Macroeconomic

MACROECONOMIC AGGREGATES AGGREGATE-DEMAND & AGGREGATE-SUPPLY

BY :- SHIVPAL SINGHJ(ITM, NAVI MUMBAI)

INTRODUCTION TO ECONOMICS

Economics is a study of social science.Developed out of the broader field of political economy owing to a desire to use an empirical approach.Aim to explain “how” economics work and economic agent “interact”.Analysis is applied throughout society, business finance and government, etc.

Contd….Expanding domain in the social science

has been described as “economics imperialism”.

Common distinctions are drawn between various dimensions of economics.

The textbook distinction are drawn between micro and macro concepts.

Defines as “the science which studies human behaviour as a relationship between end users and means which have alternative uses”.

ECONOMICS

MICROECONOMICS

MACROECONOMICS

MICROECONOMICSMicroeconomic examines the economic

behaviour of agents.Microeconomics focus on “What” and “For

whom”.Explores how various system of

incentives and way of making decisions work.

Provides the concept of economic efficiency.

Examines whether the production meet the highest value and if not what change would increase that value.

MACROECONOMICS

Macroeconomics considers the performance of a country as a whole.

Deals with situation/condition with a long run effect.

We try to understand changes in- rate of economics growth. rate of inflation. unemployment. our trade performance with other

countries.Help to evaluate the relative success or failure

of government economic policies.

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 Demand, Aggregate Supply and General price level, Wage level, and Cost structure.

DIFFERENCE BETWEEN MICROECONOMICS AND

MACROECONOMICSMICROECONOMICS MACROECONOMICS

1).Microeconomics is the study of decisions that individuals make.

1).Macroeconomics is the field of economics that study the behaviour of the company as a whole.

2).It focusses on supply and demand and forces that determine the price levels.

2).It looks at economies wide phenomenon such as GDP.

3).Company strategy is to maximize profit and capacity to compete in industry.

3).It looks at how an increase/decrease in net profit would effect a nation capital account.

4).Microeconomics takes up a bottoms-up approach to analyze the economy.

4).Macroeconomics takes a top-down approach to analyze the economy.

AGGREGATE-DEMAND

In economics aggregate demand is the total demand for final goods and services in the economy at a given time and price level.

Aggregate demand is the gross domestic product of a country when inventory levels are static.

Aggregate DemandThe sum of all expenditure in the economy

over a period of timeMacro concept – WHOLE economyFormula:

AD = C+I+G+(X-M)◦ C= Consumption Spending◦ I = Investment Spending◦ G = Government Spending◦ (X-M) = difference between spending on

imports and receipts from exports (Balance of Payments)

Aggregate Demand –Key VariablesConsumption ExpenditureInvestment ExpenditureGovernment ExpenditureImport SpendingExport Earning

Consumption ExpenditureExogenous factors affecting consumption:

◦ Tax rates◦ Incomes – short term and expected income over

lifetime◦ Wage increases◦ Credit◦ Interest rates◦ Wealth

Property Shares Savings Bonds

Investment ExpenditureSpending on:

◦ Machinery◦ Equipment◦ Buildings◦ Infrastructure

Influenced by:◦ Expected rates of return◦ Interest rates◦ Expectations of future sales◦ Expectations of future inflation rates

Government SpendingDefenceHealthSocial WelfareEducationForeign AidRegionsIndustryLaw and Order

Import Spending (negative)Goods and services bought from

abroad – represents an outflow of funds from the country (reduces AD)

Export Earnings (Positive)Goods and services sold abroad –

represents a flow of funds into the country (raises AD)

Aggregate Demand CurveThe aggregate

demand (AD) curve is a curve that shows the negative relationship between aggregate output (income) and the price level

Deriving the Aggregate Demand Curve

To derive the aggregate demand curve, we examine what happens to aggregate output (income) (Y) when the price level (P) changes, assuming no changes in government spending (G), net taxes (T), or the monetary policy variable (Ms).

Deriving the Aggregate Demand Curve

The AD curve is not a market demand curve, and it is not the sum of all market demand curves in the economy. It is a more complex concept.

Aggregate Demand Curve Aggregate demand falls when

the price level increases because the higher price level causes the demand for money to rise, which causes the interest rate to rise.

It is the higher interest rate that causes aggregate output to fall.

At all points along the AD curve, both the goods market and the money market are in equilibrium.

Reasons why AD is downward slopingThe consumption link: The

decrease in consumption brought about by an increase in the interest rate contributes to the overall decrease in output.

The real wealth effect, or real balance, effect: When the price level rises, there is a decrease in consumption brought about by a change in real wealth.

Shifts in ADChanges in

Governmental Policies

Changes in Monetary Policy

Changes in Expectations of Households and Firms

Factors that Effect Aggregate Demand 1. Income 2. Wealth 3. Population 4. Interest rates 5. Credit availability 6. Government demand 7. Taxation 8. Foreign demand 9. Investment 10. Expectations (a) Inflationary (b) Income (c) Wealth (d) Interest rate

(+)(+)(+)(–)(+)(+)(–)(+)(+)

(+)(+)(+)(+)

AGGREGATE SUPPLY

AGGREGATE SUPPLY

Aggregate supply is the total supply of goods and services in an economy.

AGGREGATE SUPPLY CURVE

Curve shows relation between aggregate quantity of output supplied by all the firms in an economy and overall price level.

It is not a market supply curve ,and it is not simple sum of all individual supply curves.

Rather than an aggregate supply curve, what does exist is a “price/output response” curve

AGGREGATE SUPPLY IN THE SHORT RUN

In the short run, the aggregate supply curve (the price/output response curve) has a positive slope


Macroeconomists focus on whether or not the economy as a whole is operating at full capacity.As the economy approaches maximum capacity, firms respond to further increases in demand only by raising prices.


At low levels of aggregate output the curve is fairly flat.As economy approaches capacity, the curve becomes nearly vertical.At capacity, the curve is vertical.

The Response of Input Prices to Changes in the Overall Price Level

There must be a lag between changes in input prices and changes in output prices, otherwise the aggregate supply (price/output response) curve would be vertical.Wage rates may increase at exactly the same rate as the overall price level if the price-level increase is fully anticipated. Most input prices, however, tend to lag increases in output prices.

WHY IS THE SHORT RUN CURVE UPWARD SLOPING?

Short-run aggregate supply curve slopes upward because:

Contracts make some wages and prices “sticky.”

Firms are often slow to adjust wages.

Menu costs make some prices sticky

Shifts of the Short-RunAggregate Supply Curve

A decrease in aggregate supply

An increase in aggregate supply

Bad weather, natural disasters, destruction from wars

Good weather

Public policy waste and inefficiency over-regulation

Public policy supply-side policies tax cuts deregulation

Stagnation capital deterioration

Economic growth more capital more labor technological change

Higher costs higher input prices higher wage rates

Lower costs lower input prices lower wage rates

Shifts to the LeftDecreases in Aggregate Supply

Shifts to the RightIncreases in Aggregate Supply

Factors That Shift the Aggregate Supply Curve

Shifts of the Short-RunAggregate Supply Curve

The Equilibrium Price LevelAD represents money and goods market in equilibrium.AS represents price/output decisions of all firms in ecomony. P0 and Y0 correspond to equilibrium in the goods market and the money market and a set of price/output decisions on the part of all the firms in the economy.

The Long-RunAggregate Supply Curve

Costs lag behind price-level changes in the short run, resulting in an upward-sloping AS curve. Costs and the price level move in tandem in the long run, and the AS curve is vertical.


Output can be pushed above potential GDP by higher aggregate demand. The aggregate price level also rises.


When output is pushed above potential, there is upward pressure on costs, and this causes the short-run AS curve to the left.Costs ultimately increase by the same percentage as the price level, and the quantity supplied ends up back at Y0.


Y0 represents the level of output that can be sustained in the long run without inflation. It is also called potential output or potential GDP.

Macroeconomic Model Building

Model Building Overview◦Much of the work of economists is model

building.◦Models help to explain the relationship

between economic variables and help to answer why economic problems or conditions occur.

◦Model building consists of: Identifying variables Establishing assumptions Collecting and analyzing data Interpreting conclusions

Classical Economics◦Popularly accepted theory prior to the

Great Depression of the 1930s.◦Says the economy will automatically

adjust to full employment. Classical economics is mainly based upon:1. Barter economy2. Supply creates its own demand in a macro

economy.3. Wages and prices are flexible and increase or

decrease to ensure that the economy operates at full employment.

4. Savings always equals investment, because changes in the interest rate bring savings and investment into equality.

Keynesian Economics◦ Based on the work of John Maynard Keynes, who

focused on the role of aggregate spending in determining the level of macroeconomic activity.

◦ Introduced the idea that a macro economy seeks an equilibrium output level.

Keynesian theories -◦ The labour market ◦ The market for loanable funds (money

market) ◦ The Multiplier ◦ Keynesian inflation theory

THE LABOUR MARKET –•Keynes didn't have the same confidence in the labour market as Classical economists• Wages would be 'sticky downwards‘ ( mean that wages would not necessarily fall enough to clear the market and unemployment would linger)

MARKET FOR LOANABLE FUNDS (MONEY MARKET) •Any increase in savings would mean that people spent less. This would mean a decrease in aggregate demand•Firms would be even less inclined to invest because they would find the demand for their products decreasing.

MULTIPLIER EFFECT-

KEYNESIAN VIEW ON INFLATIONDEMAND-PULL INFLATION -.As aggregate demand grows so does the level of output • Full employment- leads to inflation

COST-PUSH INFLATION•Increased pressure on the labour market (as nearly everyone has a job) •Rise in wages•This in turn will cause costs to increase.

KEYNESIAN POLICIES-Reflationary policies

Reflationary policies which boost the level of economic activity might include:

Increasing the level of government expenditure

Cutting taxation (either direct or indirect) to encourage spending

Cutting interest rates to encourage saving

Allowing some money supply growth

KEYNESIAN POLICIES Deflationary policies

Deflationary policies which dampen down the level of economic activity might include:

• Reducing the level of government expenditure

• Increasing taxation (either direct or indirect) to discourage spending

• Increasing interest rates to discourage saving

• Reducing money supply growth

AN EXAMPLE-

BIBLIOGRAPHYMACROECONOMICS –THEORY &

POLICY—H L AHUJAMACROECONOMICS—M L

JHINGANPRINICPLES OF ECONOMICS—

PEARSONWIKIPEDIAWIKINOMICS.COM

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