Macro economics for business decisions

Answer key for First Internal Assessment Test:

Q1. Explain the meaning and features of macro economics?

Answer: macroeconomics we study the whole economic system like national income, total
savings and investment, total employment, total demand, total supply, general price level. We
study how these aggregates and averages of economy as a whole are determined and what causes
fluctuations in them. The aim of the study is to understand the reason for the fluctuations and to
ensure the maximum level of employment and income in a country.

Macroeconomics is also known as the theory of income and employment, since the subject
matter of macroeconomics revolves around determination of the level of employment and
income.

At the time of the Great Depression, government participation through monetary and fiscal
measures in the economy increased considerably. Since the study of millions of individual
economic units is almost impossible, macroeconomics provided tools for the assessment of
economic policy. Macro policies make it possible to control inflation and deflation, and moderate
violent booms and recessions.

The main functions of macroeconomics are the collection, organizing, and analysis of data;
determining national income; and formulating appropriate economic policies to maintain
economic growth and full employment in a developing country.

Main features of macro economics

1) Unit of study / nature of analysis – Aggregate and Macroscopic.

Macro-Economic deals with the study of Economy as a whole. It is concerned with the aggregate
concepts such as National Income, National Output, National Employment, General level of
Prices, Business cycle etc.

2) Theory of National income and employment:

Macroeconomics studies the concept of national income, its different elements, methods of
measurement and social accounting.

Macroeconomics deals with aggregate demand and aggregate supply that determines the
equilibrium level of income, output and employment in the economy.

It explains the causes of fluctuations in the national income, that leads to business cycles i.e.
inflation and deflation
3) Theory of money and interest

Changes in demand for, and supply of money have considerable effect on the level of
employment. Macroeconomics therefore, studies functions of money and theories relating to it.
Banks and financial institutions rates of interest are also studied under macroeconomics.

Monetary and fiscal policies of government are also studied under therein

4) A Bird’s eye view of the Economy:

Macro Economy gives an overall view of the economy. It summaries & connects various
aggregates so as to show the interrelationship between them.

5) Theory of general price level:

Determination of and changes in general price level and what is the importance of various factors
which influence general price level

are also studied under macroeconomics. Problems concerning inflation or general rise in prices
and deflation or general fall in prices are also studied under macroeconomics.

6) A more realistic approach:

Although Macro Economics is difficult to study and is complicated., yet it tends to be more
realistic because the entire economy is taken into consideration and thus helps in Policy decision
taking.

7) Based on interdependence – A General Equilibrium analysis :

Macro-Economic analysis deals with the behavior of large aggregates and their functional
relationship. It is a General Equilibrium approach in which everything depends on everything
else and therefore there is an element of interdependency among the Macro-Economic variables
for e.g. changes in the level of investment will finally result in changes the levels of Income,
levels of output, employment and eventually the level of Economic growth.

8) Special Growth Models

Study of problems relating to economic growth and development [increase in per capita real
income] forms part of macroeconomics. It studies various factors that contribute to economic
growth and development.

Macroeconomics has been useful in developing special growth models. These growth models are
applied for economic development because the economics of growth is, in essence, the study of
macroeconomics.

9) Neglect of Heterogeneity
The Macro Economy approach overlooks the facts that there exist differences in individual units.
The conclusions based on aggregates are not uniformly applicable to different individual units
for e.g. when we say that the National Income is increasing it does not necessarily implied that
Income of every individual to increasing.

Q2.Explain various resources of economic system?

Answer: The various resources of an economic system are:

A) Labour: Labour is the time human beings spend producing goods and services.
Labour measure of the work done by human beings.
B) Capital
C) Land
D) Entrepreneurship

Economic resources

Economic resource 1: Land

Land is an economic resource that includes all natural physical resources like gold, iron, silver,
oil etc. Some countries have very rich natural resources and by utilizing these resources they
enrich their economy to the peak.

Such as the oil and gas development of North Sea in Norway and Britain or the very high
productivity of vast area of farm lands in the United States and Canada. Some other developed
countries like Japan have smaller economic resources. Japan is the second largest economy of the
world but reliant on imported oil.

Economic resource 2: Labor

The human input in the production or manufacturing process is known as labor. Workers have
different work capacity. The work capacity of each worker is based on his own training,
education and work experience.

This work capacity is matters in the size and quality of work force. To achieve the economic
growth the raise in the quality and size of workforce is very essential.

Economic resource 3: Capital

In economics, Capital is a term that means investment in the capital goods. So, that can be used
to manufacture other goods and services in future.

Following are the factors of capital:

Fixed Capital

It includes new technologies, factories, buildings, machinery and other equipments.

Working Capital

It is the stock of finished goods or components or semi-finished goods or components. These

goods or components will be utilized in near future.

Capital productivity

New features of capital building, machinery or technology are commonly used to improve the
productivity of the labor. Such as the new ways of farming helps to enhance the productivity of
the agriculture sector and give more valuable jobs in this sector which motivates people to come
out for work.

Infrastructure

It is a stock of capital that is used to maintain the whole economic system. Such as roads, railway
tracks, airports etc.

Economic resource 4: Entrepreneurship

The Entrepreneur is person or individual who wants to supply the product to the market, in order
to make profit. Entrepreneurs usually invest their own capital in their business. This financial
capital is generally based on their savings and they take risks linked to their investments. This
risk-taking can be rewarded by the profit of the business. Entrepreneurship is, thus, an important
economic resource.

Following are the factors of Entrepreneurship:

Income

Wealth

Labor and Wages

Capital and Interest

Profit and Enterprise

Q3. Explain the linkage between macro economics, business planning and decision
making?

Answer: Importance of Decision Making in Business

Decision making is an important job of corporate managers. They have to take decisions
regarding the employment of land, labor, and capital in such a manner that output may be
maximized at least possible cost. Hence, they are always in search of optimum combination of
resources which would maximize corporate profit.

Appropriate decision making is the strength of business. Success in business depends on proper
and correct decision making. Location, scale of operation, quantum of resources to be employed,
marketing etc are some of the important problems calling for decisions in business where
macroeconomics may be applied for better results.

Macro Economic Analysis

Macroeconomics is concerned with the study of aggregate economic variables. It is concerned

with the whole economy and studies the level and the growth of national income, the levels of
employment, the level of private and government spending, the balance of payments, the
consumption & the investment, saving functions and oscillations in business cycles. The
objective of macroeconomics is to maintain macro equilibrium of the economy. According to
Edwin Mansfield, ‘Macro economics deals with the behavior of aggregates like gross national
product and the level of employment. A. koutsoyiannis says, ‘the aggregate econometric models
are relevant for the study and prediction of aggregate magnitudes, such as total output of any
economy, total employment, consumption, investment etc.

In all the economies of the world whether free or controlled, business and macroeconomics have
become same. In the business decisions, tracking of macroeconomic variables has become an
important element. (Macroeconomics, 2002) Managers face difficulty in decision making,
understanding of macroeconomics helps CEO’s in running the business. Overall economic
activity, economic policies (industrial policy, trade policy, monetary policy, fiscal policy),
inflation affects the business. Decisions of CEO’s or managers are affected by this aggregate
which makes up the overall environment of business. Future demand and investment depends
upon the growth and the state of the economy.

Role of Macroeconomic Analysis in formulation of Business Policies

Macro economics helps the business in in-depth knowledge of macro economic environment of
business relating to industrial policy, licensing policy, economic planning monetary and fiscal
framework and overall economic policy. (Mathur, 2002)The role of macro economics in business
policy formulation is being discussed in the following points:

1. Macro economic policy

Macro economics helps in formulation of economic policy. The subjects of an economic policy
are monetary policy, fiscal policy, incomes policies and policy on balance of payment. Economic
policy should be such that it promotes the business environment and provides impetus to
business activities. (Mathur, 2002)

2. Economic planning
A serious attempt towards self sustained growth of business is only possible by efficient
planning. Planning is now a days synonymous with growth and development. Identification of
priority areas, estimation of resources and coordination among various sectors of economy can
be done through proper planning. Planning directs the growth in desirable corners.

3. Solving macro paradoxes:

Macro economics helps in solving macro paradoxes like paradox of thrift related to savings,
paradox of assumption by commercial banks that all depositors would not withdraw their money
on any particular day and their right to withdrawal.

4. Tracing effect of government policy on business

Macro economics helps in tracing the implications of government policy changes on existing
business activity.

5. Help in solving problem of general unemployment

Effective demand is the focal point of macro economics. Reduction in effective demand brings
economic depression and thereby general unemployment. Hence, the level of effective demand
should be increased in order to increase the level of employment. (Mathur, 2002)

6. Analysis of trade cycles

Macro economics tries to know about the behavior and occurrence of booms and slumps and
their implication on business activity. This analysis is very useful for a free enterprise economy.
Business cycles are bound to occur. Macro economics helps the business in facing booms and
slumps so that negative impact is minimized.

7. Macro analysis helps in development of micro analysis

In the deductive method process of logic goes from general to particular. We go on deducting to
draw specific conclusions. Many of micro economic conclusions are outcome of macro
conclusion. The assumption that consumer is rational has been decided only after knowing about
the behavior of a group. A medico is allowed to specialize in some part of human body from
surgical view point only when he has understood the anatomy and physiology of human body.

8. Inability of micro economics to study some areas

Micro economics is not able to study monetary problems, fiscal problems, financial sector
problems, foreign exchange regulation problems and inflationary and recessionary situations
problems. Business needs to be protected from these ticklish problems and therefore, needs the
help of macro economics.

9. Macro economic models

Macro economics helps in building or constructing macro economic models. The major objective
function of a macro economic model is to maintain the macro equilibrium in the country at the
full employment level. The role of government through its monetary and fiscal operations
becomes important as independent variables i.e. these policies are used to explain the dependent
variable i.e. maintaining macro equilibrium.

Macroeconomic Variables and Business Decisions are highly linked:

Business depends on the growth rate, when economic growth slows down; the overall economic
environment becomes unfavorable to business. In a period of slow growth, the aggregate demand
is very much reduced and the business has no choice but to curtail its operations. (Misra & Puri,
2007) Business depends on the inflation rate. Inflation of a mild sort increase aggregate demand
which, in turn, opens up fresh opportunities for business growth. In such an environment, not
only the demand for existing goods increases but the business can also introduce new items for
which demand may be created through dynamic marketing. Savings and investment in a country
determine its business potential. Investment can be undertaken in directly productive activities or
in infrastructure.

Excessive current account deficit in a country’s balance of payments is not desirable for business
activity. Such a situation leads to a shortage of foreign exchange, which in turn forces restriction
on imports. (Misra & Puri, 2007)This may have serious implications for the efficiency in
production. In the interest of business the current account position has to be comfortable.

In addition, the net inflows from external assistance and direct foreign investment should be
fairly large, but this should not be allowed to result in an overvalued exchange rate.

In case the situation is otherwise, the country’s exports will fall and the business firms will feel
seriously constrained account of it.

Phase of economy is highly significant for the business. From the point of view of business, the
prosperity phase of business cycle is ideal. In this phase, the economy expands in response to
growing aggregate demand and the business firm has many options. There is expectation of rise
in prices which induces managers to expand the scope of their activities. A company can
introduce new products in this period and markets can be created for these products.

Forces of recession get strengthened during recession. The recession usually gets reflected in the
form of stock market crash and some fall in prices. The aggregate demand gradually declines and
thus incentive for investment is killed. (Misra & Puri, 2007) At this time managers abandon new
projects, resulting in a sharp reduction in demand for capital equipment.

Since, finance is a basic requirement of business, the level of development of the financial
system is of crucial importance for business. The basic function of financial markets – both
money and capital market is the collection of savings and their transfer to business enterprises
for investment purposes and thereby stimulating capital formation which in turn accelerates and
process of business growth. The effective channel of domestic savings and obtaining finance
from abroad are the important activities in the transfer process. In the transfer process, the
principal activity is allocation of funds from the savings surplus to the savings deficit units.
Financial markets, if they are well developed, allocate financial resources efficiently among the
various business enterprises. (Misra & Puri, 2007)

Q4.Briefly explain the concepts of national income?

Answer: There are various concepts of National Income, such as GDP, GNP, NNP, NI, PI, DI,
and PCI which explain the facts of economic activities.

GDP at market price: Is money value of all goods and services produced within the domestic
domain with the available resources during a year.

GDP = (P*Q)
Where,
GDP = gross domestic product
P = Price of goods and services
Q= Quantity of goods and services
GDP is made up of 4 Components
consumption
investment
government expenditure
net foreign exports of a country
GDP = C+I+G+(X-M)
Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import

Gross National Product (GNP): Is market value of final goods and services produced in
a year by the residents of the country within the domestic territory as well as abroad.
GNP is the value of goods and services that the country's citizens produce regardless of
their location.
GNP=GDP+NFIA or,

GNP=C+I+G+(X-M) +NFIA

Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import
NFIA= Net factor income from abroad.

Net National Product (NNP) at MP: Is market value of net output of final goods and
services produced by an economy during a year and net factor income from abroad.
NNP=GNP-Depreciation
 or, NNP=C+I+G+(X-M) +NFIA- IT-Depreciation
Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import
NFIA= Net factor income from abroad.
IT= Indirect Taxes

National Income (NI): Is also known as National Income at factor cost which means
total income earned by resources for their contribution of land, labour, capital and
organisational ability. Hence, the sum of the income received by factors of production
in the form of rent, wages, interest and profit is called National Income.
Symbolically,
NI=NNP +Subsidies-Interest Taxes
or, GNP-Depreciation +Subsidies-Indirect Taxes
or, NI=C+G+I+(X-M) +NFIA-Depreciation-Indirect Taxes +Subsidies

Personal Income (PI): Is the total money income received by individuals and
households of a country from all possible sources before direct taxes. Therefore,
personal income can be expressed as follows:
PI=NI-Corporate Income Taxes-Undistributed Corporate Profits- Social Security
Contribution +Transfer Payments.
Disposable Income (DI) : It is the income left with the individuals after the payment of
direct taxes from personal income. It is the actual income left for disposal or that can
be spent for consumption by individuals.
Thus, it can be expressed as:

DI=PI-Direct Taxes

Per Capita Income (PCI): Is calculated by dividing the national income of the country
by the total population of a country.
Thus, PCI=Total National Income/Total National Population

Q5.Distinguish between micro economics and macro economics?

Answer:

Parameter Micro Economics Macro Economics

Economic Unit It is the study of individual It is the study of economy as a
economic units of an economy whole and its aggregates.

Scope It deals with individual income, It deals with aggregates like

individual prices and individual national income, general price level
output, etc. and national output, etc.
Central Problem Its Central problem is price Its central problem is determination
determination and allocation of of
resources level of income and employment.

Main tools Its main tools are demand and Its main tools are aggregate
supply of a particular demand and
commodity/factor. aggregate supply of economy as a
whole.

Use It helps to solve the central It helps to solve the central problem
problem of
of what, how and for whom to full employment of resources in the
produce in the economy economy.

Equilibrium It discusses how equilibrium of a It is concerned with the

Analysis consumer, a producer or an determination of
industry equilibrium level of income and
is attained. employment of the economy

Determinants Price is the main determinant of Price is the main determinant of

Micro economic problems Micro economic problems

Limitation It is based on unrealistic it is assumed that there is a full

assumptions, i.e. In employment in the society which is
microeconomics not at all possible.
It has been analyzed that 'Fallacy of
Composition' involves, which
sometimes doesn't proves true
because it
is possible that what is true for
aggregate may not be true for
individuals too.

Approach While analyzing any economy, The macroeconomics takes a top-

microeconomics takes a bottom- down
up approach into the consideration.
approach,

Example Examples are: individual income, Examples are: National income,

individual savings, price national
determination of a commodity, savings, general price level,
individual firm's output, aggregate
consumer's demand, aggregate supply, poverty,
equilibrium unemployment etc.