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macro economics part 1 notes

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  • 1. Module – 1:- MACROECONOMICSIntroduction to Economics:-Economics is one of those words that can be seen regularly in the newspapers and on TV news shows. Most peoplehave some vague idea of what the word economics means and in subsequent paragraphs an attempt has beenmade to describe Economics and its few concepts.Economics is the social science studying the production, distribution and consumption of goods and services. It is acomplex social science that spans from mathematics to psychology. At its most basic, however, economics considershow a society provides for its needs. Its most basic need is survival; which requires food, clothing and shelter.The term economics comes from the Ancient Greek oikonomia, "management of a household, administration"from oikos, nomos, "custom" or "law", hence "rules of the house (hold)".Economics has been studied since sixteenth century and is the oldest of the social studies. Most of the businessdisciplines arose in attempt to fill some of the institutional and analytical gaps in the areas with which economicswas particularly well suited to examine. The subject matter examined in economics is the behavior of consumers,businesses, and other economic agents, including the government in them production and allocation processes.Therefore, any business discipline will have some direct relation with the methods or at least the subject matterwith which economists deal.So, Economics is the study of the allocation of scare resources to meet unlimited human wants.In other words, economics is the study of human behavior as it pertains to the material well-being of people (aseither individuals or societies).Adam Smith, generally known as the father of Economics defined Economics as ‘science of wealth’.Robert Heilbroner describes economics as a "Worldly Philosophy."It is the organized examination of how, why and for what purposes people conduct their day-today activities,particularly as relates to the production of goods and services, the accumulation of wealth, earning incomes,spending their resources, and saving for future consumption. This worldly philosophy has been used to explain mostrational human behavior.Economics is best described as the study of humans behaving in response to having only limited resources (scareresources) to fulfill unlimited wants and needs. Scarcity refers to the limited resources in an economy.The concept of Economics has been changing during different stages of developing Economics as subject. Thedifferent stages are as follows:-1. Wealth Concept:- During the eighteenth and the early part of nineteenth century, classical economists, such asAdam Smith, J.B. Say and Walkar defined Economics as the science of wealth. Adam Smith systematized the conceptin the form the book which was entitled as ‘‘an enquiry into the nature and cause of the wealth of nations.’’ Theseeconomists stated that Economics is related to and concerned with wealth. 1 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55
  • 2. Excessive emphasis on wealth enabled the businessmen and industrialists to amass wealth by any means, whetherfair or foul. Social reformers like Thomas, Carlyle, John Ruskin, Charles Dickens and William Morris reacted sharplyto the wealth concept of Economics. They branded Economics as a dismal science, gospel of Mammon and scienceof bread and butter etc. Wealth concept of Economics was bitterly criticized, because it assumed wealth as an endof human activities. If it is accepted in life, there will be no place for love, affection, sympathy and patriotism.2. Welfare Concept:- According to this concept, Economics is not the science of wealth but it is concerned withhuman welfare. It studies and emphasizes wealth as a means of satisfying human wants, not as an end of humanactivities. Marshall was the pioneer of welfare thought. According to him, ‘‘Political Economy or Economics is thestudy of mankind in the ordinary business of life. Thus it is on the one side a study of wealth and on the other, andmore important side a part of the study of man.’’ The important feature of welfare concept is Economics is thescience of human welfare.Welfare concept was also criticized by the pioneers of ‘Scarcity Concept’. According to these economists, it will bean injustice to the subject, if it is restricted to ordinary business of life, concerned with economic activities andrelated to human welfare only.3. Scarcity Concept:- The profounder of this concept was ‘Lionel Robbins’. According to him, ‘‘Economics is thescience, which studies human behaviors as a relationship between ends and scarce means which have alternativeuses.’’ The important features of this concept are:(i) Economics is a positive science. (ii) Economics is the study of human behavior. (iii) Our wants are unlimited.(iv) Our resources are limited/scarce. (v) Resources can be put to alternative uses.According to this approach certain universal truth are regarded as the basis of economic problems. Every individualand economy has unlimited wants and scarce means to satisfy these wants. Inability to satisfy unlimited wants withlimited resources creates the problems of choice making i.e., fixing priority of wants to be satisfied. As resources canbe put to alternative uses, we will have to take decision as to which specific want should be satisfied with particularmeans. In this way, choice making or decision making is the means of tackling all these economic problems.4. Development Concept:- Scarcity concept explains the presence of economic problems. It is concerned with thepositive aspect of the subject. The profounder of this concept is Professor Samuelson, who presented the growth-oriented definition of Economics. According to him, ‘‘Economics is the study of how man and society choose, with orwithout the use of money to employ scarce productive resources, which could have alternative uses, to producevarious commodities over time and distribute them for consumption now and in the future among various peopleand groups of society.The important features of this concept may be summarized as under:(i) Problem of choice making arises due to unlimited wants and scarce means. (ii) Wants have tendency to increasein the modern dynamic economic system. (iii) Economics is not concerned with the identification of economicproblems but it should also suggest ways and means to solve the problems of unemployment, production, inflationetc. (iv) Economists should also suggest how the resources of the economy should be distributed among variousindividuals and groups.(v) Economists should also point out the plus and minus points of different economic systems.Economics can be classified into two general categories. (1) Microeconomics and (2) Macroeconomics. 2 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55
  • 3. Microeconomics is concerned with decision-making by individual economic agents such as firms and consumers.In other words, microeconomics is concerned with the behavior of individuals or groups organized into firms,industries, unions, and other identifiable agents.Macroeconomics is concerned with the aggregate performance of the entire economic system. Unemployment,inflation, growth, balance of trade, and business cycles are the topics that occupy most of the attention of studentsof macroeconomics.Macroeconomics may be defined as that branch of economic analysis which studies the behavior of not oneparticular unit, but of all the units combined together. Macroeconomics is a study in aggregates.Scope/Field of Macroeconomics:-The scope/field covered by macroeconomics may be set forth below:-  Theory of Income, Output and Employment with its two constituents, namely the theory of consumption function and the theory of investment function. The theory of business cycles is also a part and parcel of the theory of income, output and employment.  Theory of Prices with its constituents of the theories of inflation, deflation and reflation.  Theory of Economic growth dealing with the long-run growth of income, output and employment as applied to developed and underdeveloped countries.  Macro Theory of Distribution dealing with the relative shares of wages and profits in the total national income.Importance of Macroeconomics:- The growing popularity of macroeconomics naturally raises the question:why should we go in for macroeconomics? What is the main justification in having it as a distinct branch of moderneconomic theory? Is not microeconomics adequate in itself? Where, then, lies the necessity of macroeconomics?The argument may at first, appear logical. But, as we shall see, there are several pitfalls in a reasoning of this type. Itis not possible to discover the behavior of the aggregate from the behavior of individual units. But, for the present,we are concerned with pointing out the main justification of macroeconomics.As popularity for macroeconomics is growing few of the importance of macroeconomics are listed below:  The study of macroeconomics becomes indispensable for the formulation and successful execution of govt. economic policies.  The study of macroeconomics is indispensable for understanding the working of the economy of a country.  No science can study its entire field without attempting some sort of aggregative approach.  The study of macroeconomics is indispensable even for the purpose of building and developing microeconomics.  The study of microeconomics can be defended on the ground that it is indispensable for the proper and accurate knowledge of the behavior-patterns of the aggregate variables.  Macro economics has afforded an inconsiderable help to govt. all over the world in formulating and implementing appropriate economic policies.  The study of macro economics is very important for evaluating the overall performance of the economy in terms of national income. 3 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55
  • 4.  The popularity of macroeconomics has greatly increased in recent years on account of the fact that it deals with most of the controversial and challenging issues of the day, namely, Unemployment, inflation, growth, balance of trade, and business cycles.Difference between Microeconomics and Macroeconomics:The difference between Microeconomics and Macroeconomics may be summarized as below:- 1. The word ‘micro’ has been derived from the Greek word ‘micros’ which means small. Microeconomics is the study of economic actions of individuals and small groups of individuals. On the contrary, macroeconomics is the study of aggregates. It is the study of the economic system as a whole. 2. The basis of microeconomics is the price mechanism which operates with the help of demand and supply forces. These forces help to determine the equilibrium price in market. On the other hand, the basis of macroeconomics is national income, output and employment which are determined by aggregate demand and aggregate supply. 3. The main objectives of microeconomics on demand side are to maximize utility whereas on supply side is to maximize profits at minimum cost of production. On the contrary, the main objectives of macroeconomics are full employment, economic growth, price stability and favorable balance of payment. 4. Microeconomics is based on different assumptions concerned with rational behavior of individuals. On contrary, macroeconomics bases its assumptions on such variables as the aggregate volume of the output of the economy. 5. Microeconomics is based on the partial equilibrium analysis which helps to explain the equilibrium conditions of an individual, a firm or an industry. On the contrary, macroeconomics is based on general equilibrium analysis which is an extensive study of a number of economic variables and their interrelations etc. 6. Microeconomics is considered as a static analysis. On the other hand, macroeconomics is considered as a changing analysis.Limitations of Macro Economics Fallacy of Composition:- In Macro economic analysis the “fallacy of composition” is involved, i.e. aggregate economic behavior is the sum total of the economy of individual activities. But what is true of individuals is not necessarily true to the fiscal entirely. For instance, savings are a private virtue but a public vice. If total savings in the economy increases, they may initiate a depression unless they are invested. Again, if an individual depositor withdraws his money from the bank, there is no risk. But if all depositors simultaneously do this, there will be a run on the banks and the banking system will be affected adversely. To Regard the Aggregates as Homogenous:- The main defect in macro analysis is that it regards the aggregates as homogenous without caring about their internal composition and structure. The average wage in a nation is the sum total of wages in all professions, i.e. wages of clerks, typists, teachers, nurses etc. But the volume of aggregate employment depends on the relative structure of wages rather than on the average wage. If, for instance, wages of nurses increase but of typist rises much aggregate employment would increase. 4 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55
  • 5. Aggregate Variables may not be Important Necessarily:- The aggregate variables which form the economic system may not be of much significance. For instance, the national income of a country is the total of all individual income. A hike in national income does not mean that individual incomes have risen. The increase in national income might be the result of the increase in the incomes of a few rich people in the nation. Thus a rise in the national income of this type has little significance from the point of view of the community. Indiscriminate Use of Macro Economics Misleading:- An indiscriminate and uncritical use of macro economics in analyzing the complexities of the real world can frequently be misleading. For instance, if the policy measures needed to achieve and maintain full employment in the economy are applied to structural redundancy in individual firms and industries, they become irrelevant. Likewise, measures aimed at controlling general prices cannot be applied with much advantage for controlling prices of individual products. Statistical and Conceptual Difficulties:- The measurement of macro economics concepts involves a number of statistical and conceptual complexities. These problems relate to the aggregation of micro economic variables. If individual units are almost similar, aggregation does not present much difficulty. But if micro economic variables relate to dissimilar individual units, their aggregation into one aggregation into one macroeconomic variable may be incorrect and hazardous.National Income:-National Income is defined as the sum total of all the goods and services produced in a country, in a particularperiod of time. Normally this period consists of one year duration, as a year is neither too short nor long a period.National product is usually used synonymous with National income.In estimating national income, only productive activities are included in the computation of national income. Inaddition, only the values of goods and services produced in the current year are included in the computation ofnational income. Hence, gain from resale is excluded but the services provided by the agents are counted. Similarly,transfer payments are excluded as there is income received but no good or service produced in return. However,not all goods and services from productive activities enter into market transactions. Hence, imputations are madefor these non-marketed but productive activities eg imputed rental for owner-occupied housing. Thus, nationalincome refers to the market value or imputed value of additional goods and services produced and servicesperformed in the current period.Alfred Marshall in his ‘Principle of Economics’ (1949) defines National income as “The labor and capital of a country,acting on its natural resources, produce annually a certain net aggregate of commodities, material and immaterial,including services of all kinds…..and net income due on account of foreign investments must be added in. This is thetrue net National income or Revenue of the country or the national dividend.”Irving Fisher defined national income as “The national dividend or income consists solely of services as received bythe ultimate consumers, whether from their material or from human environments. Thus, a piano or an overcoatmade for me this year is not a part of this year’s income, but an addition to capital. Only the services rendered to meduring this year by these things are income.” 5 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55
  • 6. Basic Concepts in National Income:-> Gross Domestic Product (GDP):- Gross Domestic Product is the market value of the final goods and servicesproduced within the domestic territory of a country during one year inclusive of depreciation.Gross Domestic product (GDP) refers to the total value of goods and services produced within the geographicalboundary of a country before the deduction of capital consumption.> GDP at Constant Prices and Current Prices:- If the domestic product is estimated on the basis of the prevailingprices, it is called GDP at current prices.If the GDP is measured on the basis of some fixed prices, that is prices prevailing at a point of time or in some baseyear, it is known as GDP at constant or real gross domestic product.> GDP at Factor Cost and GDP at Market Price:- GDP at factor cost is estimated as the sum of net value added bydifferent producing units and the consumption of fixed capital, we can also estimate GDP as the sum of domesticfactor incomes and consumption of fixed capital.GDP at Market Price is estimated by deducting the value of intermediate consumption from the value of outputproduced by all the producers within the domestic territory of a country. In other words, it is estimated as the sumtotal of gross value added at the market price.> Net Domestic product (NDP):- Net Domestic Product refers to the total value of goods and services producedwithin the geographical boundary of a country after the deduction of capital consumption.Net Domestic Product at market price is the market value of final goods and services produced by all the producersin the domestic territory of a country during an accounting year exclusive of consumption of fixed capital. It is equalto the net value added at market price> Gross National Product (GNP):- Gross National Product refers to the total value of goods and services produced byproductive factors owned by residents of the country both inside and outside of the country before the deduction ofcapital consumption.GNP at market price is sum total of all the goods and services produced in a country during a year and net incomefrom abroad. GNP is the sum of Gross Domestic Product at Market Price and Net Factor Income from abroad.> Net National Product (NNP):- Net National Product refers to the total value of goods and services produced byproductive factors owned by residents of the country both inside and outside of the country after the deduction ofcapital consumption.> NNP at Factor Cost:- Net National Product at factor cost is also called as National income. Net National Product atfactor cost is equal to sum total of value added at factor cost or net domestic product at factor cost and net factorincome from abroad. 6 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55
  • 7. > Private Income:- Central Statistical Organization defines Private Income as “the total of factor income from allsources and current transfers from the government and rest of the world accruing to private sector” or in otherwords the private income refers to the income from socially accepted source including retained income ofcorporation.> Personal Income:- Prof. Peterson defines Personal Income as “the income actually received by persons from allsources in the form of current transfer payments and factor income.”Personal income is that income which is actually received by the individuals or households in a country during theyear from all sources.> Disposable Personal Income:- Prof. Peterson defined Disposable Income as “the income remaining withindividuals after deduction of all taxes levied against their income and their property by the government.”Disposable Income refers to the income actually received by the households from all sources. The individualcandispose this income according to his wish, as it is derived after deducting direct taxes. 7 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55
  • 8. 8 BY: VIKRAM.G.B Lecturer, P.G Dept of Commerce Vivekananda Degree College, Bangalore-55