UNIT I Introduction to Macro Economics

Meaning of Economics:
The word Economics originates from the Greek work Oikonomikos which can be divided into two
parts: (a) Oikos, which means Home, and (b) Nomos, which means Management. Thus,
Economics means Home Management. The head of a family faces the problem of managing the
unlimited wants of the family members within the limited income of the family. In fact, the same is
true for a society also. If we consider the whole society as a family, then the society also faces the
problem of tackling unlimited wants of the members of the society with the limited resources available
in that society. Thus, Economics means the study of the way in which mankind organises itself to tackle
the basic problems of scarcity. All societies have more wants than resources. Hence, a system must be
devised to allocate these resources between competing ends.
Branches of Economics: Nature of Economic Science
Economic theory, as it stands today, has several branches. Of these, two are most important. These
are microeconomics and macroeconomics. We shall now briefly mention the major features of these
two branches to have an idea regarding the nature of economics.
Microeconomics: Microeconomics is that branch of economics which is concerned with the decisionmaking of a single unit of an economic system. How does an individual (or a family) decide on how
much of various commodities and services to consume? How does a business firm decide how much
of its product (or products) to produce? These are the typical questions discussed in microeconomics.
Determination of income, employment, etc. in the economic system as a whole is not the concern of
microeconomics. Thus, microeconomics can be defined as the study of economic decision-making by
micro-units.
Usefulness of Microeconomics:
1. Determination of demand pattern: The study of microeconomics has several uses. It determines
the pattern of demand in the economy, i.e., the amounts of the demand for the different goods and
services in the economy, because the total demand for a good or service is the sum total of the
demands of all the individuals. Thus, by determining the demand patterns of every individual or family,
microeconomics determines the demand pattern in the country as a whole.
2. Determination of the pattern of supply: In a similar way, the pattern of supply in the country as a
whole, can be obtained from the amounts of goods and services produced by the firms in the
economy. Microeconomics, therefore, determines the pattern of supply as well.
3. Pricing: Probably the most important economic question is the one of price determination. The
prices of the various goods and services determine the pattern of resource allocation in the economy.
The prices, in turn, are determined by the interaction of the forces of demand and supply of the goods
and services. By determining demand and supply, microeconomics helps us in understanding the
process of price determination and, hence, the process of determination of resource allocation in a
society.
4. Policies for improvement of resource allocation: As is well-known, economic development stresses
the need for improving the pattern of resource allocation in the country. Development polices,
therefore, can be formulated only if we understand how the pattern of resource allocation is

determined. For instance, if we want to analyse how a tax or a subsidy will affect the use of the scarce
resources in the economy, we have to know how these will affect their prices. By explaining prices
and, hence, the pattern of resource allocation, microeconomics helps us to formulate appropriate
development policies for an underdeveloped economy.
5. Solution to the problems of micro-units: Finally, it goes without saying that, since the study of
microeconomics starts with the individual consumers and producers, policies for the correction of any
wrong decisions at the micro-level are also facilitated by microeconomics. For example, if a firm has
to know exactly what it should do in order to run efficiently, it has to know the optimal quantities of
outputs produced and of inputs purchased. Only then can any deviation from these optimal levels be
corrected. In this sense, microeconomics helps the formulation of policies at the micro-level.
In every society, the economic problems faced by different economic agents (such as individual
consumers, producers, etc.) can be analysed with the help of microeconomic theories. This shows that
economics is a social science which aims at analysing the economic behaviour of individuals in a social
environment.
Limitations of Microeconomics: However, microeconomics has its limitations as well:
1. Monetary and fiscal policies: Although total demand and total supply in the economy is the sum of
individual demands and individual supplies respectively, the total economic picture of the country
cannot always be understood in this simplistic way. There are many factors affecting the total
economic system, which are outside the scope of microeconomics. For example, the role of monetary
and fiscal policies in the determination of the economic variables cannot be analysed completely
without going beyond microeconomics.
2. Income determination: Microeconomics also does not tell us anything about how the income of a
country (i.e., national income) is determined.
3. Business cycles: A related point is that, it does not analyse the causes of fluctuations in national
income. The ups-and-downs of national income over time are known as business cycles.
Microeconomics does not help us in understanding as to why these cycles occur and what the
remedies are.
4. Unemployment: One of the main economic problems faced by an economy like India is the problem
of unemployment. This, again, is one of the areas on which microeconomics does not shed much light.
Because, if we are to find a solution to the unemployment problem, we must first understand the
causes of this problem. For that, in turn, we must understand how the total employment level in the
economy is determined. This is difficult to understand from within the confines of microeconomics.
Macroeconomics: Introduction
The term macro was first used in economics by Ragner Frisch in 1933. But as a methodological
approach to economic problems, it originated with the mercantilists in the 16th and 17th centuries.
They were concerned with the economic system as a whole. From the 18th century physiocrats to
modern economists have contributed to the development of macro economic analysis. But credit
goes to Keynes who finally developed a general theory of income, output and employment in the wake
of the great depression.

Definition of macro economics:

Macroeconomics is that branch of economics which is concerned with the economic magnitudes
relating to the economic system as a whole, rather than to the microeconomic units like individuals or
firms. It has, therefore, been called aggregative economics.
Macro economics has been defined in various ways, they are:
In the picturesque language of Kenneth Boulding, Macroeconomics deals ... not with individual
income but with national income, not with individual prices but with the price level, not with individual
outputs but with national output.
Prof. Gardner Ackley defines, macro economics thus: macro economics itself with such variables as
the aggregates volume of output of an economy, with the extent to which its resources are employed,
with the size of national income, with the general price level.
Macro economic theory is the theory of income, employment, prices and money.
Macro economics is, that part of economics which studies the overall averages and aggregates of the
system.
Macro economics is, the study of the forces of factors that determine the levels of aggregate
production, employment and prices in an economy and their rates of change over time.
It is evident from the above definitions that the subject-matter of macro economics is to explain what
determines the level of total economic activity, that is, the size of the national income and
employment and fluctuations in it in the short-run. It also explains what causes the general price level
to rise and determines the rate of inflation in the economy.
Macro economics deals with how an economy grows, it analyses the chief determinates of economic
development and the various stages and process of economic growth. The problem of increasing
productive capacity and national income in the long run. The problem of increasing productive
capacity and national income over time is called the problem of economic growth. Thus, what
determines rate of growth of an economy is also the concern of macro economics.
The justification of a separate macro approach to the study of several economic problems lies in the
fact that micro approach is not only inadequate but may lead to misleading conclusions. In economics,
what is true of the parts is not necessary true of the whole. After all, the problem of the aggregates
is not merely a matter of adding or multiplying what happens in respect of the various individual parts
of the economy. It may be quite different and far more complicated than a mere summation or
multiplication.
Nature of macro economics:
Macro economics is the study of aggregates or averages covering the entire economy, such as, total
employment, national income, national output, total investment, total consumption, total savings,
aggregate supply, aggregate demand, and general price-level, wage level and cost structure. In other
words, it is aggregate economics which examines the interrelations among the various aggregates,
their determination and causes of fluctuations in them. Thus in the words of Prof. Ackley,
macroeconomics deals with economic affairs. In the large, it concerns the overall dimensions of
economic life. It looks at the total size and shape and functioning of the entire economy. It studies
the character of the forest independently of the trees which compose it.

Macro economics is also known as the theory of income and employment, or simply income analysis.
It is concerned with the problems of unemployment, economic fluctuations, inflation or deflation.
International trade and economic growth. It is the study of the causes of unemployment, and the
various determinants of employment. In the field of business cycles it concerns itself with the effect
of investment on total output, total income, and aggregate employment. In the monetary sphere it
studies the effect of the total quantity of money on the general price-level. In international trade, the
problems of balance of payments and foreign aid fall within the purview of macroeconomics analysis.
Above all, macroeconomics theory discusses the problems of determination of the total income of a
country and causes of its fluctuations. Finally it studies the factors that retard growth and those which
bring the economy on the path of economic development.
Importance of macro economics: Macro economics is of theoretical and practical importance. They
are:
1. To understand the working of the economy:
The study of macro economics variables is indispensable for understanding of the working of the
economy. Our main economic problems are related to the behaviour of total income, output,
employment and the general price level in the economy. These variables are statistically measurable,
thereby facilitating the possibilities of analyzing the effects on the functioning of the economy. As
Timbergen observes, macro economic concepts help in, making the elimination process
understandable and transparent. For instance, one may not agree on the best method of measuring
different prices, but the general price level is helpful in understanding the nature of the economy.
2. In economic policies:
Macro economics is extremely useful from the point of view of economic policy. Modern
governments, especially of the underdeveloped countries, are confronted with innumerable national
problems. They are the problems of overpopulation, inflation, balance of payments, general underproduction etc. The main responsibility of these governments rests in the regulation and control of
overpopulation general prices, general volume of trade, general output etc. Timbergen says,
Working with macro economics concepts is a bare necessity in order to contribute to the solutions of
the great problems of our times. No government can solve these problems in terms of individual
behaviour. Macroeconomic study helps in the solution of certain complex economic problem like:
a. general unemployment:
Unemployment is caused by decrease in aggregarte demand. In order to eliminate it, aggregate
demand should be raised by increasing total investment, total output, total income and total
consumption. Thus, macro economics has special significance in studying the causes, effects and
remedies of general unemployment.
b. National income:
The study of macro economics is very important for evaluating the overall performance of the
economy in terms of national income. With the advent of the great depression of the 1930s it became
necessary to analyse the causes of general unemployment. This led to the construction of the data
on national income. National income data help in forecasting the level of economic activity and to
understand the distribution of income among different groups of people in the economy.

c. Economic growth:
Economic growth is the key factor that determines standards of living over generations. Currently, we
see that there is significant divergence of standard of living among different countries. The main
reason for this varying standard of living among countries is the different levels of economic growth
in the past. Over the past several decades, economies of the currently developed countries have
shown moderate to high growth rates for a sustained period, while the economies of developing
countries have not. The developing countries may have had occasional periods of high growth; but
they have not sustained high growth performance over a long period. In other words, the developed
countries have experienced higher long-term economic growth than the developing countries.
Macroeconomics analyzes how and why different countries are growing at different rates, and
suggests how countries can accelerate their growth rates.
d. Monetary problems:
It is in terms of macroeconomics that monetary problems can be analyzed and understood properly.
Frequent changes in the value of money-inflation or deflation- affect the economy adversely. They
can be counteracted by adopting monetary, fiscal and direct control measures for the economy as a
whole.
e. Business cycles:
Growth of most countriesdeveloped as well as developing countries go through ups and downs. The
term business cycle refers to economy-wide fluctuations in production or economic activity over time
between periods of relatively rapid economic growth, and periods of relative stagnation or decline.
The duration of a business cycle can be several months or even a few years. Despite being termed
cycles, these fluctuations in economic activity usually do not follow a mechanical or predictable
periodic pattern.
The downward phase of business cycle, when economic activity contracts, is called recession.
Recession can lead to job losses and other hardships for the population in the concerned economy.
Macroeconomics studies business cycles and suggests policies so that recession can be avoided as far
as possible or made short-lived. The upward phase of the business cycle is called economic boom.
During this period, many new jobs are created and the unemployment rate in the economy falls.
f. For understanding the behaviour of individual units:
Macro economics helps in the understanding the behaviour of individual units. Demand for individual
products depends upon aggregate demand in the economy. Unless the causes of deficiency in
aggregate demand are analyzed, it is not possible to understand fully the reasons for a fall in the
demand of individual products. The reasons for increase in costs of a particular firm or industry cannot
be analyzed without knowing the average cost conditions of the whole economy. Thus, the study of
individual units is not possible without macro economics. Thus macro economics enriches our
knowledge of the functioning of an economy by studying the behaviour of national income, output,
investment, saving and consumption. Moreover, it throws much light in slowing the problems of
unemployment, inflation, economic instability and economic growth.
Scope or Subject matter of macro economics:
The subject matter of macro economics are as follows:
1. Income and employment determination: The determination of national income and of total
employment in the country are vital concerns of macroeconomics. Since the volume of unemployment

is simply population minus the number of people employed, unemployment is determined as soon as
the employment level is known.
2. General price-level and inflation:
Another macro economic issue is to explain the problem of inflation. Inflation had been a major
problem faced by both the developed and developing countries in the last 50 years. Upward
movement of the general price level is known as inflation. Thus, if we want to understand the process
of inflation and find ways of controlling it, we must resort to the study of macroeconomics.
3. Business cycles:
Throughout history market economies have experiences business cycles. Business cycles refer to
fluctuations in output and employment with alternating periods of boom and recession. During boom
or prosperity both output and employment are at high levels, whereas in recession both output and
employment fall as a consequence large unemployment came into existence in the economy. When
recession is extremely severe, they are called depression. What are the causes of these business cycles
is an important macro economic issue which has been highly controversial. The objective of macro
economic policy is to achieve economic stability with equilibrium at full- employment, level of output
and income.
4. Economic growth:
Another important issue in macro economics is to explain what determines economic growth in a
country. Theory of economic growth has been recently developed as an important branch of macro
economics.
5. Balance of payments and exchange rate:
Balance of payments is the record of economic transactions of the residents of a country with the rest
of the world during a period. The objective of preparing such a record is to present an account of all
the receipts of goods imported, services rendered, and capital received by the residents of a country
and the payments made for goods imported, services received and capital transferred to other
countries by residents of a country. There may be deficit or surplus in balance of payments. Both
create problems for an economy. An important effect is that the transactions in balance of payments
are influenced by the exchange rate. The exchange rate is the rate at which a countrys currency is
exchanged for foreign currencies. The instability in exchange rate has been a major problem in recent
years which has given rise to serious balance of payments problems.

Limitations of macro economics:

There are, however certain limitations of macro economic analysis. Mostly these stem from attempts
to yield macro economic generalizations from individual experiences.
1. Fallacy of composition:
In macro economic analysis the fallacy of composition is involved, that is, aggregate economic
behaviour is the sum total of individual activities. But what is true of individuals is not necessarily true
of the economy as whole. For instance, savings are a private virtue but a public vice. If total savings
in the economy increase, they may initiate a depression unless they are invested. Again, if an
individual depositor withdraws his money from the bank there is no danger but if all the depositors
do this simultaneously the banking system will be adversely affected.

2. To regard the aggregates as homogeneous:

The main defect in macro analysis is that it regards as homogeneous without taking into consideration
their internal composition and structure. The average wage in a country is the sum total of wages in
all occupations, that is, wage of clerks, typists, teachers, nurses etc. But the volume of aggregate
employment depends on the relative structure of wages rather than on the average wage. If, for
instance, wages of nurses increase but of typists fall, the average may remain unchanged. But if the
employment of nurses fall and typists rises much, aggregate employment would increase.
3. Aggregate variables may not be important necessarily:
Aggregate variables which form the economic system may not be of much significance. For instance,
the national income of a country is the total of all individual incomes. A rise in national income does
not mean that individual incomes have risen. The increase in national income might be the result of
the increase in the incomes of a few rich in the country. Thus a rise in the national income of this type
has little significance from the point of view of the community. Prof. Boulding calls these difficulties
as, macro economics paradoxes, which are true when applied to a single individual but which are
untrue when applied to the economic system as a whole.
4. Indiscriminate use of macro economics is misleading:
An indiscriminate and uncritical use of macro economics in analyzing the problems of the real world
can often be misleading. For instance, if the policy measures needed to achieve and maintain full
employment in the economy are applied to structural unemployment in individual firms and
industries, they become irrelevant. Similarly, measures aimed at controlling general prices cannot be
applied with much advantage for controlling prices of individual products.
5. Statistical and conceptual difficulties:
The measurement of macro economic concepts involves a number of statistical difficulties. These
problems relate to the aggregation of micro-economic variables. If individual units are almost similar
aggregation does not present much difficulty. But if microeconomic variables relate to dissimilar
individual units, their aggregation into macro economic variable may be wrong and dangerous.

Differences between Microeconomics and Macroeconomics:

Microeconomics
It is that branch of economics which deals with
the economic decision-making of individual
economic agents such as the producer, the
consumer, etc.
It takes into account small components of the
whole economy.
It deals with the process of price determination
in case of individual products and factors of
production.
It is known as price theory (since it explains the
process of allocation of economic resources
along alternative lines of production on the
basis of relative prices of various goods and
services.)
It is concerned with the optimisation goals of
individual consumers and producers (e.g.,
individual consumers are utility-maximisers,
while
individual
producers
are
profitmaximisers.)
It studies the flow of economic resources or
factors of production from any individual owner
of such resources to any individual user of these
resources, etc.
Microeconomic theories help us in formulating
appropriate policies for resource allocation at
the firm level.
It takes into account the aggregates over
homogeneous or similar products (e.g., the
supply of steel in an economy.)

Macroeconomics
It is that branch of economics which deals with
aggregates and averages of the entire economy,
e.g., aggregate output, national income,
aggregate savings and investment, etc.
It takes into consideration the economy of any
country as a whole.
It deals with general price-level in any economy.

It is also known as the income theory (since it

explains the changing levels of national income
in any economy during any particular time
period.)
It is concerned with the optimisation of the
growth process of the entire economy.

It studies the circular flow of income and

expenditure between different sectors of the
economy (say, between the firm sector and the
household sector.)
Macroeconomic theories help us in formulating
appropriate policies for controlling inflation (i.e.,
rising price-level), unemployment, etc.
It takes into account the aggregates over
heterogeneous or dissimilar products (say, the
Gross Domestic Product of any country during
any year.)

Conclusion: The study of microeconomics and that of macroeconomics are complementary to each
other. The limitations of microeconomics are covered by macroeconomics. On the other hand,
macroeconomics does not make a detailed study of the individual consumer or producer. This is taken
care of by microeconomics. One can hope to form a comprehensive notion of what economics is all
about only when one is acquainted with both microeconomics and macroeconomics.