Macroeconomics and the Circular Flow of Economic Activity

Economics splits into two main subareas. Macroeconomics looks at the economy as a whole, using aggregate data for large groups of people, companies, or products. Microeconomics focuses on individual parts, like a single household or firm. Both offer valuable outlooks. For example, Ford deciding on a new vehicle line would weigh macroeconomic factors—national personal income, unemployment, interest rates, fuel costs, national sales of new vehicles—and microeconomic ones, such as consumer demand versus supply, competing models, labor and material costs, and current prices and incentives.

To see how the sectors interact, trace the circular flow of inputs and outputs among households, businesses, and governments. Households provide inputs—natural resources, labor, capital, entrepreneurship, knowledge—to businesses, which convert them into goods and services. In return, households receive income from rent, wages, interest, and ownership profits. Businesses receive revenue from consumer purchases. Governments supply publicly provided goods and services—highways, schools, police, courts, health services, unemployment insurance, social security—and receive taxes from households and businesses to complete the flow.

Changes in one flow affect the others. If government raises taxes, households have less to spend, so businesses reduce production and economic activity declines—unemployment may rise. Cutting taxes can stimulate activity. Keep this interdependence in mind as we explore macroeconomics and microeconomics.

The United States and most other countries pursue three main macroeconomic goals: economic growth, full employment, and price stability. A nation's economic well-being depends on defining these goals carefully and choosing the best policies to achieve them.

The most basic measure of economic growth is GDP. The Bureau of Labor Statistics publishes quarterly GDP figures. When GDP rises, the economy grows. The rate of growth in real GDP (adjusted for inflation) matters too. The U.S. has recently grown at a slow but steady 3–4 percent annually, keeping unemployment relatively low. China, growing at 6–7 percent per year, owes much of its rapid growth to technology—most tablets and laptops are made there.

Business cycles vary in length, height, and impact. An increase in business activity raises output, income, employment, and prices until they peak, then decline. A downturn is followed by a recovery. The most recent U.S. downturn began in December 2007 and ended in June 2009. Businesses must monitor these phases: during growth, hiring is hard and supplies scarce; during downturns, firms run below capacity, raising costs per unit. For example, if Mars Corp. can produce a million candy bars a day but sells only half a million, its plant operates inefficiently.

Now test how well you can apply the circular flow to a policy change.

Full employment doesn't mean 100 percent employment. Some people choose not to work for personal reasons—attending school, raising children—or are temporarily unemployed while waiting to start a new job. Thus, the goal is jobs for all who want and can work.

The circular flow