8 Essential Macroeconomics Concepts you Must Know
Written with ♥ by Katrina Esther
“A study of economics usually reveals that the best time to buy anything is last year.” — Marty Allen. Macroeconomics may seem a daunting subject, but it really isn’t. Once you understand the basics, everything else falls into place. Besides, how could you not want to know how prices are set, what your country produces annually and anything else that affects your wallet? Read on to learn more.
Forget “gross national product”. It’s too many words, and you sound smarter saying GDP. Remember that GDP is the total value of everything produced by a country. Not just the stuff, but the services as well. It’s probably the most important economic indicator, as it’s a measure of the health of a nation’s economy. Politicians, economists, investors (and yes, even students!) should be aware of what GDP is.
The annual GDP is perhaps most useful when compared to the GDP of past years. That way, we can tell if the economy is growing, shrinking, or stagnant. Knowing how a nation’s GDP varies from year to year can also help us predict future fluctuations in the economy, the jobless rate and the performance of the stock market.
The US has the biggest economy on the planet, and thus the highest GDP. Nevertheless, fluctuations in the American economy (and thus GDP) affect residents in the US, but also the rest of the world as well. Politics and economics are often intertwined. The GDP in the Ukraine has dropped more than 4% recently, the conflict in the country negatively affecting the economy.
Production Possibility Frontier
PPF is the term you’ll hear; a graph is almost always what you’ll see. The concept is one we are all already familiar with. You can’t have it all. PPF refers to how a national economy makes use of its finite resources. “Guns and Butter” is the example you’ll often hear used. We can use our fixed resources to make guns and/or butter. The more guns we make, the less butter we can produce, and vice versa.
Consumer needs and market demand comes into play when resources are allocated to the production of goods. If a nation is at war, guns are far more effective than butter at killing enemy insurgents. They will also be in higher demand.
However, if a country is facing a food shortage, butter will help fill empty stomachs while guns will not. Price and the international market play a part too. If we can sell a gun for a larger profit than a stick of butter, it makes sense to do so.
This one is easy. It’s what makes up a market for a certain good. You can think of it as all the producers and consumers that are involved in buying and selling the same thing.
The gas market would be an example. When you pull in to the pump for a tank of gas, it’s going to be the exact same gallon of product that you’re pouring into your Porsche, regardless of whether it is Shell, Chevron or Costco who’s getting rich from your purchase. Gas is gas is gas.
If Costco bought up all the other gas stations, they would have a monopoly. They would control all of the gas supply. They would have no competitors, and could set prices as high or low as they wished.
If Costco bought all their competitors except Shell and Chevron, we would have an oligopoly. A few companies would control the supply of a given product. In this case, gas. But they would have limited competition, and consumers would have limited choice as to where to purchase their fuel.
Perfect competition lives in the world where unicorns roam free in sunny groves filled with money trees. It exists only in the minds of economists. Theoretically, it is the ultimate free market. There are neither borders, nor barriers to the movement of goods and labor. Everyone has access to the means to buy and sell anything, and nobody has influence over price, production or information. Not even the unicorns.
Learn more with our market structure sample essay.
The Supply and Demand Curve
Economics professors will want to bring more graphs to the party. It’s far simpler than they’ll make it look. It’s all about price. Where the supply of a commodity meets the demand for that good is where the price is set. There are four keys that you will need to memorize:
- More demand + same supply = increase in price (product is in short supply)
- Less demand + same supply = decrease in price (fewer buyers for the product)
- Same demand + more supply = decrease in price (more product, same demand)
- Same demand + less supply = increase in price (not enough product to meet demand)
Learn more with our Supply and Demand Simulation Essay
The Federal Reserve
The central banking system for the United States is known as The Federal Reserve, or the Fed. This means that they control the Treasury Department’s funds, as well as funds belonging to other banks located around the nation. In addition, the Federal Reserve also heads up the monetary policy here in the U.S. The main goal of this is to maintain a strong and thriving economy as well as to direct the United State’s monetary policy.
Other than keeping up with a thriving economy, the Fed has six goals of monetary policy. These goals include price stability, high employment rates, strong economic growth, financial market and institution stability, maintaining a stable interest rate, and foreign-exchange market stability. Achieving and maintaining the success of these goals helps to ensure the United States remains on a stable path of healthy growth. Who doesn’t like that?
In addition to these goals and responsibilities of the Federal Reserve, they also play a large role in everyday banking. Banks all around the nation need the services the Fed offers to function. Some of these services include wiring of funds, check clearing, currency shipments, and supplying information to the banks and financial institutions regarding economic trends and financial issues.
Price Floors and Ceilings
Basically, price floors and ceilings are price controls. Examples of when the government intervenes in the free market economy and changes the equilibrium of the market, is when price floors and ceilings are being used.
Minimum prices set by the government for specific goods and services that they believe are being sold at unfair prices are price floors. The government believes that producers of goods and services such as these deserve assistance. When price floors are set on certain goods and services, there is likely to be a surplus because producers are unlikely to foresee any trouble in producing large quantities of their goods.
Price ceilings are maximum prices set forth by the government for certain commodities and services that the government feels are being sold at extremely high prices. The government sets forth price ceilings because they feel consumers need help purchasing these items. When the government sets the price ceiling too far below the market price, there will almost always be a supply shortage or excess demand. You wouldn’t want peanut butter selling for $10 a container, would you?
Government Tariffs and Quotas
A tariff is a tax placed on an imported good. Sometimes, the taxes are so inflated that no buyer will choose to import that good overseas. In cases such as this, the buyer must seek that item at local vendors instead.
An import quota is a quota that restricts the amount of goods entering into the country. The government is able to determine which businesses are able to sell goods by issuing them a special license. In addition to the license, each certificate specifies the exact quantity of units permissible to sell to a vendor within a country.
Both tariffs and quotas are trade limitations used to regulate the free flow of goods and services between countries. Both restrictions require businesses to purchase goods from local vendors, and are designed to protect these local industries from competition overseas.
Curious to learn more, imagine you were the Speaker of the House giving a speech about the international trade and finance.
Foreign Currency Exchange Rates
Foreign exchange markets are the world’s most fluid financial markets, with exchange rates foregoing impulsive fluctuations along narrow and wide margins. Exchange rates are determined predominantly by the amount of currencies bought and sold for speculation and international transactions in property, goods, and services.
Short-term exchange rates are foreign exchange markets that function on a regular basis, with almost every currency in the world being traded at a given time somewhere across the world. Because of this, short-term exchange rates fluctuate nearly every minute. From a market perspective, short-term currency rates are most sensitive to world events.
Long-term exchange rates are much more highly affected by the monetary policy of national governments as well as the entire world’s economic climate. Global demand for both output and currency are affected.
As you can see, Macroeconomics really helps make sense of markets and the study of supply and demand. Once you get the jist of it, you can start getting ahead financially, which makes everything about your learning a win-win.
Understanding these topics should give you a solid footing in your macroeconomics course. Good luck!