Central Problems of an Economy

Central Problems of an Economy

Every economy faces some problems. These problems are associated with growth, business cycles, unemployment and inflation. The macroeconomic theory is designed to explain how supply and demand in the aggregate interact to concern with these four problems. Economists these very important national problems as macroeconomic problems — that is, as problems that could not be understood or solved without an understanding of the workings of the economic system as a whole. The four distinctively macroeconomic problems are:
Recession
Unemployment
Inflation
Economic Growth or Stagnation

Recessions, Depressions and Economic Fluctuations

The event that created modern macroeconomics was called “the Great Depression,” but the general term for decreasing national production, in modern economics, is a recession.But why do economists regard a recession as a problem?
It is not self-evident that a drop in production is a bad thing. For example, it might be that people want to enjoy more leisure, and spend less time producing goods and services. If production dropped for that reason, we would have no reason to think of it as an economic problem.
But, in some periods of recession, we have evidence that this was not what happened. In many recession periods, businesses that announced they were hiring had long lines of people who wanted to apply, with many more people than they could hire. This suggests that the people standing in line for a job had more leisure than they wanted, and would have preferred jobs and income to buy more goods and services. In the 1930’s, some people sold apples or pencils in the street to get a little income, typically much less than they would have had in their old jobs. Again, this suggests that people had too much leisure and would have preferred more work and income. If this is so, then it seems that something was going wrong. In different terms, it seemed that the recession had caused unemployment.
Another possibility is that production might drop because a war or disaster had destroyed factories and other capital goods. But, in 1933, it seems very unlikely that the productive capacity of the economy could have dropped by 30%. There had been no war. And in fact, factories had been closed that could have been reopened and put to work, at the same time as many people were looking for work. Perhaps these circumstances show why the recession is regarded as a major economic problem.

Unemployment

Our second macroeconomic problem is unemployment. This problem is highly correlated with recession, but is distinct, and we need to look at it in its own terms. Unemployment occurs when a person is available to work and currently seeking work, but the person is without work. The prevalence of unemployment is usually measured using the unemployment rate, which is defined as the percentage of those in the labor force who are unemployed.
Economists distinguish between various types of unemployment. For example, cyclical, frictional, structural and classical, seasonal, hardcore and hidden. Real-world unemployment may combine different types. The magnitude of each of these is difficult to measure, partly because they overlap.
Unemployment is a status in which individuals are without job and are seeking a job. It is one of the most pressing problems of any economy especially the underdeveloped ones. This has macroeconomic implications too some of which are discussed below:
Reduction in the Output: The unemployed workforce could be utilized for the production of goods and services. Since they are not doing so, the economy is losing out on its output.
Reduction in Tax Revenue: Since income tax is an important part of the revenue for the government. The unemployed are unable to earn, the government loses out on the income tax revenue.
Rise in the Government Expenditure: The government has to give unemployment insurance benefits to the claimants. Hence the government will lose from both sides in terms of unemployment benefits and loss of tax revenue.

Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.
A rising price level — inflation — has the following disadvantages:
It creates uncertainty, in that people do not know what the money they earn today will buy tomorrow.
Uncertainty, in turn, discourages productive activity, saving and investing.
Inflation reduces the competitiveness of the country in international trade. If this is not offset by a devaluation of the national currency against other currencies, it makes the country’s exports less attractive, and makes imports into the country more attractive, which in turn tends to create unbalance in trade.
Inflation is a hidden tax on “nominal balances.” That is, people who hold bonds and bank accounts in dollars lose the value of those accounts when the price level rises, just as if their money had been taxed away.
The inflation tax is capricious — some lose by it and some do not without any good economic reason.
As the purchasing power of the monetary unit becomes less predictable, people resort to other means to carry out their business, means which use up resources and are inefficient.