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Module 1
INTRODUCTION OF
MACRO ECONOMICS
2
Session Outline
• Classification of economics
• Development of macroeconomics
• Meaning and Definition of macro Economics
• Nature and Scope of Macro Economics
• Importance of macro Economics
• Limitations of macro Economics
• Macro Problems
• Macro Theories
• Basic concepts of macroeconomics
• Policy instruments
• Diagnosing health of the economy
• Circular flow of income
• Interdependence of Micro and Macro
• Micro Vs Macro
3
Classification of Economics
• Macroeconomics
• Microeconomics
4
• Microeconomics deals with the behavior of
individual entities like individuals, markets,
firms, households, etc.
• Thus it looks into the micro aspects of the
economy, whereas macro economics studies
the broader aspects of the economy and
studies the behavior of an economy as a
whole.
Development of Macroeconomics
5
Development of Macroeconomics
• Keynes pioneered a new approach to
macroeconomics and macroeconomic policy.
• Any discussion on macroeconomics starts with
J M Keynes, the famous economist.
6
• Prior to Keynes, the business cycles were considered
to be inevitable, and there was no concrete approach
to solve these problems. These economists known as
Classical economists focused only on the micro
aspects of the economy. The Great Depression of
1930s left many of these economists helpless.
• In this backdrop, Keynes came up with a new
approach to look at the economy. In his book, 'The
General Theory of Employment, Interests and
Money'.
Development of Macroeconomics
7
• Keynes argued that it is possible that high unemployment and
underutilization of the capacities may take place and continue
in the market economy. He also argued that government can
play a bigger role during the economic depressions by
effective utilization of monetary and fiscal policies.
• After the World War II, the focus of economics was just aimed
at countering unemployment and inflation, and some
economists proposed a fixed money growth rate to address
these issues like inflation and unemployment. Hence these
economists were called as monetarists as they have given
importance to money.
Development of Macroeconomics
8
Development of Macroeconomics
• In the last few decades, another school of thought
has gained prominence among noted economists.
These economists opine that people should be given
enough incentives for their earnings, rather than
imposing taxes on their earnings. This group of
economists advocates incentives for savings, known
as supply side economists.
MEANING OF MACRO ECONOMICS
• According to Prof. Ackley,” Macro Economics deals with
the economic affairs in the large, it concerns the overall
dimensions of economic life.”
• Macro economics is the study of aggregate behaviour of the
economy as a whole.
• It is concerned with the Macro Economic Problems such as
growth of output and employment, NI, Rates of Inflation and
Deflation , BOP, Trade cycles , Exchange Rates, Total
Investment, Total Demand, etc………..
• It is the study of Interrelationships among these various
aggregates.
Scope of Macro Economics
1. Theory of national Income
2. Theory of Output and Employment
3. Theory of Prices
4. Theory of Economic Growth
5. Theory of International Trade
6. Theory of Business Cycles
7. Theory of Distribution
Importance of Macro Economics
1. Formulation of Successful Economic Policies
2. Regulation and Control of entire economy
3. Study large and Complex developing Micro Economics
4. Tracing of Economic Problem.
5. Helpful in Economic Planning
6. Study of changes in Price level
7. Study of Theories of shifting Equilibrium
8. Helpful in understanding the Dis-equilibrium in BOP
9. Full employment
10. High living standards
11.Reduction of economic inequality
12.Rapid economic growth
13.Steady foreign exchange position
12
Full employment
13
High level of output (GDP)
• The ultimate aim of any economy is to provide the desired
goods and services. The economy should be in a position to
offer these goods and services in ample number. To measure
the output of any economy, Gross Domestic Product (GDP) is
the most comprehensive estimate. GDP measures the market
value of the entire output in a country during a particular
year.
• There are two variants in GDP- Nominal and Real. When
nominal GDP is adjusted for inflation, it gives real GDP.
• The importance of GDP can be analyzed by the fact that any
predictions regarding the future growth or fall in the economy
or date on the past economic performances are made in the
GDP percentage. In the recent figures released by the Central
Statistical Organization, India’s economy grew by 9.4%, in
the second quarter of 2007.
14
Price Stability
• Stable prices are the third macroeconomic
objective. Consumer price index (CPI) is the most
commonly used measure of overall price level in an
economy. CPI is the measure of the cost of
different types of goods bought by the average
customer. Inflation denotes the rise or fall in
general price level in the economy. Inflation rates,
shows the rate of change in the price index. When
the inflation is high, the purchasing power of the
customers reduces.
• A negative fall in the prices is known as deflation,
as witnessed during the Great Depression of
1930s. Whereas, hyperinflation refers to the rise in
prices by thousands of percentage points, resulting
in the collapse of the price systems. Hyperinflation
was witnessed in Weimer Germany in the 1920s
and again in Brazil in 1980s and Russia in 1990s.
15
Sustainable Balance of Payments
• Globalization has resulted in increased transactions
between a country and the rest of the world.
Balance of Payments records all these transactions,
both imports and exports. Countries keep a close
watch on their international trade.
• The barometer that shows the efficiency of
international trade is the net exports. It is the
difference between the value of exports and value
of imports. Net exports are also called as the
balance of trade.
• Every country desires to have a positive balance of
trade.
16
Economic growth
• Every country wishes to and strives for
having a constant growth in its economy.
There are two parameters that judge the
rate of growth that an economy achieves.
 Increase in production possibility curve or
schedule
 Growth in GDP or per capita income
• If GDP is growing at g% per annum and
population at p%, per capita GDP must be
growing by= (1+g / (1+p) - 1
Limitations of Macro Economics
1. Fallacy of Composition
2. To regard the Aggregates as Homogeneous
3. Aggregate Variables may not be important
Necessarily
4. Indiscriminate Use of Macro Economics
misleading
5. Statistical and Conceptual Difficulties.
Macro Problems
1. Disequilibrium in BOP
2. Level of Unemployment
3. Low level of Aggregate Demand
4. Inflation and Deflation
5. Situation of Depression
6. Lack of Investment
7. Less Economic Growth
Macro Theories
1. Theory of National Income
2. Theories of Income, Output and Employment
3. Theories of Investment
4. Theories of Money
5. Theories of Interest Rates
6. Theories of Inflation
7. Theories of Business Cycles
8. Theories of Growth
20
Basic Concepts
• Stocks and Flows
• Equilibrium and Disequilibrium
• Statics and Dynamics and Comparative
Static
21
Basic Concepts in Macroeconomics
• In macroeconomics study, various variables are used. Some
are stock variables and some are flow variables.
Variables like money supply, CPI,
Foreign exchange reserves, which can
be measured at any given point of
time are called as stock variable.
• Whereas variables like GDP, inflation,
imports, consumption and investment,
which can be measured only over a period
of time, are flow variables.
22
Basic Concepts in Macroeconomics
• Equilibrium reflects balance between the opposing
forces, whereas disequilibrium reflects lack of such
balance.
• In economic parlance, equilibrium does not mean a
motionless state; rather, here the action is more
repetitive in nature.
• Economic models consist of stock and flow variables.
These can be either in the state of equilibrium or
disequilibrium at a given point of time.
• Models that do not consider the behavior of variables
from one time period to another in an explicit manner
are called ‘static’ models.
• Dynamic models consider the movements of variables
over different time periods in an explicit manner.
• Comparative Statics is the method of analysis in which
different equilibrium situations are compared.
23
Diagnosing Health of the Economy
• National Product and Domestic Product
• Aggregate Consumption
• Gross Domestic Savings
• Gross Domestic Capital Formation
• Wholesale Prices, Consumer Prices and Inflation
• Employment
• Balance of Payments
• Rate of Growth
24
Policy Instruments
• Fiscal Policy
• Monetary Policy
25
Fiscal Policy
• Fiscal policy is concerned with the use of taxes and
government expenditures. Government has to meet various
expenditures like salaries, defense expenses, infrastructure
development, etc. Another part of government expenditure
also goes in the form of transfer payments like financial
assistance to the elderly and unemployed. All these expenses
leave a positive effect on the overall economy. The impact of
government spending is also felt on the overall spending in
the economy, thus influencing the size of the GDP.
26
Fiscal policy
• The other part of the fiscal policy is generation of
revenues for the government. Taxes are the main
source of revenue for any government. Taxes
affect the economy and the individuals in two
ways. First, taxes imposed on the income of the
people bring down the disposable income in the
hands of the consumers. This reduces the
spending in the economy. Second, the taxes
levied on goods and services make them costlier.
This discourages the firm to invest in capital
goods.
27
Monetary Policy
• Monetary policy is the second most widely
used macroeconomic policy instrument.
Monetary policy helps government,
managing the nation’s money, credit, and
banking system. There are various entities
that are part of the monetary system of
an economy. Central bank regulates the
monetary system, and other entities like
banks, insurance companies, NBFCs are
also a part of the monetary system.
28
Monetary Policy
• In India, Reserve Bank of India is the
custodian of the monetary system of the
economy. Central bank brings changes in
the interest rates, reserve requirements,
etc. These changes make significant
impact on the overall functioning of the
economy.
• For example, the lowering of interest
rates on housing loans helped the growth
of the housing sector. As a result of low
rate of interest, it became easier to avail a
housing loan and to own a house. This has
resulted in the growth of many allied
industries as well.
29
Exchange Rate Policy
• Exchange rates are determined by the
demand and supply functions.
• India follows a flexible exchange rate
policy, which is determined by the demand
and supply, where RBI has a right to
intervene in the market. In order to
regulate the foreign exchange
transactions, government has come out
with an act FERA, which was replaced by
Foreign exchange management act
(FEMA).
30
Employment Policy
• Employment policies are adopted by
government in order to increase the
employment level in the country. As
a part of this policy, governments
come out with various polices.
For example, in India, government has
introduced various policies and schemes
like, Jawahar Rozgar Yojna etc.
31
Price and Incomes Policy
• This policy aims at regulating the prices in the
market and also to ensure the minimum
wages to the workers.
32
International Trade Policy
• Globalization has given a big push to the international trade. This
has resulted in framing of specific polices by many countries to
cope with the new challenges. International trade policy
addresses issues like tariff and non tariff barriers.
• In line with the changing economic scenario, government came
out with export-import (EXIM) policy in 1997. The policy’s
primary aim is to increase the exports. It has been renamed as
foreign trade policy to reflect the new approach.
• Example: The recent policy announced in January 2006 has taken
up a series of policy initiatives to fine tune the policy 2002-07.
The policy aims at bringing down the transaction costs,
accelerating the exports and making the country a manufacturing
hub for quality goods and services. SEZs to promote not only
manufactured goods but also agricultural products. Special
emphasis is placed on exploiting Indian Labour skills to further
exports.
33
The Circular Flow of Income
• Two Sector Economy
• Closed Economy
• Open Economy
34
Two-Sector Economy
(When All Income is Consumed)
Household Sector
Private Consumption
(C) Rs.1000
Productive Sector
Wages and Profits (i.e.
income (Y)
Rs.1000
C
Y
C
AD
AD
Y
ium
AtEquilibr




:
35
Closed Economy
Household
Sector
Private
Consumption (C)
Rs.800
Productive
Sector
Wages and Profits
(i.e. income (Y)
Rs.1000
Savings (S)
Rs.200
Investment
Rs.200
I
S
ium
InEquilibr
I
C
S
C
AD
AD
Y
ium
AtEquilibr






:
36
Open Economy
Household Sector
Private Consumption
(C) Rs.800
Productive Sector
Wages and Profits (i.e.
income (Y) Rs.1000
Savings (S) Rs.100
Imports (M) Rs.50
Taxes (T) Rs.50
[Withdrawals (W) Rs.200]
Investment (I) Rs.80
Exports (E) Rs.60
Government
Expenditure (G) Rs.60
[Injections (J) Rs.200]
J
C
X
G
I
C
Y
AD
Y
ium
AtEquilibr







:

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Introduction to Macroeconomics: Key Concepts and Theories

  • 2. 2 Session Outline • Classification of economics • Development of macroeconomics • Meaning and Definition of macro Economics • Nature and Scope of Macro Economics • Importance of macro Economics • Limitations of macro Economics • Macro Problems • Macro Theories • Basic concepts of macroeconomics • Policy instruments • Diagnosing health of the economy • Circular flow of income • Interdependence of Micro and Macro • Micro Vs Macro
  • 3. 3 Classification of Economics • Macroeconomics • Microeconomics
  • 4. 4 • Microeconomics deals with the behavior of individual entities like individuals, markets, firms, households, etc. • Thus it looks into the micro aspects of the economy, whereas macro economics studies the broader aspects of the economy and studies the behavior of an economy as a whole. Development of Macroeconomics
  • 5. 5 Development of Macroeconomics • Keynes pioneered a new approach to macroeconomics and macroeconomic policy. • Any discussion on macroeconomics starts with J M Keynes, the famous economist.
  • 6. 6 • Prior to Keynes, the business cycles were considered to be inevitable, and there was no concrete approach to solve these problems. These economists known as Classical economists focused only on the micro aspects of the economy. The Great Depression of 1930s left many of these economists helpless. • In this backdrop, Keynes came up with a new approach to look at the economy. In his book, 'The General Theory of Employment, Interests and Money'. Development of Macroeconomics
  • 7. 7 • Keynes argued that it is possible that high unemployment and underutilization of the capacities may take place and continue in the market economy. He also argued that government can play a bigger role during the economic depressions by effective utilization of monetary and fiscal policies. • After the World War II, the focus of economics was just aimed at countering unemployment and inflation, and some economists proposed a fixed money growth rate to address these issues like inflation and unemployment. Hence these economists were called as monetarists as they have given importance to money. Development of Macroeconomics
  • 8. 8 Development of Macroeconomics • In the last few decades, another school of thought has gained prominence among noted economists. These economists opine that people should be given enough incentives for their earnings, rather than imposing taxes on their earnings. This group of economists advocates incentives for savings, known as supply side economists.
  • 9. MEANING OF MACRO ECONOMICS • According to Prof. Ackley,” Macro Economics deals with the economic affairs in the large, it concerns the overall dimensions of economic life.” • Macro economics is the study of aggregate behaviour of the economy as a whole. • It is concerned with the Macro Economic Problems such as growth of output and employment, NI, Rates of Inflation and Deflation , BOP, Trade cycles , Exchange Rates, Total Investment, Total Demand, etc……….. • It is the study of Interrelationships among these various aggregates.
  • 10. Scope of Macro Economics 1. Theory of national Income 2. Theory of Output and Employment 3. Theory of Prices 4. Theory of Economic Growth 5. Theory of International Trade 6. Theory of Business Cycles 7. Theory of Distribution
  • 11. Importance of Macro Economics 1. Formulation of Successful Economic Policies 2. Regulation and Control of entire economy 3. Study large and Complex developing Micro Economics 4. Tracing of Economic Problem. 5. Helpful in Economic Planning 6. Study of changes in Price level 7. Study of Theories of shifting Equilibrium 8. Helpful in understanding the Dis-equilibrium in BOP 9. Full employment 10. High living standards 11.Reduction of economic inequality 12.Rapid economic growth 13.Steady foreign exchange position
  • 13. 13 High level of output (GDP) • The ultimate aim of any economy is to provide the desired goods and services. The economy should be in a position to offer these goods and services in ample number. To measure the output of any economy, Gross Domestic Product (GDP) is the most comprehensive estimate. GDP measures the market value of the entire output in a country during a particular year. • There are two variants in GDP- Nominal and Real. When nominal GDP is adjusted for inflation, it gives real GDP. • The importance of GDP can be analyzed by the fact that any predictions regarding the future growth or fall in the economy or date on the past economic performances are made in the GDP percentage. In the recent figures released by the Central Statistical Organization, India’s economy grew by 9.4%, in the second quarter of 2007.
  • 14. 14 Price Stability • Stable prices are the third macroeconomic objective. Consumer price index (CPI) is the most commonly used measure of overall price level in an economy. CPI is the measure of the cost of different types of goods bought by the average customer. Inflation denotes the rise or fall in general price level in the economy. Inflation rates, shows the rate of change in the price index. When the inflation is high, the purchasing power of the customers reduces. • A negative fall in the prices is known as deflation, as witnessed during the Great Depression of 1930s. Whereas, hyperinflation refers to the rise in prices by thousands of percentage points, resulting in the collapse of the price systems. Hyperinflation was witnessed in Weimer Germany in the 1920s and again in Brazil in 1980s and Russia in 1990s.
  • 15. 15 Sustainable Balance of Payments • Globalization has resulted in increased transactions between a country and the rest of the world. Balance of Payments records all these transactions, both imports and exports. Countries keep a close watch on their international trade. • The barometer that shows the efficiency of international trade is the net exports. It is the difference between the value of exports and value of imports. Net exports are also called as the balance of trade. • Every country desires to have a positive balance of trade.
  • 16. 16 Economic growth • Every country wishes to and strives for having a constant growth in its economy. There are two parameters that judge the rate of growth that an economy achieves.  Increase in production possibility curve or schedule  Growth in GDP or per capita income • If GDP is growing at g% per annum and population at p%, per capita GDP must be growing by= (1+g / (1+p) - 1
  • 17. Limitations of Macro Economics 1. Fallacy of Composition 2. To regard the Aggregates as Homogeneous 3. Aggregate Variables may not be important Necessarily 4. Indiscriminate Use of Macro Economics misleading 5. Statistical and Conceptual Difficulties.
  • 18. Macro Problems 1. Disequilibrium in BOP 2. Level of Unemployment 3. Low level of Aggregate Demand 4. Inflation and Deflation 5. Situation of Depression 6. Lack of Investment 7. Less Economic Growth
  • 19. Macro Theories 1. Theory of National Income 2. Theories of Income, Output and Employment 3. Theories of Investment 4. Theories of Money 5. Theories of Interest Rates 6. Theories of Inflation 7. Theories of Business Cycles 8. Theories of Growth
  • 20. 20 Basic Concepts • Stocks and Flows • Equilibrium and Disequilibrium • Statics and Dynamics and Comparative Static
  • 21. 21 Basic Concepts in Macroeconomics • In macroeconomics study, various variables are used. Some are stock variables and some are flow variables. Variables like money supply, CPI, Foreign exchange reserves, which can be measured at any given point of time are called as stock variable. • Whereas variables like GDP, inflation, imports, consumption and investment, which can be measured only over a period of time, are flow variables.
  • 22. 22 Basic Concepts in Macroeconomics • Equilibrium reflects balance between the opposing forces, whereas disequilibrium reflects lack of such balance. • In economic parlance, equilibrium does not mean a motionless state; rather, here the action is more repetitive in nature. • Economic models consist of stock and flow variables. These can be either in the state of equilibrium or disequilibrium at a given point of time. • Models that do not consider the behavior of variables from one time period to another in an explicit manner are called ‘static’ models. • Dynamic models consider the movements of variables over different time periods in an explicit manner. • Comparative Statics is the method of analysis in which different equilibrium situations are compared.
  • 23. 23 Diagnosing Health of the Economy • National Product and Domestic Product • Aggregate Consumption • Gross Domestic Savings • Gross Domestic Capital Formation • Wholesale Prices, Consumer Prices and Inflation • Employment • Balance of Payments • Rate of Growth
  • 24. 24 Policy Instruments • Fiscal Policy • Monetary Policy
  • 25. 25 Fiscal Policy • Fiscal policy is concerned with the use of taxes and government expenditures. Government has to meet various expenditures like salaries, defense expenses, infrastructure development, etc. Another part of government expenditure also goes in the form of transfer payments like financial assistance to the elderly and unemployed. All these expenses leave a positive effect on the overall economy. The impact of government spending is also felt on the overall spending in the economy, thus influencing the size of the GDP.
  • 26. 26 Fiscal policy • The other part of the fiscal policy is generation of revenues for the government. Taxes are the main source of revenue for any government. Taxes affect the economy and the individuals in two ways. First, taxes imposed on the income of the people bring down the disposable income in the hands of the consumers. This reduces the spending in the economy. Second, the taxes levied on goods and services make them costlier. This discourages the firm to invest in capital goods.
  • 27. 27 Monetary Policy • Monetary policy is the second most widely used macroeconomic policy instrument. Monetary policy helps government, managing the nation’s money, credit, and banking system. There are various entities that are part of the monetary system of an economy. Central bank regulates the monetary system, and other entities like banks, insurance companies, NBFCs are also a part of the monetary system.
  • 28. 28 Monetary Policy • In India, Reserve Bank of India is the custodian of the monetary system of the economy. Central bank brings changes in the interest rates, reserve requirements, etc. These changes make significant impact on the overall functioning of the economy. • For example, the lowering of interest rates on housing loans helped the growth of the housing sector. As a result of low rate of interest, it became easier to avail a housing loan and to own a house. This has resulted in the growth of many allied industries as well.
  • 29. 29 Exchange Rate Policy • Exchange rates are determined by the demand and supply functions. • India follows a flexible exchange rate policy, which is determined by the demand and supply, where RBI has a right to intervene in the market. In order to regulate the foreign exchange transactions, government has come out with an act FERA, which was replaced by Foreign exchange management act (FEMA).
  • 30. 30 Employment Policy • Employment policies are adopted by government in order to increase the employment level in the country. As a part of this policy, governments come out with various polices. For example, in India, government has introduced various policies and schemes like, Jawahar Rozgar Yojna etc.
  • 31. 31 Price and Incomes Policy • This policy aims at regulating the prices in the market and also to ensure the minimum wages to the workers.
  • 32. 32 International Trade Policy • Globalization has given a big push to the international trade. This has resulted in framing of specific polices by many countries to cope with the new challenges. International trade policy addresses issues like tariff and non tariff barriers. • In line with the changing economic scenario, government came out with export-import (EXIM) policy in 1997. The policy’s primary aim is to increase the exports. It has been renamed as foreign trade policy to reflect the new approach. • Example: The recent policy announced in January 2006 has taken up a series of policy initiatives to fine tune the policy 2002-07. The policy aims at bringing down the transaction costs, accelerating the exports and making the country a manufacturing hub for quality goods and services. SEZs to promote not only manufactured goods but also agricultural products. Special emphasis is placed on exploiting Indian Labour skills to further exports.
  • 33. 33 The Circular Flow of Income • Two Sector Economy • Closed Economy • Open Economy
  • 34. 34 Two-Sector Economy (When All Income is Consumed) Household Sector Private Consumption (C) Rs.1000 Productive Sector Wages and Profits (i.e. income (Y) Rs.1000 C Y C AD AD Y ium AtEquilibr     :
  • 35. 35 Closed Economy Household Sector Private Consumption (C) Rs.800 Productive Sector Wages and Profits (i.e. income (Y) Rs.1000 Savings (S) Rs.200 Investment Rs.200 I S ium InEquilibr I C S C AD AD Y ium AtEquilibr       :
  • 36. 36 Open Economy Household Sector Private Consumption (C) Rs.800 Productive Sector Wages and Profits (i.e. income (Y) Rs.1000 Savings (S) Rs.100 Imports (M) Rs.50 Taxes (T) Rs.50 [Withdrawals (W) Rs.200] Investment (I) Rs.80 Exports (E) Rs.60 Government Expenditure (G) Rs.60 [Injections (J) Rs.200] J C X G I C Y AD Y ium AtEquilibr        :