Introduction to Macroeconomics

ECON605 - Managerial Economics

Amity Business School

Amity University, Uttar Pradesh

October, 2018
Where the telescope ends, the microscope begins.
Which of the two has the grander view?
What macroeconomics is about

 Macroeconomics is the study of the structure and performance of

national economies and of the policies that governments use to try
to affect economic performance
 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

 When we study the consumption behaviour or equilibrium of a

consumer; the production pattern & equilibrium of a firm, the entire
analysis is ‘micro’ in nature……because we study a unit and not the
system in which it is operating
What macroeconomics is about

 Macroeconomics considers the performance of the economy as a

whole.
 We try to understand changes in
 The rate of economic growth
 The rate of inflation
 Unemployment
 Our trade performance with other countries
 Macroeconomics also includes an evaluation of the relative
success or failure of government economic policies
 Need for a separate theory of macroeconomics
 The behaviour of the economic system as a whole or the macroeconomic
aggregates is not merely a matter of addition or multiplication or averaging of
what happens in the various individual parts of the whole. In the economic
system what is true of parts is not necessarily true of the whole.
 The application of micro-approach to generalise about the behaviour of the
economic system as a whole or macroeconomic aggregate is incorrect and may
lead to misleading conclusions. Therefore, a separate macro-analysis is
needed to study the behaviour of the economic system as a whole as well
as in respect of various macroeconomic aggregates.
 Laws or generalisations are true of constituent individual parts but untrue and
invalid in case of the whole economy, paradoxes exist.
 Savings are always good for an individual since they save with some purpose in
view. But savings are not always good for the society as a whole. If an economy
is in the grip of depression and unemployment caused by the deficiency of
aggregate effective demand, the increase in savings by individuals will lead to a
fall in aggregate consumption demand of the society which will cause aggregate
demand to fall. As a result, national income will decline.
 So what is ‘the economy’?

 The economy is made up of four sectors sometimes called economic

agents:
 Households who receive payments (income) for their services (eg labour
and land) and use this money to buy the output of firms (ie consumption or
household spending).
 Firms who use land labour and capital to produce goods and services for
which they pay wages rent etc (income) and receive payment (expenditure)
 Government (also known as the public or state sector) and
 International eg consumers buying overseas products (M) and foreigners
buying Indian products (X)
Key concepts in macroeconomics

 Gross Domestic Product (GDP)

 The monetary value of all goods and services produced within the UK in a
given time period
 Real GDP
 The volume of goods and services produced within the country (i.e. GDP
adjusted for changes in the price level)
 Nominal GDP
 Is GDP evaluated at current market prices. Nominal differs from real GDP
in that it includes changes in prices due to inflation or a rise in the overall
price level.
 Economic Growth
 The percentage rate of increase of real GDP
 Inflation
 The annual percentage rate of change of the general price level
Issues addressed by macroeconomics

 What determines a nation’s long-run economic growth?

 What causes a nation’s economic activity to fluctuate?
 What causes unemployment?
 What causes prices to rise?
 How does being a part of a global economic system affect nations’
economies?
 Can government policies be used to improve economic
performance?
Issues addressed by macroeconomics - long-run
economic growth

 Economic growth is the increase in the market value of the goods

and services that an economy produces over time. It is measured
as the percentage rate change in the real gross domestic
product ( GDP ). Determinants of long-run growth include
growth of productivity, demographic changes, and labour force
participation.

 Rich nations have experienced extended periods of rapid economic

growth.

 Poor nations either have never experienced them or economic growth

was offset by economic decline.
 Issues addressed by Macroeconomics – increased
output

 Output in economics is the "quantity of goods and service produced in a

given time period, by a firm, industry, or country", whether consumed or
used for further production.

 The concept of national output is essential in the field of macroeconomics

It is national output that makes a country rich, not large amounts of
money.
 The result of an economic process that has used inputs to produce a
product or service that is available for sale or use somewhere else.
 Net output, sometimes called netput is a quantity, in the context of
production, that is positive if the quantity is output by the production
process and negative if it is an input to the production process.
Issues addressed by Macroeconomics – rate of
growth of output

 Growth rate of output displays how a firm's or economy's outputs

change on a year-to-year basis. The output could represent anything
such as widgets a company manufactures, total output of an economy
or total services performed. The growth rate shows if a company or
economy is growing or declining. In addition to outputs, investors
can use growth rate to determine how an investment is performing from
year to year by comparing an investment's return each year.
 Rates of growth of output (or output per worker) are determined by:
 rates of saving and investment;
 rates of technological change;
 rates of change in other factors.
Issues addressed by Macroeconomics – business
cycles

 The business cycle describes the rise and fall in production

output of goods and services in an economy.

 Business cycles are generally measured using rise and fall in real –
inflation-adjusted – gross domestic product (GDP), which
includes output from the household and non-profit sector and the
government sector, as well as business output.

 "Output cycle" is therefore a better description of what is measured.

The business or output cycle should not be confused with market
cycles, measured using broad stock market indices; or the debt
cycle, referring to the rise and fall in household and government
debt.
Issues addressed by Macroeconomics – recession

 A recession is a significant decline in economic activity that

goes on for more than a few months. It is visible in industrial
production, employment, real income and wholesale-retail trade.

 The technical indicator of a recession is two consecutive

quarters of negative economic growth as measured by a
country's gross domestic product (GDP), although the
government does not necessarily need to see this occur to call a
recession
Issues addressed by Macroeconomics – unemployment

 Recessions are usually accompanied by high unemployment: the

number of people of working age who are available for work and
are actively seeking it but cannot find jobs.

Unemployed
Unemployme nt Rate   100%
Labour Force
 The unemployment rate can stay high even when the economy is
doing well.

 Unemployment Rate in India increased to 3.52 percent in 2017 from

3.51 percent in 2016. Unemployment Rate in India averaged 4.05
percent from 1983 until 2017, reaching an all time high of 8.30
percent in 1983 and a record low of 3.41 percent in 2014.
Issues addressed by Macroeconomics – inflation

 Inflation is the rate at which the general level of prices for goods
and services is rising and, consequently, the purchasing power of
currency is falling. Central banks attempt to limit inflation — and
avoid deflation — in order to keep the economy running smooth
 When prices of most goods and services are rising over time it is
inflation. When they are falling it is deflation.
 The inflation rate is the percentage increase in the average level
of prices.
 When the inflation rate reaches an extremely high level the
economy tends to function poorly. The purchasing power of
money erodes quickly, which forces people to spend their money as
soon as they receive it.
Issues addressed by Macroeconomics – the
international economy

 International economics deals with the economic activities of various

countries and their consequences. It studies economic and political
issues related to international trade and finance.
 International economics is a field concerned with economic
interactions of countries and effect of international issues on the
world economic activity.
 An economy which has extensive trading and financial relationships
with other national economies is an open economy. An economy
with no relationships is a closed economy.
 International trade and borrowing relationships can transmit
business cycles from country to country.
Issues addressed by Macroeconomics – trade
imbalances

 A trade deficit is an economic measure of international trade in

which a country's imports exceeds its exports.
 A trade deficit represents an outflow of domestic currency to
foreign markets. It is also referred to as a negative balance of
payment (BOT).
 Trade imbalances (trade surplus and deficit) affect output and
employment.
 Trade surplus: exports exceed imports.
 Trade deficit: imports exceed exports.
Issues addressed by Macroeconomics – exchange
rate

 An exchange rate is the rate at which onecurrency will be

exchanged for another. It is also regarded as the value of one
country's currency in relation to another currency. ... The
spot exchange rate refers to the current exchange rate.
 The amount of Indian rupees that can be purchased with a unit of
foreign
 The trade balance is affected by the exchange rate
Macroeconomic Policy

 Types of macroeconomic policies:

 Fiscal policy: government spending and taxation at different
government levels.
 Monetary policy: the central bank’s control of short-term
interest rates and the money supply
 Growth policies: are government policies that focus on
stimulating aggregate supply instead of aggregate demand
 A nation’s economic performance depends on:
 natural and human resources;
 capital stock;
 technology
 economic choices made by citizens;
 macroeconomic policies of the government.
 Macroeconomic Policy

 Monetary policy consists of the process of drafting, announcing and

implementing the plan of actions taken by the central bank, currency board or
other competent regulatory authority of a country that determines the scope and
impact of the key drivers of the economic activity in that country. Activities which
are integral to monetary policy consists of management of money supply and
interest rates which are aimed at achieving macroeconomic objectives like
controlling inflation, consumption, growth and liquidity. These are achieved
by actions such as modifying the interest rate, buying or selling government
bonds, regulating foreign exchange rates, and changing the amount of money
banks are required to maintain as reserves.
 Fiscal policy is the means by which a government adjusts its spending levels
and tax rates to monitor and influence a nation's economy. It is the sister strategy
to monetary policy through which a central bank influences a nation's money
supply.
 These two policies are used in various combinations to direct a country's
economic goals. Here we look at how fiscal policy works, how it must be
monitored and how its implementation may affect different people in an economy.
Budget Deficits

 A budget deficit occurs when an individual, business

or government budgets more spending than there is revenue
available to pay for the spending, over a specific period of time.
Debt is the aggregate value of deficits accumulated over time.
 The economy is affected when there are large budget deficits: the
excess of government spending over tax collection.
 The large budget deficits of the 1980s and early 1990s are unusual.
 Borrowing from the public might divert funds from more productive
uses.
 Federal budget deficits might be linked to the decline in
productivity growth.
Aggregation

 Total level of demand for desired goods and services (at any time
by all groups within a national economy) that makes up the gross
domestic product (GDP).Aggregate demand is the sum of
consumption expenditure, investment expenditure, government
expenditure, and net exports.

 Macroeconomists ignore distinctions between individual product

markets and focus on national totals.

 The process of summing individual economic variables to obtain

economy-wide totals is called aggregation.
The main objectives of government economic policy

 The key elements of the Government's strategy are:

 Delivering macroeconomic stability (a very broad macroeconomic
aim)

 Meeting the productivity challenge (an important supply-side target)

 Increasing employment opportunity for all (a labour market

objective)

 Ensuring fairness for families and communities (commitment to

equity)

 Protecting the environment (green economics has a macroeconomic

dimension)
Macroeconomic stability…

 What are the government’s main economic objectives?

 Low inflation
 Steady and sustained growth
 High levels of employment
 Improvements in living standards
The classical approach

 The invisible hand of Economics: General welfare will

be maximized (not the distribution of wealth) if:
 there are free markets;
 individuals act in their own best interest.

 To maintain markets’ equilibrium – the quantities

demanded and supplied are equal:
 Markets must function without impediments.
 Wages and prices should be flexible.

 Thus, according to the classical approach, the

government should have a limited role in the
economy.
The Keynesian Approach

 Keynes (1936) assumed that wages and prices adjust slowly.

 Thus, markets could be out of equilibrium for long periods of time
and unemployment can persist.
 Therefore, according to the Keynesian approach, governments
can take actions to alleviate unemployment.
 The government can purchase goods and services, thus increasing
the demand for output and reducing unemployment.
 Newly generated incomes would be spent and would raise
employment even further.
Evolution of the Classical-Keynesian Debate

 After stagflation – high unemployment and high inflation

– of the 1970s, a modernized classical approach
reappeared.
 Substantial communication and cross-pollination is
taking place between the classical and the Keynesian
approaches.
Unified Approach to Macroeconomics

 Individuals, firms and the government interact in goods,

asset and labour markets.
 The macroeconomic analysis is based on the analysis
of individual behaviour.
 Keynesian and classical economists agree that in the
long run prices and wages adjust to equilibrium levels.
 The basic model will be used either with classical or
Keynesian assumptions about flexibility of wages and
prices in the short run.
Components of a macroeconomy

 A model to understand the

functioning of a macro
economic system or the
economy as a whole is
called the ‘Circular Flow
of Income Model’
 Everyone’s expenditure is
some else’s receipt. Every
transaction must have two
sides
What trends can you see
Current economic data
Current economic data
Current economic data
Current economic data
Current economic data
Current economic data
Macroeconomics variables
 Aggregate Output

 Aggregate output - national income and product

accounts, NIPA
 Gross Domestic Product (GDP)
o The value of the final goods and services produced in an economy during a
given period
Y = C + I + G + X – Im
o In a closed economy, all output is sold domestically, and expenditure is divided
into three components: consumption, investment, and government purchases.
Y = C + I + G where Y is the national income, C is the total consumption, I is the
total investment and G is the total government expenditure.
o In an open economy, some output is sold domestically and some is exported to
be sold abroad. We can divide expenditure on an open economy’s output Y into
four components: Cd, consumption of domestic goods and services, Id,
investment in domestic goods and services, Gd, government purchases of
domestic goods and services, X, exports of domestic goods and services. The
division of expenditure into these components is expressed in the identity
Y = Cd + Id + Gd + X.
Slide #38
Aggregate Output - GDP

Y = Cd + Id + Gd + X.
The sum of the first three terms, Cd + Id + Gd, is domestic spending on domestic goods
and services. The fourth term, X, is foreign spending on domestic goods and services(the
value of exports). Since total domestic spending is a sum of spending on domestic as well
as foreign goods and services, we can say that,
C = Cd + Cf, I = Id + If, G = Gd + G f.
We substitute these three equations into the identity above:
Y = (C − Cf ) + (I − I f ) + (G − G f ) + X.
We can rearrange to obtain
Y = C + I + G + X − (Cf + I f + G f).
The sum of domestic spending on foreign goods and services (Cf + I f + G f) is expenditure
on imports (IM). We can thus write the national income accounts identity as
Y = C + I + G + X − IM.
Since the value of total imports is a part of domestic spending and it is not a part of
domestic output, it is subtracted from the total output.This gives us the value of Net Exports
(NX = X − IM), the identity becomes
Y = C + I + G + NX.

Slide #39
Aggregate Output - GDP

 Three approaches for defining GDP

 Final good
 Value added
 Income

Slide #40
Aggregate Output - GDP

 GDP: The final goods approach

Firm 1: Steel Company
Revenues from sales $100
Expenses (wages) $80
Profit $20
What is GDP?
$310 or $210
Firm 2: Car Company
Revenues from sales $210
Expenses $170
Wages $70
Steel purchases $100
Profit $40
Slide #41
Aggregate Output - GDP

 GDP: Value added approach

GDP ($210) 
Value added steel ($100)  value added cars ($110)

Slide #42
Aggregate Output - GDP

 GDP: Income side

GDP (income) = indirect taxes +labour income + capital income
• Income (steel) • Income (car)
– Labor = $80 – Labor = $70
– Capital = $20 – Capital = $40
$100 $110

GDP (income)  $100  $110  $210

Compared to:

GDP (value added - -$210)  value added steel ($100)

 value added car ($110)
Slide #43
Aggregate Output - GDP

 Nominal & Real GDP

 Nominal GDP is GDP evaluated at current market prices.
Therefore, nominal GDP will include all of the changes in market prices
that have occurred during the current year due to inflation or deflation
 Real gross domestic product is an inflation-adjusted measure that reflects
the value of all goods and services produced by an economy in a given
year, expressed in base-year prices, and is often referred to as "constant-
price," "inflation-corrected" GDP or "constant dollar GDP."

 Unlike nominal GDP, real GDP can account for changes in price level and
provide a more accurate figure of economic growth.

 If Nominal GDP Growth > Real Growth, inflation is positive. If not,

inflation is negative. GDP: The total value (value = in terms of money) of all
goods / services produced in the country. ... Real GDP is nominal
GDP adjusted for inflation, so most likely nominal values are greater
than real values of GDP
Slide #44
Aggregate Output - GDP

Slide #45
Aggregate Output - GDP

 Observation

 Real GDP = value of final goods in constant prices

 The increase in real GDP is less than nominal GDP when prices
are rising
 More variation in real GDP than nominal GDP

Slide #46
Aggregate Output - GDP

 Synonyms for GDP accounting

• Real GDP
o GDP in terms of goods
o GDP in constant dollar
o GDP adjusted for inflation
o GDP in 1992 rupee

Slide #47
Aggregate Output - GDP

 GDP -- refers to real GDP

 Yt -- real GDP in year t
 GDP -- nominal GDP
 Yt = nominal GDP in year t

Slide #48
Other major macroeconomic variables

 The unemployment rate

number unemployed (U )
Unemployme nt Rate (u ) 
labor force (L)

Labor Force (L)  employed (N )  unemployed(U )

Slide #49
Other major macroeconomic variables

 Counting the unemployed

• Current population survey
o 60,000 households monthly
o Employed -- job holders
o Unemployed -- job seekers
 1998
N  131.4
U  6.2
6.2 (U )
u  4.5% 
131.4 (N )  6.2(U )

Slide #50
Other major macroeconomic variables

 Discouraged workers

 A discouraged worker is a person of legal employment age who is not

actively seeking employment or who does not find employment after
long-term unemployment.
 This is usually because an individual has given up looking or has had
no success in finding a job, hence the term "discouraged".

 In other words, even if a person is still looking actively for a job, that
person may have fallen out of the core statistics of unemployment rate
after long-term unemployment and is therefore by default classified as
"discouraged“ since the person does not appear in the core statistics of
unemployment rate.

Slide #51
Other major macroeconomic variables

 Unemployment and economic activity

 Okun's law is an empirically observed relationship between unemployment

and losses in a country's production
 The "gap version" states that for every 1% increase in the unemployment
rate a country's GDP will be roughly an additional 2% lower than its
potential GDP
 The "difference version" describes the relationship between quarterly
changes in unemployment and quarterly changes in real GDP. The stability
and usefulness of the law has been disputed
 Okun’s Law
o High output growth -- reduces unemployment
o Low output growth -- increases unemployment

Slide #52
Other major macroeconomic variables

 The Inflation Rate

 The inflation rate is calculated using the price increase of a
defined product basket. This product basket contains products
and services, on which the average consumer spends money
throughout the year. ... In 2017, the inflation rate in India was
around 3.6 percent compared to the previous year.
 A sustained rise in the price level
• Two measures of the price level
o GDP Deflator
o Consumer Price Index (CPI)

Slide #53
Other major macroeconomic variables

 The GDP deflator

 Average price of final goods produced

 GDP deflator in year t = Pt
nominal GDPt $Yt
Pt  
Real GDPt Yt

 Pt is an index number
 P1993 = 102.6 (1992 = 100)
 Index numbers are used to measure rate of change over time
Pt  Pt - 1
Rate of inflation   %Pt
Pt - 1

$Yt
Pt 
Yt
$Yt  Pt  Yt

Slide #54
Other major macroeconomic variables

 Consumer price index (CPI)

 The Consumer Price Index (CPI) is a measure that examines

the weighted average of prices of a basket of consumer goods
and services, such as transportation, food and medical care. It is
calculated by taking price changes for each item in the
predetermined basket of goods and averaging them.
 The CPI is not equal to the GDP deflator
o Some final goods are sold to business, government, and foreigners
o Some consumer goods are imported

Slide #55
Other major macroeconomic variables

 Steps in calculating the CPI

 Consumer expenditure survey to determine a market basket
of items
 Bureau of labor statistics (BLS) field workers price the items
monthly (xx cities, xx,xxx stores)
 A base period is chosen,

Slide #56
Other major macroeconomic variables

 The Phillips curve

• The Phillips curve is an economic concept

developed by A. W. Phillips stating that
inflation and unemployment have a stable and
inverse relationship. The theory claims that
with economic growth comes inflation, which in
turn should lead to more jobs and less
unemployment.
o Low unemployment --inflation rate increases
o High unemployment -- inflation rate
decreases

Slide #57
The central questions of macroeconomics

 What determines the level of aggregate output?

 Demand?
 Supply?
 Government, education, and savings?
• Short-run (a few years)  demand
• Medium-run (10+ years)  supply
• Long-run (50+ years)  government, education, savings

Slide #58