Introduction to

Macroeconomics
Module 1

Economics is what economists do- Jacob Viner

Macroeconomics
Macroeconomics is the study of the behavior and performance of the economy as a whole.

Definition:
Gardner Ackley: Macroeconomics concerns the overall dimensions of economic lifeMore
specifically, macroeconomics concerns itself with such variables as aggregate volume of an
economy, with the extent to which its resources are employed, with size of the national
income, with the general price level, etc.
K.E. Boulding: Macroeconomics is the study of the nature, relationship and behavior of
aggregates of economic quantities.Macroeconomics deals not with individual quantities
as such, but aggregates of these quantitiesnot with individual incomes, but the national
income, not with individual prices, but with the price levels, not with individual output, but
with the national output.
N.G. Mankiw: macroeconomics is the study of the economy as a whole- including growth in
incomes, changes in prices, and the rate of unemployment. It attempts both to explain
economic events and to advise policies to improve economic performance.

Nature of
Macroeconomics

Macroeconomics is relatively a new branch of economics

A full fledged macroeconomics appeared only after the publication of Keynes
General Theory of Employment, Interest and Money in 1936
Macroeconomics is more normative by nature (unlike positive science)
Macroeconomics is both a theoretical as well as policy science
Evolution of Macroeconomics
Classical and Neo Classical School of Thought (1776-1930)
Most of the classical theories built on micro foundation
Macroeconomics not developed as a separate branch of economics

Keynesian School of Thought (1930s-1960s)

The publication of Keynesian General Theory of Employment, Interest
and Money laid the foundation of modern macroeconomics
Post Keynesian Schools of Thought (early 1970s onwards)
Monetarism (from demand management to monetary management)
New Classical School ( emphasized on the role of individuals rational expectations)
New Keynesian School (problems of information and cost of changing prices lead
price rigidities which cause fluctuation in output and employment)

Anatomy of Economics
Economics

Microeconomics

Product Pricing

Macroeconomics

Factor Pricing

Theory of Demand
Theory of production and cost

Rent

Theory of Eco. Welfare

Wages

Interest

Profits

Macroeconomics
looks at the economy as a whole. Economy-wide phenomena, including
inflation, unemployment, workings of the monetary system, business
cycle, economic policies (fiscal & monetary), economic growth and its
determinants, etc.

Macroeconomic goals
Full employment:
This is the situation at which all available resources (labor, capital, land,
and entrepreneurship) are used to produce goods and services. It enables
more production that can reduce the scarcity problem.
Stability:
This is avoiding or limiting fluctuations in production, employment, and
prices. It reduces uncertainty of the future.
Growth:
This is increasing the economy's ability to produce goods and services. It
improves living standards and better addresses the scarcity problem.

Macroeconomics

Theory of income
& employment

Theory of general
price level

Theory of consumption
function

Theory of economic
growth

Economic Policies

Theory of
investment

Macroeconomics is concerned with the behavior of the economy as a

whole. It deals with
the economys total output of goods and services,
the growth rate of output,
the rates of inflation and unemployment,
the balance of payments,
Prime concern of
exchange rates,
macroeconomics
booms and recessions,
economic policies, etc.

Types of macroeconomics
Macro static
Comparative macro static
Macro dynamic

Importance of macroeconomics
Understanding the working of the economy
Explaining the behavior of economic complexities and finding solution
Formulating economic programs and policies
Analyzing various macroeconomic issues
Any other ?

Limitations of Macroeconomics
It ignores the changes in the constituent elements of aggregates
It may lead to misleading conclusion as aggregates are not a reality but a
picture or approximation of reality
Many consider macroeconomics as an intellectual attraction
Other ?

What is 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.

What is Macroeconomics?
When we study the consumption
behaviour or equilibrium of a
consumer; the production pattern &
equilibrium of a firm, the entire
analysis is micro in nature
because
we study a UNIT and not the
SYSTEM in which it is operating.

Why study Macro

economics?
The economic well being of
consumers rich or poor is affected by
movement in interest rates, exchange
rates, inflation etc.
Businesses stand to gain or lose
considerable amounts of money when
their economic environment changes,
regardless of how well they are
managed.

Why study Macro

economics?

Being prepared for such changes in

fortunes can have considerable value;
more generally, it makes us all better
citizens able to grasp the complex
challenges that our societies face.
Macroeconomics is relevant to voters
who wonder what their governments
are up to?

Why study Macro

economics?

Study of Macroeconomics also help

governments avoid the worst economic
crises that have afflicted modern
industrial societies in the past century
depressions and hyperinflations.
These extreme situations can tear at a
societys social fabric, yet can be
prevented when policy-makers apply
sound economic principles.

Roots of Macro economics

Before the publication of Keynes
General Theory., the distinction
between Micro & Macro economic
issues did not arise at all.
The need for separate study of macro
economics was felt by Keynes while
understanding and analysing the
Great Depression of 1929.

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.

The Great Depression What happened ?

Stock Markets crashed!

9000 banks filed for bankruptcy
Banks that survived stopped giving loans.
People cut down spending
Large amounts of inventories started piling
up
Businesses stopped production.layoffs!
( 25% unemployment)
Purchasing power declined
Hawley Smoot tariff imposed on imports in
1930
Decline in world trade & economic retaliation.

The Roots of
Macroeconomics
The accepted economic theory of the

pre Keynesian era, believed that the

economy usually remains at full
employment level( full utilization of
resources). If there are any
departures from this situation, these
are purely temporary and for a short
period of time.
However, these classical models
failed to explain the prolonged
existence of high unemployment
during the Great Depression. This
provided the impetus for the
development of macroeconomics.

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.

NATURE & SCOPE OF

MACROECONOMICS
Macroeconomics 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.
Macroeconomics 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.

Scope of macroeconomics
As a method of economic analysis
macroeconomics is of much theoretical and
practical importance.
(1)To Understand
Economy:

the

Working

of

the

The study of macroeconomic variables is

indispensable for understanding 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.

(ii) In National Income:

The study of macroeconomics 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 analyze the causes of
general
overproduction
and
general
unemployment.

(iii) In Economic Growth:

The economics of growth is also a study in
macroeconomics. It is on the basis of
macroeconomics that the resources and
capabilities of an economy are evaluated.
Plans for the overall increase in national
income, output, and employment are
framed and implemented so as to raise the
level of economic development of the
economy as a whole.

(iv) In Monetary Problems:

It is in terms of macroeconomics that
monetary problems can be analysed 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.
(v) In Business Cycles:
Further macroeconomics as an approach
to economic problems started after the
Great Depression. Thus its importance
lies in analyzing the causes of economic
fluctuations and in providing remedies.

(3) For Understanding the

Behaviour of Individual Units:
For understanding the behaviour of
individual
units,
the
study
of
macroeconomics is imperative. 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.

Key Macro Economic

Variables
1. National Income and GDP
2. Unemployment
3. Economic growth
4. Inflation
5. International Trade
6. Balance of Payment
7. Monetary & Fiscal Policy
8. Interest Rate
9. Stock Market
10.Business Cycle
11.Exchange Rate

1. Gross Domestic Product

& National Income

GDP refers to the monetary value of all the

finished goods and services produced within a
country's borders in a specific time period, though
GDP is usually calculated on an annual basis.

It includes all of private and public consumption,

government outlays, investments and exports less
imports that occur within a defined territory.

Thegross domestic product(GDP) is one the

primaryindicatorsused to gauge the health
of a country'seconomy.

National Income
National Income is the total value of all
goods and services produced within a
nation over a specified period of time,
representing the sum of wages, profits,
rents, interest and pension payments
to residents of the nation.
It gives correct picture of the economy
and purchasing power of people in the
country.

2. Unemployment
The Unemployment Rate:
to be unemployed, a person must want
to work and be actively looking for a job
(but have not yet found one)
the labor force consists of those who are
employed and those who are unemployed
the unemployment rate is equal to the
number of unemployed people divided by
the labor force

3. Economic Growth
Economic growthis the increase in
themarket valueof the goods and
services produced by aneconomyover
time.
Also, economic growth is the increase
in the capacity of an economy to
produce goods and services, compared
from one period of time to another.

4. Inflation
In economics inflation means, a rise in general level
of prices of goods and services in a economy over a
period of time. When the general price level rises,
each unit of currency buys fewer goods and
services. Thus, inflation results in loss of value of
money. Another popular way of looking at inflation
is "too much money chasing too few goods".
Inflation is caused when goods and services are in
high demand, creating a drop in availability.
Consumers are willing to pay more for the items
they want, causing manufacturers and service
providers to charge more. Supplies can decrease for
many reasons: A natural disaster can wipe out a
food crop or a housing boom can exhaust building
supplies, among other situations.

5. International trade
International trade is the exchange of goods
and services between countries. This type of
trade gives rise to a world economy, in which
prices, orsupplyand demand , affect and are
affected by global events.
International trade allows to expand markets
for both goods and services that otherwise
may not have been available to all. It is the
reason why you can pick between a Japanese,
German or American car.
As a result of international trade, the market
contains greater competition and therefore
more competitive prices, which brings a
cheaper product home to the consumer.

6. Balance Of
Payments(BOP)

Thebalance of payments(BOP) of a country is

the record of all economic transactions between
the residents of a country and the rest of the
world in a particular period (over a quarter of a
year or more commonly over a year).
These transactions are made by individuals,
firms and government bodies. Thus the balance
of payments includes all external visible and
non-visible transactions of a country during a
given period, usually a year.
It represents a summation of country's current
demand and supply of the claims on foreign
currencies and of foreign claims on its currency.

7. Monetary policy
Monetary policyis the process by which
themonetary authorityof a currency controls
thesupply of money, often targeting an
inflation rateorinterest rateto ensure price
stability and general trust in the currency.
Further goals of a monetary policy are usually
to
contribute
toeconomicgrowth
and
stability, to lowunemployment, and to
predictableexchange
rateswith
other
currencies.

7. Fiscal Policy
Fiscal policy is the means by which a
government adjusts its spending
levels and tax rates to monitor and
influence a nation's economy.
It is the sister strategy to monetary
policy through which a central bank
influences a nation's money supply.
These two policies are used in various
combinations to direct a country's
economic goals.

8. Interest Rate
Aninterest
rateis
the
rate
at
whichinterestis
paid
by
borrowers
(debtors) for the use of money that they
borrow
fromlenders
(creditors).
Specifically,
the
interest
rate
is
apercentageofprincipal paid a certain
number of times per period for all periods
during the total term of the loan or credit.
Many different interest rates in the
economy vary by duration and degree of
risk.

9. Stock market
Astock
marketorequity
marketis
the
aggregation of buyers and sellers (a loose network of
economic transactions, not a physical facility or
discrete entity) ofstocks (also called shares); these
may includesecuritieslisted on astock exchangeas
well as those only traded privately.
History has shown that the price ofstocks and other
assets is an important part of the dynamics of
economic activity, and can influence or be an
indicator of social mood.
An economy where the stock market is on the rise is
considered to be an up-and-coming economy. In fact,
the stock market is often considered the primary

10. Business cycle

The termbusiness cycle(oreconomic
cycleorboombust cycle) refers to fluctuations in
aggregate production, trade and activity over
several months or years in a market economy.
The business cycle is the downward and upward
movement of levels ofgross domestic product (GDP)
and refers to the period of expansions and
contractions in the level of economic activities
(business fluctuations) around its long-term growth
trend.
These fluctuations occur around a long-term growth
trend, and typically involve shifts over time between
periods of relatively rapid economic growth
(anexpansionorboom), and periods of relative
stagnation or decline (a contraction orrecession).

11. Exchange Rate

The Exchange Rate between twocurrenciesis
the rate at which one currency will be
exchanged for another.
It is also regarded as the value of one
countrys currency in terms of another
currency.
governs the terms on which international
trade and investment take place
nominal exchange rate is the rate at which
monies of different countries can be
exchanged for one another
real exchange rate is the rate at which the
goods and services produced in different
countries can be exchanged for one another

Importance of
Macroeconomics

It helps us understand the functioning of a

complicated modern economic system. It
describes how the economy as a whole
functions and how the level of national income
and employment is determined on the basis of
aggregate demand and aggregate supply.
It helps to achieve the goal of economic growth,
a higher GDP level, and higher level of
employment. It analyses the forces which
determine economic growth of a country and
explains how to reach the highest state of
economic growth and sustain it.
It helps to bring stability in price level and
analyses fluctuations in business activities. It
suggests policy measures to control inflation
and deflation.

Contd.

It explains factors which determine balance of

payments. At the same time, it identifies causes of
deficit in balance of payments and suggests remedial
measures.
It helps to solve economic problems like poverty,
unemployment, inflation, deflation etc., whose solution
is possible at macro level only (in other words, at the
level of the whole economy).
With a detailed knowledge of the functioning of an
economy at macro level, it has been possible to
formulate correct economic policies and also
coordinate international economic policies.
Last but not least, macroeconomic theory has saved us
from the dangers of application of microeconomic
theory to the problems that require us to look at the
economy as a whole.

Limitation of
Macroeconomics
1. Excessive Generalization:
As hinted above, generalization of individual observation to the
system as a whole may lead to erratic inferences about the
system as a whole. For instance, a loss incurred by one firm in
an industry does not necessarily imply losses to all other firms
in it. Likewise, hospitality shown by one Indian does not imply
that each and every Indian will show the gesture.
2. Obsession of Aggregative Approaches:
Excessive thinking in terms of lumping the individual units
together may lead to erratic inferences. Individual units possess
individualistic traits. They are non-homogeneous in character.
One cant add up two apples and three oranges to make any
meaningful aggregate.
3. Fallacy of Deductive Inferences:
Inferences deduced about individual units from the aggregative
tendency may not always be true in respect of individual units
as well. For instance, a general rise in prices may not affect all
the sections of the community in the same manner. A consumer
suffers from rising price level while a producer benefits from it.

4. Inconsistency between Overall and Individual

Changes:
A hike in prices of industrial output and a fall in prices
of the agricultural products may offset each other to
lead to no rise in the general price level. On the basis of
stability of the general price level, one who believes that
no policy change is called for in the circumstances would
certainly jeopardize the cultivators interests.
5. Problems of Measurement of Aggregates:
In many cases measurement of aggregates involves
serious problems. You will learn more about such
problems in higher classes.
To conclude, macroeconomic analysis, by itself, may
not provide a true picture of an economy. It may appear
like the top surface of an ocean appearing calm and
unruffled from above yet harbouring quite a few storms
underneath. To locate the trouble spots, it is
microeconomic analysis that is called for.