Macroeconomics

1. Questions
1. Why is there a need for a separate theory of macroeconomics? Explain.
There is a need for separate theory of macroeconomics because microeconomics failed
to study the aggregates of the economy as a whole. As a result, there was a need for a
separate theory, which could explain the working of the economy.
It is because of the existence of these macro-economic paradoxes that there is a
justification for making macro-analysis of the behaviour of the whole economic
system or its large economic aggregates. Thus, Professor Boulding rightly
remarks, ‘It is these paradoxes more than any other factor, which justify the
separate study of the system as whole, not merely as an inventory or list of
particular items, but as a complex of aggregates.”
Professor Boulding further elaborates his point by liking the economic system
with a forest and the individual firms or industries with the trees in the forest.
Forest, he says, is the aggregation of trees but it does not reveal the same
properties and behaviour patterns of the individual trees. It will be misleading to
apply the rules governing the individual trees to generalise about the behaviour of
the forest.
Various examples of macro-paradoxes (that is, what is true of parts is not true of
the whole) can be given from the economic field. We shall give two such examples
of savings and wages, on the basis of which Keynes laid stress on evolving and
applying macroeconomic analysis as separate and distinct approach from
microeconomic analysis.
Another common example to prove that what is true for the individual may
not be true for the society as a whole in the wage-employment relationship. As
pointed out above, classical and neo-classical economists, especially A.C.
Pigou, contended that the cut in money wages at times of depression and
unemployment will lead to the increase in employment and thereby eliminate
unemployment and depression.
2. Describe the importance of the study of macroeconomics.
Macro Economics is aggregative economics which examines the interrelation among
various aggregates, their determination and causes of fluctuations in them. The practical
importance of macroeconomics has been carefully analyzed in points below.
Various national problems like overpopulation, inflation, balance of payment are
underpinning the underdeveloped economies. The study of macroeconomics helps to
bring a check on these issues.
The study of macroeconomics is very important for evaluating the overall performance of
the economy in terms of national income. The national income data helps in anticipating
the level of fiscal activity and understanding the distribution of income among different
groups of people in the economy.

2. Macroeconomics helps to evaluate the resources and capabilities of an economy, churn
out ways to increase the national income, boost productivity, and create job opportunities
to upscale an economy in terms of monetary development.
Correct economic policies formulated at macro level makes it possible to control business
cycles (inflation and deflation) and resultantly, violent booms and depressions rarely
occur.
Macroeconomics as a discipline includes diverse theories of consumption and saving. It
explains the importance of saving in the national economy and its role in the investment.
Macroeconomics studies the behavior of individual units. For instance, the reasons for
increase in the cost of a firm or industry cannot be examined without evaluating or
understanding the average cost conditions of the whole economy.
3. Define GDP, GNP and NNP. Explain the relationship between GNP and NNP.

4. 4. If the capital consumption allowance, net foreign receipt and NNP of a country in FY
2019- 2010 were USD 12b, USD 6m and 100b respectively, what were the GDP and
GNP of the country?
Capital consumption allowance (CCA), sometimes referred to as depreciation, is
the amount of money a country has to spend each year to maintain its present
level of economic production. The CCA measures how much the value of the
stock of capital goods owned by a country declines in a given year by measuring
economic depreciation, which includes not only accounting depreciation but also
other reasons for declines in value, such as destruction or obsolescence. The
capital consumption allowance (CCA) represents depreciation in the overall
economy and is expressed as a percentage of GDP. Capital consumption
allowance (CCA), sometimes referred to as depreciation, is the amount of money
a country has to spend each year to maintain its present level of economic
production. A capital consumption allowance will decline in a nation if enough of
the underlying capital goods decline in value.
5.
(a) What is consumption function? Explain the objective and subjective factors
which determine consumption expenditure in the economy.
consumption function, in economics, the relationship between consumer spending and the
various factors determining it. At the household or family level, these factors may include
income, wealth, expectations about the level and riskiness of future income or wealth,
interest rates, age, education, and family size. The consumption function is also
influenced by the consumer’s preferences (e.g., patience, or the willingness to delay
gratification), by the consumer’s attitude toward risk, and by whether the consumer
wishes to leave a bequest (see legacy). The characteristics of consumption functions are
important for many questions in both macroeconomics and microeconomics.
In macroeconomic models the consumption function tracks total aggregate consumption
expenditures; for simplicity it is assumed to depend on a basic subset of the factors
economists believe are important at the household level. Analysis of consumption
expenditure is important for understanding short-term (business cycle) fluctuations and

5. for examining long-run issues such as the level of interest rates and the size of the capital
stock (the amount of buildings, machinery, and other reproducible assets useful in
producing goods and services). In principle, the consumption function provides answers
to both short-run and long-run questions. In the long run, since income that is not
consumed is saved, the responsiveness of households to any tax policy (such as those
meant to spur aggregate saving and increase the capital stock) will depend on the
structure of the consumption function and particularly what it says about how saving
responds to interest rates. In the short run, the effectiveness of tax cuts or other income-
boosting policies (such as those meant to stimulate a recessionary economy) will depend
on what the consumption function says about how much the typical recipient spends or
saves out of the extra income.
At the microeconomic level the structure of the consumption function is of interest in
itself, but it also has a powerful influence on many other kinds of economic behaviour.
For example, individuals with only a small stock of savings who are laid off from their
jobs may be forced to take new jobs quickly, even if those jobs are a poor match for their
skills. On the other hand, laid-off consumers with substantial savings may be able to wait
until they can find a better job match. Whether a consumer is likely to have much savings
when laid off will depend on the degree of patience reflected in the consumption
function.
The standard version of the consumption function emerges from the “life-cycle” theory of
consumption behaviour articulated by economist Franco Modigliani. The life-cycle
theory assumes that household members choose their current expenditures optimally,
taking account of their spending needs and future income over the remainder of their
lifetimes. Modern versions of this model incorporate borrowing limits, income or
employment uncertainty, and uncertainty about other important factors such as life
expectancy.
According to Keynes, two types of factors influence the consumption
function:
subjective and objective. The subjective factors are endogenous or internal to the
economic system itself. The subjective factors relate to psychological
characteristics of human nature, social structure, social institutions and social
practices.
The objective factors affecting the consumption function are exogenous, or
external to the economy itself. These factors may at times undergo rapid changes.
Thus, objective factors may cause a shift in the consumption function.
Subjective Factors:
Subjective factors basically underlie and determine the form of the consumption
function (i.e., its slope and position).
The subjective factors concerned are:

6. (1) behaviour patterns fixed by the psychology of human nature
(2) the institutional arrangements of the modern social order, and social
practices relating to the behaviour patterns of business firms with respect to wage
and dividend payments and retained earnings, and the institution controlling the
distribution of income.
Human behaviour regarding consumption and savings out of increased income
depends on psychological motives.
First, there are motives which “lead individuals to refrain from spending out of
their incomes.”
Keynes enlists eight such motives:
1. The Motive of Precaution:
The desire to build up a reserve against unforeseen contingencies.
2. The Motive of Foresight:
The desire to provide for anticipated future needs, e.g., in relation to old age,
family education, etc.
3. The Motive of Calculation:
The desire to enjoy interest and appreciation, because a larger real consumption,
at a later date, is preferred to a smaller immediate consumption.
4. The Motive of Improvement:
The desire to enjoy a gradually increasing expenditure since it gratifies the
common instinct to look forward to a gradually improving standard of life rather
than otherwise.
5. The Motive of Independence:
The desire to enjoy a sense of independence and the power to do things.
6. The Motive of Enterprise:
The desire to secure a mass de manoeuvre to carry on speculation or establish
business projects.
7. The Motive of Pride:
The desire to possess or to bequeath a fortune.
To this, Keynes adds a corresponding list of motives on consumption such as
enjoyment, short-sightedness, generosity, miscalculation, ostentation and
extravagance.
Objective Factors:
Objective factors, subject to rapid changes and causing violent shifts
in the consumption function, are considered below:
1. Windfall Gains or Losses:
When windfall gains or losses accrue to people their consumption level may
change suddenly. For instance, the post-war windfall gains in stock exchanges

7. seem to have raised the consumption spending of rich people in the U.S.A., and
to that extent, the consumption function was shifted upward.
2. Fiscal Policy:
The propensity to consume is also affected by variations in fiscal policy of the
government. For instance, imposition of heavy taxes tends to reduce the disposable real
income of the community; so its level of consumption may adversely change. Similarly,
withdrawal of certain taxes may cause an upward shift of consumption function.
3. Change in Expectations:
The propensity to consume is also affected by expectations regarding future
changes. For instance, an expected war considerably influences consumption by
creating fears about future scarcity and rising prices. This leads people to buy
more than they immediately need, i.e., to hoard. Thus, the ratio of consumption
to current income will rise, which means that the consumption function will be
shifted upward.
All the above-mentioned factors will affect the consumption function in one
direction or another. However, all of them are relatively unchanging in the
normal short run and, therefore, cannot explain the changes in total consumption
during the short-run period. Income is the only variable which will change
considerably in the short run and affect consumption. Thus, it may be asserted
that consumption varies only in the level of income.
(b) What are the three forms of consumption function? Discuss.
consumption function:
The consumption function, or Keynesian consumption function, is an economic
formula that represents the functional relationship between total consumption
and gross national income. It was introduced by British economist John Maynard
Keynes, who argued the function could be used to track and predict total
aggregate consumption expenditures.
Understanding the Consumption Function:
The classic consumption function suggests consumer spending is wholly
determined by income and the changes in income. If true, aggregate savings
should increase proportionally as gross domestic product (GDP) grows over
time. The idea is to create a mathematical relationship between disposable
income and consumer spending, but only on aggregate levels.
The stability of the consumption function, based in part on Keynes'
Psychological Law of Consumption, especially when contrasted with the
volatility of investment, is a cornerstone of Keynesian macroeconomic theory.
Most post-Keynesians admit the consumption function is not stable in the
long run since consumption patterns change as income rises.
Calculating the ConsumptionFunction:
The consumption function is represented as:

8. C= A+MD
where:
C= consumer spending
A= autonomous consumption
M= marginal propensity to consume
D= real disposable
Assumptionsand Implications:
Much of the Keynesian doctrine centers around the frequency with which a
given population spends or saves new income. The multiplier, the
consumption function, and the marginal propensity to consume are each
crucial to Keynes’ focus on spending and aggregate demand.
The consumption function is assumed stable and static; all expenditures are
passively determined by the level of national income. The same is not true
of savings, which Keynes called “investment,” not to be confused with
government spending, another concept Keynes often defined as investment.
For the model to be valid, the consumption function and independent
investment must remain constant long enough for national income to reach
equilibrium. At equilibrium, business expectations and consumer
expectations match up. One potential problem is that the consumption
function cannot handle changes in the distribution of income and wealth.
When these change, so too might autonomous consumption and the
marginal propensity to consume.
Other Versions:
Over time, other economists have made adjustments to the Keynesian
consumption function. Variables such as employment uncertainty, borrowing
limits, or even life expectancy can be incorporated to modify the older, cruder
function.
For example, many standard models stem from the so-called “life cycle” theory of
consumer behavior as pioneered by Franco Modigliani. His model made adjustments
based on how income and liquid cash balances affect an individual's marginal propensity
to consume. This hypothesis stipulated that poorer individuals likely spend new income
at a higher rate than wealthy individuals.

9. Jun 12
1. Distinguish between ex-ante investment and ex-post investment.
Income determination is a crucial part of every individual’s life; people often plan to
spend a certain amount and end up either more or less than that. A decision like this is a
crucial part of any economy; it helps countries to manage revenues and expenses.
Ex-ante and Ex-post are two concepts of income decision, and it plays a significant role
in the financial planning of any country. In this regard, one takes the help of
macroeconomics to understand the variable and find an accurate result.
Difference between Ex-ante and Ex-post Investment:
2. What is meant by involuntary unemployment? Discuss the nature of unemployment in developing
countries like Bangladesh.
nvoluntary unemployment:
Involuntary unemployment occurs when a person is willing to work at the prevailing wage yet is
unemployed. Involuntary unemployment is distinguished from voluntary unemployment, where
workers choose not to work because their reservation wage is higher than the prevailing wage. In
an economy with involuntary unemployment there is a surplus of labor at the current real wage.
This occurs when there is some force that prevents the real wage rate from decreasing to the real
wage rate that would equilibrate supply and demand (such as a minimum wage above the
market-clearing wage). Structural unemployment is also involuntary. Economists have several
theories explaining the possibility of involuntary unemployment including implicit contract theory,
disequilibrium theory, staggered wage setting, and efficiency wages.The officially measured
unemployment rate is the ratio of involuntary unemployment to the sum of involuntary
unemployment and employment (the denominator of this ratio being the total labor force).
T he Nature and Causes ofUnemployment in Developing Countries!
Nature:
The nature of unemployment in under-developed countries is quite different; it is of chronic and
long-term nature. It is now almost universally recognised that the chronic unemployment and
under-employment in less developed countries are not due to the lack of aggregate effective
demand which, according to J.M. Keynes, was responsible for unemployment in developed

10. countries in times ofdepression. Ratherit is stated to be due to the lack ofland, capital and other
complementary resources in relation to the total population and labour force.
T hus,according to Joan Robinson:
“Keynes’ theory has little to say, directly, to the under-developed countries, for it was framed
entirely in the context of an advanced industrial economy, with highly developed financial
institutions and a sophisticated business class. The unemployment that concerned Keynes was
accompanied by under-utilisation ofcapacity already in existence. It had resulted from a fall in
effectivedemand.The unemployment ofunder-developed economies arises because capacity and
effective demand never have been great enough”.
The existence of unemployment due to lack of capital or other co -operating factors was an
important question which was discussed by Marx in the context of advanced industrialized
countries. Therefore such unemployment has often been called Maxian unemployment as
distinguished from Keynesian unemployment which is caused by the deficiency aggregated
demand.
Capital as the major bottleneck to growth ofemployment was made popular by Harrod-Domar
model ofeconomic growth in which capital accumulation plays a pivotal roleand according to
which rate ofgrowth ofoutput depends upon the proportion ofnational income saved, divided by
the capital-output ratio (g = s/v, where g stands for growth rate,V for the proportion ofincome
saved and V for the capital- output ratio).
This model assumes capital-coefficients (i.e., capital-output ratio and capital-labour ratios) to
remain constant. With constantcapital-outputand capital-labour ratios,the morethe capital, the
more will be both output and employment. Therefore, when adaptedto the less developed
countries, this model suggests that the rateofgrowth ofoutputand thereforeofemployment is
determinedby the growth ofcapital stock.
Lack ofWage Goods and Unemployment in Developing Countries:
They point out that when the unemployed people or disguisedly unemployed people who are
withdrawn from agriculture are engaged in some public works, they will have to be supplied with
wage-goods so that employed labourers can subsist. e can be employed in the economy,
depending upon the supply of wage-goods in the economy.

11. A prominent Indian economist Prof. A.K. Sen has also emphasisedthe supply ofwage -goods in
determining employment in developing countries. According to Prof. Sen, the quantumofwage
employment in the economy depends on the total supply ofwage-goods on the one hand and the
real wage-rate on the other. IfErepresents the quantum ofemployment, Mrepresents the supply
of wage- goods and W, the real wage-rate,then the employment which can be provided will be
given by the following equation.
E = M/W
It is thus evident from Sen’s aboveequation that ifthe supply ofwage-goods (M) is less than the
required supply to provideall labourforce, then all workers cannot be fully employed, which will
result in the emergence ofunemployment. Thus, to generateenough employment and solvethe
problem ofunemployment and under-employment, the wage-goods industries, especially
agriculture,must be accorded a high priority in the strategy ofeconomic development.
Most of the unemployment in underdeveloped countries is ofa different nature from that in
advanced and developed countries.A major partofunemployment in present-day developed
countries is ofcyclical nature which is due-to deficiency ofaggregate effective demand. But most
of the unemployment in developing countries is not cyclical. Thus, in developing countries, there
is not much Keynesian type short-term unemployment. Instead, it is a chronic problem.
Unemployment in Developing Countries:
We have explained above the two basic explanations ofunemployment and under employment
prevailing in the developing countries. We now explain below in some detail the various causes
which account for unemployment and underemployment that still prevails in the developing
countries.
1. Lack ofthe Stock ofPhysical Capital:
The major cause of unemployment and underemployment in underdeveloped countries like
Bangladesh is the deficiency ofthe stock ofcapitaIin relation to the needs of the growing labour
force. In the modern world, man by himselfcan hardly produceanything. Even the primitive man
needed some elementary tools like the bow and arrow to engage in hunting for the earning of his
livelihood.

12. This is also the problem thatthe developing countries like India are facing today. In recent times,
the labour forcein Bangladesh has been growing at morethan 2 per cent per year, yet our rate of
investment expressed as a percentage ofour stock ofcapital has not been growing at a fast enough
rate so as to keep pace with the growth of population. As a result, the country’s ability to offer
productive employment to the new entrants in the labour market has been severely limited.
2. Use of Capital Intensive Techniques:
An important factor responsible for slow growth ofemployment has been the use ofcapital-
intensive techniques ofproduction, even in consumer goods indpstries where alternative labour -
intensive techniques are available. Even before1991, under the industrial policy resolution 1956,
the development ofconsumer goods industries wereleft open for the private sector.
Even firms in modern small industry sector which wereexpected to generate largeemployment
opportunities have also tended to use capital-intensive techniques ofproduction. Thus, Prof. J.C.
Sandesara states, “theavailability ofcheap capital has tended to encourage the modern small-
scale industries sector to over-capitalize and use morecapital-intensive methods ofproduction
and thus reduceemployment potential”.
3. Inequitable Distribution ofLand:
Another cause of unemployment prevailing in the developing countries like Bangladesh is
inequitable distribution ofland so that many agricultural households have no adequate access to
land which is an important asset for agricultural production and employment.
Sub-division of land holdings under the pressure of rapid population growth since 1951 has
further reduced access to land for several agricultural households.As a result many persons who
were self-employedin agriculturehave become landless agricultural labourers who suffer from
acute unemployment and under-employment.

13. 3. Briefly explain the quantity theory of money with criticism.
Criticisms of the Quantity Theory of Money :
The QTM theoryaims to find a relationshipbetweenthe spending pattern in an
economywith respect to the flowof money in the economy.
However, not a lot of economists thinkthat this is the best way to define the rate of
inflationin an economy. Perhaps there have emergeda set of criticismsthat helpus
understand the criticisms of the QTM theory.
1. The first and foremost criticism of the theorycomesfrom the sectionof
taxpayers. Since the money supply in an economyincreases, the price of the
goods also increases.
That said, the leftover money, in order to keepthe savings process of the citizens
unobstructed, must be taxed, as is suggestedby taxationofficials. However, a lot
of economistsand taxpayers worldwide suggest that procuringmore money
from people’s salaries will onlylead to an upsurge in unemployment and rising
economic concerns of the masses.
Therefore, taxing the extra flow of moneyis a very unpopular alternative that
has led to severe criticism of the QTM theory.
2. The second criticism of the theory threw light on the theory’s inability to
consider other monetary factors apart from the money supply in an economy.
Another argument came along that led to a major criticism of the theory.
John Maynard Keynes had earlier beena supporter of the theory. However, with time
he strongly argued that the price level of goods and services was not directly
proportional to the money supply in an economy.
He, along with Ludwig von Mises argued that the theory failed to consider
other factors like the demand of money, and only focused on the factor of
money flow in an economy.
This, as stated by the latter, “failed to explain the mechanism of variations in
the value of money”. Furthermore, as Keynes laid down in his criticism of the
theory, the QTM theory failed to establish a direct relationship between M and
P.

14. Even though it did mentionthat these 2 factors were directlyproportional, the
theorycouldnot adequately explain the basis of this relationship.
3. In addition, the theoryis a sheer example of truism. Highly obvious and
nothing new, the QTM theorycertainlystates that there is a relationbetween
the moneysupply and price level in an economy.
However, it does not represent throughevidence that a particular increase inthe
money supply in an economyleads to the same increase inthe price level of
goods or services.
That said, the theoryonly recommends somethingthat is known to laymen.
However, it highly fails to prove the exact relative level between the 2 factors -
money supply and price level.
4. The fourthcriticism comesalongwith the assumptionof the theorythat all
other things remain equal or unchanged, thus, implying a situationof ceteris
paribus. Yet, in reality, other things do not always remain unchanged.
This, in turn, fails to recognize the plausibilityof the QTM theorythat entirely
focuses onthe unchanged factors inan economyother thanthe moneysupply
(M) and the price level of goods/services(P).
This also means that the money supply is not the only factor responsible forthe
change in the price levels. Since auxiliary factors caninfluence the price levels
and money supply as well, the whole theorybecomes nothingmore than a
doubtful instance of economics.
5. Another criticism of the quantity theoryof moneythat is worth notingis in
relationto the value of money. The value of money theoryestablishes adirect
relationshipbetweenthe number of goods that can be bought with a certain
amount of money.

15. However, as is the case of the QTM theory, the value of moneytheoryis
diminishedto the extent that it only focuses oncashtransactions inan economy.
In reality, the theorydoes not aim to measure the purchasing power of money,
thus, restrictingit to a certainaspect of the economic activityina nation.
4. Explain the effects of inflation on output and distribution of income.
5. What are the tools of monetary policy? To reduce the price level of the country what
policy tool will be more effective? Explain.