Macroeconomics
There is, however, an approach to economics in which the foregoing
considerations do not apply. That is the field known as macroeconomics. In
macroeconomics one is concerned with the aggregate outcome of individual actions.
Keynes's "consumption function," for example, which relates aggregate
consumption to national income, is not built up from individual consumer
behaviour; it is simply an empirical generalization. The focus is on income and
expenditure flows rather than on markets. Purchasing power flows through the
system from business investment to consumption, but it leaks out at two places in
the form of personal and business savings. Counterbalancing the savings are
investment expenditures in the form of new capital goods, houses, and so forth,
which constitute a source of new injections of purchasing power in every period.
Since savings and investments are carried out by different people for different
motives, there is no reason why "leakages" and "injections" should be equal in
every period. If they are not equal, national income, the sum of all income payments
to the factors of production, will rise or fall in the next period. When planned
savings equal planned investment, income will be at an equilibrium level, that is,
a level at which it can sustain itself; when the plans of savers do not match those of
investors, the level of income will go on changing until the two do match. One can
complicate this simple model by making investment a function of the interest rate;
by introducing the government budget, the money market, labour markets, imports
and exports, foreign investment; and so forth. But all this is far removed from the
problem of resource allocation and from the maximizing behaviour of individual
economic agents.
The result is a kind of intellectual schizophrenia in which the techniques of
microeconomics do not carry over fully into macroeconomics and vice versa. This
is widely held to be an unsatisfactory state of affairs; economists have in recent
years sought to build a bridge between the individual consumer and the overall
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consumption function and between the individual investor and the behaviour of
aggregate investment. Nevertheless, the bridge remains incomplete, and the student
of economics must be prepared to work with two boxes of tools.
Econometrics
Like mathematical economics, econometrics is something economists do
rather than a special area of interest. Econometrics refers to the study of empirical
data by statistical methods, the purpose of which is the testing of hypotheses and
the estimation of relationships suggested by economic theory. Whereas
mathematical economics considers the purely theoretical aspects of economic
analysis, econometrics attempts to falsify theories that are expressed in explicit
mathematical terms. But frequently the two go together.
The classic technique for estimating an economic relationship is that of "least
squares," which is a method of fitting a trend line to a scatter of observations that
minimizes the square of the deviations of the observed points from the line. To
take a simple example: the Keynesian theory assumes that consumers' expenditures
depend principally on income; one may interpret this to mean that consumption
depends only on income and then test the hypothesis by trying to fit a trend line to
a series of observations of income and consumption over a period of time. In so
doing, one is really saying that the observations that fall to either side of the line
are due either to errors in measuring the variables or to errors in specifying the
relationship between consumption and income. It is essential to the method of
least squares that these "errors" be randomly distributed or at any rate distributed
in known ways. When this condition is violated, least squares estimates are
unreliable. It is sometimes difficult to tell with economic data just how the errors
are randomly distributed, and it is precisely for this reason that an econometrician
is needed rather than an ordinary statistician.
A still more significant trend in recent econometrics is the tendency to move
from single-equation estimates (such as the relationship between consumption and
income) to systems of simultaneous equations. While consumption depends on
income, income also depends on consumption; this kind of interdependence requires
two equations rather than one. More generally, most economic variables are the
result of demand and supply forces that simultaneously determine quantities and
prices. To estimate a demand curve for butter from a single-equation regression
(by relating the price of butter to the quantities of butter consumed, the incomes of
consumers, and the prices of near substitutes for butter) is likely to produce a
biassed answer because the price of butter is also influenced by supply conditions
in the dairy industry. This creates the so-called identification problem, namely, the
question of whether it is possible to identify a demand curve or a supply curve
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from observed price-quantity data. The use of simultaneous equation models to
estimate economic relationships is by now perhaps the best way of distinguishing
econometrics from economic statistics.
The foregoing discussion covers only nine major branches of economics.
There are many other fields in economics, including economic history, comparative
economic systems, business cycles, economic forecasting, national income
accounting, managerial economics, business finance, marketing, the economics
of natural resources, economic geography, consumer economics, and regional
economics.
Mark Blaug
Growth and development
The study of economic growth and development is not a single branch of
economics but falls, in fact, into two quite different fields. The two fields —
"growth" and "development"— employ different methods of analysis and are
indeed addressed to two distinct types of inquiry. Development economics is easy
to describe. It is one of the three major subfields of economics, the other two
being microeconomics and macroeconomics. Development economics resembles
economic history in that it seeks to explain the changes that take place in economic
systems with the passage of time.
The subject of economic growth is not so easy to characterize. It is the most
technically demanding field in the whole of modern economics, impossible to
grasp for anyone who lacks differential calculus. Its focus is the properties of
equilibrium paths, rather than equilibrium states. One makes a model of the
economy and puts it into motion, requiring that the time paths described by the
variables be self-sustaining in the sense that they continue to be related to each
other in certain characteristic ways. Then one can investigate the way economics
might approach and reach these steady-state growth paths from given starting points.
Beautiful and frequently surprising theorems have emerged from this experience,
but as yet there are no really testable implications nor even definite insights into
how economies grow.
Growth theory began with the work of Roy Harrod in England and Evsey
Domar in the United States. Their joint product has been known ever since as the
Harrod Domar model. Keynes had shown that new investment has a multiplicative
effect on income and that the increased income generates extra savings to match
the extra investment, without which the higher income level could not be sustained.
One may think of this as being repeated from period to period, remembering that
investment, apart from raising income disproportionately, also generates the
capacity to produce more output that cannot be sold unless there is more demand,
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that is, more consumption and more investment. That is all there is to the model. It
contains one behavioral condition—that people tend to save a certain proportion
of extra income, a tendency that can be measured. It contains one technical condition
— that investment generates additional output, a fact that can be established. And
it contains one equilibrium condition — that planned saving must equal planned
investment in every period if the income level of the period is to be sustained.
Given these three conditions, the model generates a time path of income and even
indicates what will happen if income falls off the path
More complex models have since been built, incorporating different saving
ratios for different groups in the population, technical conditions for each industry,
definite assumptions about the character of technical progress in the economy,
monetary and financial equations, and much more.
Labour
Like monetary and international economics, labour economics is an old
economic speciality. It gets its raison d'etre from the peculiarities of labour as a
commodity. Labour itself is not bought and sold; rather, its services are hired and
rented out. But since people cannot be disassociated from their services, various
nonmonetary considerations play a role in the sale of labour services as contrasted
with the sale of machine time or the rental of land. Yet, the bulk of the literature in
labour economics was until recently concerned solely with the demand side of the
labour market. Wages, the textbooks all said, were determined by the "marginal
productivity of labour," that is, by the relationships of production and by consumer
demand. If the supply of labour came into the picture at all, it was merely to allow
for the presence of trade unions; unions could only raise wages by limiting the
supply of labour.
After a long period of neglect, the supply side of the labour market began, in
the 20th century, to attract the attention of economists. First, attention shifted from
the individual worker to the household as a supplier of labour services; the
increasing tendency of married women to enter the labour force and the wide
disparities and fluctuations observed in the rate that females participate in a labour
force drew attention to the fact that an individual's decision to supply labour is not
independent of the size, age structure, and asset holdings of the household to which
he or she belongs. Second, the new concept of "human capital" — that people
make capital investments in their children and in themselves by incurring the costs
of education and training, the costs of searching for better job opportunities, and
the costs of migration to other labour markets — has served as a unifying
explanation of the diverse activities of households in labour markets. In this way,
capital theoiy has become the dominant analytical tool of the labour economists,
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replacing or supplementing the traditional theory of consumer behaviour. The
economics of training and education, the economics of information, the economics
of migration, the economics of health, and the economics of poverty are some of
the by-products of this new perspective. A field that was at one time regarded as
rather cut-and-dried has taken on new vitality.
Labour economics, old or new, has always regarded the explanation of wages
as its principal task, including the factors determining the general level of wages
in an economy and the reasons for wage differentials between industries and
occupations. Wages are influenced by trade unions; the impact of their activities is
of increased importance at a time when most governments manage the economy
with one eye on the unemployment statistics. The prewar fears of chronic
unemployment gave way to the postwar fears of chronic inflation at or near levels
of full employment. In response to this a vast literature sprang up after 1945
analyzing the inflationary pressures stemming from both the supply side and the
demand side of labour markets. Whether prices were being pushed up by the labour
unions ("cost push") or pulled up by excess purchasing power ("demand pull")
became the issues in this long debate on inflation, a controversy that is, of course,
intimately related to the quarrels in monetary economics mentioned earlier.
Money
One of the oldest, widely accepted functions of government is control over
the supply of money. The dramatic effects of changes in the quantity of money on
the level of prices and the volume of economic activity were recognized and
thoroughly analyzed in the 18th century, and monetary economics has ever since
constituted one of the principal branches of economics. In the 19th century a
complex and somewhat crudely formulated tradition grew up known as the "quantity
theory of money," which held that any change in the supply of money can only be
absorbed by variations in the general level of prices (the purchasing power of
money). In consequence, prices will tend to change proportionately with the quantity
of money in circulation. As the growth of fiat paper money gave governments
increasingly effective control over the stock of circulating media, the quantity
theory of money supplied an apparently simple rationale for the management of
the economy: all that was needed to prevent inflation or deflation was to vary the
quantity of money in circulation inversely with the level of prices.
One of the targets of Keynes's attack on traditional thinking in his General
Theory of Employment, Interest and Money was this quantity theory of money.
Keynes produced a different theory of the demand for money that implied that the
impact of a change in the stock of money on the level of national income is weak
and at best indirect; the effect on prices is virtually nil, he maintained, at least in
55
economies with heavy unemployment such as prevailed in the 1930s. He put his
emphasis instead on government budgetary and tax policy and direct control of
investment. As a consequence, economists lost faith in monetary management and
came to regard monetary policy as more or less ineffective in controlling the volume
of economic activity.
In the 1960s there was a remarkable revival of the older view, at least among
a small but growing school of American monetary economists. They accepted
much of Keynesian economics but argued that the effects of fiscal policy are
unreliable unless the quantity of money is regulated at the same time. They
refurbished the quantity theory of money and tested the new version on a variety
of data for different countries and for different time periods, leading to the broad
conclusion that the quantity of money does matter.
In the late 20th century the controversy was still raging. It is notable that this
debate, unlike previous debates in the history of monetary economics, was
characterized by disputes over empirical findings—that is, it was focussed on the
testable character of different monetary theories rather than on the manner of their
formulation. Progress was made slower by the political overtones of the controversy:
in some countries, belief in the efficacy of monetary policy had become a kind of
litmus test of political conservatism. Nevertheless, a reconciliation between
Keynesians and quantity theorists needed only some agreement as to the magnitude
of monetary forces and the degree of stability of the demand for money. Monetary
economics seemed at last to be coming of age as an empirical discipline.
TRADE AND ECONOMICS
Many transportation innovations occurred because of the needs of the
military. Nevertheless, advances in vehicle designs and infrastructure (such as
bridges and roads) were soon applied to trade and commerce. The Roman road
system, originally created to move troops quickly and efficiently throughout the
empire, soon created a massive economic market centered on Rome. The European
explorers of the 15th and 16th centuries were originally seeking new paths to the
riches of the .Orient when they happened on the New World. The trillion-dollar
international trade business of today relies entirely on a reliable system of global
transportation to meet demand and provide customers all over the world with
goods and services
International trade routes connect different countries. These routes reflect
the economic interdependence of many nations of the world. Many countries are
dependent on other countries for natural resources, finished goods such as
automobiles and electronics, and parts for products assembled locally. Many of
the world's largest trade partners, such as the United States, Canada, Japan, Mexico,
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and Europe, are connected with numerous transportation services and travel routes.
In Asia, Japan has strong maritime trade relations with Southeast Asian countries
in order to exchange natural resources for manufactured goods. The U.S. ports of
New Orleans, Louisiana, and Miami, Florida, are major ports of entry for trade
with Latin American nations.
Treaties and international agreements among countries are used to protect
international shipping and travel. These agreements have related to issues such
as vessel standardization, allowable ports of entry in a nation, customs procedures,
tariffs that can be applied to certain commodities, and rights of passage through
international waters. A recent example of such an agreement is the North American
Free Trade Agreement (NAFTA), which was signed in 1992 by the governments
of Canada, the United States, and Mexico. Among other actions, NAFTA
eliminated many tariffs, allowed Mexican trucks to travel into the United States,
provided safety and regulatory standards for trucks and buses, and permitted
U.S. and Canadian investment on a limited basis in Mexican transportation firms.
Similar trade agreements will continue to characterize international transportation.
Besides the economic benefits associated with trade, there are many other
indirect economic benefits related to transportation. More than 9.5 million workers
are employed in transportation-related industries in the United States, and the
transportation-related portion of the U.S. gross domestic product (GDP) in 2000
was $314 billion out of a total GDP of $9.9 trillion. Aerospace, naval, and
automobile manufacturers are responsible for a large amount of that figure, as
are the industries that supply these manufacturers, such as the steel, rubber,
petroleum, and electronics industries
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rights reserved
Economic forecasting
It is the prediction of future economic activity and developments. Forecasting
of this nature has grown rapidly since the 1930s, largely in response to the increasing
unpredictability of the economic situation, a greater involvement of governments
in economic affairs, which requires the preparation of economic plans and
projections, and rapid improvement in the quality and coverage of economic
statistics and forecasting techniques. There is a vast array of forecasts available,
ranging from short-term predictions for specific economic variables (such as interest
rates) or of demand for individual products (such as steel or automobiles) to
medium- and long-term forecasts of the economy as a whole. Despite their lack of
certainty, such forecasts are widely used in business, government, and private
affairs to help in formulating policies, strategies, legislation, and long-term plans.
57
A useful distinction can be made between macro- and micro-economic
forecasts. Macroeconomic forecasts are designed to predict the future course of
the entire economy or of specific broad economic variables, whereas
microeconomic forecasting is designed to project the likely development of
particular economic sectors such as one industry, commodity, or firm. The best
known and most widely used form of macroeconomic forecast is that of national
income or gross national product (GNP). This predicts, in numerical terms, the
major components of a country's economic activity—private consumption,
government expenditure, private and public investment, and the balance of exports
and imports. All countries devote significant resources to this type of forecasting,
typically on a one- to five-year basis. These forecasts are used for a number of
different purposes. Governments use them to determine future economic strategy
and to predict other variables of the economy such as the likely level of inflation,
industrial output, employment, etc. Based on such a forecast, the effects of various
proposed government actions (a cut in taxation or an increase in government
expenditure, for example) can be tested before official policy is finalized.
Macroeconomic forecasts are also used outside government as a basis for
producing more detailed projections of the main components of the economy and
in the preparation of microeconomic forecasts. By studying the overall forecast of
private consumption, for example, a retailer might, by referring to established
patterns of spending, predict the amount that is likely to be spent on foodstuffs and
nonfood products and then, working in the microeconomic forecasting area, attempt
to determine future expenditures in specific product categories. Similarly, an
automobile manufacturer will attempt to predict demand for his product by looking
at the predicted level of and trends in disposable incomes and consumption and
predictions of interest and exchange rates. He will also forecast production costs
from the trend of wage increases and inflation. In general, most microeconomic
forecasting starts with some forecast or assumption about the economy as a whole
that is then modified or analyzed into its components in light of special factors and
considerations applicable to a particular product, industry, or other concern.
Forecasts range from one month to 10 years or more. However, largely owing
to the economic shocks of the last 20 years (e.g., the quadrupling of oil prices in
1972), there has been a trend away from highly numerical long-term forecasts in
favour of indications of the broad direction of economic developments, based on
both statistical evidence and more or less subjective judgments on such basic
aspects of the economy as population growth, technological progress, and social
changes. A set of long-term forecasts may be made to indicate the likely outcomes
of several different but equally plausible assumptions in a technique often called
scenario building.
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The techniques of economic forecasting have developed rapidly in recent
decades. This in part reflects the growing understanding of the ways in which
numerous economic variables affect each other. Equally important reasons are the
better availability of good statistics and the development of computer methods for
processing large amounts of data. Computer capacity has made possible the practical
development of mathematical models of the economy through which it is possible
to explore the relationships between the key determinants of the economic system
with a speed and to a degree of detail that were not possible before. Most
governments and large forecasting organizations use computers in this technique
known as econometric forecasting.
Supply and demand
Supply and demand in economics is relationship between the quantity that
producers wish to sell at various prices and the quantity of a commodity that
consumers wish to buy.
The quantity of a commodity demanded can be seen to depend on the price
of that commodity, the prices of all other commodities, the incomes of consumers,
and their tastes. In economic analysis, the last three factors are often held constant;
the analysis then involves examining the relationship between various prices and
the maximum quantity that would potentially be purchased at each of these prices.
These price-quantity combinations may be plotted on a curve, known as a demand
curve.
The quantity of a commodity that is available in the market depends not only
on the price obtainable for the commodity but also on the prices of substitutable
products, the techniques of production, and the availability and costs of labour
and other factors of production. In analyzing supply in the short run, one usually
assumes that all but the price are constant in order to observe the relationship
between various prices and the quantity potentially offered by suppliers at each
price.lt is the function of a market to equate demand and supply through the price
mechanism. If buyers wish to purchase more of a commodity than is available at
the prevailing price, they will tend to bid the price up. If they wish to purchase less
than is available at the prevailing price, suppliers will bid prices down. Thus, there
is a tendency toward an equilibrium price, at which the quantity demanded is just
equal to the quantity supplied.
As the price rises, the quantity offered usually increases, and the willingness
of consumers to buy an article normally declines, but these changes are not
necessarily proportional. The measure of the responsiveness of supply and demand
to changes in price is their elasticity. Elasticity is calculated as the ratio of the
percentage change in the quantity demanded or supplied to the percentage change
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in price. Thus, if the price of a commodity decreases by 10 percent, and the sales
of it consequently increase by 20 percent, the elasticity of demand for that
commodity is said to be 2.The demand for products that have good, readily available
substitutes is likely to be elastic, because consumers can easily replace one good
with another if its price rises. The demand for a product may be inelastic if there
are no close substitutes and if expenditures on the product comprise only a small
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