Macro Economics BBM

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Introduction to

Macro Economics


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Historical Evolution of Macro Economics

Adam Smiths Absolute Advantage Theory, David Records Comparative Advantage Theory,Great Depression I 1929(Over production, unemployment etc)World War II

Diversion of research interests from science to social science.(Lawrence Clain, John Nash, Simon Kuznets, Samuelson, JoanRabinson, Charles Chamberlin etc)

J .M. Keynes work: The General Theory of Employment, Interest and Money published in the year 1936 laid foundation for MacroEconomics.


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Definitions of Macro EconomicsMacro economics is concerned with the behavior of the economy as awhole and analyzes the causes of major problems such asunemployment, inflation, low wages, low economic growth andincreasing trade deficits.

It is a study of economic aggregates such as total employment,national product and national income, the general price level of the

economy.

It deals with both short term fluctuations business cycles and longterm changes economic growth.

Macroeconomic analysis attempts to study and explain whymacroeconomic problems exist and how they can be tackled.

Greek prefixes macro and micro were first introduced in economics

by Prof. Ragnar Frisch in 1933.


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Micro and Macro Economics

Micro Macro Economics Term derived from the Greek wordmikros which means small .

- It deals with small individual units, of the economy such as individualconsuming households, individual firms,individual industries and various productand factor markets.

Derived from the Greek word macros meaning large and therefore it is

concerned with the large or totaleconomic activity. Explains thebehaviour of whole economic system intotality.

Microscopic study of the working of theeconomy.- Discuss how the various decision-making individual units of the economysuch as thousands of consuminghouseholds, firms, workers in theeconomy do their economic activitiesand reach their equilibrium states.

Aggregative economics- Studies the behaviour of the largeaggregates such as total employment,national product or income, the generalprice level of the economy.

Discuss equilibrium of innumerableindividual units of the economy and theirinter-relationship with each other.

It explains the determination of the levelof national income and employment, andgeneral level of prices.


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General Macro economic goals:

high level of output (GDP),full employment,price stability,sustainable balance of payments andrapid economic growth.


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GROSS DOMESTIC PRODUCT (GDP)

It is the market value of all goods and services produced by

factors of production located within the boundaries of acountry, during a specified period of time usually one year.

Nominal gdp measures domestic output value in currentmarket prices.

Real gdp adjusts the nominal gdp for price changes(inflation) and so serves as a good measure of comparisonbetween time periods and between countries.

GDP is the best indicator of the economic performance of a

country both in the short run and long run.


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FULL EMPLOYMENT

It is considered as the primary and well accepted goal of macroeconomic policy of the government which will helpalleviate poverty.

The unemployment rate is defined as the percentage of labor force that is unemployed in a country.

In the recession phase of a business cycle unemployment

rate increases as demand for labor falls while in the boomphase unemployment rate decreases as demand for laborincreases.


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PRICE STABILITY

Prices affect purchasing power of money incomes and sostandard of living of people.

Inflation is a continuous rise in the general price level seen

in the upward rate of change in the price index. Anextreme form of inflation is called hyper inflation. Inflationin general reduces the purchasing power of money.

Deflation also called negative inflation rate is continuousdecrease in the general price level.


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In terms of economic stability neither high inflation norhigh deflation is advisable. Rapid price changes disturbseconomic decisions of companies because it upsets costcalculation and of individuals because it upsets realincome.

So macroeconomic policy aims for steady or gentle rise inprices rather than shock fluctuations of very high inflationor very high deflation.


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SUSTAINABLE BALANCE OF PAYMENT

Balance of payment is a systematic record of alleconomic transactions between a country and therest of the world.

Balance of trade which is a part of the balance of payment is an important indicator of the status of acountrys foreign trade.


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Balance of trade is a systematic record of merchandise exports and imports between acountry and the rest of the world.

Net exports, a measure of the BOT, is the difference

between the above two variables.

It is positive net exports if merchandise exports of acountry exceed its imports and negative net exportsif its merchandise imports exceeds it exports.


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ECONOMIC GROWTH

Economic growth usually refers to: an increase in theproduction possibility curve or schedule and growth inreal GDP or in real per capita output.

Per capital GDP growth is measured by:[1 + g] / [1+ p] 1

where,g = % growth of GDP,p = % growth of population.


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INSTRUMENTS OF MACROECONOMIC POLICY

Governments use macroeconomic policies which influenceeconomic activity so as to achieve economic objectives.

OBJECTIVES INSTRUMENTS / TOOLS

High output level Monetary policy

Low unemployment rate Fiscal policy

Stable price level Exchange rate policy &monetary policy

Maintenance of balance of payments

Prices and incomes policies

Steady economic growth Employment policy


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FISCAL POLICY

Fiscal policy refers to policy regarding expenditure and revenue of

the public authority be it the local or state or national government.

Government consists of its purchases (spending on goods,services, infrastructure construction and maintenance, salaries ofpublic servants etc) and transfer payments (financial assistance to

some select groups).

Government spending influences private spending allocations inthe economy and so the GDP level.

Government revenue, especially tax revenue, affects the economyin two ways: impacts private disposable income and so privatepurchasing power as well as saving; the first impact affects overalloutput and investment; also affects prices of goods, services andfactors of production.


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MONETARY POLICY

All modern economies are monetized usingmoney as a meaning of exchange and a storeof value i.e. liquid financial asset.

A economys monetary system consists ofinstitutions that create financial assets and itsleader is the central bank which formulates as

well as implements the monetary policy that influences total quantity of money, interest rates and the volume of credit impacting on real macro economic variables like GDP,capital formation, employment and price level.


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INTERNATIONAL TRADE POLICY

Trade policy consists of traderegulations, tariff or non-tariff based,

that restricts or promotes a countrys imports and exports.

Many countries use trade policy as astrategic tool to increase economicgrowth e.g. Far East Asian economies.

EXCHANGE RATE POLICY


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EXCHANGE RATE POLICY

Foreign exchange management is a part of monetary

policy that has an impact on trade policy because itsmost important component is management of thecountrys exchange rate.

Exchange rate: amount of domestic currency to bepaid for a unit of a foreign currency.

There are two popular exchange rate systems: Fixedexchange rate: fixed by the government and Floatingexchange rate: freely determined by demand for andsupply of currencies with intervention by themonetary authority or the government.


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PRICES AND INCOME POLICY

Government sets the prices of some

goods and services as well asdetermines wages.

Used to influence the marketeconomy inflation etc.


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EMPLOYMENT POLICY

Policy and programmes with theobjective of generating employment

opportunities.Done through government projects that

are deliberately labor intensive and alsothrough free training facilities ofunskilled labor etc.


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BASIC CONCEPTS OF MACROECONOMICS

STOCKS AND FLOWS

A stock variable is measured at a specific point of time and aflow variable is measured over a specified period of time.

STOCK VARIABLES FLOW VARIABLES

Money supply GDP

Consumer price index Inflation

Unemployment level Exports & imports

Foreign exchange reserves Consumption & investment


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EQUILIBRIUM AND DISEQUILIBRIUM

Economic equilibrium is a state of balance betweenopposing forces or actions wherein the action of thevariables is repetitive such that the continuouschange does not established position.

Disequilibrium is the absence of the above state ofequilibrium.


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STATICS AND DYNAMICS

Economic models deal with stock and flow variables whichmay be either in equilibrium or disequilibrium at a point oftime.

Models which do not consider explicitly the behavior ofvariables from one time period to another, thus not having a

time dimension and consequently indicating only thedirection of change in economic variables but not theirprocess of change are called Static Models.

Models which consider the movement of variables over different time periods thus relating what happens in currenttime to preceding as well as future time periods andconsequently able to describe movement of variables fromone disequilibrium position to another, until equilibrium isultimately reached are called Dynamic Models.


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National income accounting

National income accounting a set of rules anddefinitions for measuring economic activity in theaggregate economy i.e., in the economy as awhole.

National income accounting is a way of measuringtotal, or aggregate production


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What Is National Income?

It is the money value of all the final goods andservices produced by a country during the period of one year

Since goods are measured in different physicalquantities (for eg. Cloth in metres, etc), the value of the goods and services produced is measured inmoney and summed up to give nothing but thevalue of national income or national product.


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MEASURING NATIONAL INCOME

Three approaches:

1. Product approach.2. Income approach.3. Expenditure approach.


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PRODUCT APPROACH

Calculate total value of final output of a country.

Aggregation of the product of goods or services &their respective prices.

NI = P1Q 1 + P2Q 2 + P3Q 3 + ---+PnQ n.


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INCOME APPROACH

All factors contribute to final output.

Value of final output equals total income of production factors.

PiQ i = W i + Ri + Ii + Pi


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EXPENDITURE APPROACH

Aggregate of the flow of total expenditures on final goodsand services.

Spending entities: households, business firms &government.

National income equal to sum of expenditures of all threesectors.

Ideal result of all three approaches: same.


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DOMESTIC vs. NATIONAL CONCEPTS

NATIONAL: normal residents participating inproduction process irrespective of domestic orforeign residence. Considers origin of factors.

DOMESTIC: within the domestic territory i.e.within geographical boundaries of a country.


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GROSS vs. NET CONCEPTS

GROSS: no allowance for capital consumption i.e.Depreciation.

NET: make provision for capital consumption i.e.Depreciation.


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MARKET PRICES vs. FACTOR COST

MARKET PRICE:includes indirect taxes & excludessubsidies.

FACTOR COST:opposite of the above.


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GDP at MARKET PRICES

Most comprehensive measure.

Deduct net exports from total final expenditure.

C + I + G + (X M)


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GDP at factor cost

GDP at factor cost = GDP at market prices +Subsidies Indirect taxes.


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GNP at Factor Cost

Total income received by residents as factors anywhere inthe world.

Add wages, interests, profits and dividends received bycitizens and subtract the same items received by foreignerson assets they own in India.

GNP at factor cost = GDP at factor cost +/- Net factor incomefrom abroad.


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NNP at factor cost

NNP at factor cost = GNP at factor cost Depreciation.


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PERSONAL INOCME

PERSONAL INCOME = NNP at factor cost Corporate taxes Undistributed profits +Transfer Payments


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DISPOSABLE INCOME

DISPOSABLE INCOME = Personal Income Personal Taxes.


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Important facts

Distinguish between closed economy and open economy. A closed economy has no economic relations with the rest of the

world.

This type of economy is not affected by the economic activities of other countries. It is an imaginary economy. It is not found in theworld.

An open economy is one which has economic relations with the restof the world. Mostly all the economies in the world are of this type. Itis affected by the activities of the other countries


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DIFFICULTIES IN NATIONAL INCOMEMEASUREMENT

Difficulty of defining nation in the terminology nationalincome.

There are a number of goods and services which are difficultto be assessed in terms of money.

The failure to distinguish properly between a final and anintermediate product.

Income earned through illegal activities are not included innational income.

Transfer payments- these earnings are a part of individualincome and also government expenditure .


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DIFFICULTIES IN NATIONAL INCOMEMEASUREMENT

Capital gains or loss to property owners excluded from GNP becausethey do not result from current economic activities.

All inventory changes at original cost not replacement costs includedin GNP measure.

Depreciation valuation adjustment is full of statistical difficulties.

With price increase, monetary NI increases though production mayhave gone down & with price fall monetary NI falls though production

may have gone up.

Monetary NI an underestimation of real NI.

Public services cannot be estimated correctly.


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DIFFICULTIES IN DEVELOPINGCOUNTRIES

Large non-monetized sector.

Lack of occupational specialization.

Several productive activities do not enter market transactions.

Many people do not keep accounts.

Adequate and correct production and cost data are not

available.


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Macro Economics BBM