Macroeconomics

Lecture 1 – Introduction to Macroeconomics

Santosh K. Dash
IRMA, Anand
2024-12-02
Agenda for Today’s Session
• Microeconomics and Macroeconomics
• Introduction to various macroeconomic concepts
• Overview of various macro statistics and indicators
• Evaluation criteria
• Upcoming session plans
• Useful resources

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Learning Objectives
• This session introduces you to:
▪ The difference between microeconomic and macroeconomics
▪ The issues macroeconomists study
▪ The tools macroeconomists use
▪ Some important concepts in macroeconomic analysis
▪ Introduces various macro statistics
▪ Key indictors of the economy and interpretation

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Microeconomics and Macroeconomics
(1/2)
Parameter Microeconomics Macroeconomics
Scope Individual units (households/firms) Aggregate economy (National/Global)
Decision-making of individuals and Aggregate indicators (GDP, Growth, Inflation,
Focus Area
firms Unemployment)
How do consumers and firms make
Central Questions What causes growth/recession/Inflation?
choices?
Micro-level (individual markets and Macro-level (Overall economy and
Level of Analysis
agents) aggregates)
Policy Market regulation, taxation, Economic growth, fiscal policy, and
Implications competition policies monetary policy
Economic Agents Consumers, producers, workers, firms Governments, Central banks

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Microeconomics and Macroeconomics
(2/2)
Parameter Households Government
Budget Constraint Income Revenues (Taxes and Borrowings)
Allocation of time and money to Allocation of factors of production,
Allocation of Resources
satisfy needs and wants goods and services
Utility Happiness, Satisfaction Social Welfare, Economic Welfare

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Definitions
• Macroeconomics is the study of the growth and fluctuations of the broad
national aggregates – national income, employment, the price level, and
others – that are basic to our country’s standard of living – Robert Solow
• Macroeconomics is concerned with the behaviour of the economy as a whole
–Dornbusch, Fisher and Startz
• Macroeconomics is the study of the economy-wide phenomena – Burda and
Wyplosz
• Macroeconomics is the study of the “ordinary business of life” in the
aggregate –Froyen

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The Origin of Macroeconomics

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• “Macroeconomics” born as a field during the Great Depression.
▪ Idea that government could/should regulate the periodic ups and downs
of the economy rose to prominence.
• John Maynard Keynes, The General Theory of Employment,
Interest, and Money (1936).
▪ Basic tenet: Various “rigidities” in many markets lead to “disequilibria”
that can last a long time.

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What Macroeconomics Studies
• Macroeconomics is the study of aggerate fluctuations in the economy.
• Two clear patterns (see charts):
▪ Long-run growth
▪ Frequent and sometimes big short-run fluctuations around long-run
▪ trend
• Are the short-run fluctuations tightly related to the long-run trend?
▪ Conventional view in economics has been “no”
• Under the “no” view, a separation of fields
▪ Studying the trend (“economic growth” and “development”)
▪ Studying the fluctuations (“macroeconomics”)
• Thus, the two main areas of macroeconomic research: long-term
economic growth and shorter-term business cycles.

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India Real GDP Growth

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What Studying Macroeconomics Is
Important?
• Why should we study macroeconomics?
• Anything that effects the long-run rate of economic growth – even by a tiny
amount – will have huge effects on living standards in the long run.

Percentage increase in per capita income after...

Growth 10 years 25 years 50 years 100 years
2.0% 21.9 64.1 169.2 624.5
2.5% 28.0 85.4 243.7 1081.4
5.0% 62.9 238.6 1046.7 13050.1
5.5% 70.8 281.3 1354.2 21046.9
8.0% 115.9 584.8 4590.2 219876.1
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Important Issues in Macroeconomics
• Macroeconomics, the study of the economy as a whole, addresses
many topical issues:
▪ What do some countries grow and why some fail?
▪ Why does the cost of living keep rising?
▪ Why are millions of people unemployed even when the economy is
booming?
▪ What causes recessions?
▸Can the government do anything to combat recessions? Should it?
▪ What is the government budget deficit? How does it affect the economy?
▪ Why does the India have such a huge trade deficit?
▪ Why are so many countries poor?
What policies might help them grow out of poverty?

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• To understand policy and policy prescriptions
▪ To what extent government policies affect consumption and investment,
output and unemployment?
▪ What government policies are optimal in achieving a desirable state of
affairs? (Low unemployment, potential growth, stable inflation, etc.)
▸Role of ‘Abenomics’ in an attempt to revive Japanese economy
▸Did the September 2019 corporate tax cut raise investment in India?
▸Did demonetization have anything to do with sluggish GDP growth rates
of 2017?
▸What were the policy actions by RBI in the wake of the 2007-09
Subprime crisis?
▸How did Covid affect the economies?

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Why Learn Macroeconomics?
1. The macroeconomy affects society’s well-being.
U.S. Unemployment and
6000
10
Property Crime Rates

100,000 population
property crime
5000
percent of labor

8 (right scale)

crimes per
force

6
4000

4
unemployment
(left scale) 3000
2

0 2000
1970 1980 1990 2000

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2. The macroeconomy affects your well-being.

5 5

percent change from 12 mos earlier

4
change from 12 mos earlier
3
3
1
2

1 -1

0
-3
-1
-5
-2

-3 -7
1965 1970 1975 1980 1985 1990 1995 2000 2005
unemployment rate inflation-adjusted mean wage (right scale)
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3. The macroeconomy affects politics.
Unemployment & inflation in election years
Year Unemployment Rate Inflation Rate Election Outcome
1976 7.70% 5.80% Carter (D)
1980 7.10% 13.50% Reagan (R)
1984 7.50% 4.30% Reagan (R)
1988 5.50% 4.10% Bush I (R)
1992 7.50% 3.00% Clinton (D)
1996 5.40% 3.30% Clinton (D)
2000 4.00% 3.40% Bush II (R)
2004 5.50% 3.30% Bush II (R)
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How Would This Plot for India Look?
• Do you think this holds same for India?
▪ Less likely since here elections are fought on different issues, less to do
with economic performance or development.

• Take-home assignment
▪ Prepare a similar table for India.
▪ Add GDP growth also.

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Reading Macro Numbers and
Figures

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Index of Core Industries (ICI)
• Eight Core Sector Indicators, known as Index of Core Industries (ICI).
• Eight core industries are
▪ Coal, Crude Oil, Natural Gas, Petroleum Refinery Products, Fertilizers, Steel, Cement and
Electricity
• Comprises 40.27% of the weight of in the IIP
• Objective: Advance indication on production performance of industries of
‘core’ nature before the release of IIP by CSO.
• Monthly; published about 12 days prior to IIP.
• A widely used indicator – by RBI, MoF, Policymakers
• The Index is compiled and released by Office of the Economic Adviser (OEA),
Department of Industrial Policy & Promotion (DIPP), Ministry of Commerce &
Industry, Government of India.

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Eight Core Indicators
Latest performance (October, 2024)
• Growth of 3.1% in October 2024, compared with 12.1% in October
2023.
• Six sectors showed uptick (two mild growth) and two negative growth.
• For April-October 2024, the ICI output grew 4.1% vs compared to 8.8
percent in same period last year.
• What happened in October 2024?
▪ High base year in October 2023: ICI was 156.4 vs 138.8 (October 2022).
▪ Weaker performance in sectors like crude oil and natural gas.
▪ Higher number of holidays in the year ago month.
▪ October is a period of festive season.
• Take-home Assignment: ICI and GDP growth for last 10 years.

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Mint Macro Tracker
• Research by various agencies and banks – SBI Research, BoB
Research.
• Mint Macro Tracker
▪ Launched in October 2018, it provides a monthly comprehensive report
on the state of economy - by focusing on four broad segments –
▸Consumer economy, producer economy, external sector, and ease of living –
▸Identified by sixteen high frequency indicators.
▪ The numbers here reflect their status apropos of their five-year growth
trend.

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Snapshot of the Tracker
▪ As of July 2024:
▸Three indicators are still in the red! (below the five-year trend line)
▸Seven indicators are in amber (at par with the five-year trend line)
▸Six indicators are in green (above the five-year trend line)

▪ As of July 2023:
▸Eight indicators are still in the red! (below the five-year trend line)
▸Two indicators are in amber (at par with the five-year trend line)
▸Six indicators are in green (above the five-year trend line)

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Purchasing Managers’ Index (PMI)
• In India, the Nikkei India Composite Output Index is a weighted average of
the Manufacturing Output Index and the Services Business Activity Index
and tracks business trends across private sector activity, based on data
collected from a representative panel of around 800 companies.
• The index tracks variables such as sales, new orders, employment,
inventories and prices.
• A reading above 50 indicates expansion in business activity and below
50 indicates that it is generally declining.
• The variables used to construct India’s PMI for manufacturing sector are:
▪ Output, New Orders, Employment, Input Costs, Output Prices, Backlogs of Work,
Export Orders, Quantity of Purchases, Suppliers‟ Delivery Times, Stocks of
Purchases and Stocks of Finished Goods.

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PMI Composite since September 2021

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Central Questions in Macroeconomics
1) Economic Instability
• Why do output, inflation, and employment fluctuate so much?
▪ What factors explain the steady expansion of output in 2003-2008?
▪ Why was inflation so high during 2010-13?

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Central Questions in Macroeconomics
2) The Inflation-Unemployment Relationship
• Effects in the Short Run – Decreased unemployment will be associated with
higher levels of inflation. Since demand for labour is a function of output
prices, firms are more likely to hire if prices of their commodities are
increasing.
• But, is this relationship likely to endure in the long run?
▪ If both workers and firms have expectations about the increase in prices, then
such expectations will get reflected in the wage contracts. This will have a
peculiar effect of high inflation and high unemployment.
• Supply shocks and Stagflation

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Central Questions in Macroeconomics
3) What Explains Long-run Growth?
• Why do some economies grow and some fail?
• What explains the decline of growth post 2015 in India?

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Central Questions in Macroeconomics
4) What Do Deficits Persist? Implications?
• Why do deficits persist?
▪ Trade deficit (current account deficits)
▪ Budget deficit (fiscal deficit)
• What are the consequences of running high deficits?
• Is running trade deficits key to the functioning of global economy?
• What are the consequences of running high borrowing?
• Are they unsustainable in the long run?

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Economic Models
• Models are simplified versions of a more complex reality.
▪ Irrelevant details are stripped away.
• They are used to:
▪ Show relationships between variables.
▪ Explain the economy’s behavior.
▪ Devise policies to improve economic performance.
• However, no one model can address all the issues we care about.

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Example of a model:
Supply & Demand for New Cars
• It shows how various events affect price and quantity of cars.
• Assumes the market is competitive: each buyer and seller is too
small to affect the market price.
• Variables:
𝑸 𝒅 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑐𝑎𝑟𝑠 𝑡ℎ𝑎𝑡 𝑏𝑢𝑦𝑒𝑟𝑠 𝑑𝑒𝑚𝑎𝑛𝑑
𝑸 𝒔 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑡ℎ𝑎𝑡 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑟𝑠 𝑠𝑢𝑝𝑝𝑙𝑦
𝑷 = 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑛𝑒𝑤 𝑐𝑎𝑟𝑠
𝒀 = 𝑎𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑒 𝑖𝑛𝑐𝑜𝑚𝑒
𝑷𝒔 = 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠𝑡𝑒𝑒𝑙 (𝑎𝑛 𝑖𝑛𝑝𝑢𝑡)

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The Demand for Cars
Demand equation: 𝑸 𝒅 = 𝑫 (𝑷, 𝒀)
• It shows that the quantity of cars consumers demand is related to
the price of cars and aggregate income.

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• General functional notation shows only that the variables are
related.
▪ 𝑸 𝒅 = 𝑫 (𝑷, 𝒀 )

• A specific functional form shows the precise quantitative

relationship.
▪ 𝑫 (𝑷, 𝒀) = 60 – 10𝑷 + 2𝒀

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The Market for Cars: Demand
demand equation: P
𝑸𝒅 = 𝑫(𝑷, 𝒀) Price
of cars

The demand curve

shows the relationship
between quantity D
demanded and price, Q
other things equal. Quantity
of cars

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The Market for Cars: Supply
supply equation: P
𝑸𝒔 = 𝑺(𝑷, 𝑷𝒔 ) Price
of cars S

The supply curve shows

the relationship
between quantity D
supplied and price, Q
other things equal. Quantity
of cars

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The Market for Cars: Equilibrium
P
Price
of cars S

equilibrium
price
D
Q
Quantity
of cars
equilibrium
quantity
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The Effects of an Increase in Income
demand equation: P
𝑄𝑑 = 𝐷(𝑃, 𝑌) Price
of cars S

An increase in income
increases the quantity P2
of cars consumers P1
demand at each price… D2
D1
Q
…which increases the Q1 Q 2
Quantity
equilibrium price and of cars
quantity.

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The Effects of a Steel Price Increase
P S2
Supply equation:
𝑄 𝑠 = 𝑆(𝑃, 𝑃𝑠 ) Price
of cars S1

An increase in Ps P2
reduces the quantity of
cars producers supply at
P1
each price… D
Q
…which increases the Q2 Q1
Quantity
market price and of cars
reduces the quantity.

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Endogenous vs. Exogenous Variables
• The values of endogenous variables are determined in
the model.
• The values of exogenous variables are determined
outside the model:
▪ The model takes their values & behavior as given.
• In the model of supply & demand for cars,
Endogenous: 𝑃, 𝑄𝑑 , 𝑄 𝑠

Exogenous: 𝑌, 𝑃𝑠

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A Multitude of Models
• So we will learn different models for studying different issues (e.g.,
unemployment, inflation, long-run growth).
• For each new model, you should keep track of:
▪ Its assumptions
▪ Which variables are endogenous, which are exogenous
▪ The questions it can help us understand, and those it cannot

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Prices: Flexible vs. Sticky
• Market clearing: An assumption that prices are flexible, adjust to
equate supply and demand.
• In the short run, many prices are sticky –
adjust sluggishly in response to changes in supply or demand. For
example,
▪ Many labor contracts fix the nominal wage for a year or longer
▪ Many magazine publishers change prices only once every 3-4 years

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Prices: Flexible vs. Sticky
• The economy’s behavior depends partly on whether prices are
sticky or flexible:
• If prices are sticky, then demand won’t always equal supply. This
helps explain:
▪ Unemployment (excess supply of labor)
▪ Why firms cannot always sell all the goods they produce
• Long run: Prices flexible, markets clear, economy behaves very
differently.

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Evaluation Criteria
• Class participation (10%)
• Mid-term (30%)
• Group presentations (20%)
• End-term (40%)

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Upcoming Session Plans
• Circular Flow of Income in an Economy
• National Income Accounting and GDP
• Business Cycles
• Economic Growth
• Fiscal Policy and Government’s Budget
• Monetary Policy and the Central Bank
• The Keynesian Cross
• Goods Market Equilibrium – The IS Curve
• Money Market Equilibrium – The LM Curve
• Policy Analysis in the IS-LM Framework
• Labour Markets, Aggregate Supply, and Aggregate Demand
• AS-AD and Policy
• Balance of Payments and The Mundell-Fleming Model

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Resources
• Textbooks
▪ ‘Macroeconomics’ by Gregory Mankiw
▪ ‘Macroeconomics – Theories and Policies’ by Richard T. Froyen
▪ ‘Macroeconomics’ by Dornbusch, Fisher, and Startz
▪ ‘Principles of Macroeconomics’ by Gregory Mankiw
▪ ‘Macroeconomics’ by Oliver Blanchard
▪ ‘Macroeconomics’ by Errol D’Souza

• Blogs
▪ Paul Krugman (https://www.nytimes.com/column/paul-Krugman)
▪ Gregory Mankiw (http://gregmankiw.blogspot.com/)
▪ TT Ram Mohan (http://ttrammohan.blogspot.com/

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Resources (Contd.)
Online Resources
• ‘Economics & Finance’ section of Project Syndicate (https://www.project-
syndicate.org/section/economics)
• The Economist (https://www.economist.com/)
• Evonomics (http://evonomics.com/)
• The Editorial Page and ‘Explained’ section in Indian Express

Data Sources
• Central Statistical Organization (CSO) (http://www.mospi.nic.in/)
• CMIE - Economic Outlook (https://economicoutlook.cmie.com/)
• World Development Indicators (https://data.worldbank.org/indicator)
• Google Public Data Explorer (https://www.google.com/publicdata/directory#)
• Trading Economics (https://tradingeconomics.com/)

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