Macro economics


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Macro economics

  2. 2.  Essentially the study of the behaviour and performanceof the economy as a whole Deals with the functioning of the economy as a whole,including how the economy’s total output of goods andservices, the price level of goods and services and thetotal employment of resources are determined andwhat causes these magnitudes to fluctuate. Studies the relationship and interaction between thefactors and forces that determine the level and growthof output and employment, general price level andbalance of payment position of an economy.MACROECONOMICS
  3. 3. Macroeconomics has both theoretical and policy orientationsTheoretical OrientationMacroeconomic theories use macroeconomic models toexplain the bahaviour of macroeconomic variables andspecify the nature of relationship between themPolicy OrientationMacroeconomics as a policy science provides aframework and instruments, i.e., fiscal and monetary policyetc. for restructuring the economy and guiding it on the pathof growth and stabilityMACROECONOMICS
  4. 4.  Observe of Macroeconomics Study of the economic actions of individuals and smallgroups of individuals The study of particular firms, particular households,individual prices, wages, incomes, individual industry,particular commodities. In its approach, microeconomics proceeds to examinehow output and employment are allocated among individualindustries and firms with industries and how the pricesof various products of these individual firms areestablished assuming the total output, total employment andspending for all goods and services as given.MICROECONOMICS
  5. 5. MACROECONOMICS &MICROECONOMICSItem Given VariableTotaloutputMicro Total output of the economy as awholeDistribution of output, employmentand total spending amongparticular goods and services ofindividual firms and industriesMacro Distribution of output, employmentand total spending among particulargoods and services of individualfirms and industriesTotal output of the economy as awholeGeneralpricelevelMicro General Price level Relative price or exchange ratiosamong individual goods andservicesMacro Relative price or exchange ratiosamong individual goods and servicesDetermination of general price level
  6. 6. Macroeconomics and Microeconomics are not separable Analysis of the economy is not conducted separately in two watertight compartments Macroeconomic theory has a foundation in Microeconomic theoryand Microeconomic theory has a foundation in Macroeconomictheory Macroeconomics – Nation’s material well-being will be greater,the closer the economy comes to full-utilisation of its totalresources, given the allocation of resources Microeconomics – Material well-being will be greater, the closerthe economy comes to optimal allocation of resources, given thedegree of utilisation of total resources, partial to full Common basic goal – Maximum well-being for the population as awhole which can only be attained with both full utilisation andoptimum allocation of all available resourcesMACROECONOMICS &MICROECONOMICS
  7. 7. Classical Macroeconomics - Before 1930 Had not developed any coherent macroeconomic theory or model Macroeconomic thoughts were in the form of certain postulates If market forces of demand and supply are allowed tohave free play then(i) There will always be full employment in the long-run(ii) There will neither over-production nor under-production(iii) The economy will always be in equilibrium in thelong-run Government spending crowds our private investment But the great depression of 1930’s exposed the inadequacy of thetheoretical foundations of the laissez-faire doctrineGROWTH OF MACROECONOMICS
  8. 8. Keynesian Macroeconomics - 1930 –1960 Revolutionary Book – “ General theory of Employment, Interestand Money” – 1936 Keynesian macroeconomic theories are associated mainly withemployment, growth and stability. Level of output and employment in an economy is determined bythe aggregate demand. Unemployment is caused by lack of aggregate demand. Economic fluctuations are caused by demand fluctuations. The demand deficiency can be removed through compensatorygovernment spending. Started showing signs of its failure during 1970’s - StagflationGROWTH OF MACROECONOMICS
  9. 9. Post Keynesian Macroeconomics - include growth of Monetarism – Milton Friedman – A Monetary History of theUnited States Role of money is central to growth and stability of national output Shift in the emphasis from aggregate demand for real output to moneydemand and supply and its policy orientation from demandmanagement to monetary management Difference between the monetarists and Keynesians in Relationship between money supply and inflationInflation is caused by rapid expansion of money supply inthe economy and in order to control in inflation there should beconstant growth of money supply Role of GovernmentA free market economy is inherently stableGovt. or its Central bank should not adopt activediscretionary monetary policy, rather it should pursue a policy ofstable rate of growth of money supplyGROWTH OF MACROECONOMICS
  10. 10.  Supply side Economics – Arthur Laffer Change in aggregate demand will either increase inflation orunemployment rate Emphasised the role of the factors operating in the supply side of themarket Contraction in supply, given the aggregate demand curve, results in rise inprice level and inflation on one hand and fall in aggregate output and rise inunemployment on the other In crease in aggregate supply, given aggregate demand, will lead toincrease in employment and reduction in inflation More work or labour, and higher investment will lead to increase inaggregate supply Reduction in income tax Encourages more saving, work and investment In crease in Govt. revenue to reduce budget deficitGROWTH OF MACROECONOMICS
  11. 11.  Neo-Classical Macroeconomics – Robert E. Lucus Consumers, workers and producers behave rationally to promote their interest andwelfare Emphasises the role of individual’s rational expectations about future economicevents, especially those on the supply side of the economy, and about the futuregovernment policies People’s expectations about government’s monetary and fiscal policiesdetermine the behaviour of aggregate supply and aggregate demand When Govt. makes a deficit budget, people expect that rates of interest will rise They will attempt to take new loans when rates of interest are lower andtherefore, the interest rates rise immediately rather than in future If Central bank of a country increases money supply, consumers, workers andproducers will expect rationally a rise in price level On the basis of rational expectations, workers get their wages raised, producersraise their profits, lenders and bankers raise interest etc. As a result, the effect of expansion in money supply on these persons get cancelled There is no need for the Govt. to intervene in the economy through macroeconomicpoliciesGROWTH OF MACROECONOMICS
  12. 12. To find a reasonable answer and a feasible solution to the followingMacroeconomic problems What determines the levels of economic activity and employmentin a country? How is the equilibrium level of national income determined? What causes fluctuations in the national output and employment? What determines the general level of prices in a country? What causes inflation and unemployment? What determines the levels of foreign trade and trade balance? What causes trade deficits and disequilibrium in the balance ofpayments of a country? How do the monetary and fiscal policies of the government affectthe economy?IMPORTANCE OFMACROECONOMICS
  13. 13.  Macroeconomic Paradoxes – (Boulding) Results obtained fromthe study of the behaviour of individual firms or industries may lead us tomisleading conclusions about the working of the macroeconomy. Paradox of Thrift -Saving is a virtue for an individual but not for the economy as whole.Efforts to save more, reduces consumption demand and thus nationaloutput and income and also increases unemployment Wage – Employment Paradox –Cut in money wages in an individual industry will lead to moreemployment in that industry.But for the society or economy, reduction in money wages will createmore unemployment.Fall in money wages  Decline in aggregate demand  Decline inemployment since demand for labour is a derived demandIMPORTANCE OFMACROECONOMICS
  14. 14.  Understanding the Working of the Economy –Macroeconomics explains the causes of important problems of theeconomy such as unemployment, inflation, instability in foreignexchange rate. Prescribing Policy Measures –Working of the macroeconomic concepts is a bare necessity inbringing solutions to important problems like overpopulation,inflation, balance pf payments, underproduction etc. Accelerating Economic Growth –Economic growth helps in solving the problems of poverty andunemployment.Economic growth can be obtained through increase in the rate ofsaving and investment and improvement in technology (Harrod-Domar and Solow growth model)IMPORTANCE OFMACROECONOMICS
  15. 15.  Understanding Business Cycles -No unanimity in macroeconomic theory about the properexplanation of business cycle.However, fluctuations in aggregate demand due to volatile natureof investment demand together with the interaction of multiplierand accelerator provides an adequate explanation for businesscycle (Keynes). Individual Decision Making –Fall in the demand for an individual product can only beunderstood, if the causes of deficiency of aggregate demand areanalysed.Knowledge about macroeconomics helps an individual to assessthe impact of Government’s economic policy.IMPORTANCE OFMACROECONOMICS
  16. 16. SOME CONCEPTS USED IN MACROECONOMIC ANALYSIS Stock Refer to the quantity of a variable at a point of time Example Water stored in a lake Fixed deposit in a bank Number of persons employed Assets like plant, building, machinery etc. Supply of Money Accumulated SavingsFlow Expressed per unit of time Example Water flowing in or out per unit of time (per day / per week) Interest earned on the fixed deposit Annual return from fixed assets such as plant, building, machinery etc. Gross National Product Consumption Expenditure Change in InventoriesSTOCK AND FLOW VARIABLES
  17. 17. PARTIAL AND GENERAL EQUILIBRIUM Equilibrium Position of rest characterized by absence of change Position in which forces working in opposite directions are in balanceand there is no in- built tendency to deviate from this positionPartial Analysis of a part of an economy, isolated and insulated throughassumptions from the influence of the changes in rest of the economy Based on assumption of ceteris paribus Concerned with two types of economic problemsPertaining to only particular aspects economic behavior of a certainindividual , firm or industryStudies only the first-order consequences of the economic events itanalyses
  18. 18. PARTIAL AND GENERAL EQUILIBRIUM General Theory of interrelationship among all parts of the economy. Only if all consumers, all firms, all industries and all factor servicesare in equilibrium simultaneously and they are interlinked throughcommodity and factor prices Exists when• All prices are in equilibrium• Each consumer gets maximum satisfaction• All firms in the industry are in equilibrium at all prices and outputs• Supply and demand for productive resources are equal at equilibriumprices Partial equilibrium analysis is encompassed in the general equilibriumanalysis
  19. 19. STATIC AND DYNAMIC ANALYSIS Static Macro-economic phenomenon studied under static conditions. Static macro-model assumes no change in the size of the economy, nationaloutput, prices and employment Basic forces of change like, stock of capital, technology, population, nature ofbusiness organisation, tastes and preferences of the people remain constant Variables used in this analysis have no time frame - All variables belong tothe same time frame Abstraction from realityDynamic Macro-economic phenomenon studied under changing or dynamic conditions Studies the factors and forces that set an economy in motion and lead or do notlead it to a new equilibrium Takes into account the time lag involved in the process of adjustment Studies the nature and magnitude of changes and finds whether they areoscillatory (convergent or divergent) or dampening.
  20. 20. ALTERNATIVE ECONOMIC SYSTEMSEconomic System refers to the mode of production and the distribution ofgoods and services within which economic activity takes place.Broader sense – The way different economic elements., i.e., individuals,firms and government agencies are linked together to form an organic wholeMarket EconomyPrivate PropertyProfit MotivePrice Mechanism – No control by central authorityConsumers sovereigntyFreedom of enterpriseCompetitionLimited role of State
  21. 21. ALTERNATIVE ECONOMIC SYSTEMSCommand EconomyPublic ownershipCentral planning-Definite objectives and price - Authoritarian methods todetermine resource use and priceMixed EconomyPrice mechanism and economic planning working side by sidePublic sectorPrivate sectorJoint sectorFreedom and control
  22. 22. THREE PROBLEMS OF ECONOMICORGANISATIONWHAT, HOW and FOR WHOM to produceWhat goods and services are to produce and in what quantityHow to produce these goods and servicesHow these goods and services so produced are distributedamong the households
  23. 23. MARKETS SOLVING THE THREE ECONOMIC PROBLEMSWhat goods and services are to produce and in what quantity Solved through price mechanism that works through supply anddemand for goods and services Problem of nature of commodities and their quantities is decided bythe preferences of the consumers Price of a commodity reflects the tastes & preference of the consumerHigh price – Urgency of desire for certain commodity & vice-versa Price acts simultaneously as a beacon light and a warning signal forthe producer or the consumer as the case may be. Consumer sets the price and producers manufacture thosecommodities which he wants more
  24. 24. MARKETS SOLVING THE THREE ECONOMIC PROBLEMSHow to produce these goods and services Price also determines the techniques to be used for production Every producer aims at using the most efficient production process orproducing goods at minimum cost Choice of production process depends on relative prices of the factorservices and quantity of goods to be produced Producer uses expensive factor services in less quantities relative tocheap resources Capital expensive to labour – Labour intensive technique Capital relatively cheaper – Capital intensive technique Production of capital goods in larger outputs – complicated &expensive machines and techniques
  25. 25. MARKETS SOLVING THE THREE ECONOMIC PROBLEMSFor whom to produce these goods and servicesThree main activity of the economy- Production, Consumption, & Exchange Production leads to consumption Consumption necessitates production These two flows interrelatedand interdependent through exchange Households Firms Real Flow Financial Flows
  26. 26. Economic Role of Government Capitalist Economy – Limited roleMaintenance of law & order, Protection from external aggression Socialist Economy – Owns and regulates the entire consumption andproduction process Mixed Economy – Strengthens market system Household & GovernmentHousehold sector outflows - TaxesHousehold sector inflows - Transfer Payments in shape of old agepension, unemployment relief etc & purchaseof services of householdFirms and GovernmentFirm sector outflows - Corporate and other taxesFirm sector inflows – Subsidies and transfer payments to firms andpurchase of goods
  27. 27. Economic Role of Government
  28. 28. The circular flow of incomeTwo Sector Model
  29. 29. FIRMS(suppliers of goods and services,demanders of factor services)HOUSEHOLDS(demanders of goods and services,suppliers of factor services)The interdependence of goods andfactor markets
  30. 30. Q1P1QF2PF2Q2P2PF1QF1D2D2The interdependence of goodsand factor marketsPQPQRs.Rs. RsRs..RsRs..RsRs..FactorservicesGoodsGoodsFactorservicesS SD1 D1(1)Consumerdemand(4)Factorsupply(3)Factordemand(2)ProducersupplyOO