Chapter 5 - Lessons from Macroeconomics

Overview:

This chapter summarizes important lessons and points from macroeconomics that are key to understanding changes and trends in the national economy and the rest of the world.

Objectives:

After completing this chapter, you will be able to:

• Describe the basic concepts and terms from macroeconomics that are important for farm managers
• Understand the basics of domestic macroeconomic issues important for farm managers
• Understand the basics of international macroeconomic issues important for farm managers

Key Points:

• Gross Domestic Product (GDP) is the market value of all the final goods and services produced within a country within a certain period.
• A rising GDP per capita is an indicator of rising income and a rising standard of living.
• A recession is a period with significant decline in economic activity spread across the economy, lasting more than a few months, and normally visible in measures of real GDP, real income, employment, industrial production, and wholesale–retail sales.
• The unemployment rate is the total number of unemployed expressed as a percent of the labor force.
• The natural rate of unemployment is the normal rate around which the actual rate fluctuates.
• Inflation is the increase in the overall level of prices.
• The Consumer Price Index (CPI) is based on the cost of a fixed basket or set of consumer goods.
• The money supply in an economy is more than just the currency in circulation. It is measured in two ways. M1 is the total of currency plus demand deposits (that is, checking accounts and similar accounts), traveler's checks, and other check-writable deposits. M2 is all of M1 plus savings deposits, small time deposits, money market mutual funds, and a few other minor categories.
• Monetary policy involves controlling the money supply to control the market interest rate and setting certain short-term interest rates.
• Fiscal policy is the use of taxation and government spending to stabilize the economy (and to provide incentives to a few industries identified as critical to the economy).
• The exchange rate is the value of one currency in terms of another currency. The real exchange rate is the rate at which a person can trade the goods and services of one country for the goods and services of another country.
• The gains from trade are the result of persons and countries producing what they have comparative advantage in and then trading for other goods and services.
• Trade restrictions constrain our ability to benefit from the gains from trade but are used by a country to protect its industries and improve food security.

Key Terms:

• Currency exchange rate: The price of one country’s currency in terms of the currency of another country.
• Fiscal policy: The use of taxation and government spending to stabilize the economy and to provide incentives to a few industries identified as critical to the economy.
• Gross domestic product (GDP): the market value of all the final goods and services produced within a country within a certain time period. GDP is used to measure economic growth.
• Gross national product (GNP): GNP is similar to GDP but includes the income produced by a country’s citizens working in other countries as well as in their home country.
• Inflation: An increase in the overall level of prices in an economy
• Macroeconomics: The study of economy-wide issues, including economic growth, inflation, changes in employment and unemployment, trade with other countries and the balance of payments, monetary and fiscal economic policy, the role of central banks, and so on.
• Monetary policy: Controlling the money supply to control the market interest rate and setting certain short-term interest rates.
• Recession: “A period with significant decline in economic activity spread across the economy, lasting more than a few months, and normally visible in measures of real GDP, real income, employment, industrial production, and wholesale-retail sales”. This is the definition used by the National Bureau of Economic Research.
• Unemployment rate: The total number of unemployed people divided by the total labor force. The total labor force is the total number of people employed plus the unemployed (that is laid off or actively looking for a job).

Study Notes:

This chapter is a summary of lessons and points from macroeconomics that farmer managers should know in order to understand the changes and trends in the national and global economies and the potential impact on his or her own farm business.

The chapter starts with some definitions of basic concepts and terms and then, from a farmer’s perspective, looks at the issues involved in understanding one’s domestic national economy and the global economy.

BASIC MACROECONOMIC CONCEPTS AND TERMS

Several concepts and terms are used in macroeconomics and useful to a farm manager for understanding the workings of national and global economies. These are listed below. Instead of repeating them, the reader is referred to the definitions and descriptions in the text.

• National Income
• Recession and Depression
• Unemployment
• Inflation
• Money Supply

DOMESTIC ISSUES

Domestic macroeconomic issues involve concerns about the fluctuations in economic activity that we refer to as the business cycle. The business cycle has three phases: expansion, recession, and recovery. Government macroeconomic policy strives to stabilize the business cycle and avoid the peaks and troughs. Governments have two basic tools for this stabilization effort: monetary policy and fiscal policy.

Monetary Policy

Monetary policy involves controlling the nation’s money supply and setting certain interest rates and regulations of banks.

Monetary policy can be either expansionary or contractionary. Expansionary policy raises the money supply and thus lowers interest rates to stimulate the economy through increased borrowing and spending by businesses and citizens. Contractionary policy is the opposite: decreasing the money supply and thus raising interest rates. Expansionary policy creates a period of low interest rates or “easy money,” and contractionary policy creates a period of high interest rates of “tight money.”

The interest rate is essentially the price of money. So expansionary policy lowers the price of money to encourage people and businesses to borrow and expand activity in order to create more jobs and income. And contractionary policy raises the price of money to discourage borrowing and expansion.

Discouraging borrowing and expansion may seem like poor policy, but if an economy is growing very fast it may be thought of as overheating. An overheating economy may create higher inflation rates, bubbles in asset values, among other bad events, and thus a bust or recession may be created due to the economy growing too fast. So contractionary policy can be a rational choice for a period of time in order to keep an economy growing at a more stable rate.

Fiscal Policy

Fiscal macroeconomic policy is the use of taxation and government spending to stabilize the economy.

During a recession, an expansionary fiscal policy could consist of lowering taxes, increasing government spending, or both. This will put more money in the economy and hopefully encourage people to spend more and businesses will hire more workers. However, this will also increase the government’s budget deficit and with more money in the economy, inflation may increase.

In an overheated expansion, a contractionary fiscal policy could consist of raising taxes, reducing government spending, or both. This will probably cause business and people to spend less, credit to become tighter, and business to lay off workers. However, the government budget deficit will decrease and inflation may decrease.

INTERNATIONAL ISSUES

International macroeconomic issues, especially, for agriculture, revolve around currency exchange rates and trade.

Exchange rates are essentially the price of one country’s currency in terms of the currency of another country. The importance of currency exchange rates to agriculture and farmers is in how fluctuations affect trade. As the exchange rate of one’s home country currency declines, other countries find that currency less expensive to buy. Thus, the products from the country with the lower exchange rate are also less expensive for other countries. So this is good news for a farmer who wants to export more product. But this is also bad news for a farmer who needs to buy inputs (fertilizer, for example) from other countries since the lower valued currency means inputs from other countries are more expensive.

Trade occurs between people and between countries because each side sees benefits from the trade. Gains from trade occur because of differences in comparative advantage. Comparative advantage results from your having a lower opportunity cost to produce a product than another producer, which means that you should produce that product and trade for other products. This can happen between neighbors in the same locality and between producers in different countries.

Having comparative advantage does not mean international trade will occur. Tariffs, quotas, and sometimes complete restriction on exports and imports are used to protect local industries and to raise money for the government.

Trade policy, tariffs, and non-tariff restrictions have been contentious for centuries. The World Trade Organization (WTO) is designed to facilitate the discussion between countries to lower trade barriers and to help resolve trade disputes.

In this chapter, the basic concepts, terms, and issues of macroeconomics have been explained for both national and global economies.

Try this. Read and listen to the news and complete Worksheet 5.1 to note some of the current macroeconomic issues that are being debated or changing and how farmers may be affected.

Worksheet:

Worksheet 5.1 Current macroeconomic issues.pdf

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