Open Economy Macroeconomics:
Open economy macroeconomics is nothing but macroeconomics. It is a massive economic phenomenon. Before we discuss and head into the details of macroeconomics, one should know about the economy. It is also mandatory to know the fundamentals of economics. Basic knowledge about economy and economics will make it easy to understand the open economy macroeconomics.
What is an Economy?
The economic system is another term for the economy. It is a condition which is responsible for the production and distribution of goods and services in a country. It also refers to the manner in which the people are a part of gainful employment. In other words, in an economy, all the sources of employment and production are within a specific geographical area. The economy often constitutes of individuals, households, firms, factories, banks and government. These elements act and interact to produce and consume both/either goods and/or services.
Therefore, an economy is a social organism through which people make their living. It also refers to the manner in which the country organizes its economic activities. There are various economies and economic systems in the world today. For example, the Indian economy, the Economy of Japan, Economy of the USA etc.
What is Economics?
Economics is the ‘queen of social sciences’. It is one of the most influential sections of knowledge. Economics teaches the art of economizing and behaving logically. It also focuses on rational decision making. Although economics is ancient and well-developed over the years, it does not have any rigid definition. All the definitions of economics are broadly classified into 3 key groups.
- Welfare definition
- Wealth definition
- Scarcity definition
In simple words, economics is the study of the description and analysis of the nature of economics.
What is an Open Economy?
An open economy is an important category of the world economies. In this economy, there are economic activities between the domestic community and overseas community. Businesses, as well as people, can trade in goods and services. These trades can either be with other people or businesses in the international community. And finally, the funds that were a part of the trade transaction flow as investments across the border.
Approaches to Economic Theories
There are many economic theories. However, modern economists have laid down 2 approaches to analyze economics and economic theories.
In this article, we will only introduce you to the concept of macroeconomics.
Introducing Open Economy Macroeconomics
Macroeconomics is also known as the macro approach to economics. It was an outstanding contribution of John Maynard Keynes. He was the most influential economist of the 20th century. However, his macro approach became famous only after the publication of the great book “General Theory of Employment” in the year 1936.
The term ‘macro’ in economics is a Greek word ‘makros’. This means large or big. Therefore, macro approach or macroeconomics studies the broad economic aggregates. It is the study of the entire economy as a whole. In other words, it concerns with the aggregates and averages of the entire economy. The subject matter of macroeconomics includes: (1) The theory of output and employment (2) General price level and inflation (3) Trade cycles (4) Consumption and investment function (5) Economic growth.
According to Professor Kenneth E Boulding, “Macroeconomics deals not with individual quantities as such but with aggregates of these quantities, not with individual incomes but with the national incomes.”
The depression of the 1930s, industrialization and the growing public sector has led to the growth of macroeconomics. Also, the increase in government interference has also led to the growth of macroeconomics. Since macroeconomics mainly concerns with incomes and employment, it is also known as “the theory of income and employment”.
Importance of Open Economy Macroeconomics Approach
In recent years, the analysis of the economic system as a whole has increasing importance. This type of macro approach will give the following benefits.
- A clear picture of the economy. The macro approach gives a clear picture of the economy. It is helpful in understanding the functioning of complicated economic systems.
- Formulation of economic policies. The macroeconomic approach is quite useful in the formulation of economic policies of a nation. Since it gives a clear picture of the economy, formulation of such useful policies is effective. A few such policies are monetary policies, employment policies, trade policies etc.
- Study of economic growth. Macroeconomics studies economic growth and economic development. By studying the growth of national income and generation of income, etc, it helps to formulate policies. These policies will, therefore, be not only suitable but very relevant and appropriate as well.
- Study of trade cycles. Macro approach studies the fluctuations in the broad economic aggregates. It considers the cause of effect of trade cycles.
- Consideration of economic problems. Macroeconomic approach studies the various economic problems that an economy faces. Apart from that, it also suggests various solutions to solve these problems.
Limitations of the Macro Approach
The macroeconomic approach also suffers from some defects. A few such limitations, demerits and disadvantages are as follows.
- Neglects microstudy. Microeconomics completely neglects micro study. It does not consider individuals, production units, sectors and components of the economy. Therefore, the study of the macroeconomic approach of the open economy is incomplete.
- No clear picture. Since macroeconomics studies aggregates and averages, it does not give a clear picture of the functioning of the economy.
- Wrong conclusions. The macroeconomic study may sometimes lead to wrong conclusions. Because what is true of an economy may not be true of an individual. Also, since it does not consider the micro elements of the economy, the readings may often be inaccurate. Thus, macroeconomic conclusions may often be misleading.
- Excessive generalization. The greatest defect of macroeconomics is its excessive generalization. Its approach, most of the time, is misleading. It may, therefore, directly lead to wrong conclusions.
Other Important Terms/Points to Remember
- Positive Economics explains the causes and consequences of things. It studies the facts as they are and not as they ought to be. A positive science is one which merely explains and explores. Therefore, positive science gives a more critical analysis of the existing facts.
- Normative Economics discusses the rightness and wrongness of things. It studies the things as the ought to be and not for what they actually are. Not only does it explore and explain but also prescribes rules of conduct.
- Economic Statics denotes a state where there is a continuous, regular, certain and constant movement. There is no change in economic statics. It refers to the phenomenon of the same period and where time factor has no role to play.
- Economic Dynamics is the study of economic variables in a dynamic state. Economic variables are population, capital, income, fashion, habit, techniques of production, etc.
Thus, to conclude, macroeconomics has its own critical limits. Yet it has a great significance in the study of the modern economy.
This was our article about open economy macroeconomics. For an introduction to macroeconomics, you can refer to this article!