Economists think about the overall wellbeing of a nation’s economy by looking at several key concepts and have developed several policy tools to help the overall economy grow.
Scroll down or use the menu to the right to learn more about microeconomics and macroeconomic principles.
How does the economy function as a whole?
While microeconomics focuses on the actions of individual agents within the economy, macroeconomics inform how the economy functions as a whole.
What is macroeconomics?
Macroeconomics is the study of a national economy as a whole and its major aggregates – Consumption, Investment, National Savings, etc.
Macroeconomics can help answer some of these important questions:
Successful macroeconomic policy tries to maintain price stability, full employment, and external economic balance through the following tools:
Governments focus on limiting inflation to ensure the stability of prices and wages
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Inflation refers to an increase in the general price level, measured in percentage terms. We can measure this multiple ways:
Price stability helps create an environment conducive to investment, entrepreneurship, and innovation. Purchasing power for households is better maintained with low, stable inflation, enabling a better standard of living and the ability to smooth consumption.
For firms, price stability enables better planning and a focus on business improvements.
Measurement of inflation data is an extremely important task that involves large teams of economists and researchers who constantly track the prices of goods and services across a country. Over time, measurements of inflation provide important feedback for policymakers.
The labor market refers to the people in an economy who are working (full-time or part-time, formally or informally) or actively looking for paid work.
Governments pay close attention to these metrics:
At the same time, governments want an active labor market to drive economic growth
Greater labor force participation across the board ultimately means that a country’s economy can potentially produce more goods and services.
It is also important to understand what proportion of people are employed and whether there is excess labor since this will affect wages and other prices.
We will look at how labor fits into theories of growth in the development economics theory module.
The Informal Sector: Labor in Developing Economies
In many developing countries, a significant share of the labor force is in the informal sector. Individuals working in the informal economy may be more vulnerable to shocks and have fewer opportunities to increase earnings.
Externally, governments try to stabilize the value of their currency to buy and sell goods abroad
A stable exchange rate allows a country’s economy to be able to buy and sell goods and services abroad. Producers can buy important inputs from foreign suppliers and anticipate the cost of operating. Consumers abroad can buy a country’s exports and producers at home can be reimbursed adequately to cover costs.
We will look at how international trade can promote or inhibit growth in the International Trade Principles module.
The nominal exchange rate (ER) is the price of one currency in terms of another. Governments traditionally pursue one of two policies relating to exchange rates:
Fixed exchange rate – Government commits to buying and selling currencies at the fixed rate to keep the rate stable.
Floating exchange rate – Government lets the market determine the exchange rate at any given moment.
How does the government achieve macroeconomic stability?
Governments use both monetary and fiscal policy to maintain macroeconomic balance
Governments use two main tools to achieve macroeconomic stability:
Countries use monetary policy to stabilize the overall economic environment
Monetary Policy Tools
To help reduce inflation, interest rates can be increased by decreasing the money supply through sales of government securities (e.g., a bond). If the goal is to boost spending and investment, the Central Bank can lower the interest rate by increasing the money supply and increasing the amount of cash in circulation.
A Central Bank can raise or lower the required amount of cash reserves that banks must hold to decrease or increase the money supply.
A Central Bank can loosen or tighten the lending requirements for banks to either make it easier or more difficult for individuals and firms to borrow.
Effective monetary policy responds to two concepts related to a national currency
Monetary policy that establishes strong international credit is good for growth
It is important for countries to have access to international credit markets. International credit allows countries to borrow from abroad for additional spending. Monetary policy that does not ensure stable currency values will make it hard to borrow or repay international loans.
Monetary policy that fails to check inflation can quickly destabilize the economy
Hyperinflation: Economic Collapse in Venezuela
While not unique to Venezuela, uncontrolled inflation can quickly destabilize an economy. Since 2017, Venezuela’s economy collapsed with prices of goods quickly outpacing salaries. Businesses could no longer pay outside suppliers of essential goods.
At the height of the Venezuelan economic crisis in 2018, annual inflation was estimated at more than 65,000%
Fiscal policy uses government spending on programs to stimulate economic development
To spur economic growth, a government may decide to spend some of its resources on important programming. For example:
We will look at what types of government policies may be used to fuel economic development in the development economics theory module.
Governments can fund fiscal policy initiatives through the following mechanisms:
Governments traditionally fund spending through taxes on consumption, trade, corporate profits, and wages.
Governments can obtain funds by issuing government bonds, which are purchased by investors in both domestic and international financial markets. For more information, take a look at the principles of international trade module.
Development Banks: Financing Development
Many developing countries receive loans from international development banks to fund government programs that will enable achievement of an important development goal. The most well-known development bank is the World Bank, which was established in 1944.
This module on micro and macro economics gave you an idea of some of the underlying factors that inform economic decisions made my individuals, firms, and governments.
The other three modules in this toolkit will take a deeper look at the factors that spur economic growth.
Learn more about Development Economics