When the price of a product you want to buy goes up, it affects you. But why does the price go up? Is demand greater than supply? Does the cost go up because of the raw materials needed to make it? Or, is it a war in an unknown country that affects the price? To answer these questions, we need to turn to macroeconomics.

What Is Macroeconomics? 

Macroeconomics is the study of the behavior of the economy as a whole. This is different from microeconomics, which concentrates more on individuals and how they make economic decisions. While microeconomics looks at single factors that affect individual decisions, macroeconomics studies general economic factors.

Macroeconomics is very complicated, with many factors that influence it. These factors are analyzed with various economic indicators that tell us about the overall health of the economy.

The U.S. Bureau of Economic Analysis provides official macroeconomic statistics.

Macroeconomists try to forecast economic conditions to help consumers, firms, and governments make better decisions:

  • Governments turn to macroeconomics when budgeting spending, creating taxes, deciding on interest rates, and making policy decisions.



Explaining The World With Macroeconomic Analysis

Gross Domestic Product (GDP)

Output, the most important concept of macroeconomics, refers to the total amount of goods and services a country produces, commonly known as the gross domestic product (GDP). This figure is like a snapshot of the economy at a certain point in time.

When referring to GDP, macroeconomists tend to use real GDP, which takes inflation into account, as opposed to nominal GDP, which reflects only changes in price. The nominal GDP figure is higher if inflation goes up from year to year, so it is not necessarily indicative of higher output levels, only of higher prices.

The United States had the largest GDP in the world at the end of 2018 at $20.4 billion, according to the International Monetary Fund.

The one drawback of GDP is that information has to be collected after a specified time period has passed, a figure for the GDP today would have to be an estimate. GDP is nonetheless a stepping stone into macroeconomic analysis. Once a series of figures is collected over a period of time, they can be compared, and economists and investors can begin to decipher business cycles, which are made up of the periods alternating between economic recessions (slumps) and expansions (booms) that occur over time.

From there we can begin to look at the reasons why the cycles took place, which could be government policy, consumer behavior, or international phenomena among other things. Of course, these figures can be compared across economies as well. Hence, we can determine which foreign countries are economically strong or weak.




Unemployment is based on a survey of about 60,000 households each month.

Macroeconomists agree when the economy witnesses growth from period to period, which is indicated in the GDP growth rate, unemployment levels tend to be low. This is because with rising (real) GDP levels, we know output is higher and, hence, more laborers are needed to keep up with the greater levels of production.



If nominal GDP is higher than real GDP, we can assume the prices of goods and services has been rising. Both the CPI and GDP deflator tend to move in the same direction and differ by less than 1%.

Demand and Disposable Income

What ultimately determines output is demand. Demand comes from consumers (for investment or savings, residential and business-related), from the government (spending on goods and services of federal employees), and from imports and exports.

Demand alone, however, will not determine how much is produced. What consumers demand is not necessarily what they can afford to buy, so to determine demand, a consumer's disposable income must also be measured. This is the amount of money left for spending and/or investment after taxes.

Disposable income is different from discretionary income, which is after-tax income less payments to maintain a person's standard of living.

To calculate disposable income, a worker's wages must be quantified as well. Salary is a function of two main components: the minimum salary for which employees will work and the amount employers are willing to pay to keep the employee. Given demand and supply go hand in hand, salary levels will suffer in times of high unemployment, and prosper when unemployment levels are low.

Demand inherently will determine supply (production levels) and an equilibrium will be reached. But in order to feed demand and supply, money is needed. A country's central bank (the Federal Reserve in the U.S.) typically puts money in circulation in the economy. The sum of all individual demand determines how much money is needed in the economy. To determine this, economists look at the nominal GDP, which measures the aggregate level of transactions, to determine a suitable level of money supply.

What the Government Can Do

There are two ways the government implement macroeconomic policy. Both monetary and fiscal policy are tools to help stabilize a nation's economy. Below, we take a look at how each works.

Monetary Policy

A simple example of monetary policy is the central bank's open market operations. When there is a need to increase cash in the economy, the central bank will buy government bonds (monetary expansion). These securities allow the central bank to inject the economy with an immediate supply of cash. In turn, interest rates—the cost to borrow money—are reduced because the demand for the bonds will increase their price and push the interest rate down. In theory, more people and businesses will then buy and invest. Demand for goods and services will rise and, as a result, the output will increase. To cope with increased levels of production, unemployment levels should fall and wages should rise.

On the other hand, when the central bank needs to absorb extra money in the economy and push inflation levels down, it will sell its T-bills. This will result in higher interest rates (less borrowing, less spending, and investment) and less demand, which will ultimately push down the price level (inflation) and result in less real output.

Fiscal Policy

The government can also increase taxes or lower government spending in order to conduct a fiscal contraction. This lowers real output because less government spending means less disposable income for consumers. And, because more consumers' wages will go to taxes, demand will also decrease.

A fiscal expansion by the government would mean taxes are decreased or government spending is increased. Either way, the result will be growth in real output because the government will stir demand with increased spending. In the meantime, a consumer with more disposable income will be willing to buy more.


Key Takeaways

  • Macroeconomics is the branch of economics that studies the economy as a whole.
  • Macroeconomics focuses on three things: national output, unemployment, and inflation.
  • Governments can use macroeconomic policy including monetary and fiscal policy to stabilize the economy.
  • Central banks use monetary policy to increase or decrease the money supply, and use fiscal policy to adjust government spending.

The Bottom Line

The performance of the economy is important to all of us. We analyze the economy by primarily looking at the national output, unemployment, and inflation. Although it is consumers who ultimately determine the direction of the economy, governments also influence it through fiscal and monetary policy.