Key Concepts in Macroeconomics: Money, Jobs, and Prices
Foundational Economic Concepts
Defining the Economic System
An economic system is the way individuals organize a society to solve their basic economic problems.
The Circular Flow of Income
The circular flow of income is the flow of goods and services and payments among households, businesses, and the public sector.
Balance of Payments (BOP)
The Balance of Payments (BOP) is the systematic recording of financial transactions occurring during a given time between residents of one country and residents of the rest of the world.
Analyzing Unemployment and Its Causes
Types of Unemployment
Cyclical Unemployment
Cyclical Unemployment occurs when workers are idle because the level of aggregate demand in the economy is insufficient to provide employment to all resources.
Seasonal Unemployment
Seasonal Unemployment is caused by changes in labor demand at different times of the year.
Frictional Unemployment
Frictional Unemployment occurs when workers voluntarily leave a job to find a better one, or are temporarily between jobs.
Structural Unemployment
Structural Unemployment is due to mismatches between the skills of the workforce and the qualifications required by the employer.
Effects of Unemployment
The primary effects of unemployment include:
- A fall in actual production.
- Decreased aggregate demand.
- Increasing government deficits.
Theoretical Views on Unemployment
Keynesian View
Keynesian Unemployment is involuntary; it occurs because the level of aggregate demand is insufficient to sustain full employment.
Classical Economists' View
The Classical Economists argue that unemployment is voluntary because it would disappear if workers accepted lower wages, reaching the equilibrium level.
Money and Explanatory Theories of Inflation
The Functions of Money
Money serves three essential functions:
- Means of Payment: It is accepted by the community for the execution of transactions and the cancellation of debts.
- Unit of Account: It is the unit in which prices are fixed and accounts are kept. It provides a measure of value used to calculate the worth of different goods and services.
- Store of Value: It is not only a means to conduct transactions but also a financial asset that serves as a store of value, allowing wealth to be carried over time.
Explanatory Theories of Inflation
Monetarist Theory
The Monetarist theory posits that the cause of inflation is the increase in the amount of money exceeding production growth. If the money supply increases without corresponding production growth, operators will have greater liquidity. Since money is held primarily for transactions, operators will try to spend the excess by acquiring other earning assets or increasing their demand for current goods and services. Monetarists argue that changes in the money supply do not affect production or employment, only prices.
Keynesian Theory
The Keynesian theory suggests that, in certain circumstances and in the very short term, the demand for money can absorb increases in the money supply without disruptions to prices. The relationship between money supply and the price level is not as straightforward as favored by the monetarists, and an alteration in the amount of money can have effects on production as well as prices.