Macroeconomic Goals and

Instruments
 Macroeconomics
In 1933 Ragnar Frisch used the words
micro and macro. Before 1930 the
subject matter of economics was
considered as micro. After establishing
the theory of Lord Keynes – ‘ the
general theory of employment, interest
and money, it can be divided as micro
and macro.
The word macro comes from the greek
word ‘makros”. It means large or big. So
it is concerned with aggregate and
average of the entire economic system.

It deals how an economy can grow.

It includes GNP, NNP, GDP, NI,
Employment level, Total output level,
General price level etc.
 Macroeconomics

Macroeconomics is the study of the

behavior of the economy as a whole. It
concerns the business cycles that lead
to unemployment and inflation, as well
as the longer-term trends in output and
living standards.
 Macroeconomic Goals
Output
⚫ High level and sustainable growth

Employment
⚫ High level of employment and low involuntary
unemployment
Stable Prices
The condition in which the average price level in the
economy does not change or changes very slowly.
International trade
⚫ Export and import equilibrium and exchange rate
stability
 1. Output

The ultimate objective of economic

activity is to provide the goods and
services that the population desires.
The most comprehensive measure of
the total output in an economy is the
gross national product (GNP).
GNP

Nominal GNP is measured in actual market

prices.
Real GNP is calculated in constant or
invariant prices.
Potential GNP is the long-run trend in real
GNP. It represents the long-run productive
capacity of the economy or the maximum
amount the economy can produce while
maintaining stable prices.
 Potential and Actual GNP
Real GNP
($)

Potential GNP

Actual GNP

Years
 2. Employment

The unemployment rate measures the

fraction of the labour force that is
looking for but cannot find the work.
The labour force includes all employed
persons and those unemployed
individuals who are seeking jobs.
The unemployment rate tends to move
with the business cycle.
 Stable Prices

The third macroeconomic goal is to

maintain stable prices within free
markets.
A market economy uses prices as a
yardstick to measure economic values.
Rapid price changes lead to economic
inefficiency.
This is a key part of the macroeconomic
goal of stability (the other two are full
employment and growth).

Price stability is commonly indicated by the

inflation rate, calculated as percentage
changes in either the Consumer Price
Index (CPI) or the GDP price deflator.
However, price stability is more generally
the ABSENCE of large or rapid increases
or decreases in the price level.
The most common measure of the
overall price level is the consumer price
index (CPI). The CPI measures the cost
of a fixed basket of goods bought by the
typical urban consumer.
The rate of inflation measures changes
in the level of prices. It denotes the rate
of growth or decline of the price level
from one year to the next.
Inflation or Deflation
An inflation occurs when the level of
price is growing (the rate of inflation is
positive).
A deflation denotes that the level of
price declines (the rate of inflation is
negative).
A disinflation is a decrease in the rate of
inflation. The slowing of the rate of
inflation per unit of time.
 International trade
International trade is becoming
increasingly important to most country’s
economy.
International trade is beneficial to
society even if some individuals are
harmed by it.
International trade includes import and
export of goods, services, capital,
borrowing and lending money etc.
Net export is the numerical difference
between the value of a country’s
exports and the value of its imports.
When net exports are positive, a trade
surplus exists.
A trade deficit occurs when the value of
imports is greater than the value of
exports.
Exchange Rate Stability
Foreign exchange rate represents the
price of own currency in terms of the
currency of other nation.
When a nation’s exchange rate rises, the
prices of imported goods fall while
exports become more expensive for
foreigners  the nation becomes less
competitive in world markets and net
exports decline.
Changes in exchange rates can also
affect output, employment, and inflation.
 Macroeconomic Policy
Instruments

A policy instrument is an economic

variable under the control of
government that can affect one or more
of the macroeconomic goals
 Macroeconomic Policy
Instruments
Fiscal Policy
Monetary Policy
International Economic Policy
Incomes Policy
Fiscal policy is the use of government
expenditures and taxes to affect
aggregate demand and aggregate
supply.
Government expenditure come in two
distinct forms, first, there are government
purchase, i.e., purchase of tanks,
construction of roads, salaries for employees
and so forth. Another is, government
transfer payments, which boost the incomes
of targeted groups such as, the elderly or the
unemployed.
The other part of fiscal policy is collection of
tax. Tax affects the overall economy in two
ways, i.e., taxes affects people’s incomes;
taxes tend to affect the amount people
spend on goods and services as well as the
amount of private saving; taxes affect the
prices of goods and factors of production
and thereby affect incentives and behaviour
of the producers.
 Monetary Policy
The second major instrument of
macroeconomic policy is monetary
policy, which conducts through the
management of the nation’s money,
credit and banking system. The exact
nature of monetary policy is the central
bank controls the money supply and
relationships among money output and
inflation which is one of the most
fascinating, important, and
controversial areas of
macroeconomics.
 Monetary Policy

Monetary policy determines the money

supply as well as interest rates, in order
to achieve desired economic objectives.
Changes in the money supply move
interest rates up or down and affect
spending in sectors such as investment,
housing, and net exports.
Monetary policy has an important effect
on both actual GNP and potential GNP.
 International Economic Policy

International Economic Policy consists of

two sets of policies:
⚫ Trade policies, which consist of tarrifs,
quotas, and other devices that restrict or
encourage imports and exports.
⚫ Exchange-rate setting. Exchange rate
represents the price of one currency in
terms of the currencies of the other nations.
There are different systems to regulate
foreign exchange market.
Incomes Policy

Incomes policies are government

attempts to moderate inflation by direct
steps (legislated wage, price controls).
Incomes policies are the most
controversial of all macroeconomic
policies.
Broadly, the objective of macroeconomic
policies is to maximize the level of national
income, providing economic growth to raise
the utility and standard of living of
participants in the economy.

There are also a number of secondary

objectives which are held to lead to the
maximization of income over the long run.
There are variations between the objectives
of different national and international
entities.
Realization of Macroeconomic Goals

Macroeconomics

Economy Macroeconomic
Policy
 Business Cycle
Business cycles are a type of fluctuation
found in the aggregate economic activity of
nations that organize their work mainly in
business enterprises.

Business cycles are the "ups and downs" in

economic activity, defined in terms of
periods of expansion or recession.

During expansions, the economy, measured

by indicators like jobs, production, and sales,
is growing–in real terms, after excluding the
effects of inflation.
Recessions are periods when the economy
is shrinking or contracting. Business
Cycle (or Trade Cycle) is divided into the
following four phases :-

Prosperity Phase : Expansion or Boom or

Upswing of economy.
Recession Phase : from prosperity to
depression .
Depression Phase : Contraction or
Downswing of economy.
Recovery Phase : from depression to
prosperity .
1. Prosperity Phase
When there is an expansion of output,
income, employment, prices and profits,
there is also a rise in the standard of living.
This period is termed as Prosperity phase.
The features of prosperity are :-
High level of output and trade.
High level of effective demand.
High level of income and employment.
Rising interest rates.
Inflation.
Large expansion of bank credit.
Overall business optimism.
A high level of MEC (Marginal efficiency of
capital) and investment.
Recession Phase
During a recession period, the economic
activities slow down. When demand starts
falling, the overproduction and future
investment plans are also given up. There
is a steady decline in the output, income,
employment, prices and profits. The
businessmen lose confidence and become
pessimistic (Negative). It reduces
investment. The banks and the people try
to get greater liquidity, so credit also
contracts. Expansion of business stops,
stock market falls. Orders are cancelled
and people start losing their jobs. The
increase in unemployment causes a sharp
decline in income and aggregate demand.
Depression Phase
When there is a continuous decrease of output,
income, employment, prices and profits, there is a
fall in the standard of living and depression sets
in.
The features of depression are :-
Fall in volume of output and trade.
Fall in income and rise in unemployment.
Decline in consumption and demand.
Fall in interest rate.
Deflation.
Contraction of bank credit.
Overall business pessimism.
Fall in MEC (Marginal efficiency of capital) and
investment
 Recovery Phase
During the period of revival or recovery, there
are expansions and rise in economic
activities. When demand starts rising,
production increases and this causes an
increase in investment. There is a steady rise
in output, income, employment, prices and
profits. The businessmen gain confidence
and become optimistic (Positive). This
increases investments. The stimulation of
investment brings about the revival or
recovery of the economy. The banks expand
credit, business expansion takes place and
stock markets are activated. There is an
increase in employment, production, income
and aggregate demand, prices and profits
start rising, and business expands. Revival
slowly emerges into prosperity, and the
business cycle is repeated.
AD & AS
 Aggregate Demand
AD refers to the total amount that different sectors
in an economy willingly spend in a given period.
It is the sum of spending by consumers, businesses,
and government. It depends on the level of prices,
monetary policy, fiscal policy and other factors such
as wars and weather.
The components of AD include consumption
spending by consumers, factories & equipments
bought by businesses, government spending and net
exports.
⚫ AD = C + I + G + (X-M)

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 Aggregate Supply
AS refers to total quantity of goods and services that
the nation’s businesses willingly produce and sell in
a given period of time. It depends upon price level,
productive capacity of the economy, and the level of
costs.
In general, business like to sell everything they can
produce at high prices. But sometimes, prices and
spending levels may be depressed, so businesses
may find excess capacity with them.

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Thus, AS depends on price level that businesses
can charge, and economy’s capacity or potential
output.
Potential output is determined by the availability
productive inputs such as labor and capital (and
their prices), and the managerial and technical
efficiency with which those inputs are combined.

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AD, AD interaction, and agg price output determination

Using both AD & AS, we P

AS
achieve the resulting

Price Index
equilibrium. National
output GNP, and price B C
level settle at that level E
where demanders willingly A
buy what businesses D
willingly sell. Resulting
Q
output and price level Real GDP
determine employment, Fig-1: AS, AD
unemployment and Interaction
international trade. 37
Figure 1, shows the AS and AD curves of an entire
economy. Downward sloping AD curve represents
what everyone in the economy- consumers,
businesses, foreigners and government- would buy
at different aggregate price levels (with other factors
held constant).
Upward sloping AS curve represents what
businesses will produce and sell at different prices
with other factors held constant).
Equilibrium: The economy is in eqlm at E, where
AD equals AS, and all buyers and sellers are
satisfied with their purchases, sales and prices; and
aggregate output and prices are determined.

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