1 Macro Introduction

CHAPTER
1
Introduction to
Macroeconomics
Prof Arjun Madan
Lecture Slides on Macro Economics Indicators
Introduction to Macroeconomics
Microeconomics examines the behavior of individual
decision-making unitsbusiness 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.
2004 Prof Arjun Madan
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Microeconomists generally conclude that markets work
well. Macroeconomists, however, observe that some
important prices often seem sticky.
Sticky prices are prices that do not always adjust
rapidly to maintain the equality between quantity
supplied and quantity demanded.
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Macroeconomics is the study of the behaviour of
the economy as a whole. It examines the overall
level of a nations output, employment, prices, and
foreign trade.
P. A. Samuelson
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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.
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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.
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GENESIS OF MACRECONOMICS:
1) Although macroeconomic elements can be traced back
to the periods of Mercantilism and Physiocracy, the
analytical elements of macroeconomics started only with
the classical economists.
2) The expression macroeconomics was used by Frisch in
1933.
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Classical economists applied microeconomic models, or
market clearing models, to economy-wide problems.
However, simple classical models failed to explain the
prolonged existence of high unemployment during the
Great Depression. This provided the impetus for the
development of macroeconomics.
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GENESIS OF MACRECONOMICS (CONT.)

A systematic attempt to study macroeconomics started
with the publication of Keyness General Theory of
Employment, Interest and Money in (1936).
Although most of his teachers in Cambridge were the
classical economists, Keynes fundamentally differed with
their understanding, analysis and policy implications.
Lets see some of the basic differences between the
Classical
economists
and
Keynes
on
many
macroeconomic issues.
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4. Differences between the Classicals

and Keynes
Classical Views
Keynesian Views
1. There is a direct
relationship between the
money supply and the
price level
1. No such direct
relationship exists. The
relation is only indirect.
2. Saving investment
equality is brought about
by the rate of interest
mechanism
2. The equality between

saving and investment is
brought about by the
income level.
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Differences between the Classicals

and Keynes cont.
3. Rate of interest is a flow.
3. Rate of interest is a stock.
4. Labour supply depends

on the real wage rate.
4. Supply of labour depends

on the money wage rate.
5. The economy is at full

employment equilibrium
5. The economy is at
underemployment
equilibrium.
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and Keynes cont.
6. The automatic
adjustments works.
7. No speculative demand
for money.
8.Wages are flexible.
9. Supply creates its own
demand.
6. There is no such thing.

7. There is speculative
demand for money.
8. Wages are rigid
downward.
9. Supply is generally
greater than demand
(they are not equal)
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and Keynes cont.
10.Rate of interest is a
reward for saving.
11. Laissez Faire
12. When the wage level
goes down, employment
goes up.
10. Rate of interest is a

reward for parting with
liquidity.
11. No Laissez Faire.
12. When wage level goes
down, employment goes
down.
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and Keynes (contd.)
13. Saving is good.
13. Saving is bad.
14. Balanced Budget
14. Unbalanced Budget.
15. Long Run
15. Short Run
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Recent Macroeconomic History

Fine-tuning was the phrase used by Walter Heller to
refer to the governments role in regulating inflation and
unemployment.
The use of Keynesian policy to fine-tune the economy in
the 1960s, led to disillusionment in the 1970s and early
1980s.
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Recent Macroeconomic History

Stagflation occurs when the overall price level
rises rapidly (inflation) during periods of
recession or high and persistent unemployment
(stagnation).
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Inflation and Deflation

Hyperinflation is a period of very rapid increases in the
overall price level. Hyperinflations are rare, but have
been used to study the costs and consequences of
even moderate inflation.
Deflation is a decrease in the overall price level.
Prolonged periods of deflation can be just as damaging
for the economy as sustained inflation.
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Recession and Depression

A recession is a period during which aggregate output
declines. Two consecutive quarters of decrease in
output signal a recession.
A prolonged and deep recession becomes a
depression.
Policy makers attempt not only to smooth fluctuations in
output during a business cycle but also to increase the
growth rate of output in the long-run.
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Macroeconomics as a Theoretical
Science
Explains the behaviour of macroeconomic variables and
specifies the nature of relationship between them;
Provides an insight into, the working of the economy;
and
Is a necessary condition for the formulation of appropriate
macroeconomic policies to achieve predetermined goals.
Macroeconomics as a Policy Science

Provides a sound theoretical framework for investigating
the causes and effects of economic problems;
Provides guidelines for finding appropriate

measures to solve the problem, and
policy
Analyses
the
working
and
effectiveness
of
macroeconomic policies, especially the monetary and
fiscal policies, on the economy.
Origin and Growth of Macro Economics

The Classical Macro Economics
The Keynesian Revolution
The Post-Keynesian Developments
The Classical Macroeconomics

According to classical school of thought, if market forces of
demand and supply are allowed to work freely, then
i.
there will always be full employment in the long

run, and unemployment, if any, will be a short-run
phenomenon;
ii.
there will be neither over-production nor underproduction at the aggregate level; and
iii. the economy will always be in equilibrium in the
long run.
The Keynesian Revolution

The level of output and employment in an economy is
determined by the aggregate demand given the
resources.
The unemployment in any country is caused by lack of
aggregate demand and economic fluctuations are
caused by demand deficiency.
The demand deficiency can be removed through
compensatory government spending.
Post-Keynesian Developments in
Macroeconomics
Monetarism: A Counter Revolution,
Neo-classical macroeconomics,
Supply-side economics, and
Neo-Keynesianism.
Monetarism
According to the Monetarists, the role of money is
central to the growth and the stability of national output
Money supply is the main determinant of output and
employment in the short run and price level in the long
run
Neo-classical Macroeconomics
The neo-classical school emphasizes the role of
individuals rational expectations about future economic
events, especially those taking place on the supply side of
the economy and expectations about future government
policies.
Supply-side Economics
Supply-side Economics is led by Arthur Laffer.
Emphasis is on the role of factors operating the supply
side of market.
Laffer Curve: a cut in the tax rate shifts aggregate supply
curve rightward and leads to a rise in output and
employment
Macroeconomic Issues
1. Achieving and maintaining a high rate of economic
growth,
2. Preventing business cycles when symptoms come up,
3. Controlling inflation and stabilising price level,
4. Solving the problems of unemployment and poverty,
5. Containing growing budgetary deficits, and
6. Managing international economic issues.
Growth Related Issues

In Developed countries:
i.
How to combat the recessionary trend in the economy,

and
ii.
How to accelerate the growth rate.
In Developing countries:
i.
How to maintain the current high growth rate;
ii.
How to prevent the overheating of the economy; and
iii.
How to keep inflation under control within its tolerable

and desirable limits.
The Rate of Economic Growth

Measured by growth in the Gross Domestic Product or
GDP.
GDP is defined as the market value of all the final goods
and services produced in a country in a given year.
Economists have two ways of measuring GDP, the flowof-cost or income approach and the flow of product
or expenditures approach.
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The Rate of Economic Growth

Flow of cost, or
income, approach
Flow of product, or
expenditures, approach
Consumption expenditures by
households
plus
Investment expenditures by
businesses
Wages
plus
Rents
plus
Interest
=GDP
plus
Government purchases of
goods and services
plus
plus
Profits
Net exports=total exports-total

imports
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Nominal vs. Real GDP

Nominal GDP is measured in actual market prices.
Real GDP is nominal GDP adjusted for inflation.
Moreover, when we divide nominal GDP by real GDP,
we obtain the GDP deflator-another valuable inflation
index.
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Output Growth
GDP is the best widely available measure of the level
and growth of output in the economy.
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Actual vs. Potential GDP

Actual GDP represents what we are producing.
Potential GDP represents the maximum amount the
economy can produce without causing inflation.
When actual GDP is less than potential GDP, we are in
the recessionary range of the economy.
When actual GDP is above potential GDP, we run the
strong risk of inflation.
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The Issue of Business Cycles

Business cycle refers to high magnitude of fluctuation in
the economyhigh growth in GDP/GNP in one period
followed by a sharp decline in the next period.
Business Cycles
Closely related to the issue of economic growth and real
GDP as a measure of such growth is the problem of
business cycles.
The term business cycle refers to the recurrent ups and
downs in real GDP over several years.
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Level of business activity
Business Cycles
Time
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Do Business Cycles Exist

A central concern of macroeconomists is to determine
whether a business cycle exists and, if so, what are the
forces behind it.
More importantly, both macroeconomists and the
political leaders they may serve, want to know what
macroeconomic policies may be used to control or
harness the business cycle.
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At The Same Time

A central concern of business is to determine whether
the economy is going into a contraction or expansion-with a correct guess being the difference between a big
profit or a big loss.
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The Issue of Inflation

Inflation is defined as persistent and considerable
increase in the price level over a long period of time.
Inflation is generally associated with, and is often caused
by, the high growth rate itself.
Inflation
Defined as an upward movement of prices from one year
to the next.
Measured by the percentage change in price indices
such as the Consumer Price Index, the Producer Price
Index, or the so-called GDP deflator.
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Some Inflation Indices

The Producer Price Index is based on a number of
important raw materials.
The Consumer Price Index or CPI is calculated by
pricing a basket of goods and services purchased by a
typical household.
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Education
1%
Personal care
1%
Insurance and pensions

9%
Entertainment
5%
Housing
32%
Health
6%
Miscellaneous
5%
Clothing
5%
Food
17%
Transportation
19%
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The Issue of Unemployment and

Poverty
Unemployment refers to that part of the labour force, or
workforce, which is willing to work at the prevailing wage
rate and is looking for a job but is not getting employment.
Unemployment and poverty have been a perennial problem
in both DCs and LDCs.
Unemployment % change on year ago
India
9.9 (2012)
China
4.1
Japan
3.9
US
7.4
Mexico
4.9
Greece
27.6
Unemployment
The unemployment rate is measured as the number of
unemployed persons divided by the number of people in
the labor force.
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Kinds of Unemployment
In talking about unemployment, economists distinguish
between three kinds: frictional, cyclical, and
structural.
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Frictional Unemployment
Frictional unemployment is the least of the
macroeconomists worries.
It occurs as a natural part of the job-seeking process as
people quit their jobs just long enough to look for and
find another one.
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Cyclical Unemployment
Cyclical unemployment is a much more serious problem.
It occurs when the economy dips into a recession.
It is this type of unemployment that macroeconomists
have historically spent most of their time trying to solve.
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Structural Unemployment
Structural unemployment occurs when a change in
technology makes someones job or job skills obsolete.
E.g., the auto worker replaced by a robot or the
telephone information operator replaced by a
computerized voice synthesizer.
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The Issue of Budgetary Deficits

The government budget refers to the annual revenue
and expenditure of the government of a country.
To control and regulate the economy -fiscal policy.
Budget Balance as % of GDP
India
-5.1
US
-4.0
China
-2.1
Canada
-2.8
Pakistan
-8.8
Mexico
-1.8
The International Economic Issues

Growing balance of payments deficits,
Exchange rate fluctuation, and
Excessive inflow or outflow of capital.
Country
Current A/c balance in

$bn
% of GDP
(2013)
India
-87.8
-4.5
China
+ 211.6
+2.1
US
-425.7
-2.7
Saudi Arabia
+ 151.4
+16.0
Stock and Flow Variables

Stock Variables-The stock variables refer to the quantity
or value of certain economic variables given at a point in
time, e.g., stock of capital or Business Inventories on 31st
March 2006 or Money supply on 31st December 2007.
Flow Variables- The flow variables are the variables that
are expressed per unit of time, e.g., salary per hour,
Savings per week, Consumption per month, or GDP per
year.
Equilibrium and Disequilibrium

Equilibrium- In economic sense, equilibrium refers to a
state or situation in which opposite economic forces, e.g.,
demand and supply, are in balance and there is no inbuilt tendency to deviate from this position.
Disequilibrium- This is the state in which the opposite

forces (e.g., demand and supply) are in imbalance. The
factors causing disequilibrium arise out of the working
process of the economy.
Partial Equilibrium Analysis

Partial equilibrium analysis is the analysis of a part of the
economy, isolated and insulated through assumptions
from the influence of changes in the rest of the economy.
Partial equilibrium analysis is based on ceteris paribus
assumption.
General Equilibrium Analysis

General equilibrium analysis is carried out where the
objective is to analyse the economic system as a whole
without using the restrictive assumptions of the partial
equilibrium analysis.
It takes a comprehensive and realistic view of the

economic system.
Static and Comparative Statics

Analysis
Static analysis- When an economy is studied under static
conditions, it is called static analysis. The variables used
in this kind of analysis have no past or future and all
variables belong to the same point in time.
Comparative statics analysis- Comparative statics is a
comparative study of economic conditions at two static
equilibrium positions at two different points in time.
Dynamic Analysis
When a macroeconomic phenomenon is analysed under
changing or dynamic conditions, it is called dynamic
analysis.
Economic dynamics studies the factors and forces that set
an economy in motion and lead it to a new equilibrium at a
higher or lower level.
It takes into account the time lag involved in the process of
adjustments.
Macroeconomic Model Building

A macroeconomic model is the representation of the
economic phenomenon in terms of a set of behavioural
assumptions, definitions, simultaneous equations, and
identities.
Eg: Keynesian Model of Income determination
AD = C + I + G + X
Government in the Macroeconomy

There are three kinds of policy that the
government has used to influence the
macroeconomy:
1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies
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Government in the Macroeconomy

Fiscal policy refers to government policies concerning
taxes and spending.
Monetary policy consists of tools used by the Federal
Reserve to control the quantity of money in the
economy.
Growth policies are government policies that focus on
stimulating aggregate supply instead of aggregate
demand.
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Economic Indicators
Relation to the Business Cycle / Economy
Procyclic: A procyclic economic indicator is one that
moves in the same direction as the economy. So if the
economy is doing well, this number is usually increasing,
whereas if we're in a recession this indicator is decreasing.
GDP is an example.
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Economic Indicators
Countercyclic: A countercyclic economic indicator is one
that moves in the opposite direction as the economy. The
unemployment rate gets larger as the economy gets worse.
Acyclic: An acyclic economic indicator is one that has no
relation to the health of the economy and is generally of
little use. The number of runs made by Sachin Tendulkar
has no relationship to the health of the economy.
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Economic Indicators
Leading: Leading economic indicators are indicators
which change before the economy changes.
Stock market returns are a leading indicator.
Leading economic indicators are the most important type
for investors as they help predict what the economy will
be like in the future.
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Economic Indicators
Lagged: A lagged economic indicator is one that does not
change direction until a few quarters after the economy
does. The unemployment rate is a lagged economic
indicator as unemployment tends to increase for 2 or 3
quarters after the economy starts to improve.
Coincident: A coincident economic indicator is one that
simply moves at the same time the economy does. The
Gross Domestic Product is a coincident indicator.
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Some Important Economic Indicators

Total Output, Income, and Spending
Employment, Unemployment, and Wages
Production and Business Activity
Prices
Money, Credit, and Security Markets
Federal Finance
International Statistics
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The Methodology of Macroeconomics

Connections to microeconomics:
Macroeconomic behavior is the sum of all the
microeconomic decisions made by individual

households and firms. We cannot understand the
former without some knowledge of the factors that
influence the latter.
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Aggregate Supply and

Aggregate Demand
Aggregate demand is the
total demand for goods and
services in an economy.
Aggregate supply is the
total supply of goods and
services in an economy.
Aggregate supply and
demand curves are more

complex than simple
market supply and demand
curves.
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1 Macro Introduction

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CHAPTER

Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

households and firms together.

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

The Roots of Macroeconomics

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

The Roots of Macroeconomics

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

The Roots of Macroeconomics

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

GENESIS OF MACRECONOMICS (CONT.)

Lecture Slides on Macro Economics Indicators

4. Differences between the Classicals

2004 Prof Arjun Madan

2. The equality between

Lecture Slides on Macro Economics Indicators

Differences between the Classicals

3. Rate of interest is a stock.

4. Labour supply depends

4. Supply of labour depends

5. The economy is at full

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

Differences between the Classicals

2004 Prof Arjun Madan

6. There is no such thing.

Lecture Slides on Macro Economics Indicators

Differences between the Classicals

2004 Prof Arjun Madan

10. Rate of interest is a

Lecture Slides on Macro Economics Indicators

Differences between the Classicals

13. Saving is bad.

14. Balanced Budget

14. Unbalanced Budget.

15. Long Run

15. Short Run

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

Recent Macroeconomic History

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

Recent Macroeconomic History

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

Inflation and Deflation

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

Recession and Depression

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators

2004 Prof Arjun Madan

Lecture Slides on Macro Economics Indicators