Micro and Macro Economics
Microeconomics is one of the economic branches which examines the actions of individual agents in an economy. These agents include firms and households. Microeconomics is interested in the decisions that the individual agents make using their limited resources and impact on the supply and demand of goods and services in the economy. Macroeconomics examines the economies that consist of individual economic agents. Macroeconomics explores the economic phenomenon such as the GDP and how it relates to factors such as price levels, national income, and unemployment. Macroeconomics, in an economy, evaluates the aggregate behavior. Microeconomics and macroeconomics are similar in the sense that they focus on the allocation of resources. However, the division between the two branches of economics is important so that relationships between economic events are evaluated and analyzed comprehensively.
Sectors of the Economy
Economists use various types of frameworks to represent the economy. One of the most popular frameworks is referred to as the circular flow diagram. A large number of people and other organizations interact in the complex modern economy. The economic agents that are involved in an economy are grouped into the government sector, households, firms, and the rest of the world. As will be shown below, the different sectors of the economy interact in the markets.
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The household sector includes everyone who consumes services and goods that are produced by the economy. It also includes everyone seeking to meet unlimited needs and wants. That is the major reason the sector handles consumption expenditures. The sector is responsible for providing the economy with labor services, used in production, in return for wages and salaries. The household sector of the economy interacts with the rest of the economy through various channels. When households provide labor services, they receive income from the firms. They also receive money from the government sector in the form of transfers and still have to pay the government through taxation.
The firms make up the business sector of the economy where production takes place. The firms pull together the necessary factors of production land, capital, and labor for the production to take place. Such institutions as partnerships, corporations, and proprietorships are involved in combining resources for the production of goods and other services in an economy.
The government sector plays a critical role in the economy. It is through the government sector that a legal framework is established upon which the economy operates. Within the sector, there are the ruling bodies of the local, state, and federal governments. The prime function of the government sector is to regulate the economy through passing laws. The sector interacts with the households and the firms through the role that it plays in collecting taxes from the two agents. The government sector can influence the type of activities that an economy can engage in through taxation. Those activities that the government would like to encourage are taxed less heavily in comparison with other activities that the government would wish to discourage. From the taxes, the government can offer the economy goods and services commonly referred to as public goods. Slavin (2008) states that the allocation of government spending influences how households and firms allocate their private resources. Also, the government gives transfers to the household sector. Transfer payments may include the social security benefits entitled to the physically challenged or aged among the households. The transfer payments play a leading role in redistributing income among households. However, if the government expenditures exceed the income from tax revenues, it is forced to borrow from the financial markets to finance the deficit.
The financial sector is in the center of the circular model. Through this sector, the firms and households can sustain each other through savings and investments. The financial sector interacts with the government and the foreign sector. As established above, when the government experiences a budget deficit, it borrows from the financial markets. In the case when the government runs a budget surplus, it would provide an additional source of saving. Forstater (2007) acknowledges that the financial sector has the potential to provide an additional source of investment if other nations purchase assets in the country.
The rest of the world represents the activities that occur across national borders. U.S. households consume various goods and services from other nations in the form of imports. In 2013, international trade accounted for 30% of the GDP and it is predicted to grow rapidly. The firms, households and the government also trade with the rest of the world by borrowing and lending to them. For a long time now, China has formed a big part of the sources of funds for the U.S. government and households. On the other hand, the U.S. firms and households have made huge investments over Asia and other parts of the world.
Importance of International Trade
Countries can produce and consume beyond their PPF if their economies can specialize in goods and service with comparative advantage. A country has a comparative advantage in the production of one good if it can manage to produce the good at a lower opportunity cost than any other nation. The mutual gains that nations can access by concentrating on producing different products are huge. An economy/country that chooses to facilitate international trade stands to gain. The country gains by buying the products from other countries that are able to produce at a lower opportunity cost. It should then offer those goods that it generates at low opportunity cost for sale to other nations. Without international trade, each economy is left to use its products on a production level on or outside its PPF. But with specialization and international trade, the living standards of the households are improved since every involved country can consume products outside its PPF. The added consumption is, therefore, the gains from international trade. Another huge benefit that countries can attain from international trade is receiving a higher relative price for the exported goods and paying lower relative prices for those it imports.
- Microeconomics and macroeconomics are important divisions in an economy as they facilitate the analysis of economic events. They are also important because the idea of limited resources is a major concern in today’s economy.
- The circular flow of income represents the interaction between the different sectors of the economy. The economic agents in an economy are vital for economic growth.
- The production possibilities curve representing the model of the economy can be stimulated to shift outward through engaging in trade. Through focusing on specialization and comparative advantage, the economy can stimulate growth.
- International trade encourages innovation and ensures nations benefit from economies of scale.
- The concept of scarce resources requires that economies develop strategies that support allocative efficiency.