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The Magic Square and Hexagon of Macroeconomic Policy Objectives

What should you understand by Magic Square and Hexagon, economic policy goals, and measures in macroeconomics? The explanation begins like this: Every economy, according to its economic order, pursues a number of quantitative and qualitative economic policy goals. Each relevant goal of the national economy requires a series of economic policy measures. The resulting economic policy measures are aimed at maximizing the common social welfare and economic welfare of an economy. The qualitative and quantitative target categories together form a hierarchy of objectives: the magic square and the magic hexagon.

The quantitative economic policy goals are grouped under the magic square, while the qualitative goals extend the magic square by two additional goals to form a magic hexagon.

“What is magic about this from the perspective of economists? It is probably the resulting goal harmonies and goal conflicts between the individual macroeconomic economic policy goals of the magic square and hexagon”.

Hypothesis to Review

The Magic Square – 4 Macroeconomic Policy Objectives

The magic square consists of four macroeconomic economic policy goals: steady economic growth $g_t$, a high level of employment $u_t$, a stable level of price $P_t$, and a steady foreign trade equilibrium $NX_t$.

Objective 1: Steady economic growth

Steady economic growth means that an economy should always have a stable and positive real growth rate of the gross domestic product (GDP). Assume that $Y_t$ is the real GDP-Level of your Country at Time $t$. The real GDP-growth rate for Period $t$ can be defined as follows:

g_t=\frac{(Y_t -Y_{t-1})}{Y_{t-1}}

Objective 2: High employment level and low unemployment rate

A high level of employment also promotes low unemployment rates. To quantify the rate of unemployment $u_t$, three variables are needed; Number of persons capable of working $L_t$, the number of employed $N_t$, and the number of unemployed $U_t$.

u_t=\frac{U_t}{L_t}=\frac{(L_t-N_t)}{L_t}=1-\frac{N_t}{L_t}

Objective 3: Stable price level and low inflation

A stable price level ($P_t$) also requires a low rate of inflation $\pi_t$ or price stability. Ensuring price stability in the European Union (EU) is the task of monetary policy. This is controlled by the European Central Bank (with the Deutsche Bundesbank as a member) in Frankfurt am Main in the Eurozone (Monetary Union). Before the foundation of the Monetary Union, each country controlled its own monetary policy. In the monetary union, monetary policy is coordinated collectively. The inflation rate can be calculated as follows:

\pi_{t}=\frac{P_t-P_{t-1}}{P_{t-1}}

Objective 4: Steady foreign trade balance and a current account surplus

Steady foreign trade equilibrium ideally results from the fact that the current account shows neither a surplus nor a deficit.

The Magic Hexagon – 6 Macroeconomic Policy Objectives

The magic hexagon is created by adding two qualitative macroeconomic economic policy goals to the magic square: the fair distribution of wealth, income, assets and resources and the sustainable use of environmental resources.

NX_t=X_t-\frac{IM_t}{\varepsilon}=0

Objective 5: Principle of equity in the distribution of wealth

The equitable distribution of wealth, income, assets and resources requires the correction of quantitative targets by means of the principle of justice in order to guarantee equal opportunities for all generations.

Objective 6: Principle of sustainability and environmental protection

The sustainable use of both natural and non-natural resources requires the correction of quantitative targets by means of the sustainability principle in order to guarantee the necessary environmental protection for all generations.

    The Economic Concept of Opportunity Costs

    The economic concept of opportunity costs is the most fundamental issue of economics as a social science. It explains the decision-making and behavior of economic subjects. Economic subjects are private households, firms, and the government as a public household. While explaining the economic concept of opportunity costs, focus on the question: why do people choose to do, consume, or even spend time and resources on what they do? How do you make your choices and decisions?

    Definition of Opportunity Costs

    Opportunity costs are defined as costs incurred by a forgone alternative (opportunity). A foregone opportunity can either be the opportunity to incur costs, the opportunity to gain revenues, earn profits or cause losses. Economic subjects constantly get involved in decision-making processes, where choices have to be made. Take the following examples:

    • Example 1: non-monetary opportunity costs – the reason why a student would attend high school (an institution of education) is determined by the opportunity cost incurred if the student would not attend the school e.g. the impression of the parents about their daughter or son. Such opportunity cost are not measurable in monetary units.
    • Examples 2: mental accounting – whenever you act or choose not to act in certain manner, you are weighing alternative options and therefore intrinsically accounting for cost that would be incurred by alternative mode of behavior.
    • Example 3: relative costs – a job-seeker may prefer a job that pays less, but offers a better work-life balance, at the cost of a better paying job under worse work-life balance.
    • Example 4: Specialization and relative cost/benefit advantage – the opportunity cost of Germany producing autos are the cost incurred for not producing other goods that Germany prefers to import from other countries, e.g. Coffee from Kenya.
    What are opportunity costs?
    What are opportunity costs? (C) Evansonslabs

    Literature

    The following Literature will help you to expand the spectrum of knowledge in this Field:

    • Varian, H. R. (2020). Intermediate Microeconomics: A modern approach ; media update (Ninth Edition, International Student Edition). New York, London: WW Norton et Co.

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    What is Economics?

    What is Economics, and how can students define economics as a science? Therefore, our motivation in this article is to find a general definition of economics. In much of economic literature, there is also consensus and conflict on some description of economics as a science. So how do we start? To neatly define economics in lectures, we need a broad view of the term economics.

    Consequently, Economics can be defined as an interdisciplinarysocial, and behavioral science. Therefore, economic research focuses on explaining the behavior of decision-makers. Economics also explains the implications of the behavior of the decision-makers that affect society at the microeconomicmacroeconomic, and political levels. Such an analysis of different decision-makers consequently needs an interdisciplinary approach. Decision-makers in economics are in particular private households, firms, and governments. 

    Microeconomic level

    At the microeconomic level, economics explains the human nature of making both individual rational and irrational decisions, social interactions, and behavior under risk. Individuals, organizations, and governments make allocation and distribution decisions daily, which economic subjects would like to evaluate. Economics derives the rules of determining; how efficient or optimal the decisions of economic subjects are. It, therefore, determines the necessary rules and coordination mechanisms usable in decision-making processes. Some of the coordination mechanisms include market, government, private, entrepreneurial coordination in an economy. An economy is the environmental unit of economic analysis. 

    Macroeconomic level

    Economics is also an environmental dimension of macro-environment analysis in the PESTEL-Framework in strategy management. Other PESTEL dimensions include the political, social, ecological, technological, and legal environment. At the macroeconomic level, economics discusses the aggregated effect at the level of the whole economy using the six macroeconomic objectives (magic hexagon).

    Policy Level

    At the political level, economics deals with the implication of economic decisions of different interest groups in an economy and derives policy recommendations to help maximize social welfare. Consumers, entrepreneurial, government interests are not always similar. Employees’ and employers’ political interests also differ. Therefore, economic policies are essential and help in balancing the different interests as well as maximizing the welfare of society.

    Economics deals with Rational and Irrational Behavior

    Evident in all economic literature is the issue of rational and irrational behavior as the central point of discussion. In economic theory, the economist tries to explain how people should make decisions depending on their goals and restrictions they face. Rational decisions are those decisions that respect the restrictions and goals of an individual, while irrational behavior could e.g. incur either a higher cost (not respecting restrictions) or lower utility (not respecting the goals) as compared to the rational decision. Rational decision is influence by the cost of opportunities.

    Economics is about the Maximum and the Minimum Principle

    Economists derive two principles of decision-making that drive the process of making decisions within economic subjects. The maximum principle and the minimum principle.

    The Maximum Principle

    The maximum principle suggests the following: Attain the maximum output with a predefined amount of inputs.

    What is economics?
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    The Minimum Principle

    The minimum principle suggests the following: Utilize the minimum input to attain a predefined amount of output.

    Photo by Pixabay on Pexels.com

    How to research about Economics

    Find a detailed definition of Economics in the International Encyclopedia of the Social & Behavioral Science (2001, Pages 4158-4159) via Science Direct.

    Understanding the definition of Economics

    In order to understand Economics, it is essential to differentiate between decision-making from three different perspectives: private consumption and income decisions, public consumption and revenue generation, entrepreneurial production and supply of goods and services in an economy. As discussed above, economics is the science of rational decision-making. Firstly, economists try to explain how economic subjects make rational decisions, the limitations of rational decision-making, human interactions and their outcomes. Secondly, economists try to capture the limits of rational behavior and explain how decision-making takes place under imperfect environment conditions; e. g. information asymmetries, uncertainty, imbalance in power between decision-makers … etc.

    Economic subjects

    The concept of economic subjects is the notion of viewing people in an economy as (1) private households, (2) as firms (or organizations) and as (3) the government (also a form of organization). In general, this means that there are three economic subjects;

    • Private Households
    • Firms (private and public organizations)
    • Government (Public household and organization)

    What is an Economy?

    An economy is the analytical unit of interest for all economic analysis and includes the people, biosphere and all resources available e.g. a political unit (e.g. Germany, China, France, Ghana) or a unit specified by certain characteristics such as a continent, a supranational unit, an international coalition of nations, etc.

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