Introduction to macro economics

•Introduction to Macro Economics

What is Macro Economics?

• Macroeconomics looks at the economy as a whole, dealing with such aggregate phenomena as growth in total output and living standards, commonly called’ economic growth’, business cycles, inflation, unemployment. Productivity, and the balance of payments.

• Macro-economics is concerned largely with the behavior of economic aggregates, such as total national product, total investment, and exports for the entire economy. It is also concerned with the average price of all goods and services, rather than the prices of specific products. These aggregates result from activities in many different markets and from the behavior of different decision-makers such as consumers, governments, and firms.

•National output and national income are central topics in macroeconomics.

• Growth theory aims to explain the long-term trend in potential GDP, while the short-run macroeconomic model usually focuses on explaining the GDP gap.

Central Questions of Macro Eco

1.What determines longer term economic growth?2.What causes short term fluctuations in output, employment and prices?3. How can unemployment be reduced?

• How can rate of growth be accelerated?

• What causes inflation?• How external sector influences us?• What kind of economic policies

should we have to promote welfare aspect of economic growth?

• Optimization functions(a)Consumption now or in future (b) Who is to sacrifice present

generation or next generation

Evolution of Macro Economic Thought

Father of Eco 1.Adam Smith (1723-1790) Wealth of Nations(1776) (a) Engine of Eco Growth _Division of labour _Specialization _Technical progresss _Accumulation of capital _System of free enterprise economy

It is not from the benevolence of the Butcher, the Brewer or the Baker, that we except our dinner, but from their regard to their own interest.

Tools of Macro Economic Policy

• Fiscal policy : Denotes the use of taxes & expenditure. _Taxes affects people income _Taxes also determine (a) Decisions of investors (b) Investment climate Monetary Policy Central bank (RBI) manages the policy through managing(1) Nations money supply(2) Credit & banking system(3) Exchange rate policies

Issues in macro Economics

• What determines the level of economic activities?

• How is the equilibrium level of national income determined?

• What causes fluctuations in the national income, output & employment.

• What determines the general level of prices?

• What determines the level of foreign trade and balance of payments?• How does monetary and fiscal

polices of the government affect the economy?• What economic policies can steer

the economy on long term path?

•What are the sources of inflation or general price rise?• How can inflation be

controlled?• How can a nation raise its

rate of economic growth?

Central Questions of Macro Economics

•Why do output employment some times fall and some times rise?•How can unemployment

be reduced?

• The macroeconomic theory that we now study explains the deviation of actual form potential GDP, that is , the GDP gap.

• The determination of GDP in the short run depend on the behavior of key categories of aggregate spending: consumption, investment, government spending, and net exports.

• Analysis of the short run in macroeconomics is concerned with explaining why national output can deviate form its potential level. It is about the GDP gap and how to keep both positive and negative gaps as small as possible-that is, how to keep actual GDP as close as possible to potential GDP.

• The long run in macroeconomics is the period it takes the economy to return to the level of potential GDP once it has been disturbed.

• Consumption spending depends on disposable income and wealth. Investment spending depends on real interest rates and business confidence.

• A necessary condition for GDP to be in equilibrium is that desired domestic spending is equal to actual output.

What Macro Economists Do

• Macro economic forecasting• Macro economic analysis• Macro economic research Research proceeds through formulation & testing of

economic theories. An economic theory is a set of ideas about the

economy organized in a logical framework. Models enable economists to explain an economic

phenomenon by linking them to independent variables c=c+cyd

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“Economics is the study of how men & society choose, with or without the use of money, to empoy scarce productive resources which could have alternative uses, to produce various commodities over time, and distribute them for consumption now and in the future among various people and groups.”

Prof. Samuelson

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Issues in Macro Economics • Why a country is poor or rich. How a

country can become rich?• Road to economic progress and high

rate of growth• What is inflation; why its takes place• How can we achieve full employment• Social Responsibility of Business

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Macro Economic Aggregates

Aggregation involves adding apples & Oranges

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Solution• Gross Domestic Product (GDP)- A

measure of Economic Activity.• Aggregate consumption- volume of

goods and services devoted to current consumption during a period.

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• Aggregate investment- Volume of goods and services devoted to capital formation during a period.• Whole sale price index• Consumer price index• Total money supply, bank credit,

foreign exchange reserve etc.

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Government in Macro Economy

Classical View• Leave the economy to markets• Economy is always in full

employment • Supply creates its own demand

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• Over production & unemployment are short run phenomenon• Price & wage flexibility bring about

full employment• No govt interference or least

interference

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Keynesian View

• Investment is highly volatile • Govt to actively participate in economic

life to correct the fluctuations in investment, consumption , savings, output, employment, incomes, through pro-active monetary and fiscal policy.