Introduction to Macroeconomics

1. CONCEPT OF
MACROECONOMICS
Learning Objectives
At the end of this introductory lecture, the students
should know the following
Definition of macroeconomics
Similarities/difference between micro- and
macroeconomics
Meaning of macroeconomic theory
Importance of macroeconomics
Difference between macroeconomic objectives and
goals
Basic concepts such as variables, parameters,
functions and equations

2. Learning Objectives(Contd)
• Difference between stocks and flows
• Real and nominal variables
• Business Cycles
• Short run and long run analysis
• Macroeconomic models and their uses and
• The methodology of macroeconomics

3. Meaning of macroeconomics
• Macroeconomics is the branch of economic theory which
deals with the study of the national economy in aggregate
terms.
• In its broader sense, macroeconomics also includes the
study of the international economy on an aggregate basis.
• Thus, macroeconomic theory refers to the analysis of the
relationships between the aggregate variables in the
economy, such as consumption, savings, income,
employment, exports and imports etc.

4. Similarities between Microeconomics and
Macroeconomics
• In principle, it could be said that there is no difference between micro-
and macroeconomics- they differ only in degree. That is degree of
aggregation. However, in practice there are some differences.

5. Differences between Micro- and
Macroeconomics
• Microeconomics studies the behaviour of individual economic
decision units- the consumers, households and firms and the way
in which their decisions interrelate to determine relative prices of
goods and factors of production and the quantities of these which
will be bought and sold in the market.
• Macroeconomic theory studies broad economic aggregates such
as consumption, income, employment, investment, general price
level etc. and their interrelationships.

6. Differences between Micro- and
Macroeconomics (cont’d)
• Distinction can also be made on the basis of the kind of
variables studied, and the units of analysis;
• In microeconomics, we talk about the level of employment for
a firm to maximize its profit. Though in macroeconomics, we
also talk about employment, but at an aggregate level. The
same distinction is also applicable to output.
• Under microeconomics the unit of analysis are the household
and firms. But under macroeconomics, we talk about aggregate
behaviour of households and firms.

7. Meaning of Macroeconomic Theory
• It refers to the analysis of the hypothesized relationship between
aggregate variables in the economy, such as national consumption,
savings, income, employment, exports and imports.

8. Importance of Macroeconomics
• The study of macroeconomic concepts is helpful in many ways.
The estimates of GNP provide the economist with a useful tool
to analyse the performance for an economy over time. An
analysis of the composition of the GNP furnishes information
about the size of the contribution of each sector of the economy
to the GNP.
• When economics is studied with a view to increasing the
material well being of the nation, macroeconomic theory
assumes greatest significance. Thus, when the primary purpose
of the study of economics is to investigate the nature and causes
of the community welfare, economics becomes the study of
macroeconomics.

9. Importance of Macroeconomics
(cont’d)
• Macroeconomic analysis is interesting both from the practical and the
theoretical points of view. From the policy-oriented point of view,
macroeconomic analysis tell us how the various macroeconomic
variables such as GNP, total employment, general price level, wage
rate, consumption, saving, investment, interest rate will be affected by
any given change in the government’s spending or tax policy, central
bank’s monetary policy, foreign exchange rate, labour supply, labour
productivity etc.

10. Importance of Macroeconomics
(cont’d)
• When any one or more of these events occur, macroeconomic models can be
used to predict the quantitative impact of these events on endogenous
variables. On the theoretical side, macroeconomic analysis can help to
resolve some of the controversial theoretical issues such as the issue of
neutrality of money – whether a change in the total supply of money affects
only the general price level, leaving real macroeconomic variables such as
GNP, employment and interest rate in the economy unaffected or whether it
also affects the real variables in the economy.

11. Basic Concepts in Macroeconomics
• Variables: Variable are quantities which vary during a specified period
of time under consideration. Such variables can be divided into two
forms: exogenous and endogenous variables.
• Parameters: Parameters are influences which are not allowed to
change in a relationship. These are assumed to have constant values.
For example consider the simple consumption function C= f (Y) = a
+bY; b which is the marginal propensity to consume is a parameter.

12. Basic Concepts in Macroeconomics
(cont’d)
• Functions: Functions are relationships between two or more variables
such that a change in the value of one variable is related to the change in
the value of some other variables in some regular and predictable
manner. For example, if two variables C (consumption) and Y (income)
are so related that, for a value assigned Y, one or more values of C are
determined, then C is said to be a function of Y; C = f(Y)
• Here, Y is the independent variable and C is the dependent variable. A
function can be linear, quadratic or cubic.
• Equation: It is a statement that two expressions are the same. In
economics we distinguish between three types of equations
• Definitional equations or identities e.g. Y= C + S
• Behavioural equation or functional relationships.e.g.C= f(Y)= a + bY

13. Equilibrium conditions: in equilibrium the variables in the system/model
have values such that there is not inherent tendency for them to change e.g.
Md = Ms
• Stocks and Flows: the basic distinction between a stock variable and a flow
variable is that a stock variable is a quantity measured at a point (or moment,
or instant) in time, and a flow variable is quantity which can only be
measured in terms of a specific period of time.
Although both variables are dated, stock variables only have a time reference
associated with them, while flow variables have a time dimension.
If a variable has magnitude at a point in time it is a stock variable; if it has
magnitude only when time is allowed to run for some period, it is a flow
variable.
For example, ones asset at any point can be measured, say N80,000. This
could be sub-divided into N 20,000 in cash, N 30,000 in bonds and N 30,000
in physical assets. It could be seen that all these assets have magnitude at any
point in time and, thus, they are stock variables.

14. • But suppose one is asked how much income he earned, or how much he
consumed or how much work he did at any point in time. It may be
difficult to answer. Income is earned over a period of time. Same is
applicable to consumption and work. These, then are flow variables, since
a time dimension is associated with them.
• Note that that time period which a flow variable is measured is very
important.
• Stock or flow status of macroeconomic variables

15. • GNP is a flow variable since it measures the total gross output of
goods and services per annum
• Consumption (C), investment (I), and government expenditure (G)
are all flow variables
• Labour force and number of employed are stock variables
• Government tax receipts T are a flow variable
• The total public debt is a stock variable
• Finally, total money supply Ms is a stock variable.

16. Macroeconomic Models
• Macroeconomic models are logical, internally consistent
ways of describing the workings of an economy. A
macroeconomic model could be expressed in words,
graphically or mathematically. One of the advantages of
using mathematics is to ensure that model does not suffer
from logical flaws.
• Models are often modified on the basis of new ideas and
new occurrences, which make the existing model to be
inadequate to explain certain phenomenon.

17. Uses of Macroeconomic Models
Models are usually built to address several things:
• To analyse or explain macroeconomic issues (e.g. the effect of
taxation on consumption
• To contribute to theoretical debate
• To predict macroeconomic phenomena
• Basically, the roles of macroeconomic models are to predict the
direction of change in macroeconomic variables as well as to analyse
macroeconomic issues

18. Real and Nominal Variables
• Economists use the term real variable when talking about
variables that are adjusted for inflation. Real output, for
example, is the total amount of goods and services
produced, adjusted for price-level changes. It is the measure
of output that would exist if the price level had remained
constant.
• Nominal output is the total amount of goods and services
measured in current prices. In summary, real variable is the
nominal variable divided by the price index. It is the
nominal variable adjusted for inflation.

19. Business cycle
A business cycle is the upward or downward
movement of economic activity or real GDP that
occurs around the growth trend.

20. Business Cycles
Peak
Total Output
Expansion
Recession
Expansion
Time
Quarters
Secular Growth Trend
upturn

21. Four Phases of a Business Cycle
Many analysts/economists have attempted to
measure business cycles and also to set
reference dates for the beginnings and ends of
contractions and expansions. Thus, business
cycle is divided into phases as follows:

22. •Expansion
•The Peak; the top of a cycle is called a
peak. A boom is a very high peak,
representing a big jump in output.
Eventually an expansion peaks.
•A downturn: this describes the
phenomenon of economic activity
starting to fall from a peak.

23. In a recession, the economy is not doing well and many people
are unemployed. Formally, a recession is a decline in real output
that persists for more than two consecutive quarters of a year.
A depression is a large recession. There is no formal line
indicating when a recession becomes a depression. In general, a
depression is much longer and more severe than a recession. It
has been suggested that if unemployment exceeds 12% for
more than a year, the economy is in a depression.

24. •Trough: the bottom of a recession or
depression is called the trough. As total
output begins to expand, the economy
comes out of the trough; which may turn
into the peak. And the process starts
again.

25. The study of business cycles is essential to
business because it enables them to predict
whether the economy is going into a
contraction or an expansion. Making the
right prediction will determine whether the
business will be profitable or not

26. The Short Run and the Long Run
In analysing macroeconomic problems economists generally
use two frameworks – a short run and a long run framework.
Issues of growth are generally considered in a long run
framework. Business cycles are generally considered in a short
run framework.
Economists use these two frameworks because the short run
forces that cause business cycles are different from the long
run forces that cause growth.

27. Difference between the Two Frameworks
The long run growth framework focuses on supply; that is why it
is sometimes called supply-side economics. Since supply is so
important in the long run, policies that affect production, such
as incentives that promote work, capital accumulation and
technological change are usually considered.
The short run business cycle framework focuses on demand.
Thus, the focus is on ways to increase or decrease components
of aggregate expenditures.

28. Macroeconomic Objectives and Goals
This refers to the broad national objectives,
which can change from time to time depending
on the economic fortunes of a particular
country.

29. Such objectives include:
•Stable domestic prices
•Full employment
•Rapid economic growth
•Balance of payments equilibrium; and
•Exchange rate stability

30. Note that objectives are not the same as goals,
although they are often used interchangeably. Goals
are like milestones towards the desired objective.

31. Macroeconomic Variables
These include:
• Aggregate consumption
• Savings
• Investment
• Inflation rate
• Unemployment rate
• National income
• Imports and exports etc

32. Methodology of Macroeconomics
Macroeconomics adopt two basic methodologies in their study
• Positive Economic Analysis
• Normative Economic Analysis

33. • Positive Economics
The figure below illustrates the main approach
followed for positive economic analysis.
Positive economic analysis attempts to determine
verifiable relationships among economic variables,
thus yielding positive (factual) statements or
relationships. We start by formulating Hypothesis
(theory) using basic concepts and gathering of
information/data. Data are generated from real world
observations.

34. POSITIVE ECONOMIC ANALYSIS
HYPOTHESIS
(THEORY)
DATA OR
INFORMATION
HYPOTHESIS
TESTING
KNOWLEDGE
(Economic “Laws”
(Explanations
(Prediction

35. Normative Economic Analysis
This deals with value judgement about what ought to be, what
ought to have been or what ought to become. It deals with such
generalised notions as welfare, happiness, freedom, fairness,
justice, equality and progress.
Normative economic analysis uses the knowledge derived from
positive economic analysis as a basic building block. Such
knowledge rests on data and verified hypothesis reflecting,
‘what it’.
When ‘what is’ is compared to ‘what ought to be’ as reflected in
our desired goals, problems may then be identified

36. As soon as problems are identifies (and verified), policy
proposals must be guided by economic knowledge and by
an appreciation of our desired goals. These policy proposals
are usually of two forms
The government might be called upon to stop doing some
things that the private sector can do best
The government might be called upon to do something so as
to correct for some perceived problems within the market
economy.

37. NORMATIVE ECONOMIC ANALYSIS
KNOWLEDGE
(Economic “Law”
(Explanations
(Predictions
DESIRED GOALS E.g.
-Stability
-Growth
-Efficiency
PROBLEM
IDENTIFICATION
POLICY
PROPOSALS