Stocks vs.

Flows Variables
MACROECONOMIC ENVIRONMENT
PGP I, Term II, SeptemberDecember 2015

LECTURE 2
MACRECONOMY
A LONG & A SHORT VIEW
Prof. D. TRIPATI RAO
Indian Institute of Management Lucknow
tripati@iiml.ac.in, September 22, 2015

MACROECONOMICS

Structure, Performance & Behaviour
a top-down view of the ECONOMY
study in AGGREGATE
output, employment & inflation
business cycle
monetary & fiscal policy
BOP & exchange rate

Reflection on
 organised & simplified structure
 to understand: Y, U (L) & P

 most

economic variables are observable &

measurable
 broadly classified into quantities & prices
 Quantities are classified as
1. Stocks: quantities measurable at a point in time
2. Flows: quantities measurable over a period or per
unit of time
 production of business enterprises
 structures, plan & machinery are stock of capital
 capital stock enters the Balance Sheet
 flows as income from sales & expenses
enter the Profit & Loss Account

Stocks vs. Flows Variables

 National Accounts
 Stocks: National Wealth
 Private Individuals: land, house & properties
 Flows: National Income broadly classified into
quantities & prices
 Private Individuals: wages, salaries & income
 Inferences
1. stocks & flows are closely related
2. bigger capital stock generates higher income flows
3. quantities measurable at a point in time

Difference in degree not in kind

Stock vs. Flow variables

Stock

Flow

Firms Inventory

Production, Sales & Inputs

Wealth

Income

Money

Monetary Expenditure

Government Debt

Government Deficit

Outstanding Bank Loans

Bank Lending

Total No. of Unemployed

No of People Losing Job

Amount of Capital

Amount of Investment

MICROECONOMICS
Focus is on individual behaviour/decisions/choices
factors influence those choices
for instance, strategic decisions of:
firms on: production, price & labour
households on: to consume or save
Microeconomics is interested in:
how many resources firm can use
how much resources HHs can consume
Microeconomics looks at the trees
Macroeconomics watches the forest

Macroeconomic Fundamentals

Main Aggregates
 GDP Growth, Unemployment Rate & Inflation
 C, S & I (as a % of GDP)

Ten Leading Indicators
1.Prodn of Machinery & Equipment
2.Sales of Heavy Commercial Vehicles
3.Non-Food Credit (Pvt. Corporate Credit Off-take)
4.Railway Freight Traffic
5.Cement Sales
6.Corporate Sales
7.Fuel & Metal Prices
8.Real Rates of Interest
9.BSE Sensex
10.GDP Growth Rates of US & Europe

Microeconomics vs. Macroeconomics

Change in Price for changes in DD & SS
 price adjusts to restore the equilibrium
 automatic/instantaneous: Market Clearing

Partial Equilibrium
 one individual decision making unit
 firm/industry/sector/single market

Comparative Statistics
 studying two or more equilibrium positions only

Studying Macroeconomics

Dynamics?
 Transition: time path & adjustment process

General Equilibrium?
 Behaviour of ALL individual DMUs
 studying different markets simultaneously
 overall impact on the economy

Causal Relation
 Define variables
 Empirical observations - behavioural relationship
 Mix of Variables:
 Endogenous (explained in the model)
 Exogenous (taken as given/outside)

Non-Obvious Outcomes
In MACROECONOMICS
 It is just NOT scaling up
 Rational individual behaviour may not necessarily
ends up in optimal macroeconomic outcomes:
for ex:
 each one standing up in the stadium for a better
view of a play => nobody gets a better view!
 farmers/farms producing more output to earn
higher profit simultaneously => price falls!
 Policy making => tight rope walking

Picture of Stick-Man & Model Building

12.00%

Unemployment Rate

Model Building

A simplification exercise

Focus is on underlying causal relations

Precise/near-exact mathematical specification

10.00%

8.00%

Ex: Cartography/Drawing Charts/Photographs

Features

6.00%

Empirically they can be proved/disproved

 Aunt Martha Syndrome
 Designed for a specific purpose only
Kelly Johnson, Lead Engineer, Lockheed Spy Planes
 Keep it Simple, Stupid

4.00%

2.00%

0.00%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Indian Macroeconomic Indicators

Year

Annual
Growth Rate
(%)

Unemployment
FDI
Rate
(Technology)
(%)
($Bln)

2008-09

6.7

6.8

17.5

2009-10

8.6

10.7

18.7

2010-11

8.9

10.8

7.7

2011-12

6.7

9.8

22.1

2012-13

4.5

8.5

19.8

2013-14

4.7

8.8

21.5

MACROECONOMICS FOCUS
1.(Very) LONG RUN ECONOMIC GROWTH
What are the determinants of long run economic growth?
Why do countries exhibit differential long run growth
trajectory?
Why does a country, more often, not being able to sustain
high growth?

2.SHORT RUN ECONOMIC FLUCTUATIONS

- Business Cycles
Why does an economy exhibit cyclical peaks & troughs at a
regular basis?
What effects does it have on output, unemployment &
inflation?
Should you require, to stabilize, govt. intervention?

Macroeconomic & Social Policy Framework of Economy

Policy
Authority

Central
Bank

Policy

Monetary

Taxation
Public Exp.

Physical

Social

Private
Economic Agents

Money
Supply
Int. Rates

Fiscal

Ministry
of
Finance

Policy
Instruments

Controls thr.
Regulations
Exp. On
Health
Education &
Social
Welfare

Influence
On
Behavior
Of

Households
Firms
Banks (FIs)

Macroeconomic
outcomes
Output
Employment
Price(s)

Fast Growth Period Correlation Between Per Capita

GDP Growth & Potential Determinants of Growth
Determinants
PC-GDP
Natural Resources Rent/GDP

0.76

Savings/GDP

0.52

Gross Capital Formation (Capital Stock)

0.37

Gross Fixed Investment

(Investment)

0.36

FDI Inflows

0.47

Structural Transformation
of the World Economy

Emerging Economies (BRICS)

Growth In India's Per Capita Income (In INR)

Share of GDP in Different Sectors (2011)

45000

39904

40000
35000
30000
21065

25000
14157

20000
15000

10712
7114

10000
5000

2013-14(PE)

2007-08

2010-11(3R)

2004-05

2001-02

1998-99

1995-96

1992-93

1989-90

1986-87

1983-84

1980-81

1977-78

1974-75

1971-72

1968-69

1965-66

1962-63

1959-60

1956-57

1953-54

1950-51

12.0

Structural Change in Indian Economy Annual Rates of India's GDP

Growth

10.0
8.0
6.0

Growth Pangs

 GDP Growth
GDP growth slowed down in 2013/14 to 4.7%
Exports witnessed 22.51% growth in 2006/07 whereas
declined by 1.82% in 2012-13. Picked up to 4.1% in
2013/14. Shrunk by -20.66% in March-August 2015
 Industrial Growth
3.4 % in April 2014. 4.2% y-o-y during July 2015
manufacturing 4.7%, electricity 11.4%
garments, electrical machinery, furniture, motor vehicles,
basic metals
capital goods & consumer goods 10.6% & 11.4%
consumer non-durables declined by 4.6%
CAD stands 1.2% during April-June 2015

4.0
2.0
0.0
-2.0
-4.0

due to falling trade

-6.0

India Inc Limping: Where are the Profits?

Decoding Indian Economic

Growth Slowdown
Conundrum
2013 through 2015 Status

 Aggregate net profit of 2941 companies:

shrinking by 17% & weak earnings
IT (profit growth only 4%)
Pharma (-2%)
 Weak Corporate Performance
fall in revenue in April-June 2015 (-2.93%)
only marginal rise in net profits (2.77%)
total expenditure of India Inc. (-5.22%)
high interest costs
capital goods, power & steel are struggling
demand-led sectors IT, FMCG & automobiles

Long Run
Output AS
Prices - AD & AS

Time Horizon
P

Short Run
Output AD
Prices AD

AS
AS

Sep
9/11
Asian
Crisis

Dotcom
Bust

Agricultural
Shock

AD1
AD0

AD1
AD0

Global
Financial
Crisis

Q
P

AS0

BOP
Crisis

AS1

Medium Run
Output AD & AS
Prices AD & AS

AD1
AD0

MACROECONOMIC Growth
 VERY Long Run Growth
economys capacity to produce goods & services
1. accumulation of capital (K) & population growth
2. improvement/new technology
3. DCs:- well functioning infrastructure
4. full-employment of resources

 LONG Run Growth

economy with productive capacity

what determines/causes inflation?
level of output:- determined by SS-side
productive capacity is fixed
inflation/price level determined by
the level of DD relative to SSied output

 SHORT Run Growth: output determined by AD

Many a Slip between the Cup and the Lip

Exogenous Shocks
Tech Innovation
Natural Shocks
O
U
T
P
U
T

Trend Path
Potential GDP

Output
Gap

Peak

Actual GDP
Trough
TIME