Nature and Scope of

Macro-Economics

The term ‘macro’ was first used in economics by Ragner

Frisch in 1933. But as a methodological approach to
economic problems, it originated with the Mercantilists
in the 16th and 17th centuries. They were concerned with
the economic system as a whole.

In the 18th century, the Physiocrats adopted it in their

Table Economies to show the ‘circulation of wealth’ (i.e.,
the net product) among the three classes represented by
farmers, landowners and the sterile class. Malthus,
Sismondi and Marx in the 19th century dealt with
macroeconomic problems. Walras, Wicksell and Fisher
were the modern contributors to the development of
macroeconomic analysis before Keynes.

Certain economists, like Cassel, Marshall, Pigou,

Robertson, Hayek and Hawtrey, developed a theory of
money and general prices in the decade following the
First World War. But credit goes to Keynes who finally
developed a general theory of income, output and
employment in the wake of the Great Depression.

Nature of Macroeconomics:

Macroeconomics is the study of aggregates or averages

covering the entire economy, such as total employment,
national income, national output, total investment, total
consumption, total savings, aggregate supply, aggregate
demand, and general price level, wage level, and cost
structure.

In other words, it is aggregative economics which

examines the interrelations among the various
aggregates, their determination and causes of
fluctuations in them. Thus in the words of Professor
Ackley, “Macroeconomics deals with economic affairs in
the large, it concerns the overall dimensions of economic
life. It looks at the total size and shape and functioning of
the “elephant” of economic experience, rather than
working of articulation or dimensions of the individual
parts. It studies the character of the forest,
independently of the trees which compose it.”

Macroeconomics is also known as the theory of income

and employment, or simply income analysis. It is
concerned with the problems of unemployment,
economic fluctuations, inflation or deflation,
international trade and economic growth. It is the study
of the causes of unemployment, and the various
determinants of employment.

In the field of business cycles, it concerns itself with the

effect of investment on total output, total income, and
aggregate employment. In the monetary sphere, it
studies the effect of the total quantity of money on the
general price level.

Scope of Macroeconomics:
As a method of economic analysis macroeconomics is of
much theoretical and practical importance.
 (1) To Understand the Working of the Economy:

The study of macroeconomic variables is indispensable

for understanding the working of the economy. Our main
economic problems are related to the behaviour of total
income, output, employment and the general price level
in the economy.

These variables are statistically measurable, thereby

facilitating the possibilities of analysing the effects on the
functioning of the economy. As Tinbergen observes,
macroeconomic concepts help in “making the
elimination process understandable and transparent”.
For instance, one may not agree on the best method of
measuring different prices, but the general price level is
helpful in understanding the nature of the economy.

(2) In Economic Policies:

Macroeconomics is extremely useful from the point of
view of economic policy. Modern governments,
especially of the underdeveloped economies, are
confronted with innumerable national problems. They
are the problems of overpopulation, inflation, balance of
payments, general underproduction, etc.

(3) For Understanding the Behaviour of Individual

Units:

For understanding the behaviour of individual units, the

study of macroeconomics is imperative. Demand for
individual products depends upon aggregate demand in
the economy. Unless the causes of deficiency in
aggregate demand are analysed, it is not possible to
understand fully the reasons for a fall in the demand of
individual products.

The reasons for increase in costs of a particular firm or

industry cannot be analysed without knowing the
average cost conditions of the whole economy. Thus, the
study of individual units is not possible without
macroeconomics.
 Concept Of Consumption

Consumption is defined as the use of goods and services

by a household. It is a component in the calculation of
the Gross Domestic Product (GDP). Macroeconomists
typically use consumption as a proxy of the overall
economy.

When valuing a business, a financial analyst would look

at the consumption trends in the business’ industry. It is
an important step, as it helps the analyst with the
assumption section of the financial model.

Consumption in Neoclassical Economics:

Neoclassical economists view consumption as the final
purpose of an economic activity, hence, the per person
value is an important factor in determining the
productive success in an economy.
Macroeconomists use this economic measure for two
reasons. The first is to assess aggregate savings in each
household; savings refer to the portion of income that is
not used for consuming goods and services. Aggregate
savings in the economy feeds into the national supply of
capital. Therefore, it can be used to assess the long-term
productive capacity of an economy.

Secondly, consumption behavior provides a good

measure of the total national output in the economy. The
total output can be used to understand the reasons for
macroeconomic fluctuations in the business cycle.

The behavior data can be used to measure poverty,

understand the retirement rate in households, and test
theories of competition in the economy. Data from
households allows macroeconomists to understand
spending behavior, and the figures can be used to
examine relationships between consumption and factors
such as unemployment and education costs.
Importance of Consumption:
Modern economists give a lot of importance to the level
of consumption in the economy because it characterizes
the economic system the country currently operates in.

1. The beginning of all economic activity:

Consumption is the start of all human economic activity.
If a person desires something, he will take action to
satisfy this desire. The result of such an effort is
consumption, which also means the satisfaction of
human wants.

2. End of economic activities:

If, for example, a person desires a sandwich, they will
take the effort to make the sandwich. Once it is made,
the food is consumed, resulting in the end of an
economic activity.

3.Consumption drives production:

According to economist Adam Smith,
“Consumption is the sole purpose of all production.” It
means that the production of goods and services is
dependent on the level of consumption.

3. Economic theories:
The study of consumption theory has helped economists
formulate numerous theories such as the Law of
Demand, the Consumer Surplus concept, and the Law of
Diminishing Marginal Utility. These theories help analysts
understand how individual behavior affects the input and
output in the economy.

4. Government theories:
Consumption habits also help the government formulate
theories. The minimum wage rate and tax rate are
determined based on the habits of individuals. It also
helps the government make decisions on the production
of essential and non-essential commodities in a country.
It also provides the government with insight into the
saving to spending ratio in the economy.
 5. Income and employment theory:
Consumption plays an important role in the income and
employment theory under Keynesian economics as put
forth by John Maynard Keynes. Keynesian theory states
that if consuming goods and services does not increase
the demand for such goods and services, it leads to a fall
in production. A decrease in production means
businesses will lay off workers, resulting in
unemployment. Consumption thus helps determine the
income and output in an economy.

Consumption Cycle

Consumption and the Business Cycle:

Consumption expenditure in the private sector accounts
for two-thirds of the Gross Domestic Product (GDP). The
remaining one-third consists of government expenditure
and net exports. Private consumption is divided into
three categories: Durable goods that are defined as
goods with a lifetime greater than three years, services
that include travel and car repairs, and non-durable
goods such as food that can be immediately consumed.
The consumption flow and expenditure (consumption
expenditure) can help analysts understand the
fluctuations in the business cycle. Producers of durable
goods only earn income from the sale of the initial
product (expenditure), not from consuming the goods
following the purchase.

Hence, it is expenditure and not consumption flow that

determines short-term economic prosperity. Due to the
nature of durable goods, economists have created a
rational optimization framework to account for the
goods. During an economic downturn, consuming
durable goods decreases because the goods require a
significant investment, and consumers will put off the
purchases until economic conditions improve.

When the economy recovers, spending on durable goods

increases and becomes more volatile than spending on
non-durable goods. A change in interest rates, tax rates,
or other stimulus measures affects spending on durables
more than any other kind of spending
 Theories of Consumption

The three most important theories of consumption are as

follows:
1. Relative Income Theory of Consumption
2. Life Cycle Theory of Consumption
3. Permanent Income Theory of Consumption.

1. Relative Income Theory of Consumption:

An American economist J.S. Duesenberry put forward the
theory of consumer behaviour which lays stress on
relative income of an individual rather than his absolute
income as a determinant of his consumption. Another
important departure made by Duesenberry from
Keynes’s consumption theory is that, according to him,
the consumption of a person does not depend on his
current income but on certain previously reached income
level.
2. Life Cycle Theory of Consumption:
An important post-Keynesian theory of consumption has
been put forward by Modigliani and Ando which is
known as life cycle theory. According to life cycle theory,
the consumption in any period is not the function of
current income of that period but of the whole lifetime
expected income.

Thus, in life cycle hypothesis the individual is assumed to

plan a pattern of consumption expenditure based on
expected income in their entire lifetime. It is further
assumed that individual maintains a more or less
constant or slightly increasing level of consumption.

3. Permanent Income Theory of Consumption:

Permanent income theory of consumers’ behaviour has
been put forward by a well-known American economist,
Milton Friedman. Though Friedman’s permanent income
hypothesis differs from life cycle consumption theory in
details, it has important common features with the
latter. Like the life cycle approach, according to
Friedman, consumption is determined by long-term
expected income rather than current level of income.

It is this long-term expected income which is called by

Friedman as permanent income on the basis of which
people make their consumption plans. To make his point
clear, Friedman gives an example which is worth quoting.
According to Friedman, an individual who is paid or
receives income only once a week, say on Friday, he
would not concentrate his consumption on one day with
zero consumption on all other days of the week.

He argues that an individual would prefer a smooth

consumption flow per day rather than plenty of
consumption today and little con-sumption tomorrow.
Thus consumption in one day is not determined by
income received on that particular day. Instead, it is
determined by average daily income received for a
period. This is on the line of life cycle hypothesis. Thus,
according to him, people plan their consumption on the
basis of expected average income over a long period
which Friedman calls permanent income.
It may be noted that permanent income or expected
long-term average income is earned from both “human
and non-human wealth”. The income earned from
human wealth which is also called human capital refers
to the return on income derived from selling household’s
labour services, that is, efforts and abilities of its labour.

This is generally referred to as labour income. Non-

human wealth consists of tangible assets such as saved
money, debentures, equity shares, real estate and
consumer durables. It is worth noting that Friedman
regards consumer durables such as cars, refrigerators, air
conditioners, television sets as part of households’ non-
human wealth. The imputed value of the flow of services
from these consumer durables is considered as
consumption by Friedman.