Monday, 10 December 2012

The Telescope of the World : Macroeconomics

Peeking From Rooftops

Have you ever stood on top of a tall building and looked down at the people below? The random patterns, very busy yet very routine. Crowds of all sorts, carrying within them individuals. These individuals follow their own purposes but even then the view that you get seems to have common themes. None can change the collective motion, yet every one of them is part of the picture. As they say, 'what is an ocean but a multitude of drops.'
Macroeconomics is the bird's view of the economy. It studies not one or two people but thousands or millions of them. It studies the collective forces of supply and demand, as well as total production levels in the economy. It sees content as an aggregate. It looks at policies and their effects, laws and their repercussions and people and their choices. Not at the individual level but at the societal level.

  • Why did Japan's productivity boom in 1960? 
  • What could really be the cause behind the Israel-Palestine issue? 
  • Where would the electronic revolution of America lead to? 
  • How did India manage to transform it's growth rate in just two decade? 
  • How did the world pull out of the Great Depression of the 1930's? 
  • How did the FIFA World Cup 2010 help South Africa? 
  • Can we compare the 'standard of living' of two places in two different times? 
  • Is the current growth rate of Russia, good enough to keep pace with the world? 
  • What is the unemployment rate of Indonesia? 
  • What is the worth of America? 
  • How do we measure the economy of the Vatican? 
  • Was the primary difference between the two superpowers of the cold war, just property rights?

Macroeconomics is able to answer these questions to some extent, and gives us valuable insight into the economy as a whole. In my opinion, it is Macroeconomics that influences government decisions the most. Economists are brought to study the vast economy and provide useful advice on increasing growth and reducing hunger. They crunch vast numbers into statistical models and with the help of certain theory they predict and analyse the happenings of the economy. A major part of the work done by Macroeconomists is to figure out the 'value' of an economy.

 The Infamous Gross Domestic Product

China took over Japan as the world's second largest economy in 2010.

What does that actually mean?
Does it mean that Chinese live better than Japanese?
What is this measure of 'economy'?

The Gross Domestic Product acts as one form of measure for economies. In fact, there are many other methods of measuring an economy that nobody can say for sure that China really has a bigger economy than Japan. However, economists use the GDP to measure various kinds of economies and this has become the standard for the world. So what is the GDP?

The GDP of China, is the value of all things produced in China in a given period of time.

Want a longer definition?

'GDP at market prices, is the total market value of all final goods and services produced within an economy in a given period of time.'

This means that the GDP of a economy is just the value of total production, in a given period of time. For example if China produces two goods in a year, cakes and cellphones. Then the GDP of China is merely the market value of cakes added to the market value of cellphones. We must note that all cakes or cellphones that were made last year are excluded. We only consider the final goods, that were made in that year itself.

What really is this market value of all goods and services?

Let us for one moment digress from tiring economic jargon, and come back to reality. What do we really mean when we talk about the market value of any product? By this we mean the amount any body would have to spend to acquire it. Also, this means the amount a seller must receive if he is to part with it. Hence, the market value symbolizes both expenditure and income. For the consumer, the market value is the amount he must pay and for the firm (fancy term for a producing unit) it means the income it must receive in order to sell it. Hence, due to the fundamental phenomenon that in every transaction the buyer's expenditure is the seller's income, and that this value is the market value of the product; we realise that the GDP of the nation is simply its expenditure or income.

So, in simple terms, when we say that China has a larger GDP than Japan, we imply that the amount of expenditure in China is more than the amount of expenditure in Japan. Or we mean that the incomes of people and organisations collectively are more than the ones in Japan.

Does this mean that everyone in China is better off? No.
Does this mean that Chinese are more healthy? Not really.
Does this mean that Chinese have more opportunity? Not really, no.

The GDP is simply a quantitative measurement, that does not include quality. Of course, there is some relation with how welfare of a country and the welfare of its people, but the accuracy and popularity of the GDP are beginning to be questioned. In fact, in the Kingdom of Bhutan, the official measurement is the happiness! The people of Bhutan believe that the Gross National Happiness is the real measurement of the economy. It is a novel approach at understanding its people, and a new direction for the world to shortly follow. However, the GDP remains the standard measurement for the world. Here are some countries and their respective GDP's.

Is it Real-ly Nominal? 

Time always plays tricks on us. Sometimes, it fools our interpretation of how well we are doing. If GDP is increasing along with time, so are prices. And if we want to believe that we are doing well at any one point of time, we must have some other time frame to compare it with. Not only must we compare the GDPs between countries, but also we must compare GDP of past countries and present. How well have we really done today, can only be told by how well we have done in the past. So do we compare the market values for today and yesterday and figure out how much better off we are. 


There is a catch, do note, that the general price level has been rising for a long time. Items cost much more right now, than they did in their past. This inflation brought by time, can play tricks on our comparisons. If prices are usually rising, isn't the market value also rising. Hence, the GDP calculated at current prices is almost always increasing. Hence, how do we even actually account for an increase in total production? 

Stop Price, Stop!
The answer lies, in a simple trick, that economists use to compare two time frames. 
They hold the prices constant. 

They catch hold of the prices, and quite roughly, make them sit still. In effect, if in need for comparison economists use identical prices while calculating the GDP. This is called Real GDP and uses the prices that used to exist at one selected base year. This tells us, what our economy is worth if the price level was still as it was in the base year. The earlier version of the GDP that was explained was the Nominal GDP. It gave the market value at the current prices. Usually, the Real GDP is treated with more importance when it comes to comparison. Many countries often find that with a lot of rising prices, their Nominal GDP rises. This can be very misleading about how well they are doing in fact. Their Real GDP however stays the same, informing us that prices are indeed rising.

What is an Economy actually worth? 

Be it Mayans, Romans, Greeks, Germans, Indians, Chinese, Cubans or even Europan, the people of a country must know how well they are doing. Nations must understand their progress and their productivity. The GDP is one such method currently employed to measure progress. It definitely is a primitive method, and it reminds us that Economics as a subject has not evolved enough to find solutions without simplifying too much. The GDP is a simplification, that Economists use to measure different economies at different locations, both geographically and historically. What is important here, is to observe that the GDP is a attempt at finding value generation that happens when a economy functions. 
Creating Value, depends on two things- quantity and quality. Quality, in some ways is represented by price, depicting scarcity. Quantity, here is representing by amounts of goods and services produced. Even today, more complex methods exist to measure economies and hopefully in the future even more detailed methods appear that would let us incorporate many more valuable concepts. Generating ideas or religious and cultural values are also a part that defines a nation. What about Unity? Honesty? Courage? Accountability? Maybe its a bit far-fetched to think about measuring such abstract concepts, but maybe one day it may be possible. One of the prime aspects of Macroeconomics, is finding the worth of economies. 

Maybe one day everyone will know the true worth of economies.

Even then, Economics is for Everyone. 

-Pranjal Rawat