National Economy

Goals and Characteristics of a National Economy

Every country wants its economy to be successful. Thus, each nation has different goals that will ensure the success and stability of its national economy. Some goals an economy might have are:

• Efficiency.
• Equity.
• Economic freedom.
• Economic growth.
• Full employment.
• Price stability

In addition to goals, every economy has its own distinguishing features and characteristics.

These distinguishing features could be based on the natural resources a country might have in abundance, like diamonds or gold. They could be based on what a country trades with other countries. They could also be based on the quality of their education systems or financial systems. Whatever it might be, each economy will have different characteristics.

However, there are a few characteristics most national economies might have in common. Some of these include:

• Open economy. This relates to an economy that is open to selling and buying goods and services in global markets. Essentially, the economy is open to free trade.

• Closed economy. This relates to an economy that is not open to selling and buying goods and services in global markets. They do not trade with any outside economy.

• Free market economy. This refers to an economy where the prices and distribution of goods and services are determined by supply and demand with little government intervention.

• Command economy. This refers to an economy where the allocation of goods and services, the rule of law, and all economic activity is controlled by the government.

• Mixed economy. This is an economy that mixes both free-market and command economy characteristics. It combines both aspects of capitalism and socialism.

History of the Modern Economy: Theories and Developments

How did each of the countries in our previous examples decide to shape their national economy? Let's take a blast to the past!

National economies before the eighteenth century weren’t classified and differentiated like we do today. Each country had their own system and methods of trade and other financial transfers. It wasn’t until the mid-eighteenth century that the father of economics, Adam Smith, expanded on the studies of French physiocrats, notably Quesnay and Mirabeau, to argue for the free market economy.

In his famous book, The Wealth of Nations (1776), he argued that the invisible hand would create social and economic prosperity for all if there was little government interference.

Figure 1. Portrait of Adam Smith, the Father of Economics. Scottish National Gallery, Wikimedia Commons.

Keynesian Era

Adam Smith's theories were dominant in economics for a long time, but they also had many critics. One of these critics was John Maynard Keynes.

John Maynard Keynes was a British economist. He believed that free-market capitalism is unstable and strongly supported government intervention. He believed that the government is in a better position to bring about good economic performance than the market forces.

In his book, The General Theory of Employment, Interest, and Money (1936), Keynes argued that by influencing aggregate demand by means of government policies, the UK could achieve full employment alongside optimal economic performance.

He proposed these ideas during the Great Depression and he was met with criticism from the British government. At the time, the British economy was experiencing a period of serious economic downturn. The government had increased welfare spending but had also raised taxes.

Figure 2. Picture of Kaynes in 1933, Wikimedia Commons

Keynes argued that this wouldn’t encourage consumption. Rather, he argued that if the government were to stimulate the economy, they needed to increase government spending and cut taxes, as this would lead to an increase in consumer demand and the overall economic activity in Britain.

However, by the end of the 1940s, Keynesian economics became more popular and soon many nations adopted his ideology. The only significant parts of the world that had rejected Keynesian principles were the communist nations. Economic historians label the years from about 1951 to 1973 as the 'Age of Keynes'.

The Free-Market Revolution

Keynes' beliefs were later met with disagreements from some other economists, namely Fredrick von Hayek and Milton Friedman.

Hayek was a firm believer in the free market and didn’t like socialism. His arguments were based on economic foundations, but he also used politics and ethics. For example, in his book The Constitution of Liberty (1960), Hayek argued that a free market system - that is protected with strong constitutions and laws, and well-defined and enforced property rights,- will allow individuals to pursue their own values and make the best use of their knowledge.

Milton Friedman started his campaign against Keynesian theories in 1957 with his book A Theory of the Consumption Function. Keynes’ model supported short-term solutions, like tax breaks, to increase consumer spending. His idea was that the government can increase economic activity without trading off future tax revenues - essentially, the government was able to have its cake (high economic growth and activity) and eat it (maintain tax revenues).

However, Friedman showed that individuals change their spending habits when real changes occur rather than temporary ones. Therefore, individuals and families would respond to changes like an income rise rather than a short term, temporary change like a stimulus check or a tax break.

Friedman wasn’t just an economist, but also a statistician. His arguments often were based on analysing empirical data and evidence, something Keynes rarely did. Because of that, Friedman could show the holes in Keynes’ frameworks and assumptions with data.

Figure 3. Milton Friedman, Wikimedia Commons.

Friedman’s economic theories, beliefs, and views were in direct opposition to Keynes’. They started another branch of economics: monetarist economics.

The key difference between these theories is that monetarist economics involves the control of money in the economy, while Keynesian economics involves government spending. Monetarists believe that if the supply of money flowing into an economy is controlled, then the rest of the market can fix itself.

Supply-Side Economics

The debate between no government intervention and government intervention would continue throughout the years. By the time Ronald Reagan became president of the US in 1981, a new form of economics had arisen: supply-side economics.

The idea is that tax cuts for wealthy investors, entrepreneurs, etc. will provide them with a greater incentive to save and invest. Their investments will then ‘trickle down’ to the wider national economy and produce economic benefits for all. Reagan often said ‘a rising tide lifts all boats’ to explain this theory.

Present-Day Economics

Today, there are many branches and competing views of economics: behavioural economics, neoclassical economics, Keynesian economics, Monetary economics, and the list goes on.

Nation economies today, though don't need economic theories to account for resources, the allocation of goods, and services, for example, because they are already being accounted for in economic systems. Economic theory today is also much more mathematical and contains a lot of statistics and computational modelling than ever before.

Structure of a National Economy

StudySmarter has many explanations that will help you learn more about the national economy whether it's for personal interest or for your exams. Let's take a sneak peek at what you can expect.

Aggregate Demand

Aggregate demand is one fundamental concept in macroeconomics. It is essential for any economy. In our Aggregate Demand explanation, you will learn what it is and its components.

Aggregate Demand Curve

Our Aggregate Demand Curve will take your understanding of aggregate demand one step further. You will see how aggregate demand can be shown graphically and what factors will cause a movement along the curve or a shift of the curve (Look at Figures 4 and 5). You will also learn two important concepts: the multiplier effect and the accelerator theory.

Figure 4. Movement Along Aggregate Demand Curve, StudySmarter Originals

Figure 5. Outward Shift of the Aggregate Demand Curve, StudySmarter Originals

Aggregate Supply

Aggregate supply is linked closely to aggregate demand. It is also another fundamental concept in macroeconomics. You will understand the difference between the short-run and long-run aggregate supply curves, how to draw them (Look at Figure 6), and the factors that determine aggregate supply.

Figure 6. Short Run Aggregate Supply Curve, StudySmarter Originals

Macroeconomic Equilibrium

Our explanation of Macroeconomic Equilibrium will take what you have learned about aggregate demand and aggregate supply, and combine them.

Circular Flow of Income

Our Circular Flow of Income explanation will take a look at open and closed economies in more detail. You will look at four circular flow (look at Figure 7) models in depth and at the end, you will be able to determine what model describes your country's economy best.