Eco Env and Macroeconomics)

8/9/2019 Eco Env and Macroeconomics)

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Economic Environment and Policy

(Macro Economics)

Macro economics is part of our everydaylives.

If the macro economy is doing well, it is easyfor new entrants into the labour force,

such as students who have just graduated, tofind jobs.


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ON the other hand,

if the macro economy is in a slump, new jobs are

hard to find,

incomes are not growing well, and profits are low.


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Until the Great Depression of the 1930s, the scopeof economics was essential limited to Microeconomics.

Macro came into existence in 1936, the year JohnMaynard Keyespublished his revolutionary book,the General Theory of Employment, Interest and

Money.

This book laid the foundation of Macro economics.


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Macro Economics is divided underthreesub-sections:

1. Classical Macroeconomics market forces ofdemand and supply are allowed to work freely.

Full employment in the long run and unemployment if any will be inshort run,

neither over production or under production,

economy will always be in equilibrium

Great Depression of 1930s proved all the classical postulates arewrong.


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2.Keynesian Revolution and Macroeconomics associated mainly with --------

employment, growth and stability

1. level of output and employment determined by aggregate demand.

2. Unemployment in any country is caused by lack of aggregatedemand and economic fluctuations caused by demand deficiency.

3. demand deficiency is removed through compensatory governmentspending.


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3.Post-Keynesian developments: Keynesian economics started showing signs of its failures in the

early 1970s.

Especially Keynesian fiscalmeasures failed to providesolution to economic problems of -------- low growth, highunemployment with high rate ofinflation faced by mostdeveloped countries, especiallyby US.

Thisled to growth of new school ofmacroeconomic

thought called monetarists.


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Monetarism (CounterRevolution): The monetaristscame out with a new revolutionary thought -------

Role of money not the role of aggregate demand for real outputas Keynesians believe.

Money supply is the main determinant ofoutput and

employment in the short run andprice level in the long

run.


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Macro-economy can have impact on ourlives, it is important to understand how itworks.

NOW we begin by discussing the differencesbetween microeconomics and

macroeconomics.


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Micro Economics

Microeconomicsexamines the functioning ofindividual industries and the behavior of individualdecision-making units, typically business firms andhouseholds.

WITH a few assumptions about how these unitsbehave( firms maximize profits, households maximizeutility)--------------how markets work, how resourcesare allocated, and so forth.


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Macro Economics

Macro economics, instead of focusingon the factors that influence theproduction of particular products andthe behavior of individual industries,focuses on the determinants oftotalnational output.


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Macroeconomics studies not householdincome but national income, not individualprices but the overallprice level.

It does not analyze the demand for labour inthe automobile industry but instead totalemployment in the economy.


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Micro economics deals with individualdecisions; macroeconomics deals with thesum of these individual decisions.

AGGREGATEis used in macroeconomics torefer to sums.

When we speak of aggregate behaviour, we

mean the behaviour of all households andfirms together.


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Macro economics deals with the economyas a whole.

Macro economics focuses on the determinants oftotal nationalincome,

deals with aggregates such as--------aggregateconsumption and aggregate investment which refer

to -------total consumption and total investment in theeconomy and looks at the overalllevelpricesinstead ofindividualprices.


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Macro economic Concerns

Macroeconomic Concerns:

Three of the major concerns ofmacroeconomics are -----------

1.Inflation 2.Output growth

3.Unemployment


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Government policy makers would like tohave --------------------------

low inflation,

high output growth, and

low unemployment.


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1.INFLATION:

Inflation is an increase in the overall pricelevel. Keeping Inflation low has long been a

goal ofgovernment policy.Especiallyproblematic are hyperinflations.

Hyperinflation :

A

period of very rapid increasesin the overallpricelevel.


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Most Americans are unaware of what life islike undervery high inflation.

In some countries at some times people were

accustomed to prices rising by the day, bythe hour or even by the minute.


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Hyperinflations are rare.

Nonetheless, economists have devoted mucheffort to identify the costs and

consequences of even moderate inflation.


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Inflation : Inflation refers to a persistent rise in prices.

Simply put, it is a situation oftoo much money andtoo few goods.

Thus, due to scarcity of goods and the presence ofmany buyers, the prices are pushed up.

Inflation occurs when mostprices are rising by somedegree across the whole economy.


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This is caused by four possible factors, each of whichis related to basic economic principles of changes insupply and demand:

Increase in the moneysupply. Decrease in the value of money.

Decrease in the aggregate supply of goods andservices.

Increase in the aggregate demand for goods andservices.


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Look atwhat inflation is and how it works,

we will ignore the effects of money supply oninflation and concentrate specifically on the effects

of aggregate supply and demand: cost-push anddemand-pullinflation.

COST-PUSHINFLATION:

When there is a decrease in the aggregate supply ofgoods and services stemming from an increase inthe cost ofproduction, we have cost-push

inflation.


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Cost-push inflation basically means that priceshave been pushed up by increases in costs ofproduction.

Demand-PullInflation :

Demand-pull inflation occurs when there is anincrease in aggregate demand, categorized by thefour sections of the macro economy:

1.households, 2. businesses, 3.governments and4.foreign buyers


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When these foursectors concurrently want topurchase more output than the economy canproduce, they compete to purchase limited amountsof goods and services.

Buyers in essence bid prices up, again, causinginflation.

This excessive demand, also referred to as toomuch money chasing too few goods, usually

occurs in an expanding economy.


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Demand-pull inflation is a product of -------anincrease in aggregate demand that is faster thanthe corresponding increase in aggregate supply.

The converse of inflation, (i.e.) deflation, is thepersistent falling of prices.

RBI can reduce the supply ofmoney orincreaseinterest ratesto reduce inflation.


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Bank interest rate depends on many otherfactors, out of that the major one isinflation.

Whenever you see an increase on inflation,there willbe an increase ofinterest rate

also.


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Who gains from inflation? Who loses?

What costs does inflation impose on society?How severe they? What causes inflation?

What is the best way to stop it?

These are some of the main concerns ofmacro-economists.


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2.OUTPUTGROWTH: (Short run and long run)Instead of growing at an even(smooth) rate at alltimes, economies tend to experience short-termups

and downsin theirperformance. THEtechnical name for these ups and downs is the

business cycle.

BUSINESS CYCLE-------- The cycle of short-termups and downs in the economy.


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When firms cut back on production, they also layoffworkers, increasing the rate ofunemployment.

RECESSION:

A period during which aggregate output declines.It has become conventional to classify an economicdownturn as a recession when aggregate outputdeclines for two consecutive quarters.

A prolonged and deep recession is called adepression.

SINCE the beginning of the twentieth century, theUnited States has experienced onedepression(1930).


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3.UNEMPLOYMENT:

The unemployment rate ------ the percentageof the labour force unemployed --- is a key

indicator of the economys health. The unemployment rate isusually closely

related to the economys aggregate

output.


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Government in the Macro Economy

Much of our discussion of macroeconomicsconcerns the potential role of government

in influencing the economy.

There are three kinds of policy that thegovernment has used to influence the macroeconomy.

1.Fiscalpolicy

2.Monetarypolicy

3.Growth orsupply-side policies.


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1.FISCAL POLICY: Decisions on taxes and government spending.

Government policies concerning taxes and

expenditures. The Government affects the economy through its

tax and expenditure decisionsor fiscal policy.

Fiscal policy can play an important role in

stimulating the rate of growth of an economy.


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Expansionary fiscal policies--------Herethe government should cut taxes and/orraise spending----------to get the economy

out of slump. Contractionary fiscal policies---------Here

the government should raise taxes and/orcut spending ----------to bring the economy

out of an inflation.


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2.MONETARY POLICY:

Control ofmoneysupply.

The tools used by the Federal Reserve to control

the moneysupply. Taxes and spending are not the only variables the

government controls.

Through the ------- Federal Reserve, the nations

centralbank, the government can determine thequantity ofmoneyin the economy.


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Monetarypolicyis one of the two principalmeans (the other being fiscal policy) by whichgovernment authorities in an economy --------

------------------regularlyinfluence the paceand direction of the overall economic activitybut also the general rate at which pricesrise or fall.


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HERE we discuss how the centralbankinfluences the moneysupply --------------------------------------by using different tools and how this

mechanism works in ---------- controlling the trade-offsbetween inflation and

real aspects of economic activity like output andemployment.


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3.GROWTHPOLICIES (supply-side

policies): Policies that focus on increasingthe long-run growth rate.

Focus of government policy should be tostimulate aggregate supply ----- to stimulatethe potential growth ofaggregate outputand income.


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A host(multitude) of policies have beenaimed at increasing the rate of growth.

Many of these are targeted at specific

markets and are largely discussed inmicroeconomics.


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COMPONENTS OF MACROECONOMY

Macroeconomics focuses on four groups:

Households and Firms( the private sector)

The Government (the public sector) Rest of the world( the international sector).

These four groupsinteract in a variety of ways.


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INDIAN ECONOMY (Introduction)

In this chapter we study the broad profile ofthe Indian economy as it will help us inunderstanding the scope forbusiness

activityin the country. The Indian economy is often characterised asunderdeveloped which means that the

nationalincome being low in the country,

the size of the market is rather limited.


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Hence, a business firm cannot plan to expand itsactivity easily. Unlike a firm in a developed country.

The Indian economy, however, no longer suffers fromstagnation as it did under the British.

The countrys economy is now in the process ofdevelopment which is continuously creating

opportunities for increased business activity.


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Having missed the opportunity to developalong the capitalist path during the colonialperiod,

after independence India opted for a plannedcapitalist development and accordinglybuilt-up a mixed economy.


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Characteristic features of the Indianeconomy:

1.The Indian economy still remains underdeveloped.

2.The Indian economy has been growing both interms of an increase in itsper capita income andin terms ofstructural changes.

3. From its pre capitalistic form, the Indian economy

has evolved into a mixed economy.


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India--- an Underdeveloped Economy

The Indian economy is presently an underdevelopedeconomy.

Almost all important characteristic features of anunderdeveloped economy are present in the Indian

economy even after 58 years of independence.


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Underdeveloped economy is primarily anagricultural economy,

as 60 to 70 per cent of the countrys

population seeks employment in agricultural.


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REASONS:

1.Low Per-Capita Income and the rate ofcapital accumulation is also very low.

2.Predominance of Agriculture: We find64.8% of working population was employed in

agriculture in 2001, as against 69.7% in 1951.

Thus the dependence on agriculture seems to have

declined onlymarginally.


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Forinstance, 65% of India's working populationseeks employment in agriculture, only 2% of theUSAs working population is engaged in agriculturaloperations.

The Indian economy thus is essentially agrarian.

In the agriculturalsectorproductivity is low and, asa result, a large number of farmers have virtuallynopurchasing power to buyindustrial goods.


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3. Due to widespread poverty most peoplehave virtually no ability to save. (Sixth five year plan1980-85 acknowledged the fact)

4. Rapid population of growth.

5.Widespread Unemployment


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6. Scarcity of Capital.

7.Technological Backwardness.

8.Lack ofEntrepreneurs (Growth arrestingfactor).

Therefore, if some society possesses peoplewho are gifted with entrepreneurialskill, itis bound to grow rapidly.


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Some economic historians contended that thepresence of this class(entrepreneurial class) inEngland, Germany and the USA had a major role intheir development.

SUCH a class did not exist during the British periodin India.

Even afterindependence for about four decades theIndian business class did not show much

entrepreneurial skill asit operated under aprotective umbrella.


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This situation has, however, changedsince 1990-91 due to economicliberalization.


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India --- a Developing Economy

Indias economy had suffered a long period ofstagnation under the British. After independence,this long spell of stagnation was broken.

With the beginning of economic planning, an era of

economic development was observed.Economic Development in India has broadly

two facets -----

1.Quantitative.

2. Structural.


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REASONS:

1.Nationalincome trends--- The new economicpolicywhich was adopted in 1991, temporarily put

the Indian economy on a high growth path.2.Structural changes Apart from the growth in

quantitative terms, there have been significantchanges in India's economic structure since

independence.


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The Indian economy is no longer a subsistence(survival of) agrarian economy.

Now its structure provides beyond any doubt a farmore congenial environment for businessactivities as compared to about two decades ago.


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3.Growth of basic capital goods industries.

4.Development ofInfrastructure-------

It includes transport facilities, energy production, and

telecommunication system. Their development creates favorable conditions for

business growth and also for better living.

5.Progressin the Banking and Financial

Sector.


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ECONOMIC SYSTEM

Every country in this world has an economic system tofacilitate the production, trade and consumption ofgoods.

Countries across the world have evolved throughvarious ideologies to follow a mix of differentthoughts and systems.

The economic systems of the USA, Japan, Germany,France and the UK as capitalistic.

Likewise, despite differences between the economicsystems of the former Soviet Union and China, theycan both be called socialist.


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CAPITALISTIC ECONOMY:

In the broad sense, is a system ofprivate

property in both producer and consumergoods,

freedom of contract and competition,

with limited Government intervention ineconomic affairs.


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CAPITALISM has existed in a limited formin

the economies of all civilizations.

CAPITALISM is an economic system which isusually closely related to market economies.

BY definition, marker economy is an economicsystem that operates in a free market and isnot planned orcontrolled by a centralauthority.


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Although market economyis often identifiedwith capitalism, it is possible to havegovernment intervention in such aneconomy.

The key difference between marketeconomy and planned economies lies notin the degree of government influence but inhow that influence is used.

EX---1.in a market economy, if the govtwants more steel, it collects taxes to buy steelat market price.


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EX--2.However, in a planned economy, the govtwould simply ordermore steelproduction.

In contrast, on the other hand, an economy

where both centralplanning and marketmechanisms of production and distribution arepresent is known as a mixed economy.

However, governments role in a market economy

remains debatable (controversial).


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IN Soviet Union , this process was known asperestroika

while in China , the creation of a socialist

market economy was one element ofChinese economic reform.


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A capitalistic economy is characterized bythree fundamental features:

1.Free Private Enterprise

2.Market Mechanism --- Prices are determined byoperation of the forces of Demand and Supply.

(i.e.) the relative pressure of buyers and sellers onthe market, will ultimately maximize consumer

welfare. 3.Profit Motive.


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We find that even in the USA, which is a leadingcapitalist economy, production takes place in the

private and the public sectorsside byside.

BESIDES this, the government through its fiscalpolicy and various restrictive policies tries to controlthe activities of the private sector.


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INDIA, which is an underdeveloped country, does notdiffer significantly from the USA in the organization ofits economy.

In India too, both private and public sectors co-

exist.

Capitalism of today is a mixed economic system

in which the private as well as the public sectors

co-exist side by side.


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The Government, in order to ensure a certainlevel ofsocial welfare for its people,

intervenes in various ways in the functioningof the economy.


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SOCIALISTIC ECONOMY( Centrally Planned):

The planned socialist economic system ischaracterized by social ownership of means of

production, centralplanning and social welfareobjective.

Under socialism, property, (i.e.) the means ofproduction are owned, controlled, allocated, directedand managed by the state.


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Economic planning is an integral part of a socialisticeconomy.

U

nlike in a capitalist economy where all importantdecisions are taken by autonomous business units.

In a socialistic economy the responsibility of taking alldecisions related to production and economicdevelopment lies with the state.


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The socialist system was established first in Russia in1917.

After the World war II in 1949 the communists cametopower in china and thus the biggest country

became a socialist economy.

In the early 1990s, the Soviet Union disregarded andother east European countries abandoned thesocialist economic system.

At this juncture some experts proclaimed thatsocialism has lived itslife and now it has nofuture.But is it really so?


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The Chinese Economic Miracle

Chinese economic performance since 1978. is an

even biggermiracle than the East Asian, involving ------------------------------------Singapore, Hong Kong,Taiwan and South Korea.


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FDI flowsinto China rose from near zero in1978 to more than $40 billion in 2000( contrast thiswith India's $ 2.3 billion).

Whichever way one looks at it, Chinaseconomic performance is nothing short ofa miracle.


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SALIENT FEATURES OF THE SOCIALISTECONOMIC SYSTEM:

Marx and Engels have not given any detailed outlineof the socialist economy.

However, they visualized the socialist system as onein which there would not be private ownership of themeans of production.

The practical functioning of a socialist societybecame clearer after the Communist Revolution in

Russia.


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Salient features------

1.Social ownership of means of production.

2.Predominance of public sector.

3.Decisive role of planning. 4.Production guided by social benefit.

5.Abolition of exploitation of labour.


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MIXED ECONOMY:

Mixed economy is followed by socialist countrieswhere equal importance is given to both public andprivate sectors.

All economists agree that a mixed economy must beadapted for the benefit of the vast majority of the

people rather than for a small aristocratic(upperclass) orcapitalist(entrepreneurial) class.


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Today, in a world where many countries offer abroader electoral franchise, open support to thewealthywould be the equivalent to politicalsuicide.

Therefore, most ideologies claim to support theinterest of the greatest number, something that wasonce advocated onlybysocialists.


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Features of Mixed Economy

MIXED ECONOMY:In contrast to the features of a free market (capitalist) economy and

a centrally-planned (socialist) economy,

the institutional features of a mixed economy may

be listed as ------------------------1.Co-existence of public and private sectors.

2.Combination ofplanning with price system.

(Decisive role of market mechanism and supportive role ofplanning).

3.Profit motive and social welfare objective.


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4.Intervention role of the state.

5.Public sector activities guided by social

benefit.

6. SUPPORTIVE ROLE OF ECONOMIC

PLA

NNING.


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Private and Public Sectors:

A mixed economic system intends to combine theelements ofprivate capitalism with those ofstatesocialism.

The two factors in the Indian economy (i.e.) thegrowth of thepublic sector and economic planningmade it distinctly different from the capitalisteconomies of the west.


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A mixed economyresembles a capitalist

economyin more than one respect.

This is not surprising because while building a mixedeconomy no attempt is made to eliminate the basiccharacteristics of a capitalist economy.

Note:There was close similarities between thecharacteristics of the two systems--------- the mixedeconomy and capitalism.


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Features ofIndia's economy which

determine its character as a mixed

economy.

1.Private ownership of the means of production.2.Predominance of the market.

3.Private sector monopolies.

4.Public sector

5.Economic planning.


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Private ownershipproduction:

At present a big segment of the industrial sector is inprivate hands.

As a matter of fact, with the exception of some basicindustries, all other industries including ------------------

----------------heavy engineering, electronics, textiles,jute, sugar, cement, leather, detergents, consumerdurables,liquor,etc. are in private sector.


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Most of the sun-rise ITindustry is also in theprivate sector.

Agriculture, the principal economic activity in the country, is

also in theprivate sectoras the ownership ofagriculturallandis entirelypersonal.

These facts suggest that the production in such aneconomy will be done for the market and the activity

of the producers willbe motivated primarilybyprofit.


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NOTE:

It is worth noting that most of the countries in theworld have moved to the market economy fromother economic systems in last fifteen years.

THE private enterprises find it more comfortable to dobusiness in a free and open economy because ofunlimited opportunities.


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Documents

Eco Env and Macroeconomics)