macroeconomics definition essay

Principles of Macroeconomics

(3 reviews)

Copyright Year: 2016

ISBN 13: 9781946135179

Publisher: University of Minnesota Libraries Publishing

Language: English

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Reviewed by Faunce Elizabeth, Adjunct Professor, Radford University on 1/10/23

This text appropriately addresses all required areas of macroeconomic topics and provides a clear table of contents/index; however, no glossary is provided. read more

Comprehensiveness rating: 5 see less

This text appropriately addresses all required areas of macroeconomic topics and provides a clear table of contents/index; however, no glossary is provided.

Content Accuracy rating: 5

The textbook is accurate and appears to be free of errors.

Relevance/Longevity rating: 3

This text was published in 2016, and while the content is accurate, it is not current. For example, Chapter 11, Monetary Policy & The Fed, discusses the challenges The Fed faced in 2008. Given the financial impact of Covid and the current inflationary period, the recent actions of The Fed's (2022) should be addressed. Supplemental material would be needed to accompany the use of this text.

Clarity rating: 5

The text appropriately utilizes jargon and terminology needed in a fundamental macroeconomics course. Additionally, the author presents the content as if he/she was speaking directly to a class, which I believe provides clarity to the reader.

Consistency rating: 5

The text is consistent with regards to the structure of the chapters, terminology, and resources (key takeaways, "try it!", etc).

Modularity rating: 5

The textbook is appropriately divided into chapters that can then be easily broken into smaller reading sections. The instructor could easily select the chapters most relevant for their class and then break the chapter up into several class lectures or reading assignments.

Organization/Structure/Flow rating: 4

The organization of the text is probably the one area that I would change. For example, I would present chapter 16 (inflation and employment) after chapter 8 (economic growth) and I would present chapter 12 (fiscal policy) before addressing chapter 9, 10 and 11 (money creation and monetary policy).

Interface rating: 5

This book is very easy to access, with multiple options provided. Additionally, the hyperlinks to the figures, located within each chapter, were very helpful.

Grammatical Errors rating: 5

The text is generally very well written and I found no significant grammatical errors.

Cultural Relevance rating: 5

The text is in no way culturally insensitive and I found most examples and visuals generic in nature.

Reviewed by Brad Humphreys, Professor of Economics, West Virginia University on 9/12/18

The textbook covers all the topics that would typically be covered in a one semester principles of macro course. Measurement of production, employment, prices, interest rates. Short run (cycles) and long run (growth). Theoretical perspectives... read more

The textbook covers all the topics that would typically be covered in a one semester principles of macro course. Measurement of production, employment, prices, interest rates. Short run (cycles) and long run (growth). Theoretical perspectives from the Keynesian and classical perspectives. International topics (trade, globalization). The index looks reasonable.

It appears accurate to me. I teach principles of macro every semester so I am familiar with the basic content. I have not used it in a class yet, so I have not been through this book in detail.

Relevance/Longevity rating: 4

The information is up to date as of 2015. The GDP estimates are from 2014/15 as are the inflation and unemployment estimates. I assume that this will be periodically updated. Not much has changed in principles of macro recently, so keeping this text current will not be much of an issue (until the next recession occurs).

Clarity rating: 4

This is based on Tim Taylors book (they bought the rights) so the original text was written by a respected economist. It is clearly written and undergrads should find this engaging and accessible. The jargon is minimal.

The terminology and framework are completely standard for a principles of macro text. Again, I have taught principles of macro every semester for the last 3-4 years, and the terminology and framework here are what would be expected.

Modularity rating: 4

No long blocks of text. Frequent and clear subheadings. If anything, the chapters appear to be quite short. Some of the chapters appear to be approximately one 75 minute lecture of material.

Very typical organization for a principles of macro text. I have used several (two in the last 3 years - John Taylor and Coppock and Mateer), and they all have the same basic organization.

The graphs, figures, photos and tables all looked good to me. Readable. Clear.

I did not see any grammatical errors. I did not read every chapter, but I'm sure Tim Taylor's book was thoroughly edited when it was being published by a for-profit publishing house.

Examples are drawn fro all over the world, and the photos are inclusive. I did not see any culturally insensitive passages.

Ancillary Material / / The test bank is relatively small. Each chapter has about 35-40 multiple choice questions. This probably not enough for use in a large enrollment section - most test banks from for-profit publishers contain at least 100 multiple choice questions per chapter. The multiple questions all look fine to me. There are some essay questions but I teach large (300+) sections that only use multiple choice questions. / / The provided PowerPoint slides are rudimentary. They basically contain some of the figures, photos, and tables from the text. It will take some time and effort for instructors to develop complete PowerPoint slides for this book.

Reviewed by Darcy Hartman, Senior Lecturer, The Ohio State University on 6/10/15

Having spent a bit of time working my way through other textbooks to arrive at one that seemed to fit my style of teaching, I am pleasantly surprised at the comprehensiveness of this text. It covers all the main principles that would typically be... read more

Having spent a bit of time working my way through other textbooks to arrive at one that seemed to fit my style of teaching, I am pleasantly surprised at the comprehensiveness of this text. It covers all the main principles that would typically be covered, but also includes some chapters on subjects that would be great to implement given enough time. At the very least, they are a resource for students that have taken a greater interest in the course work. I am speaking specifically on the chapters toward the end relating to poverty and income inquality. Additionally, the book contains a good review of graphing and some of the mathematics utilized within the book.

Content Accuracy rating: 4

I will not suggest that I am providing a thorough review in accuracy, but from what I have reviewed, nothing seemed remiss. Perhaps a typo here or there - not enough to interrupt the flow of the material. But everything seemed in order from a content perspective.

The ability to update material would be the part most concerning to me as I do not know the updating practices for the authors. There seems to be good coverage of more recent events, and certainly there is good coverage going further back. I do not take issue with it as it stands. Even with the more expensive textbooks, it is the obligation of the professor or lecturer to keep students current while applying the principles being taught.

I think that what I appreciate most with the textbook is that it seems to be written in a very straightforward manner. One common complaint that I hear from students is that textbook explanations can be tedious to get through. Given all the examples that are provided, and all the sample problems utilized, in addition to the actual writing, I think that students, including international students, would find this a generally approachable source.

Consistency rating: 4

Again, with the caveat that I have not read through every single part of the book, in my examination of the text, I did not enounter any inconsistencies within the book. Also, I felt that the presentation seemed consistent, yet more comprehensive, than most textbooks I have utilized.

The breakdown of the text makes it very approachable from a learner standpoint. It is clear what the objectives are within each small section, and the objectives never seem overwhelming. This is useful from a teaching standpoint to keep students from feeling overwhelmed.

Organization/Structure/Flow rating: 3

The organization of the book does not align with the current way that I teach. While I am open to making adjustments, I do think that the order of some chapters could be rearranged. For example, the topic of economic growth could easily be combined with development rather than treated as an afterthought. With an increasing focus on internationalization in higher education, separating the two suggests a sense of other from my perspective. I find it confusing to have GDP included in the chapter on inflation and unemployment, but then treated separately afterward.

Interface rating: 4

There were a few distractions for me in the layout that seemed to be issues with how it displayed on my computer. These were not so serious that they would prevent me from utilizing the materials. I have not had the chance to see how it presents on an ipad, tablet or phone.

Grammatical Errors rating: 4

I spotted one or two errors, but not enough to deter me from using the book.

Cultural Relevance rating: 4

I certainly did not encounter anything that seemed culturally insensitive or offensive. I would encourage greater use of international examples, particularly when looking at policy tools. The book is U.S. focused; although this is the case with virtually every textbook that is presented to me. Internationalization of the curriculum seems to be an increasingly popular theme. That said, the book certainly utilizes enough international examples for me to consider it.

I am pleasantly surprised by this book. As I prepare for the 2015-2016 academic year, I will certainly consider using this text. I would need to get a better idea of how easily one can access the specific materials needed on demand.

Table of Contents

• Chapter 1: Economics: The Study of Choice
• Chapter 2: Confronting Scarcity: Choices in Production
• Chapter 3: Demand and Supply
• Chapter 4: Applications of Demand and Supply
• Chapter 5: Macroeconomics: The Big Picture
• Chapter 6: Measuring Total Output and Income
• Chapter 7: Aggregate Demand and Aggregate Supply
• Chapter 8: Economic Growth
• Chapter 9: The Nature and Creation of Money
• Chapter 10: Financial Markets and the Economy
• Chapter 11: Monetary Policy and the Fed
• Chapter 12: Government and Fiscal Policy
• Chapter 13: Consumption and the Aggregate Expenditures Model
• Chapter 14: Investment and Economic Activity
• Chapter 15: Net Exports and International Finance
• Chapter 16: Inflation and Unemployment
• Chapter 17: A Brief History of Macroeconomic Thought and Policy
• Chapter 18: Inequality, Poverty, and Discrimination
• Chapter 19: Economic Development
• Chapter 20: Socialist Economies in Transition

Ancillary Material

About the book.

Recognizing that a course in economics may seem daunting to some students, we have tried to make the writing clear and engaging. Clarity comes in part from the intuitive presentation style, but we have also integrated a number of pedagogical features that we believe make learning economic concepts and principles easier and more fun. These features are very student-focused. The chapters themselves are written using a “modular” format. In particular, chapters generally consist of three main content sections that break down a particular topic into manageable parts. Each content section contains not only an exposition of the material at hand but also learning objectives, summaries, examples, and problems. Each chapter is introduced with a story to motivate the material and each chapter ends with a wrap-up and additional problems. Our goal is to encourage active learning by including many examples and many problems of different types.

A tour of the features available for each chapter may give a better sense of what we mean:

Start Up—Chapter introductions set the stage for each chapter with an example that we hope will motivate readers to study the material that follows. These essays, on topics such as the value of a college degree in the labor market or how policy makers reacted to a particular economic recession, lend themselves to the type of analysis explained in the chapter. We often refer to these examples later in the text to demonstrate the link between theory and reality.

Learning Objectives—These succinct statements are guides to the content of each section. Instructors can use them as a snapshot of the important points of the section. After completing the section, students can return to the learning objectives to check if they have mastered the material. Heads Up!—These notes throughout the text warn of common errors and explain how to avoid making them. After our combined teaching experience of more than fifty years, we have seen the same mistakes made by many students. This feature provides additional clarification and shows students how to navigate possibly treacherous waters.

Key Takeaways—These statements review the main points covered in each content section.

Key Terms—Defined within the text, students can review them in context, a process that enhances learning.

Try It! questions—These problems, which appear at the end of each content section and which are answered completely in the text, give students the opportunity to be active learners. They are designed to give students a clear signal as to whether they understand the material before they go on to the next topic.

Cases in Point—These essays included at the end of each content section illustrate the influence of economic forces on real issues and real people. Unlike other texts that use boxed features to present interesting new material or newspaper articles, we have written each case ourselves to integrate them more clearly with the rest of the text.

Summary—In a few paragraphs, the information presented in the chapter is pulled together in a way that allows for a quick review of the material. End-of-chapter concept and numerical problems—These are bountiful and are intended to check understanding, to promote discussion of the issues raised in the chapter, and to engage students in critical thinking about the material. Included are not only general review questions to test basic understanding but also examples drawn from the news and from results of economics research. Some have students working with real-world data.

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Macroeconomics

Macroeconomics focuses on the performance of economies – changes in economic output, inflation, interest and foreign exchange rates, and the balance of payments. Poverty reduction, social equity, and sustainable growth are only possible with sound monetary and fiscal policies.

The world has entered a new era of rapid global change driven by major shifts in demographics, wealth, technology, and climate.

But economic growth has been uneven, has come at the expense of the environment, and has already slowed due to climate damages. Global challenges — including fiscal strains on governments exacerbated by the COVID-19 pandemic, conflicts, environmental degradation, resource depletion, and record levels of displacement — are threatening recent gains. These challenges are compounded by intensifying systemic risks, including trade tensions, rising debt levels, and increasing inequality.

To accelerate sustainable economic growth and inclusion, developing countries must tackle a variety of challenges. These include low levels of productivity and international competitiveness, inefficient public spending, inadequate domestic resource mobilization, price distortions from fiscal systems that discourage sustainability, lack of economic resilience, increasing debt levels, and the rising danger of climate change.

Last Updated: Apr 01, 2024

Economic growth must benefit all and be sustainable.  The World Bank Group is working with its clients and partners to develop smart economic policies that foster sustainable and inclusive economic growth, and address challenges to economic stability including climate change. Priority areas include:

• Fiscal policy:  Fiscal policy is key to developing sustainable trajectories for revenues, expenditures, and deficits and the management of fiscal risks, with an emphasis on determining fiscal space and funding sources and improving public expenditure management.
• Domestic resource mobilization:  Better tax systems are one of the largest untapped resources to promote poverty reduction and support climate, health, and other key government objectives.
• Debt:  Debt is a critical form of financing for the sustainable development goals, but only when borrowing is done at sustainable levels and in a transparent fashion. 
• Economics of climate change:  Climate change is no longer seen simply as an environmental problem. It is recognized as a serious financial, economic, and social problem that, left unmitigated, could push an additional 130 million people into extreme poverty by 2030, underscoring the importance of zero-carbon growth strategies.

Promoting macroeconomic stability and sustainable and inclusive growth

• The World Bank supports countries in the design and implementation of economic reforms to strengthen macroeconomic stability. Examples include assistance in the design of fiscal, revenue and debt strategies, structural reforms, and the removal of distortions that result in unsustainable balance of payments and financial sector positions.
• World Bank economists create country-specific reports — such as  Country Economic Memoranda (CEM)  and  Economic Updates  — to address questions related to economic growth. The  CEM  is a comprehensive analysis of a country's economic developments, prospects, and policy agenda. It serves as a basis for dialogue between the World Bank and the government of the country, as well as other stakeholders. The CEM identifies policy reforms for key economic sectors and provides recommendations to promote growth, reduce poverty, and improve people's lives. It also serves as a source of information and analysis for aid groups and other donors. The CEM aims to guide policy decisions and support the country's economic development efforts.

Strengthening public expenditure policies and management

• The World Bank prepares Public Finance Reviews for many of its client countries, which provide feedback and advice on enhancing countries’ overall fiscal discipline and allocative and operational efficiency of their public revenue and expenditure programs.
• The  BOOST Program  operates in over 80 countries to make available previously unattainable micro-fiscal data in accessible, comparative, and usable formats in support of expenditure analyses (counting 100+ PERs and related analytics), lending operations ( Development Policy Financing and Program for Result), and fiscal transparency (almost 40 countries publicly disseminate data in the Open Budget Portal ).

Promoting debt management and transparency

• The World Bank provides technical advice for countries to strengthen their debt management capacity as part of lending operations and through advisory services.
• The Debt Management Facility (DMF) program  offers advisory services and technical assistance, training, and peer-to-peer learning to 86 developing countries around the world. The goal of the Facility is to reduce debt-related vulnerabilities by strengthening debt management capacity, processes, and institutions, and improving debt transparency. By the end of FY23, 44 DMF countries published Debt Management Strategies, 11 countries published Annual Borrowing Plans, and 43 DMF countries published Debt Statistical Bulletins.
• We also run the Government Debt and Risk Management (GDRM) program, in partnership with Switzerland’s State Secretariat for Economic Affairs (SECO). Since 2011, the program has worked with middle-income countries to develop robust debt and risk management frameworks to reduce their vulnerability to financial shocks. Current participants include Albania, Azerbaijan, Colombia, Egypt, Ghana, Indonesia, North Macedonia, Morocco, South Africa, Serbia, Peru, Ukraine, and Vietnam.
• Working with the International Monetary Fund (IMF), the Bank implemented the  Debt Sustainability Framework (DSF) for low-income countries , which allows multilateral institutions and other creditors to assess risks to debt sustainability in lower-income countries. The framework classifies countries based on their assessed debt-carrying capacity, estimates threshold levels for selected debt burden indicators, evaluates baseline projections and stress test scenarios relative to these thresholds, and then combines indicative rules and staff judgment to assign risk ratings of debt distress. The framework guides countries in supporting the SDGs, when their ability to service debt is limited.

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Global Economy Set for Weakest Half-Decade Performance in 30 Years | World Bank Expert Answers

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Debt & Fiscal Risks Toolkit

The World Bank Group helps countries manage debt and fiscal risks effectively. We offer a specific set of tools and reports to help countries balance the need for financing development while minimizing costs and risk.

World Bank Revenue Dashboard

The Revenue Dashboard is a tool for benchmarking tax policy performance. The dashboard aims to provide policymakers and researchers with necessary data and information to conduct a high-level analysis of a country's tax ...

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How transparent are IDA countries in their debt reporting practices? This heat map presents an assessment based on the availability, completeness, and timeliness of public debt statistics and debt management documents ...

Innovations in Tax Compliance

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• business & economics

Critical Essay on Modern Macroeconomic Theory

by Frank Hahn and Robert M. Solow

ISBN: 9780262581547

Pub date: August 21, 1997

• Publisher: The MIT Press

208 pp. , 6 x 9 in ,

ISBN: 9780262082419

Pub date: December 8, 1995

• 9780262581547
• Published: August 1997
• Rights: not for sale in Europe or the UK Commonwealth, except Canada
• 9780262082419
• Published: December 1995
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• Description

Macroeconomics began as the study of large-scale economic pathologies such as prolonged depression, mass unemployment, and persistent inflation. In the early 1980s, rational expectations and new classical economics dominated macroeconomic theory, with the result that such pathologies can hardly be discussed within the vocabulary of the theory. This essay evolved from the authors' profound disagreement with that trend. It demonstrates not only how the new classical view got macroeconomics wrong, but alsohow to go about doing macroeconomics the right way. Hahn and Solow argue that what was originally offered as a normative model based on perfect foresight and universal perfect competition—useful for predicting what an ideal, omniscient planner should do—has been almost casually transformed into a model for interpreting real macroeconomic behavior, leading to Panglossian economics that does not reflect actual experience. Following an explanation of microeconomic foundations, chapters introduce the basic elements for a better macro model. The model is simple, but combined with the appropriate model of the labor market it can say useful things about the fluctuation of employment, the correlation between wages and employment, and the role for corrective monetary policy.

Frank Hahn, one of Britain's most eminent economists, is Professor of Economics at Cambridge University and author of Equilibrium and Macroeconomics (MIT Press 1985).

Robert M. Solow is Institute Professor of Economics.

Like the great debate between Einstein and Bohr on quantum physics,the debate between Hahn-Solow and Lucas's rational expectationismis a must for all serious students of macro. This is how scientificprogress should be done—by sober analysis rather than cleverrhetoric or frenzied ideology. Paul A. Samuelson, Professor of Economics, M.I.T.

Professors Hahn and Solow pick up the simple general equilibrium models of new classical macroeconomics and run with them. Of course, they head off in directions that are theirs alone. Critics of these models, and enthusiasts, will want to read this book and see how far they get. Paul M. Romer, Professor of Economics, University of Californiaat Berkeley

Related Books

Introduction

Chapter objectives.

In this chapter, you will learn about:

• What Is Economics, and Why Is It Important?
• Microeconomics and Macroeconomics
• How Economists Use Theories and Models to Understand Economic Issues
• How Economies Can Be Organized: An Overview of Economic Systems

Bring It Home

Information overload in the information age.

To post or not to post? Every day we are faced with a myriad of decisions, from what to have for breakfast, to which show to stream, to the more complex—“Should I double major and add possibly another semester of study to my education?” Our response to these choices depends on the information we have available at any given moment. Economists call this “imperfect” because we rarely have all the data we need to make perfect decisions. Despite the lack of perfect information, we still make hundreds of decisions a day.

Streams, sponsors, and social media are altering the process by which we make choices, how we spend our time, which movies we see, which products we buy, and more. Whether they read the reviews or just check the ratings, it's unlikely for Americans to make many significant decisions without these information streams.

As you will see in this course, what happens in economics is affected by how well and how fast information disseminates through a society, such as how quickly information travels through Facebook. “Economists love nothing better than when deep and liquid markets operate under conditions of perfect information,” says Jessica Irvine, National Economics Editor for News Corp Australia.

This leads us to the topic of this chapter, an introduction to the world of making decisions, processing information, and understanding behavior in markets —the world of economics. Each chapter in this book will start with a discussion about current (or sometimes past) events and revisit it at chapter’s end—to “bring home” the concepts in play.

What is economics and why should you spend your time learning it? After all, there are other disciplines you could be studying, and other ways you could be spending your time. As the Bring it Home feature just mentioned, making choices is at the heart of what economists study, and your decision to take this course is as much as economic decision as anything else.

Economics is probably not what you think. It is not primarily about money or finance. It is not primarily about business. It is not mathematics. What is it then? It is both a subject area and a way of viewing the world.

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Tips for writing economics essays

Some tips for writing economics essays  Includes how to answer the question, including right diagrams and evaluation – primarily designed for A Level students.

1. Understand the question

Make sure you understand the essential point of the question. If appropriate, you could try and rephrase the question into a simpler version.

For example:

Q. Examine the macroeconomic implications of a significant fall in UK House prices, combined with a simultaneous loosening of Monetary Policy.

In plain English.

• Discuss the effect of falling house prices on the economy
• Discuss the effect of falling interest rates (loose monetary policy) on economy

In effect, there are two distinct parts to this question. It is a valid response, to deal with each separately, before considering both together.

It helps to keep reminding yourself of the question as you answer. Sometimes candidates start off well, but towards the end forget what the question was. Bear in mind, failure to answer the question can lead to a very low mark.

2. Write in simple sentences

For clarity of thought, it is usually best for students to write short sentences. The main thing is to avoid combining too many ideas into one sentence. If you write in short sentences, it may sound a little stilted; but it is worth remembering that there are no extra marks for a Shakespearian grasp of English. (at least in Economics Exams)

Look at this response to a question:

Q. What is the impact of higher interest rates?

Higher interest rates increase the cost of borrowing. As a result, those with mortgages will have lower disposable income. Also, consumers have less incentive to borrow and spend on credit cards. Therefore consumption will be lower. This fall in consumption will cause a fall in Aggregate Demand and therefore lead to lower economic growth. A fall in AD will also reduce inflation.

I could have combined 1 or 2 sentences together, but here I wanted to show that short sentences can aid clarity of thought. Nothing is wasted in the above example.

Simple sentences help you to focus on one thing at once, which is another important tip.

3. Answer the question

Quite frequently, when marking economic essays, you see a candidate who has a reasonable knowledge of economics, but unfortunately does not answer the question. Therefore, as a result, they can get zero for a question. It may seem harsh, but if you don’t answer the question, the examiner can’t give any marks.

At the end of each paragraph you can ask yourself; how does this paragraph answer the question? If necessary, you can write a one-sentence summary, which directly answers the question. Don’t wait until the end of the essay to realise you have answered a different question.

Discuss the impact of Euro membership on UK fiscal and monetary policy?

Most students will have revised a question on: “The benefits and costs of the Euro. Therefore, as soon as they see the Euro in the title, they put down all their notes on the benefits and costs of the Euro. However, this question is quite specific; it only wishes to know the impact on fiscal and monetary policy.

The “joke” goes, put 10 economists in a room and you will get 11 different answers. Why? you may ask. The nature of economics is that quite often there is no “right” answer. It is important that we always consider other points of view, and discuss various different, potential outcomes. This is what we mean by evaluation.

Macro-evaluation

• Depends on the state of the economy – full capacity or recession?
• Time lags – it may take 18 months for interest rates to have an effect
• Depends on other variables in the economy . Higher investment could be offset by fall in consumer spending.
• The significance of factors . A fall in exports to the US is only a small proportion of UK AD. However, a recession in Europe is more significant because 50% of UK exports go to EU.
• Consider the impact on all macroeconomic objectives . For example, higher interest rates may reduce inflation, but what about economic growth, unemployment, current account and balance of payments?
• Consider both the supply and demand side . For example, expansionary fiscal policy can help to reduce demand-deficient unemployment, however, it will be ineffective in solving demand-side unemployment (e.g. structural unemployment)

Example question :

The effect of raising interest rates will reduce consumer spending.

• However , if confidence is high, higher interest rates may not actually discourage consumer spending.

If the economy is close to full capacity a rise in interest rates may reduce inflation but not reduce growth. (AD falls from AD1 to AD2)

• However , if there is already a slowdown in the economy, rising interest rates may cause a recession. (AD3 to AD3)

Micro-evaluation

1. The impact depends on elasticity of demand

In both diagrams, we place the same tax on the good, causing supply to shift to the left.

• When demand is price inelastic, the tax causes only a small fall in demand.
• If demand is price elastic, the tax causes a bigger percentage fall in demand.

2. Time lag

In the short term, demand for petrol is likely to be price inelastic. However, over time, consumers may find alternatives, e.g. they buy electric cars. In the short-term, investment will not increase capacity, but over time, it may help to increase a firms profitability. Time lags.

3. Depends on market structure

If markets are competitive, then we can expect prices to remain low. However, if a firm has monopoly power, then we can expect higher prices.

4. Depends on business objectives

If a firm is seeking to maximise profits, we can expect prices to rise. However, if a firm is seeking to maximise market share, it may seek to cut prices – even if it means less profit.

5. Behavioural economics

In economics, we usually assume individuals are rational and seeking to maximise their utility. However, in the real world, people are subject to bias and may not meet expectations of classical economic theory. For example, the present-bias suggest consumers will give much higher weighting to present levels of happiness and ignore future costs. This may explain over-consumption of demerit goods and under-consumption of merit goods. See: behavioural economics

Exam tips for economics – Comprehensive e-book guide for just £5

8 thoughts on “Tips for writing economics essays”

I really want to know the difference between discussion questions and analysis questions and how to answer them in a correct way to get good credit in Economics

Analysis just involves one sided answers while Discussion questions involve using two points of view

This is a great lesson learnd by me

how can I actually manage my time

The evaluation points in this article are really useful! The thing I struggle with is analysis and application. I have all the knowledge and I have learnt the evaluation points like J-curve analysis and marshall learner condition, but my chains of reasoning are not good enough. I will try the shorter sentences recommended in this article.

What kind of method for costing analysis is most suitable for a craft brewery, in order to analyze the cost of production of different types of beer_

Really useful!Especially for the CIE exam papers

Does anyone know how to evaluate in those advantages/disadvantages essay questions where you would basically analyse the benefits of something and then evaluate? Struggling because wouldn’t the evaluation just be the disadvantages ?? Like how would you evaluate without just stating the disadvantage?

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Microeconomics

Macroeconomics.

• What Do Investors Focus on?

The Bottom Line

Microeconomics vs. macroeconomics: what’s the difference.

Microeconomics vs. Macroeconomics: An Overview

Economics is divided into two categories: microeconomics and macroeconomics. Microeconomics is the study of individuals and business decisions, while macroeconomics looks at the decisions of countries and governments.

Though these two branches of economics appear to be different, they are interdependent and complement one another. Many overlapping issues exist between the two fields.

Key Takeaways

• Microeconomics studies individuals and business decisions, while macroeconomics analyzes the decisions made by countries and governments.
• Microeconomics focuses on supply and demand, and other forces that determine price levels, making it a bottom-up approach.
• Macroeconomics takes a top-down approach and looks at the economy as a whole, trying to determine its course and nature.
• Investors can use microeconomics in their investment decisions, while macroeconomics is an analytical tool mainly used to craft economic and fiscal policy.

Microeconomics is the study of decisions made by people and businesses regarding the allocation of resources, and prices at which they trade goods and services. It considers taxes, regulations, and government legislation.

Microeconomics focuses on supply and demand and other forces that determine price levels in the economy. It takes a bottom-up approach to analyzing the economy. In other words, microeconomics tries to understand human choices, decisions, and the allocation of resources.

Having said that, microeconomics does not try to answer or explain what forces should take place in a market. Rather, it tries to explain what happens when there are changes in certain conditions.

For example, microeconomics examines how a company could maximize its production and capacity so that it could lower prices and better compete. A lot of microeconomic information can be gleaned from company financial statements.

Microeconomics involves several key principles, including (but not limited to):

• Demand, Supply and Equilibrium : Prices are determined by the law of supply and demand . In a perfectly competitive market, suppliers offer the same price demanded by consumers. This creates economic equilibrium.
• Production Theory : This principle is the study of how goods and services are created or manufactured.
• Costs of Production : According to this theory, the price of goods or services is determined by the cost of the resources used during production.
• Labor Economics : This principle looks at workers and employers and tries to understand patterns of wages, employment, and income. 

The rules in microeconomics flow from a set of compatible laws and theorems, rather than beginning with empirical study.

Macroeconomics , on the other hand, studies the behavior of a country and how its policies impact the economy as a whole. It analyzes entire industries and economies, rather than individuals or specific companies, which is why it’s a top-down approach. It tries to answer questions such as “What should the rate of inflation be?” or “What stimulates economic growth?”

Macroeconomics examines economy-wide phenomena such as gross domestic product (GDP) and how it is affected by changes in unemployment, national income, rates of growth, and price levels.

Macroeconomics analyzes how an increase or decrease in net exports impacts a nation’s capital account, or how gross domestic product (GDP) is impacted by the  unemployment rate .

Macroeconomics focuses on aggregates and  econometric correlations , which is why governments and their agencies rely on macroeconomics to formulate economic and fiscal policy. Investors who buy interest-rate-sensitive securities should keep a close eye on monetary and fiscal policy.

John Maynard Keynes  is often credited as the founder of macroeconomics, as he initiated the use of monetary aggregates to study broad phenomena. Some economists dispute his theories , while many Keynesians disagree on how to interpret his work.

Investors and Microeconomics vs. Macroeconomics

Individual investors may be better off focusing on microeconomics, but macroeconomics cannot be ignored altogether. Fundamental  and value investors may disagree with technical investors about the proper role of economic analysis. While it is more likely that microeconomics will impact individual investments, macroeconomic factors can affect entire portfolios.

Warren Buffett famously stated that macroeconomic forecasts didn’t influence his investing decisions. When asked how he and partner Charlie Munger choose investments, Buffett said, “Charlie and I don’t pay attention to macro forecasts. We have worked together now for 54 years, and I can’t think of a time we made a decision on a stock, or on a company...where we’ve talked about macro.” Buffett also has referred to macroeconomic literature as “the funny papers.”

John Templeton, another famously successful value investor, shared a similar sentiment. “I never ask if the market is going to go up or down because I don’t know, and besides, it doesn’t matter,” Templeton told Forbes in 1978 . “I search nation after nation for stocks, asking: ‘Where is the one that is lowest priced in relation to what I believe it’s worth?’”

Can Macroeconomic Factors Affect My Investment Portfolio?

Yes, macroeconomic factors can have a significant influence on your investment portfolio. For example, the Great Recession of 2008–09 and accompanying market crash were caused by the bursting of the U.S. housing bubble and subsequent near-collapse of financial institutions that were heavily invested in U.S. subprime mortgages.

For another example of the effect of macro factors on investment portfolios, consider the response of central banks and governments to the pandemic-induced crash of spring 2020. Governments and central banks unleashed torrents of liquidity through fiscal and monetary stimulus to prop up their economies and stave off recession, which had the effect of pushing most major equity markets to record highs in the second half of 2020 and throughout much of 2021.

What Is a Global Macro Strategy?

A global macro strategy is an investment and trading strategy that centers around large macroeconomic events at a national or global level. “Global Macro” involves research and analysis of numerous macroeconomic factors, including interest rates, currency levels, political developments, and country relations.

What Is the Basic Difference Between Microeconomics and Macroeconomics?

Microeconomics is the study of how individuals and companies make decisions to allocate scarce resources. Macroeconomics is the study of an economy as a whole.

How Do Core Concepts of Microeconomics Such as Supply and Demand Affect Stock Prices?

Microeconomic concepts such as supply and demand affect stocks prices in two ways: directly and indirectly.

• The direct effect can be gauged by the impact of demand and supply disequilibrium on stock prices. When demand for a stock exceeds supply at a given point in time because there are more buyers than sellers, the stock will rise; conversely, when supply exceeds demand because there are more sellers than buyers, the stock will fall.
• The indirect effect is based on supply and demand for the underlying company’s products and services. If the company’s products are flying off the shelves because of robust demand, it may be on a probable strong earnings trajectory that would likely translate into a higher price for its stock. But if demand is sluggish and there is excess inventory (or supply) of its products, the company’s earnings may disappoint and the stock may slump.

Does My Portfolio Performance Hinge on Both Microeconomic and Macroeconomic Factors?

Yes, the performance of your portfolio hinges on both microeconomic and macroeconomic factors. Microeconomic factors such as supply and demand, taxes and regulations, and macroeconomic factors such as gross domestic product (GDP) growth, inflation, and interest rates, have a significant influence on different sectors of the economy and hence on your investment portfolio.

Microeconomics and macroeconomics are related but separate approaches to studying the economy. Microeconomics is concerned with the actions of individuals and businesses, while macroeconomics is focused on the actions that governments and countries take to influence broader economies. While both will impact an investment portfolio, most investors focus primarily on microeconomic considerations when making their investment decisions.

CNBC, Warren Buffett Archive. “ Afternoon Session — 2013 Meeting .”

Google Books. “ The Oracle Speaks: Warren Buffett in His Own Words ,” Page 101.

• A Practical Guide to Microeconomics 1 of 39
• Economists' Assumptions in Their Economic Models 2 of 39
• 5 Nobel Prize-Winning Economic Theories You Should Know About 3 of 39
• Positive vs. Normative Economics: What's the Difference? 4 of 39
• 5 Factors That Influence Competition in Microeconomics 5 of 39
• How Does Government Policy Impact Microeconomics? 6 of 39
• Microeconomics vs. Macroeconomics: What’s the Difference? 7 of 39
• How Do I Differentiate Between Micro and Macro Economics? 8 of 39
• Microeconomics vs. Macroeconomics Investments 9 of 39
• Introduction to Supply and Demand 10 of 39
• Is Demand or Supply More Important to the Economy? 11 of 39
• Demand: How It Works Plus Economic Determinants and the Demand Curve 12 of 39
• What Is the Law of Demand in Economics, and How Does It Work? 13 of 39
• Demand Curves: What Are They, Types, and Example 14 of 39
• Supply 15 of 39
• Law of Supply Explained, With the Curve, Types, and Examples 16 of 39
• Supply Curve: Definition, How It Works, and Example 17 of 39
• Elasticity: What It Means in Economics, Formula, and Examples 18 of 39
• Price Elasticity of Demand: Meaning, Types, and Factors That Impact It 19 of 39
• Elasticity vs. Inelasticity of Demand: What's the Difference? 20 of 39
• What Is Inelastic? Definition, Calculation, and Examples of Goods 21 of 39
• What Affects Demand Elasticity for Goods and Services? 22 of 39
• What Factors Influence a Change in Demand Elasticity? 23 of 39
• Utility in Economics Explained: Types and Measurement 24 of 39
• Utility in Microeconomics: Origins, Types, and Uses 25 of 39
• Utility Function Definition, Example, and Calculation 26 of 39
• Definition of Total Utility in Economics, With Example 27 of 39
• Marginal Utilities: Definition, Types, Examples, and History 28 of 39
• The Law of Diminishing Marginal Utility: How It Works, With Examples 29 of 39
• What Does the Law of Diminishing Marginal Utility Explain? 30 of 39
• Economic Equilibrium 31 of 39
• What Is the Income Effect? Its Meaning and Example 32 of 39
• Indifference Curves in Economics: What Do They Explain? 33 of 39
• Consumer Surplus Definition, Measurement, and Example 34 of 39
• What Is Comparative Advantage? 35 of 39
• What Are Economies of Scale? 36 of 39
• Perfect Competition: Examples and How It Works 37 of 39
• What Is the Invisible Hand in Economics? 38 of 39
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Macroeconomics: Meaning, Scope, Importance and Limitations

Macroeconomics / macro economic analysis:.

The word “ MACRO “. is derived from the Greek word “ MAKROS “, which means large. Macroeconomics studies the economic actions and behaviours of an economy at aggregate or average levels and explains the problems at national and international levels. Macroeconomics is also called “The Theory of Income and Employment “, because it deals with the matters of unemployment, economic fluctuations, inflation, deflation, economic development, and international trade etc.

The concept of macroeconomics was introduced during 1930 when economies were facing economic crisis. Macroeconomics studies the economy as a whole. It is concerned with total income, total output, employment, total consumption, total saving, total investment and general price level. It, is aggregative economics that provides whole view of the economy.

Macroeconomics is called income and employment theory. It deals with the problems of unemployment, trade cycles, general price level and international trade and economic growth. It studies the causes of unemployment and different determinants of employment. It is concerned with trade cycles so it examines the effect of investment on total output, total income and total employment.

It deals with monetary matters in order to check effect of total quantity of money on general price level in the field of international trade it studies problems of balance of payments and foreign aid. In fact, macroeconomics examines problems relating to determination of total income of the country and causes of changes in total income. Moreover, it studies the factors relating to economic growth.

Definition :

According to Prof. K.B. Boulding

“Macroeconomics deals not with individual quantities as such but with aggregates of these quantities, not with individual income but with national income, not with individual price but with general price level, and not with individual output but / with national output.”

According to John B. Taylor

“Macroeconomics is the branch of theoretical economics that examines the workings and problems of the economy as a whole economic growth, inflation, unemployment and economic fluctuations.”

According to Gardner Ackley

“Macroeconomics concerns with such variables as the aggregate volume of the output of an economy, with the extent to which its resources are employed, with the size of the national income and with the general price level.”

According to Allen

“The term macroeconomics is applied to study which deals with the relationship of large economic aggregates.”

According to Culbertson

“Macroeconomics means the theory of income, employment, prices and money”.

Scope of Macroeconomics:

From the above discussion we find that macroeconomics has the following scope.

1.Theory of National Income:

In macroeconomics we study ‘NI’; its different concepts and its measurement.

2. Theory of NI Determination:

The major part of macroeconomics deals with the theory of NI determination. Accordingly, in macroeconomics, we study classical and Keynesian theories of national income and employment.

3. Theory of NI Fluctuations:

In capitalist economies, the economic activities are never alike. Sometimes there is a brisk in economic life, while on the other occasions, the business activities are sluggish. Such fluctuations in economic life of a country are known as trade cycles. Why there are such fluctuations? In this context we study a lot of theories, particularly, “Samuelson’s Multiplier-Accelerator” interaction is of great importance for the readers of macroeconomics.

4. Theory of Consumption and Savings:

In macroeconomics, AD plays an important role. The AD has an important component which is Consumption (C). The consumption has a counterpart which is Saving (S). How people behave regarding consumption expenditures and savings? In this connection, starting from Keynes consumption function, we have a lot of consumption theories like Dusenberry’s Relative Income Theory”, ” Friedman’s Permanent Income Theory” and “Modigliani’s Life Cycle Income Theory “.

5. Theory of Money:

In an economy ‘money’ plays an important role. What will be the effects of changes in supply of money on the economy? What are inflation and deflation? What causes the inflation. What is demand pull and cost push inflation? What a Phillips curve shows? In this respect we study a lot of theories in macroeconomics.

6. Theory of Economic Stabilization:

As told earlier that in capitalist economies, inflation, unemployment, unequal income distribution, misallocation of resources, deficit in BOP and budget deficits are the routine problems. Therefore, to remove them or for the sake of economic stabilization, government has to intervene with the help of ” Fiscal and Monetary Policies”. The role of such policies will be analyzed in macroeconomics.

7. Theory of Growth:

The Keynes model of income and employment just deals with static and comparative static situations. But in addition to this model, we have a lot of dynamic growth models in macroeconomics where we study the growth path of the economy; effect of change in population on the level of NI: the effect of change in technology on the level of NI, etc.

Importance of Macro Economics:

We can realize the importance of the study of macroeconomics from the following points.

1. Working of Economy:

Macroeconomics is helpful to understand working of economy. Economic system is complicated. Many interdependent-economic factors affect the economy. Microeconomics cannot provide clear picture of whole economy.

2. Making Economic Policies:

Macroeconomics is used to make economic policies. There is need facts and figures abut national income, total employment, total investment, total saving and general price level. Macroeconomics can provide statistics about such variables.

3. Solves Economic Problems:

An economy can face problems like overproduction, unemployment, and rising price level. The government can solve its problems with the help of macroeconomics.

4. Studies Trade Cycles:

The capitalistic economies can face problem of trade cycles or ups and downs, in business activities. Such problems upset the proper working of economy. Macroeconomics provides solution to overcome difficulties of trade cycles.

5. Widens Scope of Microeconomics:

The laws of microeconomics are framed with the help of macroeconomics. The law of diminishing marginal utility is derived from analysis of aggregate behaviour of people.

6. Changes in Price Level:

Macroeconomics deals with the problems of changes in price level. There may be inflation, deflation, or stagflation. The changes in price level create disturbance for proper working of economy.

7. Study of National Income:

The study of national income explains various problems of economy. National income of any Country can show its economic conditions. The population control program or defense program depend upon national income. Macroeconomics is used to calculate national income.

8. Behaviour of Individual Firms:

Microeconomics studies behaviour of individual firms. Demand for a product depends upon total of such product in the economy. The causes for decrease in total demand are analyzed to note decrease in demand of a product.

Limitations:

1. dependence on individual units:.

Macroeconomics deals with aggregates and such aggregates are taken from individuals. The results of aggregates may be different from individual. What is good for individual may not be good for the economy. The saving for a person is good but it is bad for whole economy. There is decrease in national income due to saving of society. Thus, decisions for economy on the basis of individual behaviour are wrong.

2. Statistical Difficulties:

The measurement of macroeconomic problems involves statistical difficulties. These problems relate to aggregation of microeconomic variables. When microeconomic variables relate to dissimilar individual units the aggregates of such variable provide wrong results.

3. Indiscriminate Use is Bad:

Indiscriminate use of macroeconomics for analysis of problems is bad. The measures suggested to control general price level may to be useful in controlling prices of individual products.

4. Aggregate Variables May Be Useless:

The aggregate variables relating to an economic system may not provide significant results. The national income of any country may be divided by population provides per head income. An Increase in national income does not means that income of every individual has gone up.

5. Aggregates Are Not Similar:

Macroeconomics considers that aggregates are similar without checking their internal structure. Average wages are calculated with the help of total wages of all workers. The wages of one sector may increase while that of other may decreases but average will remain the same and aggregates may differ.

References:

Munir Ahmed Bhutta. Economics, Azeem Academy Publishers, Lahore.

Abdul Haleem Khawja. Economics, Khawja and Khawja Publishing House, Islamabad.

Manzoor Tahir Ch. Principles of Economics , Azeem Academy Publishers, Lahore.

Muhammad Irshad. Economics , Naveed Publications, Lahore.

K K Dewett & M H Navalur . Modern Economic Theory (Theory and Policy), S. Chand Publishing.

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25.1: Major Theories in Macroeconomics

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Keynesian Theory

Keynesian theory posits that aggregate demand will not always meet the supply produced.

Learning objectives

• Explain the main tenets of Keynesian economics

Historical Background

John Maynard Keynes published a book in 1936 called The General Theory of Employment, Interest, and Money , laying the groundwork for his legacy of the Keynesian Theory of Economics. It was an interesting time for economic speculation considering the dramatic adverse effect of the Great Depression. Keynes’s concepts played a role in public economic policy under Roosevelt as well as during World War II, becoming the dominant perspective in Europe following the war.

John Maynard Keynes : John Maynard Keynes came to fame after publishing his economic theories during the Great Depression.

At the time, the primary school of economic thought was that of the classical economists (which is still a popular school of thought today). The central tenet of the classical argument says that supply can always create demand, and that surpluses will result in price reductions to the point of consumption. Put simply, people have infinite needs and the market will self-correct to the aggregate demands and available resources. This implies a hands-of public policy where markets are capable of taking care of themselves.

Keynes positioned his argument in contrast to this idea, stating that markets are imperfect and will not always self correct. Keynes theorized that natural inefficiencies in the market will see goods that are not met with demand. This wasted capital can result in market losses, unemployment, and market inefficiency (this was called ‘general glut’ in the classical model, when aggregate demand does not meet supply). Keynes insisted that markets do need moderate governmental intervention through fiscal policy (government investment in infrastructure) and monetary policy ( interest rates ).

Main Tenets

With this overview in mind, Keynesian Theory generally observes the following concepts:

• Unemployment: Under the classical model, unemployment is often attributed to high and rigid real wages. Keynes argues there is more complexity than that, specifically that societies are highly resistant to wage cuts and furthermore that reducing wages would pose a great threat to an economy. Specifically, cutting wages reduces spending and may result in a downwards spiral.
• Excessive Saving: Keynes’s concept here is somewhat complicated, but in short Keynes notes excessive saving as a threat and prospective cause of economic decline. This is because excessive saving leads to reduced investment and reduced spending, which drives down demand and the potential for consumption. This can be another spiraling issue, as money not being exchanged is actively reducing prospective employment, revenues, and future investments.
• Fiscal Policy: The key concept in fiscal policy for Keynes is ‘counter-cyclical’ fiscal policy, which is the expectation that governments can reduce the negative effects of the natural business cycle. This is, generally, achieved through deficit spending in recessions and suppression of inflation during boom times. Simply put, the government should try to curb the extremes of economic fluctuation through informed fiscal policy.
• The Multiplier Effect: This idea has in many ways already been implied in the atom, but inversely. Consider the unemployment and excessive savings problems, and how they stand to lead to spiraling decline. The other side of that coin is that positive economic situations can spiral upwards. Take for example a government investment in transportation, putting money in the pockets of various individuals who build trains and tracks. These individuals will spend that extra capital, putting money in the hands of other business (and this will continue). This is called the multiplier effect.
• IS-LM: While the IS-LM Model is a complicated byproduct of Keynesian economics, it can be summarized as the relationship between interest rates (y-axis) and the real economic output (x-axis). This is done through analyzing the invest-saving relationship (IS) in contrast to the liquidity preference and money supply relationship (LM), generating an equilibrium where certain interest rates and outputs will be generated.

While Keynesian Theory has been expounded upon significantly over the years, the important takeaway here is that aggregate demand (and thus the amount of supply consumed) is not a perfect system. Instead, demand is affected by various external forces that can create an inefficient market which will in turn affect employment, production, and inflation.

IS-LM Model : In this figure, the IS (Interest – Saving) curve is shifted outward in a way that raises both interest rates (i) and the ‘real’ economy (Y). The implication is that interest rates affect investment levels, and that these investment levels in turn affect the overall economy.

Monetarism focuses on the macroeconomic effects of the supply of money and the role of central banking on an economic system.

• Explain the main tenets of Monetarism

In the rise of monetarism as an ideology, two specific economists were critical contributors. Clark Warburton, in 1945, has been identified as the first thinker to draft an empirically sound argument in favor of monetarism. This was taken more mainstream by Milton Friedman in 1956 in a restatement of the quantity theory of money. The basic premise these two economists were putting forward is that the supply of money and the role of central banking play a critical role in macroeconomics.

The generation of this theory takes into account a combination of Keynesian monetary perspectives and Friedman’s pursuit of price stability. Keynes postulated a demand-driven model for currency; a perspective on printed money that was not beholden to the ‘ gold standard ‘ (or basing economic value off of rare metal). Instead, the amount of money in a given environment should be determined by monetary rules. Friedman originally put forward the idea of a ‘k-percent rule,’ which weighed a variety of economic indicators to determine the appropriate money supply.

Theoretically, the idea is actually quite straight-forward. When the money supply is expanded, individuals will be induced to higher spending. In turn, when the money supply retracted, individuals would limit their budgetary spending accordingly. This would theoretically provide some control over aggregate demand (which is one of the primary areas of disagreement between Keynesian and classical economists).

Monetarism began to deviate more from Keynesian economics however in the 70’s and 80’s, as active implementation and historical reflection began to generate more evidence for the monetarist view. In 1979 for example, Jimmy Carter appointed Paul Volcker as Chief of the Federal Reserve, who in turn utilized the monetarist perspective to control inflation. He eventually created a price stability, providing evidence that the theory was sound. In addition, Milton Friedman and Ann Schwartz analyzed the Great Depression in the context of monetarism as well, identifying a shortage of the money supply as a critical component of the recession.

The 1980s were an interesting transitional period for this perspective, as early in the decade (1980-1983) monetary policies controlling capital were attributed to substantial reductions in inflation (14% to 3%)(see ). However, unemployment and the rise of the use of credit are quoted as two alternatives to money supply control being the primary influence of the boom that followed 1983.

U.S. Inflation Rates : The inflation rates over time in the U.S. represent some of the evidence put forward by monetarist economists, stating that governmental control of the money supply allows for some control over inflation.

Counter Arguments

As these counter arguments in the 1980s began to arise, critics of monetarism became more mainstream. Of the current monetarism critics, the Austrian school of thought is likely the most well-known. The Austrian school of economic thought perceives monetarism as somewhat narrow-minded, not effectively taking into account the subjectivity involved in valuing capital. That is to say that monetarism seems to assume an objective value of capital in an economy, and the subsequent implications on the supply and demand.

Other criticisms revolve around international investment, trade liberalization, and central bank policy. This can be summarized as the effects of globalization, and the interdependence of markets (and consequently currencies). To manipulate money supply there will inherently be effects on other currencies as a result of relativity. This is particularly important in regards to the U.S. currency, which is considered a standard in international markets. Controlling supply and altering value may have effects on a variety of internal economic variables, but it will also have unintended consequences on external variables.

Austrian economic thought is about methodological individualism, or the idea that people will act in meaningful ways which can be analyzed.

• Explain the main tenets of Austrian economics

The Austrian school of economics originated in the 19th century in Vienna, Austria. While there were a variety of famous economists attributed to the early foundations and later expansions of the Austrian economic perspective, Carl Menger, Friedrich von Weiser, and Eugen von Bohm-Bawerk are widely recognized as critical early pioneers. The general perspective of Austrian economic thought is methodological individualism, or the recognition that people will act in meaningful ways which can be analyzed for trends.

Central Tenets

The Austrian school of thought provided enormous value to the economic climate, both as a foundation for future economics and as a deliberate counterpoint to more quantitative analysis. Of the most important ideologies, the following central tenets are:

• Opportunity Cost: This is a concept you are likely already familiar with, and one of the most important ideas in all of business and economics. Essentially, the price of a good must also incorporate the value sacrificed of the next best alternative. Basically each choice a consumer or business makes intrinsically has the cost of not being able to make an alternative choice.
• Capital and Interest: Largely in response to Karl Marx’s labor theories, Austrian economist Bohm-Bawerk identified the building blocks of interest rates and profit are supply and demand alongside time preference. In short, present consumption is more valuable than future consumption (the time value of money).
• Inflation: The idea that prices and wages must rise as a result of increased money supply is inflation (note: this is different that price inflation). Simply put, more money in the system without a higher demand for that money will drive down the relative value of each dollar.
• Business Cycles: The Austrian business cycle theory (ABCT) is the simple observation that the issuance of credit (by banks) creates economic fluctuations that tend to be cyclical (see ). In simple terms, banks will lend out money at rates lower than the risk in which that money will be used. So when businesses fail more often than they succeed, thus losing interest as opposed to accruing it, will struggle to repay their debts. When the banks call in those debts the business cannot pay, creating negative business cycles.
• The Organizing Power of Markets: The idea of this concept is that no one person knows what the appropriate price of a good should be. Instead, markets naturally generate incentives to identify optimal price points. This negates the ideas of socialism common at the time, as communist systems will be unable to identify the appropriate exchange value of each good.

As you can see from the above points, this school of economics is largely about making qualitative observations of the markets. These observations are absolutely critical in understanding the theoretical landscape, but difficult to enact in practice.

Austrian economists are often criticized for ignoring arithmetic or statistical ways to measure and analyze economics. Indeed, Austrian economists do not often place much weight on concepts such as econometrics, experimental economics, and aggregate macroeconomic analysis. In this sense, the Austrian school of thought is something of an outsider relative to other perspectives (i.e. classical, Keynesian, etc.).

Paul Krugman criticized Austrian economics as lacking explicit models of analysis, or essentially a lack of clarity in their approach. This results in inadvertent blind spots. This is a sensible criticism in many ways, as the fundamental idea behind this economic theory is that it is driven by individuals and individuals are not always rational (indeed, they are quite often irrational). As a result of this, Austrian economics often rests on the integration of social sciences (psychology, sociology, etc.) to explain preferences and consumer behavior, which is often counter-intuitive. As a result, it is very difficult to accurately measure and provide tangible proof of the efficacy of Austrian models.

Alternative Views

Neoclassical and neo-Keynesian ideas can be coupled and referred to as the neoclassical synthesis, combining alternative views in economics.

• Summarize neoclassical and Neo-Keynesian economics

The history of different economic schools of thought have consistently generated evolving theories of economics as new data and new perspectives are taken into consideration. The two most well-known schools, classical economics and Keynesian economics, have been adapting to incorporate new information and ideas from one another as well as lesser known schools of economics (Chicago, Austrian, etc.). These different perspectives have motivated economists to generate the neoclassical and neo-Keynesian perspectives. The neoclassical perspective, in conjunction with Keynesian ideas, is referred to as the neoclassical synthesis, which is largely considered the ‘mainstream’ economic perspective.

Neoclassical

In approaching Neoclassical economics, it is most important to keep in mind the following three principles:

• People have rational preferences in the context of options or outcomes that can be identified and associated with a given value (usually monetary). In short, people make smart choices regarding how they spend their money.
• Individuals maximize utility and firms maximize profit. People will try to get the most from their money while corporations will try to invest their time and assets to capture the highest margin.
• People act independently based upon comprehensive and relevant information. People are influenced by rational forces (mostly information and logic), and will make the best personal purchasing decisions based upon this.

A brief timeline of classical to neoclassical perspectives would begin with thought processes put forward by Adam Smith and David Ricardo (alongside many others). The basic idea is that aggregate demand will adjust to supply, and that value theory and distribution will reflect this rational, cost of production model. The next phase was the observation that consumer goods demonstrated a relative value based on utility, which could deviate from consumer to consumer. The final phase, and most central to the advent of the neoclassical perspective, is the introduction of marginalism. Marginalism notes that economic participants make decisions based on marginal utility or margins. For example, a company hiring a new employee will not think of the fixed value of that employee, but instead the marginal value of adding that employee (usually in regards to profitability).

Neo-Keynesian

Neo-Keynesian economics is often confused with ‘New Keynesian’ economics (which attempts to provide microeconomic foundation to Keynesian views, particularly in light of stagflation in the 1970s). Neo-Keynesian economics is actually the formalization and coordination of Keynes’s writings by a number of other economists (most notably John Hicks, Franco Modigliani, and Paul Samuelson). Much of the conceptual value is captured in the previous atoms on Keynesian views, but the substantial value of a few neo-Keynesian ideas is worth reiterating:

• IS/LM Model: This model was put forward by John Hicks in order to capture the inherent relationship between investment and savings (IS) relative to liquidity and the overall money supply (LM) (see ). The implications of this graph pertain to the static representation of monetary policy and the effects on an economic system.
• Phillips Curve: Another important model following Keynes’s publications is the Phillips Curve, put forward by William Phillips in 1958. The idea here was also largely Keynesian, revolving around the relationship between inflation and unemployment (see ).This implies a trade off between inflation rates and the creation of employment, which governments could consider in policy making. Stagflation (economic stagnation and inflation simultaneously) created issues with this however, necessitating New Keynesian ideas (as discussed briefly above).

When learning about these economic perspectives, it is important to understand the value they add to one another and the overall efficacy of all economic theory. Economists are often the product of multiple schools of thought, and don’t fit neatly into one school or another.

• John Maynard Keynes published a book in 1936 called The General Theory of Employment, Interest, and Money, laying the groundwork for his legacy of the Keynesian Theory of Economics.
• Keynes positioned his argument in contrast to this idea, stating that markets are imperfect and will not always self correct.
• Keynes believed that wage reductions in recessions and excessive savings were potential threats to an economy.
• Keynesian theory expects fiscal policy to offset business cycles (employ counter-cyclical strategies).
• Clark Warburton, in 1945, has been identified as the first thinker to draft an empirically sound argument in favor of monetarism. This was taken more mainstream by Milton Friedman in 1956.
• More money in the system results in higher spending and vice verse. This would theoretically provide some control over aggregate demand.
• Historical implementation of monetarism demonstrated some correlation with control over inflation rates and increased economic performance. This could have been a result of other factors however.
• The Austrian school of economic thought perceives monetarism as somewhat narrow-minded, not effectively taking into account the subjectivity involved in valuing capital.
• Due to the globalization of the economy, monetarism may have a negative impact on external economies. This is particularly true of the U.S., whose capital is an international standard.
• The Austrian school of economics is one of the oldest economic perspectives, originating in the 19th century in Vienna.
• Austrian economics is attributed for the identification of opportunity cost, capital and interest, inflation, business cycles and the organizing power of markets.
• Austrian economists do not often place much weight on concepts such as econometrics, experimental economics, and aggregate macroeconomic analysis. In this sense, the Austrian school of thought is something of an outsider relative to other perspectives (i.e. classical, Keynesian, etc. ).
• Paul Krugman criticized Austrian economics as lacking explicit models of analysis, or essentially a lack of clarity in their approach. This results in inadvertent blind spots.
• The history of different economic schools of thought have consistently generated evolving theories of economics as new data and new perspectives are taken into consideration.
• The neoclassical perspective in conjunction with Keynesian ideas is referred to as the neoclassical synthesis, which is largely considered the ‘mainstream’ economic perspective.
• A critical difference between classical and neoclassical perspectives is the introduction of marginalism. Marginalism notes that economic participants make decisions based on marginal utility or margins.
• Neo- Keynesian economics is the formalization and coordination of Keynes’s writings by a number of other economists (most notably John Hicks, Franco Modigliani and Paul Samuelson).
• The important to understand that these economic perspectives add value to one another and the overall efficacy of all economic theory.
• fiscal policy : Government policy that attempts to influence the direction of the economy through changes in government spending or taxes.
• monetary policy : The process of controlling the supply of money in an economy, often conducted by central banks.
• Keynesian : Of or pertaining to an economic theory based on the ideas of John Maynard Keynes, as put forward in his book The General Theory of Employment, Interest, and Money.
• Monetarism : The doctrine that economic systems are controlled by variations in the supply of money.
• gold standard : A monetary system where the value of circulating money is linked to the value of gold.
• Opportunity cost : The cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen).
• time value of money : The time value of money is the principle that a certain currency amount of money today has a different buying power (value) than the same currency amount of money in the future.
• stagflation : Inflation accompanied by stagnant growth, unemployment or recession.
• static : Unchanging; that cannot or does not change.

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What Is Economics?

Introduction

Economics is about making choices. We make all kinds of choices every day. How much should I spend on gas? What’s the best route to work? Where should we go for dinner? Which job or career should I go for? What are the pros and cons of finishing college versus taking a job or inventing the next, best Internet startup? Which roommate should take care of washing the dishes? Can I get that dog as a pet? Should I get married, have children, and if so, when? Which politician should I vote for when they all claim they can improve the economy or make my life better? What is “the economy,” anyway? What if my personal or religious principles conflict with what people tell me is in my best economic interest?

Many people hear the word “economics” and think it is all about money. Economics is not just about money. It is about weighing different choices or alternatives. Some of those important choices involve money, but most do not. Most of your daily, monthly, or life choices have nothing to do with money, yet they are still the subject of economics. For example, your decisions about whether it should be you or your roommate who should be the one to clean up or do the dishes, whether you should spend an hour a week volunteering for a worthy charity or send them a little money via your cell phone, or whether you should take a job so you can help support your siblings or parents or save for your future are all economic decisions. In many cases, money is merely a helpful tool or just a veil, standing in for a partial way to evaluate some of the goals you really care about and how you make choices about those goals.

You might also think economics is all about “economizing” or being efficient–not making foolish or wasteful choices about how you spend or budget your time and money. That is certainly part of what economics is about. However, that’s just the tip of the iceberg. We all know that we can save money or time by being more efficient in our planning. A trip to the supermarket can be coordinated with a trip to take your child to school or to deposit a check at the bank across the street to save on gas. But we sometimes don’t choose the most efficient options. Why not? Economics is also about plumbing the depths of why we sometimes do and sometimes don’t make what seem like the most economizing or economical choices.

Is economics a science (like physics), or is it a social science, or even an art? What is the difference, and what do we know about what we can’t or don’t know for now? Can economic problems be solved by better government, more experts, bigger computers, more engineering, better education, less government, more dispersed knowledge, more markets? How can we make informed choices?

You’ve probably heard that economists disagree about a lot of things. Actually, what economists disagree about is politics or public policy, not economics. Exploring the interface between politics and economics is part of the fun.

On this page are some famous, standard definitions about what economics is all about.

Definitions and Basics

Economics is the study of given ends and scarce means. Lionel Robbins , biography, from the Concise Encyclopedia of Economics :

Robbins’ most famous book was An Essay on the Nature and Significance of Economic Science , one of the best-written prose pieces in economics. That book contains three main thoughts. First is Robbins’ famous all-encompassing definition of economics that is still used to define the subject today: “Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses.”…

What is “political economy”? Chapter I, Principles of Economics , by Alfred Marshall.

Political Economy or Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing. Thus it is on the one side a study of wealth; and on the other, and more important side, a part of the study of man. For man’s character has been moulded by his every-day work, and the material resources which he thereby procures, more than by any other influence unless it be that of his religious ideals; and the two great forming agencies of the world’s history have been the religious and the economic. Here and there the ardour of the military or the artistic spirit has been for a while predominant: but religious and economic influences have nowhere been displaced from the front rank even for a time; and they have nearly always been more important than all others put together. Religious motives are more intense than economic, but their direct action seldom extends over so large a part of life. For the business by which a person earns his livelihood generally fills his thoughts during by far the greater part of those hours in which his mind is at its best; during them his character is being formed by the way in which he uses his faculties in his work, by the thoughts and the feelings which it suggests, and by his relations to his associates in work, his employers or his employees.

Isn’t economics nicknamed the “dismal science” because it is all about running out of resources and the inevitable decline of life as we know it? Who coined the phrase “the dismal science”? The Secret History of the Dismal Science: Economics, Religion, and Race in the 19th Century , by David M. Levy and Sandra J. Peart. Econlib, January 22, 2001.

Everyone knows that economics is the dismal science. And almost everyone knows that it was given this description by Thomas Carlyle, who was inspired to coin the phrase by T. R. Malthus’s gloomy prediction that population would always grow faster than food, dooming mankind to unending poverty and hardship. While this story is well-known, it is also wrong, so wrong that it is hard to imagine a story that is farther from the truth. At the most trivial level, Carlyle’s target was not Malthus, but economists such as John Stuart Mill, who argued that it was institutions, not race, that explained why some nations were rich and others poor….

Economics on One Foot , a LearnLiberty video.

Prof. Art Carden, in memory of Ayn Rand’s philosophy on one foot, presents economics on one foot.

In the News and Examples

Diane Coyle on the Soulful Science , EconTalk podcast.

Diane Coyle talks with host Russ Roberts about the ideas in her new book, The Soulful Science: What Economists Really Do and Why it Matters. The discussions starts with the issue of growth–measurement issues and what economists have learned and have yet to learn about why some nations grow faster than others and some don’t grow at all. Subsequent topics include happiness research, the politics and economics of inequality, the role of math in economics, and policy areas where economics has made the greatest contribution….

Isn’t economics all about supply and demand? Richard McKenzie on Prices , EconTalk podcast. June 23, 2008.

Richard McKenzie of the University California, Irvine and the author of Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles, talks with EconTalk host Russ Roberts about a wide range of pricing puzzles. They discuss why Southern California experiences frequent water crises, why price falls after Christmas, why popcorn seems so expensive at the movies, and the economics of price discrimination….

Isn’t economics all about Adam Smith and the invisible hand? Adam Smith: The Invisible Hand , a LearnLiberty video.

Prof. James Otteson, using the ideas of Adam Smith, explains how the division of labor is a necessary and crucial element of wealthy nations.

Don’t all economists disagree? Henderson on Disagreeable Economists . EconTalk podcast, July 30, 2007.

David Henderson, editor of the Concise Encyclopedia of Economics and a research fellow at Stanford’s Hoover Institution, talks with EconTalk host Russ Roberts about when and why economists disagree. Harry Truman longed for a one-armed economist, one willing to go out on a limb and take an unequivocal position without adding “on the other hand…”. Truman’s view is often reflected in the public’s view that economic knowledge is inherently ambiguous and that economists never agree on anything. Henderson claims that this view is wrong–that there is substantial agreement among economists on many scientific questions–while Roberts wonders whether this consensus is getting a bit frayed around the edges. The conversation highlights the challenges the everyday person faces in trying to know when and what to believe when economists take policy positions based on research. Is it biased or science?

Humorous essay. Zero-sum games like income redistribution are more exciting than economic fundamentals like the gains from trade. Why is Economics So Boring? , by Donald Cox. Econlib, November 7, 2005.

Stan: Ollie, you know the worst part about being an economist? You meet someone at a cocktail party, you tell them you teach economics. Ollie: …and they say “Oh, yeah, I took that in college. I hated it. It was sooo boring!”… … getting the credit for Equation 14 is a zero sum game. And we care about zero sum games. There’s drama. There’s tension. There’s a loser for every winner. It makes for good TV, doesn’t it? But it’s not very common in reality. What common in reality is both sides are better off. The buyer and the seller of the car in the ad. That’s reality. No violence, no theft. Boring balloons. Boring happy people. Economics is boring….

Is economics just a fuss about language? The Economy: Metaphors We (Shouldn’t) Live By , by Max Borders.

“Argument is war.” That’s what cognitive linguists George Lakoff and Mark Johnson write in the opening chapter of their influential 1980 Metaphors We Live By. In that seminal book, Lakoff and Johnson offer a number of powerful lessons about figurative language: Metaphor is more than mere literary window dressing; metaphor is a fundamental aspect of human thought and language; and metaphors help us navigate the real world with a degree of efficiency that literal language can’t offer. It can even–for better or worse–change our perceptions of things….

A Little History: Primary Sources and References

Economics is sometimes called catallarchy or catallactics, meaning the science of exchanges. Where did this term first come from? Lecture I, Introductory Lectures on Political Economy , by Richard Whately.

It is with a view to put you on your guard against prejudices thus created, (and you will meet probably with many instances of persons influenced by them,) that I have stated my objections to the name of Political-Economy. It is now, I conceive, too late to think of changing it. A. Smith, indeed, has designated his work a treatise on the “Wealth of Nations;” but this supplies a name only for the subject-matter, not for the science itself. The name I should have preferred as the most descriptive, and on the whole least objectionable, is that of CATALLACTICS, or the “Science of Exchanges.”…

Advanced Resources

Is Economics All About Scarcity? , by Arnold Kling. Blog discussion on EconLog, January 17, 2007.

… I am two-handed on this issue. On the one hand, just because food, say, has become more abundant does not mean that we can ignore scarcity. At any moment in time, for a given state of know-how, the conventional definition of economics as dealing with the allocation of scarce resources among competing ends applies. On the other hand, some of the most interesting economic observations concern relative abundance. Look at our standard of living compared to 100 years ago. Look at South Korea compared with North Korea. Robert Lucas famously said that “The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them it is hard to think of anything else.”…

Related Topics

Is Economics a Science? Wellbeing and Welfare Scarcity Incentives Efficiency Cost-Benefit Analysis Division of Labor and Specialization Money Management and Budgeting Productive Resources Property Rights

What is inflation?

Inflation has been top of mind for many over the past few years. But how long will it persist? In June 2022, inflation in the United States jumped to 9.1 percent, reaching the highest level since February 1982. The inflation rate has since slowed in the United States , as well as in Europe , Japan , and the United Kingdom , particularly in the final months of 2023. But even though global inflation is higher than it was before the COVID-19 pandemic, when it hovered around 2 percent, it’s receding to historical levels . In fact, by late 2022, investors were predicting that long-term inflation would settle around a modest 2.5 percent. That’s a far cry from fears that long-term inflation would mimic trends of the 1970s and early 1980s—when inflation exceeded 10 percent.

Get to know and directly engage with senior McKinsey experts on inflation.

Ondrej Burkacky is a senior partner in McKinsey’s Munich office, Axel Karlsson is a senior partner in the Stockholm office, Fernando Perez is a senior partner in the Miami office, Emily Reasor is a senior partner in the Denver office, and Daniel Swan is a senior partner in the Stamford, Connecticut, office.

Inflation refers to a broad rise in the prices of goods and services across the economy over time, eroding purchasing power for both consumers and businesses. Economic theory and practice, observed for many years and across many countries, shows that long-lasting periods of inflation are caused in large part by what’s known as an easy monetary policy . In other words, when a country’s central bank sets the interest rate too low or increases money growth too rapidly, inflation goes up. As a result, your dollar (or whatever currency you use) will not go as far  today as it did yesterday. For example: in 1970, the average cup of coffee in the United States cost 25 cents; by 2019, it had climbed to $1.59. So for $5, you would have been able to buy about three cups of coffee in 2019, versus 20 cups in 1970. That’s inflation, and it isn’t limited to price spikes for any single item or service; it refers to increases in prices across a sector, such as retail or automotive—and, ultimately, a country’s economy.

How does inflation affect your daily life? You’ve probably seen high rates of inflation reflected in your bills—from groceries to utilities to even higher mortgage payments. Executives and corporate leaders have had to reckon with the effects of inflation too, figuring out how to protect margins while paying more for raw materials.

But inflation isn’t all bad. In a healthy economy, annual inflation is typically in the range of two percentage points, which is what economists consider a sign of pricing stability. When inflation is in this range, it can have positive effects: it can stimulate spending and thus spur demand and productivity when the economy is slowing down and needs a boost. But when inflation begins to surpass wage growth, it can be a warning sign of a struggling economy.

Introducing McKinsey Explainers : Direct answers to complex questions

Inflation may be declining in many markets, but there’s still uncertainty ahead: without a significant surge in productivity, Western economies may be headed for a period of sustained inflation or major economic reset , as Japan has experienced in the first decades of the 21st century.

What does seem to be changing are leaders’ attitudes. According to the 2023 year-end McKinsey Global Survey on economic conditions , respondents reported less fear about inflation as a risk to global and domestic economic growth . But this sentiment varies significantly by region: European respondents were most concerned about the effects of inflation, whereas respondents in North America offered brighter views.

What causes inflation?

Monetary policy is a critical driver of inflation over the long term. The current high rate of inflation is a result of increased money supply , high raw materials costs , labor mismatches , and supply disruptions —exacerbated by geopolitical conflict .

In general, there are two primary types, or causes, of short-term inflation:

• Demand-pull inflation occurs when the demand for goods and services in the economy exceeds the economy’s ability to produce them. For example, when demand for new cars recovered more quickly than anticipated from its sharp dip at the beginning of the COVID-19 pandemic, an intervening shortage  in the supply of semiconductors  made it hard for the automotive industry to keep up with this renewed demand. The subsequent shortage of new vehicles resulted in a spike in prices for new and used cars.
• Cost-push inflation occurs when the rising price of input goods and services increases the price of final goods and services. For example, commodity prices spiked sharply  during the pandemic as a result of radical shifts in demand, buying patterns, cost to serve, and perceived value across sectors and value chains. To offset inflation and minimize impact on financial performance, industrial companies were forced to increase prices for end consumers.

Learn more about McKinsey’s Growth, Marketing & Sales  Practice.

What are some periods in history with high inflation?

Economists frequently compare the current inflationary period with the post–World War II era , when price controls, supply problems, and extraordinary demand in the United States fueled double-digit inflation gains—peaking at 20 percent in 1947—before subsiding at the end of the decade. Consumption patterns today have been similarly distorted, and supply chains have been disrupted  by the pandemic.

The period from the mid-1960s through the early 1980s in the United States, sometimes called the “Great Inflation,” saw some of the country’s highest rates of inflation, with a peak of 14.8 percent in 1980. To combat this inflation, the Federal Reserve raised interest rates to nearly 20 percent. Some economists attribute this episode partially to monetary policy mistakes rather than to other causes, such as high oil prices. The Great Inflation signaled the need for public trust  in the Federal Reserve’s ability to lessen inflationary pressures.

Inflation isn’t solely a modern-day phenomenon, of course. One very early example of inflation comes from Roman times, from around 200 to 300 CE. Roman leaders were struggling to fund an army big enough to deal with attackers from multiple fronts. To help, they watered down  the silver in their coinage, causing the value of money to slowly fall—and inflation to pick up. This led merchants to raise their prices, causing widespread panic. In response, the emperor Diocletian issued what’s now known as the Edict on Maximum Prices, a series of price and wage controls designed to stop the rise of prices and wages (one helpful control was a maximum price for a male lion). But because the edict didn’t address the root cause of inflation—the impure silver coin—it didn’t fix the problem.

How is inflation measured?

Statistical agencies measure inflation first by determining the current value of a “basket” of various goods and services consumed by households, referred to as a price index. To calculate the rate of inflation over time, statisticians compare the value of the index over one period with that of another. Comparing one month with another gives a monthly rate of inflation, and comparing from year to year gives an annual rate of inflation.

In the United States, the Bureau of Labor Statistics publishes its Consumer Price Index (CPI), which measures the cost of items that urban consumers buy out of pocket. The CPI is broken down by region and is reported for the country as a whole. The Personal Consumption Expenditures (PCE) price index —published by the US Bureau of Economic Analysis—takes into account a broader range of consumer spending, including on healthcare. It is also weighted by data acquired through business surveys.

How does inflation affect consumers and companies differently?

Inflation affects consumers most directly, but businesses can also feel the impact:

• Consumers lose purchasing power when the prices of items they buy, such as food, utilities, and gasoline, increase. This can lead to household belt-tightening and growing pessimism about the economy .
• Companies lose purchasing power and risk seeing their margins decline , when prices increase for inputs used in production. These can include raw materials like coal and crude oil , intermediate products such as flour and steel, and finished machinery. In response, companies typically raise the prices of their products or services to offset inflation, meaning consumers absorb these price increases. The challenge for many companies is to strike the right balance between raising prices to cover input cost increases while simultaneously ensuring that they don’t raise prices so much that they suppress demand.

How can organizations respond to high inflation?

During periods of high inflation, companies typically pay more for materials , which decreases their margins. One way for companies to offset losses and maintain margins is by raising prices for consumers. However, if price increases are not executed thoughtfully, companies can damage customer relationships and depress sales —ultimately eroding the profits they were trying to protect.

When done successfully, recovering the cost of inflation for a given product can strengthen relationships and overall margins. There are five steps companies can take to ADAPT  (adjust, develop, accelerate, plan, and track) to inflation:

• Adjust discounting and promotions and maximize nonprice levers. This can include lengthening production schedules or adding surcharges and delivery fees for rush or low-volume orders.
• Develop the art and science of price change. Instead of making across-the-board price changes, tailor pricing actions to account for inflation exposure, customer willingness to pay, and product attributes.
• Accelerate decision making tenfold. Establish an “inflation council” that includes dedicated cross-functional, inflation-focused decision makers who can act quickly and nimbly on customer feedback.
• Plan options beyond pricing to reduce costs. Use “value engineering” to reimagine a portfolio and provide cost-reducing alternatives to price increases.
• Track execution relentlessly. Create a central supporting team to address revenue leakage and to manage performance rigorously. Traditional performance metrics can be less reliable when inflation is high .

Beyond pricing, a variety of commercial and technical levers can help companies deal with price increases in an inflationary market , but other sectors may require a more tailored response to pricing.

Learn more about our Financial Services , Industrials & Electronics , Operations , Strategy & Corporate Finance , and  Growth, Marketing & Sales Practices.

How can CEOs help protect their organizations against uncertainty during periods of high inflation?

In today’s uncertain environment, in which organizations have a much wider range of stakeholders, leaders must think about performance beyond short-term profitability. CEOs should lead with the complete business cycle and their complete slate of stakeholders in mind.

CEOs need an inflation management playbook , just as central bankers do. Here are some important areas to keep in mind while scripting it:

• Design. Leaders should motivate their organizations to raise the profile of design  to a C-suite topic. Design choices for products and services are critical for responding to price volatility, scarcity of components, and higher production and servicing costs.
• Supply chain. The most difficult task for CEOs may be convincing investors to accept supply chain resiliency as the new table stakes. Given geopolitical and economic realities, supply chain resiliency has become a crucial goal for supply chain leaders, alongside cost optimization.
• Procurement. CEOs who empower their procurement  organizations can raise the bar on value-creating contributions. Procurement leaders have told us time and again that the current market environment is the toughest they’ve experienced in decades. CEOs are beginning to recognize that purchasing leaders can be strategic partners by expanding their focus beyond cost cutting to value creation.
• Feedback. A CEO can take a lead role in playing back the feedback the organization is hearing. In today’s tight labor market, CEOs should guide their companies to take a new approach to talent, focusing on compensation, cultural factors, and psychological safety .
• Pricing. Forging new pricing relationships with customers will test CEOs in their role as the “ultimate integrator.” Repricing during inflationary times is typically unpleasant for companies and customers alike. With setting new prices, CEOs have the opportunity to forge deeper relationships with customers, by turning to promotions, personalization , and refreshed communications around value.
• Agility. CEOs can strive to achieve a focus based more on strategic action and less on firefighting. Managing the implications of inflation calls for a cross-functional, disciplined, and agile response.

A practical example: How is inflation affecting the US healthcare industry?

Consumer prices for healthcare have rarely risen faster than the rate of inflation—but that’s what’s happening today. The impact of inflation on the broader economy has caused healthcare costs to rise faster than the rate of inflation. Experts also expect continued labor shortages in healthcare—gaps of up to 450,000 registered nurses and 80,000 doctors —even as demand for services continues to rise. This drives up consumer prices and means that higher inflation could persist. McKinsey analysis as of 2022 predicted that the annual US health expenditure is likely to be $370 billion higher by 2027 because of inflation.

This climate of risk could spur healthcare leaders to address productivity, using tech levers to boost productivity while also reducing costs. In order to weather the storm, leaders will need to quickly set high aspirations, align their organizations around them, and execute with speed .

What is deflation?

If inflation is one extreme of the pricing spectrum, deflation is the other. Deflation occurs when the overall level of prices in an economy declines and the purchasing power of currency increases. It can be driven by growth in productivity and the abundance of goods and services, by a decrease in demand, or by a decline in the supply of money and credit.

Generally, moderate deflation positively affects consumers’ pocketbooks, as they can purchase more with less money. However, deflation can be a sign of a weakening economy, leading to recessions and depressions. While inflation reduces purchasing power, it also reduces the value of debt. During a period of deflation, on the other hand, debt becomes more expensive. And for consumers, investments such as stocks, corporate bonds, and real estate become riskier.

A recent period of deflation in the United States was the Great Recession, between 2007 and 2008. In December 2008, more than half of executives surveyed by McKinsey  expected deflation in their countries, and 44 percent expected to decrease the size of their workforces.

When taken to their extremes, both inflation and deflation can have significant negative effects on consumers, businesses, and investors.

For more in-depth exploration of these topics, see McKinsey’s Operations Insights  collection. Learn more about Operations consulting , and check out operations-related job opportunities  if you’re interested in working at McKinsey.

Articles referenced:

• “ Investing in productivity growth ,” March 27, 2024, Jan Mischke , Chris Bradley , Marc Canal, Olivia White , Sven Smit , and Denitsa Georgieva
• “ Economic conditions outlook during turbulent times, December 2023 ,” December 20, 2023
• “ Forward Thinking on why we ignore inflation—from ancient times to the present—at our peril with Stephen King ,” November 1, 2023
• “ Procurement 2023: Ten CPO actions to defy the toughest challenges ,” March 6, 2023, Roman Belotserkovskiy , Carolina Mazuera, Marta Mussacaleca , Marc Sommerer, and Jan Vandaele
• “ Why you can’t tread water when inflation is persistently high ,” February 2, 2023, Marc Goedhart and Rosen Kotsev
• “ Markets versus textbooks: Calculating today’s cost of equity ,” January 24, 2023, Vartika Gupta, David Kohn, Tim Koller , and Werner Rehm  
• “ Inflation-weary Americans are increasingly pessimistic about the economy ,” December 13, 2022, Gonzalo Charro, Andre Dua , Kweilin Ellingrud , Ryan Luby, and Sarah Pemberton
• “ Inflation fighter and value creator: Procurement’s best-kept secret ,” October 31, 2022, Roman Belotserkovskiy , Ezra Greenberg , Daphne Luchtenberg, and Marta Mussacaleca
• “ Prime Numbers: Rethink performance metrics when inflation is high ,” October 28, 2022, Vartika Gupta, David Kohn, Tim Koller , and Werner Rehm
• “ The gathering storm: The threat to employee healthcare benefits ,” October 20, 2022, Aditya Gupta , Akshay Kapur , Monisha Machado-Pereira , and Shubham Singhal
• “ Utility procurement: Ready to meet new market challenges ,” October 7, 2022, Roman Belotserkovskiy , Abhay Prasanna, and Anton Stetsenko
• “ The gathering storm: The transformative impact of inflation on the healthcare sector ,” September 19, 2022, Addie Fleron, Aneesh Krishna , and Shubham Singhal
• “ Pricing during inflation: Active management can preserve sustainable value ,” August 19, 2022, Niels Adler and Nicolas Magnette
• “ Navigating inflation: A new playbook for CEOs ,” April 14, 2022, Asutosh Padhi , Sven Smit , Ezra Greenberg , and Roman Belotserkovskiy
• “ How business operations can respond to price increases: A CEO guide ,” March 11, 2022, Andreas Behrendt ,  Axel Karlsson , Tarek Kasah, and  Daniel Swan
• “ Five ways to ADAPT pricing to inflation ,” February 25, 2022,  Alex Abdelnour , Eric Bykowsky, Jesse Nading,  Emily Reasor , and Ankit Sood
• “ How COVID-19 is reshaping supply chains ,” November 23, 2021,  Knut Alicke ,  Ed Barriball , and Vera Trautwein
• “ Navigating the labor mismatch in US logistics and supply chains ,” December 10, 2021,  Dilip Bhattacharjee , Felipe Bustamante, Andrew Curley, and  Fernando Perez
• “ Coping with the auto-semiconductor shortage: Strategies for success ,” May 27, 2021,  Ondrej Burkacky , Stephanie Lingemann, and Klaus Pototzky

This article was updated in April 2024; it was originally published in August 2022.

Want to know more about inflation?

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the Nature of Crisis: a Multi-Dimensional Perspective

This essay about defining crisis examines its complex nature across multiple dimensions including psychology, society, economics, and the environment. It explores how crises manifest as pivotal moments of intense difficulty that demand significant decisions, highlighting the personal, societal, and environmental impacts. The essay discusses the stages of a crisis, from trigger events to resolution, and emphasizes the importance of effective management and response strategies. It also considers how crises can drive innovation and reform, suggesting that they test resilience and adaptability, ultimately leading to progress and development when managed successfully. Through a comprehensive examination, the essay reveals the multifaceted character of crises and the critical responses they necessitate.

How it works

Crisis is a term that often conjures images of turmoil and upheaval, affecting individuals, communities, or even nations. It represents a point of intense difficulty or danger, where the decisions made can result in significant change. The essence of a crisis lies not just in the events themselves but also in the responses they demand and the outcomes they precipitate.

The concept of crisis is multi-faceted, operating across various domains such as psychology, sociology, economics, and environmental studies, each adding layers to its definition.

In psychology, a crisis is a pivotal moment when an individual faces an obstacle that is, for the time being, insurmountable through usual problem-solving methods. This definition underscores the personal aspect of crisis, highlighting the intense emotional and mental stress that can occur when one’s standard coping mechanisms fail in the face of a challenge.

In a broader societal context, crises can manifest as economic downturns, political instability, or significant social unrest. Here, the term describes scenarios where the structures that support daily life are disrupted, creating widespread uncertainty and hardship. The economic crisis, for instance, involves a sudden and significant decline in financial stability, which can lead to job losses, homelessness, and a decrease in consumer confidence. This type of crisis not only impacts the immediate economic conditions but also affects long-term growth prospects and the overall well-being of a society.

Environmental crises, such as natural disasters or climate change, highlight another dimension where the term applies. These situations often require immediate, coordinated responses to mitigate damage and provide relief. The defining feature of environmental crises is their capacity to alter landscapes, displace populations, and necessitate significant shifts in how communities operate and governments function.

The complexity of a crisis can often be understood through its stages of development. Initially, there is a trigger event that disrupts the status quo. This is followed by a period of escalation, where the effects of the trigger event become more pronounced and potentially spiral out of control. The peak of the crisis is typically where the highest intensity and greatest uncertainty are felt. Subsequently, the de-escalation phase occurs, involving efforts to manage and contain the crisis, aiming to restore order and stability. Finally, there is the resolution phase, where strategies are implemented to address the root causes and to mitigate future risks.

Responses to crises are as varied as their causes. Effective crisis management often involves a blend of immediate action and long-term strategy. It requires clear communication, robust planning, and often, an innovative approach to problem-solving that considers both human and systemic factors. Leaders and decision-makers play crucial roles during crises. Their ability to make informed, empathetic, and decisive choices can greatly influence the outcome and recovery process.

Moreover, crises often catalyze reform and innovation. The adversity and urgency of a crisis can break bureaucratic inertia and economic complacency, paving the way for new technologies, policies, and practices. For example, the global financial crisis of 2008 led to increased regulatory reforms in financial markets around the world, aiming to prevent a similar catastrophe. Similarly, the ongoing challenges of climate change are driving innovations in renewable energy and sustainable practices that might not have received the same focus without the pressing need imposed by environmental concerns.

In conclusion, a crisis is not merely a moment of conflict or danger but a test of resilience and adaptability. Whether it impacts an individual or spans across global systems, the defining characteristic of any crisis is the need for an effective response. Through understanding the intricate dynamics of crises, we can better prepare for and respond to the inevitable challenges they present. This comprehension is crucial not just for survival but for the progress and development that often follows in the wake of successfully navigated crises.

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