The Telescope of the World : Macroeconomics

Peeking From Rooftops

Have you ever stood on top of a tall building and looked down at the people below? The random patterns, very busy yet very routine. Crowds of all sorts, carrying within them individuals. These individuals follow their own purposes but even then the view that you get seems to have common themes. None can change the collective motion, yet every one of them is part of the picture. As they say, 'what is an ocean but a multitude of drops.'
Macroeconomics is the bird's view of the economy. It studies not one or two people but thousands or millions of them. It studies the collective forces of supply and demand, as well as total production levels in the economy. It sees content as an aggregate. It looks at policies and their effects, laws and their repercussions and people and their choices. Not at the individual level but at the societal level.

• Why did Japan's productivity boom in 1960? 
• What could really be the cause behind the Israel-Palestine issue? 
• Where would the electronic revolution of America lead to? 
• How did India manage to transform it's growth rate in just two decade? 
• How did the world pull out of the Great Depression of the 1930's? 
• How did the FIFA World Cup 2010 help South Africa? 
• Can we compare the 'standard of living' of two places in two different times? 
• Is the current growth rate of Russia, good enough to keep pace with the world? 
• What is the unemployment rate of Indonesia? 
• What is the worth of America? 
• How do we measure the economy of the Vatican? 
• Was the primary difference between the two superpowers of the cold war, just property rights?

Macroeconomics is able to answer these questions to some extent, and gives us valuable insight into the economy as a whole. In my opinion, it is Macroeconomics that influences government decisions the most. Economists are brought to study the vast economy and provide useful advice on increasing growth and reducing hunger. They crunch vast numbers into statistical models and with the help of certain theory they predict and analyse the happenings of the economy. A major part of the work done by Macroeconomists is to figure out the 'value' of an economy.

 The Infamous Gross Domestic Product

China took over Japan as the world's second largest economy in 2010.

What does that actually mean?
Does it mean that Chinese live better than Japanese?
What is this measure of 'economy'?

The Gross Domestic Product acts as one form of measure for economies. In fact, there are many other methods of measuring an economy that nobody can say for sure that China really has a bigger economy than Japan. However, economists use the GDP to measure various kinds of economies and this has become the standard for the world. So what is the GDP?

The GDP of China, is the value of all things produced in China in a given period of time.
Simple.

Want a longer definition?

'GDP at market prices, is the total market value of all final goods and services produced within an economy in a given period of time.'

This means that the GDP of a economy is just the value of total production, in a given period of time. For example if China produces two goods in a year, cakes and cellphones. Then the GDP of China is merely the market value of cakes added to the market value of cellphones. We must note that all cakes or cellphones that were made last year are excluded. We only consider the final goods, that were made in that year itself.

What really is this market value of all goods and services?

Let us for one moment digress from tiring economic jargon, and come back to reality. What do we really mean when we talk about the market value of any product? By this we mean the amount any body would have to spend to acquire it. Also, this means the amount a seller must receive if he is to part with it. Hence, the market value symbolizes both expenditure and income. For the consumer, the market value is the amount he must pay and for the firm (fancy term for a producing unit) it means the income it must receive in order to sell it. Hence, due to the fundamental phenomenon that in every transaction the buyer's expenditure is the seller's income, and that this value is the market value of the product; we realise that the GDP of the nation is simply its expenditure or income.

So, in simple terms, when we say that China has a larger GDP than Japan, we imply that the amount of expenditure in China is more than the amount of expenditure in Japan. Or we mean that the incomes of people and organisations collectively are more than the ones in Japan.

Does this mean that everyone in China is better off? No.
Does this mean that Chinese are more healthy? Not really.
Does this mean that Chinese have more opportunity? Not really, no.

The GDP is simply a quantitative measurement, that does not include quality. Of course, there is some relation with how welfare of a country and the welfare of its people, but the accuracy and popularity of the GDP are beginning to be questioned. In fact, in the Kingdom of Bhutan, the official measurement is the happiness! The people of Bhutan believe that the Gross National Happiness is the real measurement of the economy. It is a novel approach at understanding its people, and a new direction for the world to shortly follow. However, the GDP remains the standard measurement for the world. Here are some countries and their respective GDP's.

Is it Real-ly Nominal? 

Time always plays tricks on us. Sometimes, it fools our interpretation of how well we are doing. If GDP is increasing along with time, so are prices. And if we want to believe that we are doing well at any one point of time, we must have some other time frame to compare it with. Not only must we compare the GDPs between countries, but also we must compare GDP of past countries and present. How well have we really done today, can only be told by how well we have done in the past. So do we compare the market values for today and yesterday and figure out how much better off we are. 

BUT WAIT

There is a catch, do note, that the general price level has been rising for a long time. Items cost much more right now, than they did in their past. This inflation brought by time, can play tricks on our comparisons. If prices are usually rising, isn't the market value also rising. Hence, the GDP calculated at current prices is almost always increasing. Hence, how do we even actually account for an increase in total production? 

Stop Price, Stop!

The answer lies, in a simple trick, that economists use to compare two time frames. 

They hold the prices constant. 

They catch hold of the prices, and quite roughly, make them sit still. In effect, if in need for comparison economists use identical prices while calculating the GDP. This is called Real GDP and uses the prices that used to exist at one selected base year. This tells us, what our economy is worth if the price level was still as it was in the base year. The earlier version of the GDP that was explained was the Nominal GDP. It gave the market value at the current prices. Usually, the Real GDP is treated with more importance when it comes to comparison. Many countries often find that with a lot of rising prices, their Nominal GDP rises. This can be very misleading about how well they are doing in fact. Their Real GDP however stays the same, informing us that prices are indeed rising.

What is an Economy actually worth? 

Be it Mayans, Romans, Greeks, Germans, Indians, Chinese, Cubans or even Europan, the people of a country must know how well they are doing. Nations must understand their progress and their productivity. The GDP is one such method currently employed to measure progress. It definitely is a primitive method, and it reminds us that Economics as a subject has not evolved enough to find solutions without simplifying too much. The GDP is a simplification, that Economists use to measure different economies at different locations, both geographically and historically. What is important here, is to observe that the GDP is a attempt at finding value generation that happens when a economy functions. 

Creating Value, depends on two things- quantity and quality. Quality, in some ways is represented by price, depicting scarcity. Quantity, here is representing by amounts of goods and services produced. Even today, more complex methods exist to measure economies and hopefully in the future even more detailed methods appear that would let us incorporate many more valuable concepts. Generating ideas or religious and cultural values are also a part that defines a nation. What about Unity? Honesty? Courage? Accountability? Maybe its a bit far-fetched to think about measuring such abstract concepts, but maybe one day it may be possible. One of the prime aspects of Macroeconomics, is finding the worth of economies. 

Maybe one day everyone will know the true worth of economies.

Even then, Economics is for Everyone. 

-Pranjal Rawat

   

Choice, Preference and the irrational concept of Rationality.

Understanding Ourselves

Everyday in our lives, we have thousands of choices before us. Each day, we subconsciously make quick logical decisions such as whether to eat a banana over an apple, or driving to work or taking the bus, or leaning in for a kiss or just embracing. Even as laymen, we make quick calculations on what we like and what we prefer and decide in a matter of seconds. Economics, surprisingly you will find, focuses on figuring out how this happens. Consumer Behaviour Theory is the incomplete attempt at explaining why we do what we do. Consumers as the name tells, are those economic agents ( not secret agents like Mr. Bond) that have the power to consume. We consume a variety of products that we see in the market. 

In order to understand how we choose, we must first figure out what we like. Economists call this preferences. We must understand what we prefer, and to do so we must make a conclusion about our mindset. Our preferences come from our rationality. Rationality is the basis for all preferences. Hence, it becomes extremely important to try and figure out what exactly is "Rational Thinking". Once we do that we can form a model to explain what is the logic behind choice. And funnily enough, our choices, truth be told, tell us about our rationality. A circular pattern of human reasoning.

Rationality 

There are many views about Rationality, however most of them seem far from reality. Yet, apparantly, economists prefer to use a more simple but less real concept of rationality. This in my opinion, is an area where more research should be done in order to make models more realistic. 

 

Self Interest Model

1) Self Interest Model of Rationality : The self interest model makes man a very selfish being. It says that man will only look for his benefit in every transaction. While shopping for shoes, he try to get the best shoe for the lowest price. This model says that man wants to get the maximum while losing the minimum. If the cost side is not taken into consideration, man will always prefer more to less. Hence man will prefer more of a comodity to less of the same. 

2) Present Aim Model of Rationality : This model makes man a very spontaneous character. It says that, right at the moment of decision what man wants is what he will choose. If I want to eat a strawberry fruit cake right now, I will choose a strawberry cheese cake over anything else. The flaw here is not hard to see. What about the future? A working man knows he loves to sit on the couch all morning watching cartoons over going to the workplace, but he must realise the trade-off between now and later.

Bounded Rationality

3) Bounded Rationality : This model makes man a slightly confused character. It says that man does not have the perfect knowledge of the market and about the possibility of cheaper/better goods, and hence makes a rational decision based on his current knowledge. Man's understanding is bounded and hence he makes perfect imperfect decisions. He tries to make do with what he knows.

So which model do you think economists use? Bounded Rationality? Well, no! The standard model, uses the Self-Interest model of Rationality. This means to say that more is better. If we are offered more of something, we will always choose it. This might not be true is many cases, and might seem a bit hedonic.

For example, for when we gift our loved ones on christmas or on their birthday, we do not follow this. We in-fact are ready to take a loss in order to see someone else happy. Also, sometimes we are not so greedy as the model says, even if offered we might not take ten mercedes cars, because we simply won't ever require them all. However, for simplicity and a focus, we accept this and proceed.


 Rational Behavior, undergoes 3 steps.


 First, we must chose a model of Rationality, which could be Present Aim or Self-Interest. It could even be a new special model that applies only to certain people like for example, 'Teen-cigarette-10-a-day model', that says that this particular teen follows self-interest model, but must have 10 cigarettes a day as a compulsion. Regardless of these distortions for 'standard models', what is important is to slap the label of some such model onto an individual and say that the individual will remain consistent within the scope of the model. Hence that poor teen cannot deviate from his own model, by having only 9 cigarettes per day.

Second, the individual must figure out what is actually possible for him to obtain. Here the underlying issue is that people cannot buy everything. We all have limited incomes and limited wealth. We are thus constrained by incomes,prices and other factors. Hence in this massive world of choices, most of them are well out of our reach. Some of these constraints may be brought about by age (some of us are too old for certain fun activities at the entertainment park, as for me, I cannot vote!), distance (I want a home in Mars, hardly possible), climate, natural elements, laws of our countries and even time! Usually economists consider only prices and incomes to be real constraints. Luckily, we aren't them.

Third, after deciding what is possible, the individual must decide what is BEST under his Rationality.
Of all the things he purchases, he must measure all items bought to see where is the sweet spot. The balance between what is best and what is possible to buy. Note, the individual may also choose to save a little bit, for the future. This saving also has a certain sweet spot. Save too much and you cannot be happy now, save too little and you cannot be happy later. (Lazy mouse, industrious mouse story anyone?).

In very simple words, we decide how we might BEHAVE (step1), we see what we CAN choose (step2) and finally we choose the BEST of what we can (step3). 

Pi is irrational, he has an imaginary friend.

Preference & Indifference

By preference, we imply taste. What are our tastes? What do we like over what ? The first problem that economists encountered was the problem of measure.

 If we say that we prefer A over B, A must have a higher value to us than B. This value in use, in simple terms is utility. The utility we hope to derive in A is more than the utility we hope to derive from B, hence we chose A over B. This utility is more basically, just a scheme of ranking various options. If we rank A over B, we prefer A over B. 

Again, there can be a case where we decide A is equally as good as B. Here, we are indifferent in our choice. We find A indifferent to B. In other terms, the utility of A is equal to the utility of B. 

How do we measure and compare commodities so different as chocolates and shoes?

•  The Cardinal Idea : This fancy name is simply short for giving a number to satisfaction or utility. For example, a chocolate can give us 10 utils of satisfaction and a pair of shoes can give us 15 utils of satisfaction. Utils, here is the unit of satisfaction. From the example it is easy to see that we will always choose a pair of shoes over a chocolate. However, as you can see, this is a very unrealistic way of comparing two goods. For every person, the utility for chocolates of shoes varies - I might value shoes at 10 utils and chocolates at 20. Hence this model takes us very far from real life, and we do not use it anymore. 

• The Ordinal Idea : This idea says that utility can only be compared not measured. And from many comparisons, we can form a general idea about all the possibilities. If A is prefered to B and B is prefered to C, then A is prefered to C. By adding D, E, F, G and more, we can construct an entire table of preferences. 

This was how the ordinal idea gave structure to preferences. This is the model that we use to understand consumer behaviour theory. The Cardinal Model is used, in other areas of Economics.

Choices

Now that we have defined preference we go on to the part which involves the larger part of economics. Choices are the actual deal, ultimately everything is life happens not by what we think, but by what we do. This is the real stuff, our choices. We choose our governments (in some countries), we choose the type of lifestyles we live, we choose our significant others and so many more. Robert Frost spoke of a very fundamental choice that he made in his poem, 'The Road not Taken', he however was not an economist and hence his poem was not labelled,

'Countless roads/crossroads not taken, taken, thought upon and some maybe chosen again, by countless people'

Too many choices?

Phew. If you ever wondered what Economists really do, now you know. Ultimately every economist, sits with his mates, and thinks about what people might choose or have already chosen. Economics, here reminds us that ultimately it is people who influence everything. The prices, the laws, governments, fluctuations, inflations, recessions, wars, poverty, equity, incentive, etc. There are no aliens dropping from Europa who influence our economy. You may say, what about incomes and prices? Those certain constraints that influenced our decision. But once again, how really are incomes and prices decided? What about natural endowments like minerals, marine resource and population that constrain a country's choices? Well, the answer to that is, no country is 100% efficient and ultimately our fate is sealed by the hard work and
co-operation of our people.

 In short, our choices DO matter.


ONE COMMODITY WORLD


Imagine, for example you are living in the island of Mordor, where only you and Legolas live. In this world, there is only one item that you intake as food, entertainment, medicine, leisure and everything else. This is called 'Jojoba' (pronounced Hohoba) and you are the buyer and Legolas is the seller. You being European, have 100 Euros with you and each Jojoba costs 20 Euros.

First, we assume that you are following the self-interest standard of rationality. From this we obtain your preference, you prefer having 5 Jojobas over 2 Johobas. The more the better.
Next, we figure out what is feasible. As you can see, you can afford uptill 5 Jojobas. You cannot have 10 or 6 Jojobas. But you can have 4 or 3 of them.
Next, with relevance to your selfish nature, and ignoring the effects of savings, etc; you will realize that you WILL buy 5 Jojobas. You have got the BEST from what you CAN.

This is your Optimal Choice.
This is your Quantity Demanded. (With respect to the price i.e 20 Euro)

• What happens if Legolas, increases the price to 25 Euro per Jojoba?

• What happens if Legolas, reduces the price to 10 Euro per Jojoba?

Economists, would redraw that 'feasible set' and then use the preference structure to determine how demand changes. From every way we go, we will hit the Law of Demand. Economists use this approach in 2 Commodity worlds and even in N-Commodity worlds, to reprove the Law of Demand. They also figure our the interesting income effects and substitution effects (missing from above case).

Unlike us, they use complex mathematical models and utility functions to do this. Horrible sounding words like Kuhn-Tucker Conditions and Strictly Quasiconcave over compact and convex domain, are common in studies involving Consumer Behaviour.

However if you ignore the details, and be a little realistic even a child can figure out the inner clockwork design in the choices of people. Simple model building and logical ideas of Rationality, are easy to understand. The whole point of Economics is to simplify and explain beautifully how the world works. For that matter, any science should try to be simple.

Some of the people who write economics, write terrible economics. For example our dear Keynes, who saved a nation and probably the world. His General Theory is probably the single most important book in all of economic history and future. However, NO normal person outside the subject can EVER understand it. Even I can't go beyond 6 pages, without smashing it against the wall and slitting my wrists in agony. This book will go on to be an epic. Billions would have learnt so much, and understood something so fundamental, if only Keynes, would've remembered :-

Economics is for Everyone!

The Terrible Law of Demand

Most people begin their journey into the wonderful world of economics by stepping on demand. Also, this is the first step in into "Microeconomics" which basically is like standing in a garden and looking at one blade of grass. Microeconomics is easy, logical and definitely very interesting to beginners. It looks at one person going to a market and buying one or two things. It can also look at one person making something that can be sold to another. Microeconomics has grown a lot over the centuries and is now a very terribly complicated science. It uses difficult mathematical theorems and crazy assumptions to find what is "rational". By rational it means what is "common sense". So basically so much of work in Microeconomics has only told us how people apply "common sense" in everyday life. Great!

The other large part of Economics is Macroeconomics. Macro as we all should know stands for something that is large or gigantic. When we stand in the garden and study the entire neighbourhood, we are studying macroeconomics. I think they are two sides of the same coin, microeconomics studies how one person behaves and macroeconomics studies how all people behave. 

Its interesting how each science defines it own definitions of certain everyday terms. "Abdullah went up to his father and demanded he let him go the football match", here demand indicates that Abdullah really badly wants to go for the football match but in the economic sense it means something else. Economists use "Demand" in the sense of buying and selling. How much do people of Japan want fish is the demand for fish in Japan. Wait! There is a catch. This is where the economic term deviates from the everyday sense. Demand in economics is incomplete without the power to demand it. This means that if Abdullah cannot convince his father, he is not demanding but merely wanting his father to let him go. In this case, the power to demand is money. If a person cannot afford something, he cannot demand it. Hence demand is incomplete without purchasing power. 

So let us assume Abdullah is able to convince his father to a certain extent to let him go for the football match, he is able to demand. Now let us look at other part of the trouble. What does the father want in return? By this I want to bring your attention to the Price of something. As we all know, the price of apples is how much one pays for apples. Have you heard of the saying, "The best things in life are free", if so, I am referring to the things that aren't free. These second-best things in life have a price because they are not easily available. The beautiful sun on a beach is free because nobody can stop anyone from enjoying it. If someone covered the Earth with a blanket, she could charge a price on the enjoyment of the sun. Hence, the price of a something comes because it is difficult to obtain it on our own. This is Scarcity. When something is scarce or limited or not available easily, it has a price for it. 

Abdullah's Dishes
Price for a Football Match

The Law of Demand or the Law of Common Sense, says that for higher price people demand lower amounts and for lower price people demand higher amounts. Is this not evident? If the price of lollipops became lesser, would you not like to buy a little more. If the price of petrol increases tomorrow, won't your demand fall and won't you try to manage with a little less. There are many reasons for this to happen, and many Economists have tried to make sense of the obvious. 

One, because the money you hold in your pocket remains the same, you realise you can afford more lollipops if they are cheaper. If by bad luck they are more costly, you realise you cannot afford that many of them. This is called the 'Income Effect'

Two, you look at the candy jar beside the lollipops. Normally you would buy some candy and some lollipops, because you like them so. Suppose lollipops have become costlier. Now you look at the lollipops twice and decide to take more of candy, because you can eat more. This is the 'Substitution Effect'.

Three, looking back at the demand for fish in Japan. If the fishes for some reason become more costly, lesser people can afford them. If fishes become cheaper, more people can afford them. This effect has no name, but I'd like to call it 'Now-I-Can-Afford-It-Yay! Effect'. 

Think of it like this : Demand is the ugly princess, and Price is the beautiful princess.There is a tower where Demand keeps avoiding the beautiful one. The terrible law that we have just understood makes this happen. As Price climbs graciously to the topmost chamber, Demand descends to the bottom most. Price sometimes likes to come below to meet friends in the lower rooms, then Demand hurries to the upper chambers in tears. We must understand that Price is a free princess and Demand is the fleeing one. Demand avoids Price, but Price does not avoid demand. Pardon my crude anology, but it is easy to think of them like this.

According to me, Demand is beautiful concept. Economists study how it changes not only with changes in price but also in income, price of other things, taxation of government and many more. I have found that what people want is dependant on so many things, what I want is dependant on so many things. Here, Economics has helped me learn a little about myself and my wants. Economics goes on to teach us about other things about ourselves like our preferences, our reaction to various events and even what happens in our marriages!

Economics is for Everyone!

Econ is Easy!

Everyday life is buzzing with a billion ideas. Billions of actions, thoughts, feelings and emotions are played out by billions of people. We interact, we co-operate, we conflict and we compete throughout our lives. Our brilliant minds, analyse terrabytes of information regularly. We notice the laws and dynamics of nature and society and we go about our business without bothering too much. Science has apparantly developed from a small spark of fire to landing Curiosity on Mars. Social Science has transformed the way we think, and has carved out intellect, free and critical thinking from the clutches of our animal instinct.

The laws of gravity, the history of the Soviet Union, the notion of evaporation, the flow of rivers and the fact that living organisms can die are a part of the gigantic subconsciousness that we carry with ourselves everyday. We appreciate the advances and the efforts of people before us. Which one of us doesn't know Mother Teresa, Archemedes and Gandhi? Certain people and concepts have directly impacted our daily lives and that is why we know them, and we recognize them.

Economics, however remains in my opinion above the reach of the common people. When people hear the word "Economics" they probably begin to think about money dancing in complicated patterns or high business officials shaking hands or some very difficult mathematical theorems. Economics seems to me, out of the reach of the common people and out of their active subconsciousness. Maybe it has been displayed this way. Books on economics use complicated words such as "Marginal Product of Labour" and "Law of Diminishing Marginal Utility". I think, that economists assume that the subject cannot be explained without using fancy language and funny graphs.

It is not so. Economics is a science that brings together, a little bit of logic, a little bit of numbers, a little bit of common sense and most importantly a large bit of our everyday lives. It is a beautiful subject that has grown big and mature, and is just beginning to show the full extent of its scope in the 21st century. I want to believe that Economics can be taught in a simple and easy fashion. Can it be done? Complicated concepts such as utility maximization and envelope curves reduced to simple statements? The hardest of concepts must be made into simplest of statements. That is the mark of true insight.

Economics is for Everyone!