to allocate farmland to different crops or the
rearing of farm animals
» firms investigating the prices being charged by their rivals in order to set their
own prices
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Microeconomics and macroeconomics
» firms considering the economic profits of difference choices before making a
decision
» firms deciding on the best combination of factors of production to use in the
production process
» how internal and external economies of scale can affect a firm’s scale of
operations
» consideration of the different reasons for firms to adopt labour-intensive or
capital-intensive production methods (see Chapter 21)
» the advantages and disadvantages of small firms (see Chapter 20) versus the
advantages and disadvantages of different types of merger (horizontal, vertical
and conglomerate)
» a household considering the economic costs of raising a child
» workers deciding how to allocate their time and energy based on consideration
of opportunity costs
» the influence of wage differentials on labour markets (see Chapter 18)
» third parties losing out from the misallocation of resources through the overconsumption of demerit goods (see Chapter 14) and the under-consumption of
merit goods
» consideration of the advantages and disadvantages of trade unions from the
viewpoint of workers, firms and the government (see Chapter 19).
Decision makers in macroeconomics
Macroeconomics is concerned with decision making for the economy as a whole.
Examples include:
» government decisions regarding which products to tax, such as tobacco,
alcohol and petrol — this has a macroeconomic impact not only on these
industries but also on the wider economy (see Chapter 14)
» government policies to achieve economic growth, stable inflation, employment,
balance of payments stability and redistribution of income (see Chapter 25)
» government decisions to improve market efficiencies and the productive
capacity of the economy, such as through education and training, labour
market reforms, deregulation, improving incentives to work and invest, and
privatisation (see Chapter 28)
» the government setting different rates of progressive taxation (see Chapter 26)
to ensure those who earn more pay a greater proportion of income tax, without
creating disincentives to work
» government decisions and policies regarding the eradication of poverty (see
Chapter 33)
» government decisions about immigration and emigration (see Chapter 34)
» government decisions about protectionism, such as the use of tariffs and
import quotas to limit competition from international rivals (see Chapter 37)
» the decision of the population in how they allocate their income between
savings and expenditure (household consumption)
» decision making of consumers, workers, savers, lenders and firms due to the
consequences of inflation (see Chapter 31)
» the economy’s decision about the degree of international specialisation (see
Chapter 36)
» the role of speculators and multinational companies in the determination of
exchange rates (see Chapter 38).
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Decision makers in macroeconomics
Activity
Take a look at today’s newspaper (use an online version if you prefer). Find three news
stories that are microeconomic topics and another three that are macroeconomic
topics. Be prepared to share these with the rest of the class, and make sure you can
explain your reasoning.
Exam-style questions
1 Which topic is not studied in microeconomics?
A Economic growth
B Monopoly and competition
C Price elasticity of supply
D Production possibility curves
2 Which option is not studied in macroeconomics?
A The consequences of a higher interest rate
B The effects of a lower exchange rate
C The impacts of price changes in the market for smartphones
D The impacts of progressive taxation
[1]
[1]
Chapter review questions
1 What is meant by microeconomics?
2 What is meant by macroeconomics?
3 Who are the main decision makers in microeconomics and how does this differ from
the decision makers in macroeconomics?
4 Who are the decision makers affected by microeconomics?
5 Who are the decision makers affected by macroeconomics?
Revision checklist
✔ Microeconomics is the study of particular markets and sections of the
economy, rather than the economy as a whole.
✔ Microeconomics tends to use theory, rather than empirical evidence, to
explain changes in individual markets and industries.
✔ Microeconomics is concerned with decision making by individuals,
households and firms.
✔ Macroeconomics is the study of economic behaviour and decision making
of the whole economy, rather than individual markets.
✔ Macroeconomics places greater emphasis on using empirical data
as evidence to explain changes in the economy, such as booms and
recessions.
✔ Macroeconomics is concerned with decision making for the economy as a
whole.
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The role of markets in allocating
resources
By the end of this chapter, students should be able to:
★ define the market system
★ explain the key questions about resource allocation in a market system
★ explain how the price mechanism allocates resources.
The market system
The market system refers to the method of allocating scarce resources through
the market forces of demand and supply. Markets consist of buyers (who have
demand for a particular good or service) and sellers (suppliers of a particular good
or service). Also known as the price mechanism, the market system establishes
market equilibrium where demand equals supply, as shown in Figure 6.1. At this
position, the market is cleared of any shortages or surpluses.
Price ($)
Supply
Equilibrium
price
Demand
O
Equilibrium quantity
Quantity
Definitions
The market system refers
to the method of allocating
scarce resources through
the market forces of
demand and supply.
Market equilibrium
exists when the demand
for a product matches
the supply, so there is no
excess demand (shortage)
or excess supply (surplus).
Market disequilibrium
exists if the price for
a product is too high
(resulting in excess
supply, or a surplus) or too
low (resulting in excess
demand, or a shortage).
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▲ Figure 6.1 Market equilibrium
The demand curve (see Chapter 7) shows that consumers will tend to buy more
as the price falls. The supply curve (see Chapter 8) shows that firms will tend to
offer more for sale as the price rises. When the opposing market forces of demand
and supply are in balance, an equilibrium price and quantity are established,
where all products offered for sale at that price are bought by consumers.
Market disequilibrium occurs when the market price is either above or below
the equilibrium price. If the price of a product is above the equilibrium price, the
product is deemed to be too expensive for consumers, so the quantity supplied
will exceed the quantity demanded. To sell off this excess supply, the price must
be reduced.
By contrast, if the price of a product is below the equilibrium price, the product
is deemed to be too cheap to attract sufficient supply, so the quantity demanded
will exceed the quantity supplied. To create an incentive to supply more, the
price must be raised. Hence, the market system will tend to get rid of market
disequilibrium in the long run.
Key decisions about resource allocation
▲ Prices are reduced to get rid of excess supplies
Case study: Thai rice
In 2017, the export price of Thai rice rose from $365 a tonne to $425 a tonne in a matter
of weeks, driven by a sharp surge in the global demand for rice, and lower rice supply.
Thailand is the world’s second-largest exporter of rice with around 23 per cent of total
rice exports (India accounts for about 29 per cent of the world’s total rice exports).
Activity
Discuss how the significant increase in the price of rice is likely to affect the Thai
economy. Which stakeholder group(s) win or lose from this?
Key decisions about resource allocation
All economies face the basic economic problem of scarcity of resources. All
economic systems (see also Chapters 13 and 15) must address three key economic
questions about determining resource allocation:
1 What production should take place? This question is about deciding which
goods and services should be provided in the economy. For example, is it better
for the economy to have more roads and airports or to have more schools and
hospitals? As resources are limited in supply, decision makers realise there is
an opportunity cost (see Chapter 3) in answering this question.
2 How should production take place? This question is about the methods
and processes used to produce the desired goods and services. For example,
decision makers will have to decide which combination of factors of production
(land, labour, capital and enterprise) should be used in the production process.
3 For whom should production take place? This question is about which
economic agents receive goods and services. For example, should any goods
and services be provided free to everyone in the economy, irrespective of their
willingness and ability to pay for them? Or should goods and services only be
produced for those who can pay?
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tHe role of Markets in allocatinG resources
In a market system, the decision about what, how and for whom production
should take place is determined by the forces of demand and supply. See
Chapter 13 for more details on this.
Exam-style question
Which option is not a key economic question that is addressed by the
market economy?
[1]
A For whom should production take place?
B How should production take place?
C Why should production take place?
D What production should take place?
Exam-style question
With the use of a relevant example, explain how prices are determined in a
market system.
[4]
Introduction to the price mechanism
Definition
The price mechanism
refers to the system of
relying on the market
forces of demand and
supply to allocate
resources.
Study tip
To better understand
the concept of the price
mechanism, refer to
Chapters 7 and 8 on
demand and supply.
The price mechanism refers to the system of relying on the market forces of
demand and supply to allocate resources. In this system, the private sector (see
Chapter 13) decides on the fundamental questions of what, how and for whom
production should take place. For example, wage rates are determined by the
forces of demand for labour (by private sector firms) and supply of labour (by
workers who offer their labour services).
Features of the price mechanism include the following:
» There is no government interference in economic activities. Resources are
owned by private economic agents who have the economic freedom to allocate
scarce resources without interference from the government.
» Goods and services are allocated on the basis of price — a high price encourages
more supply whereas a low price encourages consumer spending. Goods and
services are sold to those who have the willingness and ability to pay.
» The allocation of factor resources is based on financial incentives — for
example, agricultural land is used for harvesting crops with the greatest
financial return, while unprofitable products are no longer produced.
» Competition creates choice and opportunities for firms and private individuals.
Consumers can thus benefit from a variety of innovative products, at
competitive prices and of high quality.
Exam-style question
Which option is not a feature of the price mechanism?
[1]
A Competition creates choice and opportunities for firms and private individuals.
B Goods and services are allocated on the basis of price.
C Resources are owned by private economic agents who have the economic
freedom to allocate scarce resources.
D Rules and regulations are imposed to correct market failures, such as the
overconsumption of demerit goods.
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Introduction to the price mechanism
Chapter review questions
1
2
3
4
5
6
What is meant by the market system?
What is meant by market equilibrium?
How does market disequilibrium occur?
What are the three key economic questions that all economies must address?
What is the price mechanism?
What are the key features of the price mechanism?
Revision checklist
✔ The market system refers to the method of allocating scarce resources
through the market forces of demand (buyers) and supply (sellers).
✔ Market equilibrium is established where the demand for a product is
equal to the supply of the product.
✔ Market disequilibrium occurs when the market price is either above
(creating surpluses) or below (creating shortages) the equilibrium price.
✔ All economies must address three key economic questions about
determining resource allocation: what, how and for whom should
production take place?
✔ The price mechanism refers to the system of relying on the market
forces of demand and supply to allocate resources.
✔ Features of the price mechanism include: no government interference
in economic activity, the allocation of resources based on price and
financial incentives, and competition creating choice and opportunities
for firms and private individuals.
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