Understanding Macroeconomics and its

Relevance
Economics is a subject that broadly addresses how individuals, firms (companies like Reliance, Airtel,
and etc), organizations (non-companies like NGO, education institutions, etc), institutions (SEBI,
NSE, RBI, and etc), and governments make decisions. Three fundamental aspects that drive these
decisions are:
1. Scarcity: Resources are scare for everybody
2. Opportunity costs: In an environment of scarcity, if one chooses one it may mean giving up
something else. Therefore, the opportunity cost of the choice is the one you gave-up.
3. Efficiency: These scare resources need to be used in an efficient manner.
What is efficiency?
An economy is said to be efficient if it produce goods and services in such a way that to increase the
economic welfare of an individual one will have to decrease the economic welfare of another
individual.
What are the decisions we are referring?
We are talking about three broad questions that will subsume many questions. Depending on who is
making decisions the context of these questions would be different. Once you understand these
questions you would appreciate how one can use the concept of economics in real life. These
questions are;
1. What products and services are to be produced and what quantities of the same? Should
you spend more on nutritious food or good books? Should ITC produce more biscuits or
more packets of Aasirvaad Atta? Should government spend more money in subsidising rice
or spend the same money in building canals to irrigate the land?
2. How would one produce these product and services? Should ITC use more labour or
expensive machine to produce biscuits?
3. For whom these products and services are produced? When ITC makes profit should it give
more bonuses to employees or more dividends to shareholders? Once government can see
ITC making lots of profit it can increase the tax and takes out a portion of the profit. The
increase in tax can be spent on building canal to increase the irrigation, which will increase in
productive of land and hence the income of the farmers.
What are the economic systems in which these decisions are made?
There are three types of economic systems;
1. Market economy (capitalism)
2. Command economy (socialism)
3. Mixed economy
Let us discuss how will ITC decide how much of biscuits to produce.

You may say it will depend on the demand for the biscuits. ITC will estimate the demand from the
market for its biscuits and decide on how much to produce. Over estimation of demand will result in
decrease in price of biscuits and underestimation of demand will result into increase in price of
biscuits. Market will decide what should be the ideal amount of biscuits to be produced. If ITC makes
higher amount of profits then other producers will be attracted to come onto the market to produce
biscuits, and profits of ITC will come down. Therefore, markets will enable the decision making
process. This kind of economic system is called market economy (capitalism). Similarly, how much
should ITC pay to its employees? Market for labour will decide the right wages.
The market economy will work only when there is perfect competition and markets works perfectly.
However, market may not work perfectly. For example, if no producers come to produce more
biscuits when demand increases, then ITC can charge high prices and exploit the consumers.
The picture below represents how different agents of the economy will interact with each other so
that markets will decide what to produce, how much to produce and for whom to produce.

On the other hand if the government believe market will not able to do a good job then it has to
make decision with respect to what to produce, how to produce and for whom to produce. For
example, the government can instruct ITC to produce certain amount of biscuits and what price to
sell them in the market and this kind of economic system is called command economy (socialism).
Similarly government can fix the salary of the employees as well.

In reality most of the economy follows the third kind of economic system, which is called mixed
economy. In this kind of economy structure government make sure market works perfectly, and no
economic agent is exploited. For example, FSSAI certification, and minimum wage regulation will
ensure consumers and labours are not exploited.
What are the production possibilities?
The production possibilities will depend on the inputs available. These are called factors of
productions. Broadly these factors production can be of three types;
1. Land: Physical assets of the economy provided by the nature including clean air, water, and
forests (broad environment). Newer technology can increase the better use of natural
resources and hence production possibility of the economy.
2. Labour: Human time and effort available for production. Skillsets of the people will define
the productive capacity of the labour. Productivity increase in labour force will increase the
production possibilities of the economy.
3. Capital: It is the resource which forms the durable goods of the economy. These goods are
needed to produce other goods and services. For example, machines, software, technical
knowhow. Increase in stock of capital increase the production possibilities of the economy.
The production possibility frontier studied in microeconomics is the foundation for economic agents
to make decisions with respects to what, how, and whom questions discussed above.
What are the differences between microeconomics and macroeconomics?
Microeconomics deals with how individuals, households, and firms make economic decisions or
behave. Besides, it also studies how does a market work and behave. On the other hand,
macroeconomics deals with how the economy as a whole performs. Let us discuss few questions.
Microeconomics questions: How much do you spend per month and how much do you save per
month? How would allocate your money between food and travel or education? Will you work more
if your employer decides to pay you more per hour of work? Will you change your job if paid more?
Macroeconomics questions: What is the total savings of the economy? How would the policy maker
enable consumers to spend more? How would government allocate the spending between defence
and education? What should be done to make sure all the citizens have jobs?
What are the key objectives of macroeconomics?
The great depression of 1930s provided the seeds of birth of macroeconomics. The study of
macroeconomics is founded by famous economist, John Maynard Keynes. His book The General
Theory of Employment, Interest, and Money provided intellectual fodder for the future economist
to advance the subject.
At a highest level, the objective of macroeconomics is to reduce the volatility of economic activities.
Broadly speaking, there are three objectives;
1. Increasing level of economic activity: Public policy maker need to work towards increasing
the level of economic activities so that citizens standard of living increases over time.

2. High level of employment: The public policy makers need to ensure that everybody who is
interested in working finds a job suitable to his/her skillsets.
3. Stable price level: Higher inflation eats out the individuals ability to spend and save, hence
the standard of living. Therefore, individuals will like to have stable prices over time.
The citizens of a country may also want to consume goods and services that are not currently
produce in the country but produced by other countries. Similarly, a firm may want to export its
products to other countries. These export and import activities of an economy increase the
complexities of macroeconomics, and policy makers may have to understand what is happening in
other economies, which is linked to its own economy. This is called the effect of globalization on
economic activities.
The policy makers have two broad instruments to meet the objectives of macroeconomics.
1. Fiscal policies: These policies involve the tax and spending policies of governments. These
policies will have effect on spending, saving, and investment activities of the economy.
2. Monetary policies: These policies involve the central bank of the economy, which decides
what should be the money supply, short-term interest rate, and exchange rates. These
policies will have effect on the prices of assets, and hence economic activities.
What are the major macroeconomic variables?
To understand the macroeconomics we need to understand the variables that are available in the
economy. Through these variables we will study the health of the economy. The health of the
economy will drive our public policy decisions for the government. At an individual and household
level these variables will also affect the level of spending and saving. Some of the important macroeconomic variables are;
1. Total output produced
2. Potential output that can be produced
3. Composition of output
4. Growth rate of output
5. Unemployment rate
6. Saving rate
7. Inflation rate
8. Interest rate
9. Total export
10. Total import
11. Exchange rate