The study of macroeconomics has become very important in the contemporary world of business and economic practices. Generally, macroeconomics involves decision made by households and firms (including government), more so in relation of how the scarce resources can be allocated in order to effectively carry out production, trade and consumption.
Viewed from a different perspective, the success of economic practices depend on the levels of demand and supply prevailing in a certain market environment, which tend to have influence on price level of products and the general consumers’ purchase behaviour.
Moreover, the effect of macroeconomic variables on the economy’s gross domestic product determines the success of an economy mainly in relation to employment levels, investment, inflation levels, and resource distribution among others.
An organization’s external environment is normally affected by the remote environment, the industry environment, and the operating environment, all of which are macroeconomic aspects that may in one way or another affect the profitability of an organization both in the short and long term.
In a national level, macroeconomic forces influence the level of government participation in economic activities as well as influencing government’s decisions pertaining to economy’s capital structure.
In this case, macroeconomic variables determine the level of gross national income of a country, which is usually measured by net worth of economic activities including production in the economy over a specific period of time, mostly one fiscal year.
One notable aspect of macroeconomics is the fact that economic growth rate tends to change frequently due to volatility of households’ living standards and changes in income distribution among different groups of people in a country.
Moreover, given that it is not always possible to maintain equity and status quo in an economy, GNP tends to focus on measuring the scale of income and wealth inequalities in the country.
Therefore, it is worth noting that, as the GDP measures the economic value of all final goods and services in the economy in a fiscal year, it becomes a valuable determinant and indicator of a country’s economic status.
According to Barro (2008, pp 2), performance of the overall economy matters to the citizens of a country because it influences incomes, job prospects and prices; therefore, it is important for the government to understand how macroeconomics work. Generally, macroeconomics are usually characterized by various variables that include among others the “health of an economy: aggregate output or income, the unemployment rate, the inflation rate, and the interest rate” (Barro, 2008).
First, unemployment is a common phenomenon in most countries; however, the level of unemployment differs from one country to another depending on the number of non-working labor force in a country. In simple terms, labor force includes the working population as well as people who are in process of hunting for jobs; however, people who are voluntarily unemployed (either formally or informally) are disqualified from this definition of labor force. Nevertheless, it is impossible to bring down the rate of unemployment to zero in an ideal economy.
The second macroeconomic variable is inflation rate, which is simply described as the tendency of general price levels rising relative to the production capacity in the economy over a given period of time. In other words, there is a high supply of money in the hands of households and firms in the economy thus increasing the aggregate demand beyond the aggregate supply, thus forcing prices of goods and services to rise.
One significant measure of inflation is the consumer price index and producer price index applicable to households and firms for the purchase of consumer goods and producer goods respectively. In addition to this, the GDP price deflator is also used as an inflation measure particularly on national and public goods and services.
The third variable of macroeconomics is the health of the economy, which is measured by the economy’s GDP. Normally, the production of goods and services usually generates income within the specific period of production, thus GDP measures the economic value of products at the prevailing market prices during the period under consideration; however, recycled goods are eliminated from this calculation.
The fourth and last macroeconomics variable is the interest rate prevailing in the economy, which is the measure of the cost of capital. In an ideal economy, the level of interest rate will influence economic activities including investment by firms and government, for instance, a high mortgage rate will discourage investment in housing while a high bond rate will increase the chances of government expenditure on investment as households and firms are more likely buy the bonds.
Nevertheless, it is important to point out that the level of interest rate is affected by fiscal and monetary policies prevailing in the economy. However, according to Okun and Tobin (1983, pp. 12), interest rates do not respond to inflation as the classical theories suggest.
There are several macroeconomic theories that tend to explain the functioning of an economy, among them being the “classical economics theory, Keynesian economics, monetarism theory, the new classical theory, and the supply-side economics” (Solow, 1998).
The classical economic theory signifies the beliefs of the classical economists who believed in the existence of full employment in an economy, mainly brought about by the fluctuation of the price of labor (wage rate) over a given period of time.
In this case, the demand and supply of labor vis-a-vis the demand and supply of employment opportunities will affect wage rate upwards or downwards; for instance, when the labor supply is higher than the available jobs, demand for labor will decline and the effect would be a decline in wages.
This process will continue until there is equilibrium between the demand and supply of jobs and labor; thus, full employment will be determined by labor supply and demand in the economy and the prevailing wage rate.
In the product market, classical theorists argue that the forces of demand and supply determine the price level, and thus government intervention will be unnecessary as long as market mechanisms are working and there is full employment.
According to the classical economists, the monetary policy would only affect prices but not employment. They perceived the fiscal policy as harmful in the cases of government borrowing, as the amount of money available for private investment and household consumption will decline from the economy, an aspect commonly referred to as crowding out.
Nevertheless, the government can increase taxation in order to raise money for its expenditure; however, the result would be to discourage consumption as purchasing power of households is reduced, as well as private investment as income from firms is reduced.
According to Solow (1998, pp 11), many modern Keynesians like James and Paul, pointed out that Keynesian economics is an environment of imperfect competition in which business firms have control over their own prices. Keynes explained that classical theories are not effective since they had ignored the aspect of aggregate demand, and the possibility of existence of demand deficit in the economy.
In this case, monetary and fiscal policies play a vital role in influencing private investment and consumption; for instance, changes in money supply affect the interest to be applied in the economy, thus having a direct influence on cost of borrowing and the level of investment to be undertaken by firms, and consumption by households.
Monetarism theory argues that market forces are vital in aligning economic activities, given the fact that labor force may not be available always.
It discounts fiscal policy as ineffective in altering output and employment; however, while monetary policy is effective, there may be inadequacy of competency in formulation of sustainable monetary policies and in this case making it difficult to put a boundary between the success rate of monetary and fiscal policies.
According to Snow and Vane (1997, pp 337), the new classical economic theory was because of the inflation in 1960’s and 1970’s, which provides a framework to support the fact that “neither fiscal nor monetary policy can be effective in altering the output and employment levels in a systematic manner” (Snow and Vane,1997).
Primarily, macroeconomics focuses on the issues pertaining to the general business environment in which a business operates.
Factors that constitute economic environment may include; the type of an economic system of a country; general trends in production, employment, income, prices, taxes and interest; structures and trends in the working of financial institutions; magnitude of trend in foreign trends; trends in labor and capital markets; government’s economic policies and social factors such as property rights, customs and habits (Kesavan, et al, 2005, pp. 8).
According to Mukherjee (2007, pp 82), scarcity of goods is common with the character of human wants changing with time. A society’s economic problem refers to scarcity of resources at large. The law of scarcity also gives rise to the economizing problem, which has been divided into three issues including “how, what and for whom.”
He also explains these problems as what commodities to produce and in what quantities, how to produce the desirable quantity of goods and services, for whom to produce the goods and services, are the economy utilities being fully utilized or are some lying idle and unemployed?
Is the economy’s capacity to produce growing or is it remaining stagnant?” A full employed economy must give up one good in order to produce another one. Here are some concepts that relate to the business environment – scarcity, opportunity cost, specialization, marginal decision making.
Resources are always scarce, thus, the amount of goods produced in an economy is always limited. However, more goods can be produced by increasing on the quality of resources. Since resources normally tend to be specialized, as a society produces more and more of one commodity, it must give up an increasing amount of another commodity.
Marginal decision-making means that each move indicates that the society is getting extra benefit that exceeds extra costs. In this case, the marginal cost of an additional amount should equal the marginal benefit of that additional amount (Mukherjee, 2007, pp89).
According to Miles and Scott (2005, pp 10), macroeconomics is about dynamics that change the nature of a firm’s market and its competitors and the demands the firm places on its managers and staff.
An example is the case of two United States car manufacturers; general motors and ford 30 years ago. During this period, the management of GM and Ford had to cope with how the economy operates. The major technical revolution has been the IT technology, which has led to change in how cars are manufactured and marketed, leading to increased skilled workforce.
The competition between how cars are manufactured in different countries has become intense, while oil prices have increased over this 30 years period, leading to a rise in demand of different types of cars. Governments across the world have responded to the damaging environment impact of burning fossil fuels by raising gasoline taxes and requiring strict emission controls, thus affecting the designs of cars. These economic trends have hence changed the business environment for car producers companies.
However, coping with technical change and shifting patterns of demand for new types of cars, as well as ensuring a sufficient number of trained workers and battling against foreign competitors have been an important strategy of how GM and Ford have remained profitable. All factors that these two car manufacturers had to cope with are macroeconomic.
To create value added factors of production, labor has to be paid wages, salary, and overtime, while the owners of capital are paid in form of rent, dividend payment, interest payments or through retained profits.
According to Solow (1998, pp 11), today’s macroeconomic theory approach on market for goods tends towards the state of perfect competition. However, monopolistic competition and the macroeconomic theory assume that markets are imperfect to allow sellers have some power over price.
In this case, macroeconomics has been integrated into theoretical and policy models of industrial and developing economies. Here, the market for products, supplies, and cost of raw materials and labor, interest rates and international competitiveness, all influence the performance of business.
The difficulties of year-to-year growth in GDP are always a reminder that economists have not learnt on strategies that can control business cycle. Nevertheless, trade and capital movements have linked the world economies to a unified trade and financial systems. Most managers are concerned by the way in which an economic outlook will affect their business. They are also concerned with the issue of permanent employment and prevention of inflation.
Normally, the closer the economy is to full employment, the lower the unemployment rate, and the greater the build up of inflationary pressure. Nevertheless, excessive demand on the available capacity and labor supply leads to increase in wages and prices, rise in interest rates and balance of payment disequilibrium (Adams, 2002, pp 12).
A remote environment is normally slow – acting, thus firms established in such environments struggle to compete. However, for an industry to perform well, it must outwit all the barriers of trade. Generally, there are factors that affect remote industries, which include customers and competitors.
Products in a market are influence mainly by the size and growth of demand depending on a country’s economy state. An industry structure includes suppliers, buyers, entrants, substitutes, and direct competition from within. If the competition is high, profitability in industries is low. One of the factors that lead to high competition is the easy entry of new competitors to the markets.
In addition, if slow growth is combined with excess capacity and high exit barriers, then it leads to low profitability. It should therefore be realized that good returns in a business always lead to many new entries to that market, as they seek to benefit from the high returns.
Corporate finance is another important area that particularly concerns the impact of agency relations within firms on financial and investment decisions, and hence on the valuation of financial instruments within firms.
Primarily, corporate financing is associated with monetary policy and taxes, which in turn affect the macroeconomic changes in these policies. Pricing models and theories in macroeconomics also fall under corporate finance.
Macroeconomic has also a common interest with finance in the areas of financial markets and asset pricing. Moreover, macroeconomics models are regularly used by firms, businesses corporations, and government as an aid in economic policies and business strategy.
Macroeconomics is all about dynamics that change the nature of a firm’s market and its competitors, AS WELL AS the demands the firm places on its managers and staff. An organization’s external environment is normally affected by the remote environment, the industry environment, and the operating environment.
In broader perspective, macroeconomics reviews how an increase or decrease in net profits affects a country’s capital. The rate of economic growth changes over time because of the average living standard of people and change of distribution of income of different groups of people in a country.
Adams, F. (2002). Perspective on the new economy. NY: World scientific publishers.
Barro, R. (2008). Macroeconomics: A modern approach. NY: Cengage learning Publishers.
Kesavan, R. et al. (2005). Engineering economics and financial accounting. New Delhi: Firewall Media.
Miles, D. and Scott, A. (2005). Macroeconomics: understanding the wealth of nations. Second edition. NJ: John Wiley and Sons.
Mukherjee, S. (2007). Modern Economic Theory. New Delhi: New Age International.
Okun, M. and Tobin, J. (1983). Macroeconomics, prices, and quantities. Washington DC: Brookings institutions publishers.
Snow, B, and Vane, H. (1997). History of economic thought. NY: Routledge publishers.
Solow, R. (1998). Monopolistic competition and macroeconomic theory. Second edition. Cambridge: Cambridge university press.