Shazeeye's Blog Thoughts on User Experience, Technology and Business

29Feb/120

Macroeconomics 101: What drives the economy?

Macroeconomics deals with the performance, structure, behavior, and decision-making of the whole economy. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. Macroeconomists develop models that explain the relationship between such factors as  unemployment, inflation, investment, and international trade (Source: Wikipedia).

Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, usually a year. It is a measure of how well an economy is doing. For every 2% increase in GDP unemployment reduces by 1% (Okun's Law). 

GDP =consumer spending + investment ((spending on goods and services by businesses) + government spending (federal, state and local) +  net exports (exports - imports)

GDP = C + G + I + NX

Consumer spending contributes 70% to a country's GDP, while investment contributes 20% and government spending contributes 5%.

Let's look at why the stimulus failed to create jobs. The stimulus (government spending) contributes to the economy at just 5%. Consumer spending which contributes to 70% of the GDP has not increased with time because average incomes have not increased in the last 10 years in the US. Consumers prefer buying cheaper options that are imported into the US which gives the profits to the country they get imported from. With so much money (government spending) out there interest rates drop thus other countries are less likely to invest in the US. Exports are cheaper and imports more expensive which is why net exports (exports-imports) is in the negative range. Industries are fearful of the recession and are holding on to their money until better times arrive (also as consumer spending has not increased so they fear no one will buy their products). Nothing is being done to fix the trade and budget deficits. In fact spending is increasing the budget deficit and to balance this current account we need to increase our capital account so we increasingly rely on imports which ultimately profits the country from where the imports came from.

Thus consumer spending is not increasing and investment may actually decrease while net exports are in the negative range so even though government spending has increased it hasn’t increased the GDP and thus the unemployment has not increased.

How do we improve the economy?

Reduce the trade and budget deficit by saving wherever possible. Provide incentives for industries to spend locally (as opposed to outsourcing) while keeping costs low. Increase consumer confidence.

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