A Complete Overview of Macroeconomic Terms and Concepts
If you’ve ever felt lost in a conversation concerning the economy, you’re not alone. Believe it or not, most people don’t understand most of the economic concepts and ideas they toss about in conversation. The following primer will allow you to gain a basic understanding (perhaps more than most people who commonly argue these ideas) of economic jargon and how it is applicable to situations. Macroeconomic Terms
Most people discuss the economy in terms of macroeconomics and the following are common macroeconomic terms that need to be defined to develop a working vocabulary for study and understanding. Gross Domestic Product (GDP)
GDP is defined as the total value of goods produced and services provided in a country for a specific year. GDP is assessed in dollars (Investopedia, 2014). It is important to understand that GDP does not provide for a measure of profitability or quality of product. There are many businesses that sell large amounts of goods but would not be considered products of quality and their profit margins on any individual good is very low. This is the basis of the Wal-Mart business model which sells low cost and low quality goods in volume. For instance, the nation’s GDP does not take this factor into account and the differences between goods and services between China and the US can vary tremendously.
None of the forms of GDP provide an accurate reflection of the nation’s welfare. Often politicians will use the GDP growth to show that the economy is growing as evidence they have performed their jobs successfully. This takes place often in presidential campaigns with candidates using the argument as either a negative or positive mark against a candidate. While growth in GDP is desirable, this growth needs to be compared with other factors such as debt. The debt to Gross Domestic Product (GDP) ratio is one of many important indicators of a countries economic health. The ratio shows the amount of national debt of country as a percentage of its GDP. The lower this debt to GDP ratio is, the healthier the economy of that nation. The low ratio is indicative of an economy that produces a large number of goods and services which means that the country has the ability to pay back its debts.
Real GDP is of goods produced and services provided in a country for a specific year which has been adjusted for inflation. This is the most accurate form of GDP because it takes into account price changes and the value of the dollar (Investopedia, 2014).
Nominal GDP of goods produced and services provided in a country for a specific year which has not been adjusted for inflation.
This is less accurate then real GDP (Investopedia, 2014).
The Unemployment rate is the percentage of the total labor force that is not employed. The unemployment rate does not include those individuals who are not working by choice (Investopedia, 2014).
The inflation rate reflects the “sustained increase in the general price level of goods and services in an economy over a period of time.” (Investopedia, 2014)The inflation rate reflects the value of the dollar because as price levels increase the currency can buy fewer goods.
Fiscal Policies are any number of regulations and control policies which the government uses to influence macroeconomic conditions. Fiscal policies are intended to control economic conditions by changing spending and other broad based economic factors. For instance, reducing taxes on income allows people more money for spending which can stimulate the economy (Investopedia, 2014).
Monetary policies are regulations or policy actions taken which directly impact the money supply. For instance, interest rates on lending can be raised or lowered in order to encourage spending which stimulates the economy (Investopedia, 2014).
Aggregate Demand (AD) Curve
The Aggregate Demand (AD) Curve is defined as the “the total quantity of all goods (and services) demanded by the economy at different price levels.”
The AD curve represents the demand and supply for an entire economy rather than just a single market, good or service (Cliff Notes, 2014).
The Philips Curve
There is an inverse relationship between the rate of inflation and the rate of unemployment in the economy which is known as the Philips Curve. In other words, when inflation is high, unemployment is low. Conversely, when inflation is low, unemployment is high. By understanding the relationship of a Phillips curve, it is possible to predict GDP to some degree. As inflation increases, unemployment decreases and thus GDP should increase (Galbraith, 1997). The economy when it is recovering will increase interest rates overtime in order to reduce inflation. This allows the economy to continue to grow and GDP will continue to increase over the next two years. Some organizations are not as dependent on economy because they provide necessary services. However, most organizations are such as retail firms which were highly impacted by interest rates which could reduce spending on goods and drive prices upwards.
Adverse aggregate supply shocks occur when there is a sudden large increase in the cost of resources. For example, if bad weather or drought wiped out a large percentage of this year’s corn crop, the price of corn would increase very rapidly, shocking the market system. The short-run aggregate supply curve would shift left, resulting in an increase in both unemployment and inflation rates, known as stagflation. Stagflation contradicted the belief that the inverse relationship between unemployment and inflation is permanently stable. When the cost of oil dramatically increased in the 1970’s due to OPEC’s monopoly of the industry and the United States faced a period of stagflation, economists realized that supply shocks imply that there is no deterministic relationship between unemployment and inflation (Ball, 1995).
Types of Unemployment
The three primary types of unemployment are,
Frictional unemployment is when a person is out of a job and searching for another one (Hubbard & O’Brian, 2010). There is always a gap in between finding jobs. Efficient labor markets play an important role and the more developed an economy, the better the job market and lower gap between the time of losing a job and finding another job.
Structural unemployment is when a person is not qualified enough for a job. It requires time before that person can reach that position/job (Hubbard & O’Brian, 2010). Structural unemployment occurs normally as a result of major shifts in the economy or restructuring of organizations often resulting in the job no longer paying what it once did. This concept is tied closely with minimum wage but not in the sense of the legal minimum wage but instead as the minimum wage willing to be paid for a job’s performance. The legal minimum wage is set by law or by negotiations in the union and forms the absolute minimum that all jobs are to be paid. Structural unemployment depends on the growth rate of an economy as well as the structure of an industry.
Cyclical unemployment is when an economy is in need of low workforce. This could also be due to economic disequilibrium. Cyclical unemployment moves with the trade cycle. The demand of the workforce is high but the market cannot supply enough jobs (Hubbard & O’Brian, 2010).
Understanding the Macro-economy
There are many misunderstood macroeconomic concepts. Many of these misconceptions deal with trade and imports and the effects of these factors on the US economy. For example, imports are often viewed by the layperson as a negative thing because the products were not made in the US. This is not true and in fact imports can have a positive effect on the economy by creating jobs and driving business in the US. Because imports are often less expensive this means that companies can utilize resources for expansion and growth rather than focusing on creating products.
The only time that imports negatively impact the economy is during a surplus of imported goods. When a surplus of imports enters the US this can create a situation in which the prices of goods are driven down. For example, when too much seafood is imported from China this large supply lowers the price of seafood. This can create a negative impacting situation in which American fisherman are forced to sell their seafood at lower costs, thus losing money.
Another misconception is that international trade is bad for the gross domestic product (GDP) because imports seem to lower the GDP. In contrast to this idea, international trade is actually beneficial for GDP. This benefit is derived if the exporting of goods is nearly balanced with the importing of goods. Currently, the US imports more than it exports and this creates a trade deficit. However, the economy is still able to grow despite the lack of exports because the inexpensive imports provide businesses with goods to sell and this helps the economy through increased revenue. If the economy is growing this means that more jobs are created for university students who are future workers.
Government choices made through policies governing tariffs and quotas control the flow of imports. Tariffs and quotas have been used to limit foreign goods but this also has the negative affect of limiting consumer choices and decreasing the profit potential of companies which sold imported goods. Using tariffs and quotas may seem like a good measure to limit trade deficit but in reality these measures only provide short-term solutions. By reducing trade tariffs and quotas this allows industries to expand both domestically and internationally. The problem is that during the short term the economies of countries involved in trade must balance such as in the case of the US and China. Currently China has an abundance of inexpensive labor and until the labor cost in China becomes more balanced with the cost of goods there will only be growth in China’s economy. This balance of trade and labor is tied with the foreign exchange rates.
Foreign exchange rate is amount which one countries currency is traded at for another countries currency. The trade deficit devalues the US dollar making worth less than other currencies. This can be a problem because when the value of the dollar is lower the cost of foreign goods becomes larger thereby increasing the trade deficit further.
Due to these issues many people believe that the United States should just restrict the flow of imports coming from countries such as China. This is not the solution because it would have the negative impact of harming the US economy. Too many American businesses are dependent on the sale of goods imported from China. Restricting imports in this manner would serve only to drive many American businesses to bankruptcy.
Today the United States is part of the global economy and is intrinsically linked with the economies of other countries. When one country experiences economic issues other countries often experience these same issues. The recession of 2008 is a good example of how an economic crisis had a ripple affect across other nations. The EU and many other countries felt the recession that the US fell into. The economic ties between the global economies requires a more innovative and critical approach than simply using tariffs and quotas to fix problems.
Ball, Laurence and Mankiw, N. Gregory. “Relative-Price Changes as Aggregate Supply Shocks”. The Quarterly Journal of Economics (1995) 110 (1): 161–193.
Colander, D. C. (2010). Macroeconomics (8th ed.). New York, NY: McGrw-Hill/Irwin
Cliff Notes. (2014). Aggregate Demand (AD) Curve. Retrieved from Cliff Notes: http://www.cliffsnotes.com/more-subjects/economics/aggregate-demand-and-aggregate-supply/aggregate-demand-ad-curve
Hubbard, R., & O’Brian, A. (2010). Economics. (3, Ed.) Boston, MA: Pearson Hall.
Investopedia. (2014). Terms. Retrieved from Investopedia: http://www.investopedia.com/
U.S. Department of Agriculture(2009). Imports from China retrieved on November 17, 2012 from http://www.ers.usda.gov/Publications/EIB52/EIB52_ReportSummary.pdf