DPUE

Economics

Chapter 1

Macro Economics
 Chapter 1: Introduction

Macro Economics:
In macroeconomics we usually simplify the analysis of how the country’s total
production and the level of employment are related to attributes (called ‘variables’) like prices,
rate of interest, wage rates, profits and so on, by focusing on a single imaginary commodity
and what happens to it. Macroeconomics tries to address situation facing the economy as a
whole. Macro Economics study in aggregates.

An analysis of in what way macroeconomics differs from microeconomics:

 In microeconomics, you came across individual ‘economic agents’ (see box) and the nature
of the motivations that drive them. They were ‘micro’ (meaning ‘small’) agents.
 In other words, microeconomics was a study of individual markets of demand and supply
and the ‘players’, or the decision-makers, were also individuals (buyers or sellers, even
companies) who were seen as trying to maximise their profits (as producers or sellers) and
their personal satisfaction or welfare levels (as consumers).
 Even a large company was ‘micro’ in the sense that it had to act in the interest of its own
shareholders which was not necessarily the interest of the country as a whole.
 For microeconomics the ‘macro’ (meaning ‘large’) phenomena affecting the economy as a
whole, like inflation or unemployment, were either not mentioned or were taken as given.
These were not variables that individual buyers or sellers could change.
 The nearest that microeconomics got to macroeconomics was when it looked at General
Equilibrium, meaning the equilibrium of supply and demand in each market in the
economy.
 Macroeconomics tries to address situations facing the economy as a whole.
 Macroeconomists had to study the effects in the markets of taxation and other budgetary
policies, and policies for bringing about changes in money supply, the rate of interest,
wages, employment, and output.
 Macroeconomics has, therefore, deep roots in microeconomics because it has to study the
aggregate effects of the forces of demand and supply in the markets.
 Macroeconomic policies are pursued by the State itself or statutory bodies like the Reserve
Bank of India (RBI), Securities and Exchange Board of India (SEBI) and similar
institutions.
Economic Agents:
Those individuals or institutions which take economic decisions are known as
economic agents.
 They can be consumers who decide what and how much to consume.
 They may be producers of goods and services who decide what and how much to produce.
 They may be entities like the government, corporation, banks which also take different
economic decisions like how much to spend, what interest rate to charge on the credits,
how much to tax, etc.

 Adam Smith is regarded as the founding father of modern economics (it was known as
political economy at that time).
 His well-known work - “An Enquiry into the Nature and Cause of the Wealth of
Nations (1776)” is regarded as the first major comprehensive book on the subject,
commonly known as “Wealth of Nations”.

Emergence of Macroeconomics:
Macroeconomics, as a separate branch of economics, emerged after the British
economist John Maynard Keynes published his celebrated book “The General Theory of
Employment, Interest and Money” in 1936. Commonly known as Keynesian Phenomenon.

Thought on classical tradition:

The dominant thinking in economics before Keynes was that all the labourers who are
ready to work will find employment and all the factories will be working at their full capacity.
This school of thought is known as the classical tradition.

The Great Depression of 1929 and the subsequent years:

 The Great Depression of 1929 and the subsequent years saw the output and employment
levels in the countries of Europe and North America fall by huge amounts. It affected other
countries of the world as well.
 Demand for goods in the market was low, many factories were lying idle, and workers were
thrown out of jobs.
 In USA, from 1929 to 1933, unemployment rate rose from 3 per cent to 25 per cent
(unemployment rate may be defined as the number of people who are not working and are
looking for jobs divided by the total number of people who are working or looking for
jobs).
 Over the same period aggregate output in USA fell by about 33 per cent. These events
made economists think about the functioning of the economy in a new way.
 The fact that the economy may have long lasting unemployment had to be theorised about
and explained.
 Keynes’ book was an attempt in this direction. Unlike his predecessors, his approach was
to examine the working of the economy in its entirety and examine the interdependence of
the different sectors. Thus the subject of macroeconomics was born.

Wage Rate:
There is sale and purchase of labour services at a price which is called the wage rate.
The labour which is sold and purchased against wages is referred to as wage labour.
The production units will be called firms. In a firm the entrepreneur (or entrepreneurs)
is in charge of affairs. He hires wage labour from the market, he employs the services of
capital and land as well. After hiring these inputs he undertakes the task of production. His
motive for producing goods and services (referred to as output) is to sell them in the market
and earn profits. In the process he undertakes risks and uncertainties.

Factors of Production:
The four factors of productions are land, labour, capital and entrepreneur. The
entrepreneur sells the product in the market. The money that is earned is called revenue. Part
of the revenue is paid out as rent for the service rendered by land, part of it is paid to capital
as interest and part of it goes to labour as wages. The rest of the revenue is the earning of the
entrepreneurs and it is called profit. Profits are often used by the producers in the next period
to buy new machinery or to build new factories, so that production can be expanded. These
expenses which raise productive capacity are examples of investment expenditure.

Factors of Production Rewards

1. Land 1. Rent
2. Labour 2. Wages
3. Capital 3. Interest
4. Entrepreneur 4. Profit
Types of External Trade Sector:
There are two types of external trade sectors:
1. Exports: The domestic country may sell goods to the rest of the world. These are called
exports.
2. Imports: The economy may also buy goods from the rest of the world. These are called
imports.

The working of the Economy of a capitalist country:

A Capitalist economy can be defined as an economy in which most of the economic
activities have the following characteristics:
a) There is private ownership of means of production.
b) Production takes place for selling the output.
c) There is sale and purchase of labour service at a price called wage rate.
The examples for capitalistic countries are, a handful of countries North America, Europe and
Asia will qualify as capitalist countries.
In a capitalist country production activities are mainly carried out by capitalist
enterprises. A typical capitalist enterprise has one or several entrepreneurs. Entrepreneurs are
those who exercise control over major decisions and bear a large part of the risk associated
with the firm. They may themselves supply the capital needed to run the enterprise or they may
borrow the capital.
To carry out the production they also need natural resources. They need the most
important element of human labour to carry out production. This is called as labour. After
producing output with the help of land, labour and capital, the entrepreneur sells the product in
the market to earn money called revenue. Part of the revenue is paid out as rent for land, interest
for capital and wage for labour and keeps the rest of the revenue as profit.
Profits are often used by the producers in the next period to buy new machinery or to
build new factories, so that production can be expanded. These expenses which raise productive
capacity are examples of investment expenditure.

The Role of Government (State) and Household Sector in both developed

and developing countries:
Role of Government:
 In both the developed and developing countries, apart from capitalist sector, there is the
institution of State.
 The role of the state includes framing laws, enforcing them and delivering justice. The State
here refers to the Government which performs various developmental functions for the
society as whole.
 It undertakes production, apart from imposing taxes and spending money on building public
infrastructure, running schools, providing health services etc. These economic functions of
the state have to be taken into account when we want to describe the economy of the
country.
Role of Household sector:
 By household we mean a single individual who takes decisions relating to her own
consumption or a group of individuals for whom the decisions relating to consumption are
jointly determined.
 Households consist of people. These people work in firms as workers and earn wages. They
are the ones who work in government departments and earn salaries or they are the owners
of firms and earn profits.
 Therefore, the market in which the firms sell their products could not have been functioning
without the demand coming from the households. Further, they also earn rent by leasing
land or earn interest by lending capital.

Points to Remember:
 The individuals or institutions which take economic decisions are economic agents.
 In 1936 British economist J. M. Keynes published his celebrated book “General theory of
employment, interest and Money”.
 All the labourers who are ready to work will find employment and all the factories will be
working at their full capacity, this school of thought is known as classical thought.
 The year of Great Depression is 1929.
 In a capitalist country production activities are mainly carried out by private enterprises.

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