Macroeconomics 19 nov


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Macroeconomics 19 nov

  1. 1. Macroeconomics November 19 2011
  2. 2. Introduction 2
  3. 3. Scarcity, Choice and Real Cost 3 Opportunity Cost
  4. 4. Macroeconomic theory » Furnishes with a set of tools from basic postulates of human behavior » Economic analysis ALWAYS establishes reference points » Helps in understanding complex relationships – How? » Can unrelated activities be related economically? » What do you think are the problems in macroeconomic analysis? 4
  5. 5. If money is the root cause… » What is the concept of money? » Is money actually a scarce commodity? » By printing more money, can the Government solve the problem of scarcity? » If we can print more money, do we need economists? » Periods of Hyperinflation » “Too much money chasing too few goods” 5 » Money is just a claim to the final output
  6. 6. Positive Economics » Always a scenario of facts Vs. what should have been… » Positive Economics: Scientific approach to the analysis of economic events; talks about what currently is happening » Example: If the price of cloth is higher, people will but less of it » Should be reducible to some form which is testable 6
  7. 7. Normative Economics » What ought to be! » Normative Economics: Economic science that encompasses statements involving value judgments » Involved prescriptions or statements about how things should ideally be » Example: Monopolies should be regulated » Advocates specific policy prescriptions, because it uses ethical judgments 7
  8. 8. Interdependence » Microeconomics assumes that t he total output, price, quantity, employment, general price level, spending etc. are fixed, given or known » Determines how resources can be optimally allocated » What microeconomics takes as given, is what macroeconomics seeks to explain and vice versa » Macroeconomic theory has a foundation in microeconomic theory and vice versa 8
  9. 9. Economic Analysis and Managerial Decisions » Demand Forecasting » Pricing and Marketing Decisions » Cost Analysis » Investment Appraisal » Specific Industry Analysis » Government, Regulation and Policy Impact Analysis » Strategic Planning 9
  10. 10. Schools of Thought » Classical Theory » Laid the basics of Macroeconomic thinking » Keynesian Theory » Built on Classical theory to explain large scale unemployment » Neoclassical Theory » Combination of the two above » Monetarism 10
  11. 11. Macroeconomic Policy Goals » Full employment » High living standards » Price Stability » Reduction of economic inequality and removal of poverty » Rapid economic growth » External balance Vs. Overall balance 11
  12. 12. Problems of setting macroeconomic goals »Choice of goals for an economy is a controversial matter »Goals can be mutually incompatible »Universally acceptable operational definitions for all goals cannot be formulated 12
  13. 13. Revised Goals » High and rising per capita incomes » Avoiding excessively high inflation » Efficient use of human and non-human resources with minimum possible unemployment of labor » Avoidance of persistent imbalances in foreign trade and excessive resort to foreign capital 13
  14. 14. Basic Concepts » Stocks and Flows: » Both variables have a time dimension associated » Stock variables: Measured at a period of time » Flow Variables: Measured over a period of time » Some flow macroeconomic variables have a direct stock counterpart variable (investment and capital stock) 14
  15. 15. Basic Concepts » Stocks and Flows: » Stocks can change only as a result of flows » What are the following: » Inflation » Unemployment » Exports and Imports » Consumption and Investment » Money supply 15
  16. 16. Basic Concepts » Equilibrium and Disequilibrium » State of balance between two opposing forces is called equilibrium » Absence of equilibrium is called disequilibrium » State of no change over time Vs. constant change » Even during a state of disequilibrium, market constantly tries to move towards equilibrium 16
  17. 17. Basic Concepts » Statics and Dynamics » Economic variables can be either stock or flow » They can be in either equilibrium or disequilibrium » If they are in equilibrium and tend to repeat themselves – stationary equilibrium » If they are in disequilibrium, possibility of the values varying in the next period also 17
  18. 18. National and Domestic Product » Thousands of outputs produced in an economy » Some products act as inputs, others act as facilitators, ultimately they are churned out as a final product » GNP and GDP are measures of aggregate production of all goods and services which either lend to consumption or add to productive capacity 18
  19. 19. National and Domestic Product » Can we add the physical outputs of all the goods and services produced in an economy? Why or why not? » The units of measurement of each product varies » Usually multiplied with their monetary values to arrive at an aggregate 19
  20. 20. National and Domestic Product » Problems of arriving at an estimate: » Consumer goods Vs. Industrial goods » Police force, defense » Goods produced and consumed within the same household » Price effect 20
  21. 21. National and Domestic Product » Problems of arriving at an estimate: » Consumer goods Vs. Industrial goods » Police force, defense » Goods produced and consumed within the same household » Price effect » GDP and GNP are also treated as a way to estimate the value added to a process 21
  22. 22. National and Domestic Product » Problems of arriving at an estimate: » Consumer goods Vs. Industrial goods » Police force, defense » Goods produced and consumed within the same household » Price effect » GDP and GNP are also treated as a way to estimate the value added to a process 22
  23. 23. National and Domestic Product » Value added in a productive process equals the incomes paid out to suppliers of these inputs which economists call primary factors of production » Thus, GDP and GNP are measures of total economic activity during a specific period of time » This influences a variety of stick and flow macroeconomic variable 23
  24. 24. National and Domestic Product » Most importantly, Income (Y) is affected as the level of employment depends on the national and domestic products » Increase in Y signifies increase in jobs, output, better standard of living » Y is determined by the level of aggregate demand (AD) » For equilibrium to exist: Y = AD 24
  25. 25. Aggregate Consumption » Aggregate of all expenditures on current consumption goods and services » Living standards correlated to per capita consumption of goods and services » Can be related to either national income or disposable income » Consumption function establishes the relationship between aggregate consumption expenditures and aggregate income; C = C(Y) 25
  26. 26. Gross Domestic Savings (GDS) » Do households and productive sector spend all the money they make (Y)? » Income that is not spent on current consumption contributes to the savings function » Do all households spend or save the same amount? » GDS = GDP – Aggregate Consumption » What is the saving of productive sector known? »Y = C + S 26
  27. 27. Gross Domestic Capital Formation (GDCF) » Role of fixed assets in production process » GDCF consists of: » Making good the depreciation » Adding to the stock of fixed assets » Adding to inventories » Depreciation and addition to fixed assets is called gross fixed investment » What is meant by investment? » Should GDS equal GDCF? 27
  28. 28. Industrial and Agricultural Production »For Indian economy, agriculture is primary and industry output is secondary. Remaining are called tertiary services »Changes in Industrial Production is measured via IIP »Concept of base year and current year »Variety of agricultural produce way lesser »Same UoM; indices can be constructed 28
  29. 29. Wholesale, Consumer Prices and Inflation »Who is most affected by change in prices? »Can we monitor the price changes of every product or service? »Need for an index was felt as each product or service displayed a different pattern of price fluctuation »Wholesale Price Index (WPI) and Consumer Price Index (CPI) 29
  30. 30. Employment »Is full employment possible? »What is the definition of unemployment? »Problems of estimating unemployment rates »Is everybody willing to work? »Does everybody who is willing, have a job? »People is transition phase »People looking for better jobs 30
  31. 31. Balance of Payments (BoP) »Existence of economic transactions with other countries »Lending and borrowing functions »Double-entry accounting system with transactions that increase the availability of foreign exchange recorded as ___ and those that use up foreign exchange recorded as __ »Current Account, Capital Account and Official Reserve Account 31
  32. 32. Balance of Payments (BoP) »Current Account »Records imports & exports of goods and services and unilateral transfers »Exports and gifts received are __; imports and gifts made are __ »Capital Account »Records inflows and outflows of capital »Inflows are __ and outflows are __ items 32
  33. 33. Balance of Payments (BoP) »Official Reserve Account »Records changes in foreign exchange reserves and reserves of monetary gold »What is meant by Balance of Trade? »Concept of surplus or deficit »BoP account has to tally always »What happens during surplus or deficit? 33
  34. 34. Rate of Growth »Every country desires a healthy rate of growth in its National and Domestic products »2 essential rates of growth: Growth rate of GDP and growth rate of per capita GDP »Both these growth rates are measured in real rates, for a year. »What is meant by ‘real’ rates? »How is it related to population? 34
  35. 35. Business Cycles and Circular Flow of Income »Every economy goes through various phases in the business cycle »Circular flow of income: »In a simple economy where all income is consumed »In a closed economy »In an open economy »Building the model 35
  36. 36. Concept of National Product »Capacity to produce goods and services over a period of time »GNP growth rate is a powerful indicator of the growth rate of an economy »Sum of all final goods and services produced during a specified time period »Output can be measure at Market Prices of Factor Cost »Concept of value addition 36
  37. 37. Relationship ep D NNPFC D ep - -N et i n tax direct es 37 GNPFC GDPMP - NDPMP - Net indire taxes ct N et ta ind xe i r s ec t - Net income from abroad NDPFC p De - - Net income from abroad ct re di in s et xe N ta - Net income from abroad - Net income from abroad - NNPMP GNPMP - - Dep GDPFC
  38. 38. Real Vs. Nominal GNP »“Real” refers to prices or values that have been adjusted for inflation or price level fluctuations »Real GNP is the GNP in current rupees deflated for changes in the prices of items included in GNP »Nominal GNP is just expressed as current rupees »Doesn’t indicate change in price levels 38
  39. 39. Real Vs. Nominal GNP »Over time Nominal values reflect changes in »Real size of an economic variable »General level of prices »For example, if nominal GNP in 1998-99 was 16 crores compared to 7 crores in ’93-94. Does this mean output has doubled? »Real GNP for ‘93-94 is only 10 crores. What does this imply? 39
  40. 40. Real Vs. Nominal GNP »What are the situations in which Nominal GNP increases? »If more output is produced »If prices rise »What are we more interested in and why? »Concept of GNP Deflator »Real GNP = Nominal GNP *(GNP deflator for base year/GNP deflator for current year) 40
  41. 41. Practice Problems » Which of the following variable(s) will come under stock variable(s) 1. Consumer Price Index 2. GDP 3. Money Supply 4. Exports 5. Both (1) and (2) above 41
  42. 42. Practice Problems » The relationship between aggregate consumption expenditure and aggregate income of household sector is known as _____ function 1. Consumption 2. Expenditure 3. Saving 4. Income 42
  43. 43. Practice Problems » Gross Domestic Savings is the difference between 1. GDP and GNP 2.GDP and GDCF 3.National Disposable Income and GDP 4.GDP and Aggregate Consumption 5.National Disposable Income and GDP 43
  44. 44. Practice Problems » Which of the following will come under flow variable(s)? 1.Unemployment 2.Foreign Exchange Reserves 3.Consumption 4.Money Supply 5.Both (1) and (2) above 44
  45. 45. Practice Problems » The act of replacing worn out assets and creating new assets is capital formation. Then GDCF consists of 1.Making good the depreciation on existing fixed assets 2.Adding to the stock of fixed assets 3.Adding to inventories 4.Both (1) and (2) above 5.All of (1), (2) and (3) above 45
  46. 46. Practice Problems » If GDP is growing at g% per annum and population at p% per annum, then per capita GDP must be growing at ____ % 1.(g+p)/2 2.(g-p)/2 3.(p-g) 4.[(1+g)/(1+p)]-1 5.None of the above 46
  47. 47. Practice Problems » The circular flow model of a free enterprise economy shows 1.How competition achieves economic efficiency under capitalism 2.How the prices of resources, goods and assets are determined 3.How resources are distributed 4.How production and household sectors interact through markets 5.Both (2) and (4) above 47
  48. 48. Practice Problems » Which is the best indicator of economic development of a developing country? 1.National Income Deflator 2.GNP at current prices 3.Real National Income 4.Per Capita Real National Income 5.GDP Deflator 48
  49. 49. Practice Problems » Which of the following is not true with respect to stock and flow variables? 1.Both variables have time dimension 2.Flow variables are always determined by stock variables 3.Stock variables are usually affected by flow variables 4.All flow variables need not have stock variable counterparts 5.Flow variables are partly determined by stock variables 49
  50. 50. Questions???
  51. 51. Have a happy Sunday!