2. Foundations of Economics
Economics is derived from the word economy.
Economy - The wealth and resources of a nation,
especially in terms of the production and
consumption of goods and services.
Economics - A social science that studies how
individuals, households, firms and governments,
make choices about allocating scarce resources
to satisfy their unlimited wants.
3. Foundations of Economics
To produce any product we need resources:
Resources:
Land.
Labour.
Capital.
Enterprise.
All these resources are limited or scarce.
If these resources were not scarce, there
would be no need of studying economics.
4. Foundations of Economics
Land – Common name given to all Natural
Resources. (Forests, Fisheries, Farms &
Mines. )
Labour – Common name given to all Human
Resources.
Capital – Common name given to all man –
made productive assets.
Enterprise – Common name given to all
enterprising (risk taking) skills.
5. Basic economic problem
Scarcity - means that society has limited
resources and therefore cannot produce all
the goods and services people wish to have.
Choice
Needs and wants of human beings are
unlimited and resources to fulfill these needs
and wants are limited.
So, economics is the study of how society
manages its scarce resources.
6. Introduction to Macroeconomics
Microeconomics examines the behavior of
individual decision-making units—business firms
and households.
Macroeconomics deals with the economy as a
whole; it examines the behavior of economic
aggregates such as aggregate income,
consumption, investment, and the overall level of
prices.
Aggregate behavior refers to the behavior of
all households and firms together.
7. What do Macroeconomists do?
Macroeconomists try to forecast economic
conditions to help consumers, firms and
governments make better decisions.
Consumers want to know how easy it will be to
find work, how much it will cost to buy goods and
services in the market, or how much it may cost
to borrow money.
Businesses use macroeconomic analysis to
determine whether expanding production will be
welcomed by the market. Will consumers have
enough money to buy the products, or will the
products sit on shelves and collect dust?
8. What do Macroeconomists do?
Governments turn to the macroeconomics
when budgeting spending, creating taxes,
deciding on interest rates and making policy
decisions.
Macroeconomic analysis broadly focuses on
three things:
National output (measured by GDP),
Unemployment and
Inflation
9. .
The Circular-Flow Model
The circular-flow model is a
simple way to visually show the
economic transactions that occur
between households and firms in
the economy.
10. .
The Circular Flow of Income and Expenditure
2 Sector Model: Households and Firms
Households
Firms
Income
100
Consumption Expend
100
Firms produce
goods and
services. The
value of income
must always be
equal to the value
of production.
This is a National
Accounting
INDENTITY
This is a fully sealed circular flow - there are no leakages
from, or injections into the flow of income and expenditure
between firms and households
11. .
Households
Firms
Income
100
Consumption
Expend 100
The Circular Flow of Income and Expenditure
3 Sector Model: Households, Firms & Banks
Saving
20
Consumption
80
Banks
Investment
20
Assume households
save 20% of their
disposable income.
This is a functional
relationship Income (Y) = C + I
Income (Y) = 80 + 20 = 100
12. .
Households
Firms
Income
100
Consumption
Expend 100
The Circular Flow of Income and Expenditure
4 Sector Model: Households, Firms, Banks & Government
Saving
20
Consumption
80
Banks
Investment
20
Government
Taxes 40
Disposable
Income 60
Saving
12
Consumption
48
Investment
12
Govt Expend
40
Income (Y) = C + I + G
Income (Y) = 48 + 12 + 40 = 100
13. .
The Circular Flow of Income and Expenditure
5 Sector Model: Households, Firms, Banks, Government& Rest of World
Households
Firms
Income
100
Consumption
Expend 100
Saving
20
Consumption
80
Banks
Investment
20
Government
Taxes 40
Disposable
Income 60
Saving
12
Consumption
48
Investment
12
Govt
Expend
40
Closed (Domestic) Economy
Rest
of
World
Imports
Exports
National Income (Y) = C + I + G + NX (Exports - Imports)
14. .
FIVE SECTORS OF THE ECONOMY
Households
Households supply factors of production to firms for
which they receive INCOME. They spend that income on
CONSUMPTION goods and services
Firms
Firms PRODUCE goods and services and pay wages,
profits etc to households. Firms also INVEST in plant
and equipment
Government Governments TAX and spend (GOVT EXPENDITURE)
Banks Households deposit their SAVING with banks and Banks
lend firms money to INVEST
Rest
of
World
IMPORTS and EXPORTS
15. Development of Macroeconomic Thought
Four Phases
Classical Economics
Keynesian Economics
Monetary Economics
Supply Side Economics
16. The Roots of Macroeconomics
The Great Depression was a period of severe
economic contraction and high unemployment that
began in 1929 and continued throughout the
1930s.
Classical economists applied microeconomic models,
or “market clearing” models, to economy-wide
problems.
However, simple classical models failed to explain the
prolonged existence of high unemployment during the
Great Depression. This provided the impetus for the
development of macro-economics.
17. The Roots of Macroeconomics
In 1936, John Maynard Keynes published
“The General Theory of Employment,
Interest, and Money”.
Keynes believed governments could
intervene in the economy and affect the level
of output and employment.
During periods of low private demand, the
government can stimulate aggregate demand
to lift the economy out of recession.
18. Recent Macroeconomic History
Fine-tuning was the phrase used by Walter
Heller to refer to the government’s role in
regulating inflation and unemployment.
The use of Keynesian policy to fine-tune the
economy in the 1960s, led to disillusionment
in the 1970s and early 1980s.
This brought the importance of money in an
economy followed by the supply side policies.
19. Output Growth:
Short Run and Long Run
A recession is a period during which aggregate output
declines. Two consecutive quarters of negative GDP
growth signals a recession.
A prolonged and deep recession becomes a
depression.
Policy makers attempt not only to smooth fluctuations
in output during a business cycle but also to increase
the growth rate of output in the long-run.
20. Government in the Macroeconomy
There are three kinds of policy that the
government has used to influence the
macroeconomy:
1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies
21. Government in the Macroeconomy
Fiscal policy refers to government policies
concerning taxes and spending.
Monetary policy consists of tools used by the
Central Bank (In India’s case, the Reserve Bank) to
control the quantity of money and credit in the
economy.
Growth policies are government policies that focus
on stimulating aggregate supply instead of
aggregate demand.
22. The Three Market Arenas
Households, firms, the government, and the
rest of the world all interact in three different
market arenas:
1. Goods-and-services market
2. Labor market
3. Money (financial) market
23. The Three Market Arenas
Households and the government purchase
goods and services (demand) from firms in
the goods-and services market, and
firms supply to the goods and services
market.
In the labour market, firms and
government purchase (demand) labour
from households (supply).
24. The Three Market Arenas
In the money market—sometimes called the
financial market—households purchase stocks and
bonds from firms.
Households supply funds to this market in the expectation
of earning income, and also demand (borrow) funds from
this market.
Firms, government, and the rest of the world also engage
in borrowing and lending, coordinated by financial
institutions.
25. Two types of flows
Each economy has two types of flows, the
nominal flow and the real flow..
The Nominal Flow – Any transaction between
any two sectors of an economy expressed in
terms of money is the nominal flow.
The Real Flow – Any transaction between
any two sectors of an economy expressed in
anything other than money is the real flow.
