Economics comprises of two major parts, Macroeconomics and Microeconomics. Today we will be discussing the policies in macroeconomics that help fix problems that are prevalent in the economy.
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- Gross Domestic Product (GDP)
Macroeconomics is the study about the whole economy as a whole such as economic output, unemployment, inflation, interest rates, and government policies. Macroeconomics is all about decision making based on economic data. It wasn’t until the great depression in the 1930s that economists realised that they would need a systematic way to measure the progress and the state of the economy. Theories were also created to help guide policies to fix potential problems in the economy. Over a hundred years ago, there was no economic data that reflected the stance of the economy but now we have an abundance e.g. expanding (growing), contracting (declining). Economists make predictions based on economic data, models and historical trends. Remember, they are just predictions, but economics is not all guess work. This is because the economy possesses too many variables and impacts are unpredictable, just like people.
As a macroeconomic term describing the total demand in an economy for all goods and service at any given price level in a given period of time, aggregate demand essentially is the demand for the Gross Domestic Product (GDP) of a country.
AD = C + I + G + (X – M)
C = Total Consumer spending on goods and services
I = Total Investment spending by companies for capital goods such a factories, equipment and computers.
G = Government expenditure for publicly provided goods and services such as roads, bridges, and medicare.
X = Exports
M = Imports
AD is essentially a country’s balance of trade. To represent AD graphically it will look something like this:
Shifts in Aggregate Demand
We know that the equation for the aggregate demand curve is AD = C + G + I + (X – M), therefore any reduction in any of the components will lead to a shift to the left. This is an example of the economy experiencing a contraction of demand. The aggregate demand curve can also shift right when the economy expands. Thus, the quantity of output demanded for a given price level rises.
Limitations of Aggregate Demand (AD)
The aggregate demand curve is useful for displaying relevant information regarding the price and demand prevalent in the economy, the relationship between price level and output or income. But there are limitations to the amount of information it provides. Although it provides the aggregate demand for the economy, it does not indicate where the economy sits on the graph.
Stabalisation of Aggregate Demand
Policies enacted by the government and central banks aim to keep economic growth, prices and unemployment rates stable. The goal is to minimise the impacts of economic problems. Thus the economy must stay as close to the trend line as possible as illustrated on the business cycle graph.
Changes such as unemployment, interest rates, and inflation also need to be considered, monitored and readily targeted when in need. Thus with the importance of keeping aggregate demand stable and free from large fluctuations which will damage the economy, economists must implement macroeconomic policies to ensure these goals are met.
|Policy Makers Have Three Ultimate Goals||Indicators of Success|
|Keep the economy growing overtime||Gross Domestic Product (GDP)|
|Limit Unemployment||Unemployment Rate|
|Keep Prices Stable||Inflation Rate|
To achieve these goals, the following strategies are implemented:
- Fiscal Policy
The fiscal policy looks into how the government controls it’s income and expenditures for the benefit of the economy. By controlling its income and expenditures, the government can influence macroeconomic productivity levels. For more information about the fiscal policy with regards to the points below, click here.
- Fiscal Policy
- Federal government budgets and budget outcomes
- Effects of budgetary changes on resource use, income distribution and economic activity
- Methods of financing deficits
- Use of a surplus
- Monetary Policy
The monetary policy is the sister policy of the fiscal policy which also targets macroeconomic goals. The monetary policy is monitored and maintained by the central bank, in this case, the Reserve Bank of Australia (RBA). The monetary policy is maintained through actions such as modifying interest rates, buying and selling government bonds and changing the amount of money banks are required to keep in the vault (Bank Reserves). For more information about the monetary policy regarding the points below click here.
- Monetary Policy
- Purpose of monetary policy
- Implementation of monetary policy by the Reserve bank of Australia
- Impact of changes in interest rates on economic activity and the exchange rate
Both these policies can be implemented in an expansionary stance or a contractionary stance to match with the situation of the economy.
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