Economics is a broad subject that can be divided into two areas: macroeconomics and microeconomics. To differentiate between the two, the analogy of the forest and the individual trees can be helpful. Macroeconomics is the study of the behaviors and activities of the economy as a whole; hence, the forest. Microeconomics looks at the behaviors and activities of individual households and firms, the individual components that make up the whole economy; hence, the individual trees. Several examples are given below.
Macroeconomics, being the study of the behaviors and activities of the economy as a whole, looks at such areas as the Federal Reserve System, unemployment, gross domestic product, and business cycles.
The Federal Reserve System was created by the Federal Reserve Act of 1913, which divided the United States into twelve districts with a Federal Reserve Bank located in each. Each of these banks is owned by the member banks located within that district. The Federal Reserve System's most important function is to control the supply of money in circulation. Monetary policies made by the Federal Reserve System's Board of Governors have a tremendous impact on the total economy. These policies influence such factors as the amount of money member banks have available to loan, interest rates, and the overall price level of the economy. Three ways in which the Federal Reserve Board regulates the economy are by changing reserve requirements, changing the discount rate, and buying and selling government securities.
Macroeconomists also study unemployment, which simply defined is a very large work force and a small job market, to determine methods to control this serious economic problem. The U.S. Department of Labor estimates the level of unemployment in the economy by using results from monthly surveys conducted by the Bureau of the Census.
Unemployment means lost production for the economy and loss of income for the individual. One type of unemployment is frictional unemployment, which includes those people who are not employed because they have been fired or have quit their job. Cyclical unemployment follows the cycles of the economy. For example, during a recession, spending is low and workers are laid off because production needs are reduced. Structural unemployment occurs when a job is left vacant because a worker does not have the necessary skills needed or a worker does not live where there are available jobs. Some unemployment is due to seasonal factors; that is, employees are hired only during certain times of the year. To help lessen the problem of unemployment, the government can use its powers to increase levels of spending by consumers, businesses, and the government itself and by lowering taxes or giving tax incentives, which makes available more money with which to purchase goods and services. This in turn puts more laid-off workers back to work. The Federal Reserve System can also increase spending by lowering interest rates.
Total economic spending, which includes consumer, business, and government spending, determines the level of the gross domestic product (GDP), which is the market value of all final products produced in a year's time. GDP is one of the most commonly used measures of economic performance. An increasing GDP from year to year shows that the economy is growing. The nation's policy makers look at past and present GDPs to formulate policies that will contribute to economic growth, which would result in a steady increase in the production of goods and services. If GDP is too high or growing too rapidly, inflation occurs. If GDP is too low or decreasing, an increase in unemployment occurs.
Fluctuations in total economic activity are known as business cycles, and macroeconomists are concerned with understanding why these cycles occur. Most unemployment and inflation are caused by these fluctuations. There are four phases of the business cycle: prosperity (peak), recession, trough, and recovery. The length and duration of each cycle varies. From its highest point, prosperity, to its lowest point, trough, these phases are marked by increases and decreases in GDP, unemployment, demand for goods and services, and spending.
Microeconomics looks at the individual components of the economy, such as costs of production, maximizing profits, and the different market structures.
Business firms are the suppliers of goods and services, and most firms want to make a profit; in fact, they want to maximize their profits. Firms must determine the level of output that will result in the greatest profits. Costs of production play a major role in determining this level of output. Costs of production include fixed costs and variable costs. Fixed costs are costs that do not vary with the level of output, such as rent and insurance premiums. Variable costs are costs that change with the level of output, such as wages and raw materials. Therefore, total cost equals total fixed costs plus total variable costs (TC TFC TVC). Marginal cost, which is the cost of producing one more unit of output, helps determine the level at which profits will be maximized. Marginal cost (MC) measures the change (in total cost when there is a change in quantity (Q) produced (MC =i>TC/i>Q). Firms must then decide whether they should produce additional quantities.
Revenue, the money a firm receives for the product it sells, is also a part of the profit equation because total revenue minus total costs equal profit (TR TC profit). Marginal revenue, which is the additional revenue that results from producing and selling one more unit of output, is also very important. As long as marginal revenue exceeds marginal cost, a firm can continue to maximize profits.
There are four basic categories of market structures in which firms sell their products. Pure competition includes many sellers, a homogeneous product, easy entry and exit, and no artificial restrictions such as price controls. A monopoly is the opposite of pure competition and is characterized by a single firm with a unique product and barriers to entry. An oligopoly has few sellers, a homogeneous or a differentiated product, and barriers to entry such as high startup costs. Where products are differentiated, nonprice competition occurs; that is, consumers are persuaded to buy products without consideration of price. The fourth market structure is monopolistic competition. It includes many sellers, differentiated products, easy entry and exit, and nonprice competition.
Gottheil, Fred M., and Wishart, David. (1997). Principles of Economics with Study Guide. Cincinnati: South-Western College Publishing.
Did this raise a question for you?