Macroeconomics

Chapter 1: Introduction
1.1. What is macroeconomics ?
 Macroeconomics is the study of the behavior of an economy as
a whole. It is the study of aggregate economic behaviors.
 It analyze the main determinants of an economy’s level of
national income, general price level , unemployment level etc.
 Moreover, macroeconomics focuses on the economic behavior
and policies that affect consumption and investment,
determinants of changes in wages and prices, monetary
policies and fiscal policies.
 Cont….
• It also deals with long-run economic growth and the short
run fluctuations which are constituents of the business cycle.
• It try to explain the behavior of economic variable over time.
This means that we need to explain the behavior of the
economy both in the long run and in the short run.
• Short-run generally refers to a time period of less than a year.
Long run refers to a time period of more than one year.
1.2. Basic concepts of Macro economics
The most important concepts that macroeconomics deals with
are Gross National Product (GNP), Gross Domestic Product
(GDP), Government Expenditure, unemployment, business cycle,
Total money supply, Inflation, Balance of Payment (BoP), Trade
Balance.. etc.
 Cont……
A. Gross Domestic Product (GDP):
 It is the sum of values of total goods and services
produced in a given country in a given period of time (a
year).
 GDP can be obtained by aggregating the values of goods
and services produced in different sectors of the economy.
B. Gross national product /GNP /
o It is the total value of all final goods and services
produced by citizens of the country
o It consists the value of all final goods and services which
are produced by citizens of the country both domestically
and abroad.
 Cont…
C. Government expenditure:
 It is the amount of resources that the
government sector of a country spends in a
given fiscal year (budget year)
 This expenditure includes both consumption
expenditure and investment expenditure in
such activities as construction of roads,
schools, clinics and hospitals, water supply,
electrification and others
 Cont…
Government consumption includes expenditure on
non-durable goods in government offices and expenditure on
national defense
D. money supply: is the sum of total currency in circulation
and demand deposits (deposited funds can be withdrawn at
any time) at banks The amount or size of money supply is
controlled to the appropriate level by Central Bank of the
country.
 it includes both cash and deposits that can be used almost as
easily as cash. i.e money that are very liquid such as cash,
checkable (demand deposits).
 Cont…
E. Inflation and Deflation:
 Inflation represents a rise in general price
level.
 During inflation prices of all goods and services become high.
As a result of this the purchasing power of money (or value
of Currency) decrease.
 inflation may occurred due to excess money supply or less
production (high demand over supply).
 Deflation refers to a decline in the general level of prices. a
declining economy can lead to deflation.
 Cont…
 Central bankers, who control a country's money supply, try
to avoid changes in price level by using monetary policy.
 Raising interest rates or reducing the supply of money in an
economy will reduce inflation.
 Inflation can lead to increased uncertainty and other
negative consequences. Deflation can lower economic
output. Central bankers try to stabilize prices to protect
economies from the negative consequences of price changes.
 Cont….
• The percentage change consumer price index (CPI) is the
most commonly used measure of inflation.
• Inflation is the average of increase in price of all goods and
services in the CPI market basket.
×100%
CPI- is computed by dividing the cost of the market basket in
year “t” by the cost of the same market basket in the base year.
 There are different types of inflations:
 Pure Inflation: it is a condition that occurs when the price of
all goods and services rise by the same percentage over the
year.
• In the case of pure inflation, there would be no change in
relative prices of the goods and services
 Cont…
Hyper Inflation: indicates increasing of the inflation rate at an
alarming rate (high rate).
Disinflation: shows a sharp reduction in the annual rate of
inflation. When disinflation occurs, the price level continues to
rise but the rate of increases is sharply reducing.
 Cont…
Effects of inflation:
 It decrease purchasing power of money
 It results redistribution of income and wealth from creditors
to debtors. Debtors can pay back loans in currency units that
have less purchasing power than what they borrowed.
 inflation can distort consumer choice by causing buyers to
purchase goods now that they might otherwise prefer to
purchase in the future
F. Trade Balance
 It is the net inflow of foreign exchange from trade (export
and import).
 Cont..
 It is the value of net export of a country. It is measured by
the difference between export from and import into a
country; i. e. total export value (X) minus total import value
(M).
 A positive value of this term shows surplus balance of trade
indicating good performance of that country.
 Cont…
G. Balance of Payment (BoP):
 It is the net inflow of resources to a given country/economy
from the rest of the world.
 In addition to the trade balance, the balance of payment
(BoP) includes the flow of resources from foreign investment,
borrowings from the rest of the world (short term, medium
term, and long term), and repayments of such borrowings.
 Cont…
H. Unemployment:
 The total population of an economy can be categorized in to
working age(15-64) and outside the working age population.
 The working age also divided in to currently active and
inactive.
 The working age category who are either employed or
actively seeking for job constitutes the labor force.
 A person is said to be unemployed if he/she is part of active
population and actively seeking job but unable to get it.
 Unemployment rate indicates the percentage of workers
with out a job in the labour force.
 Cont…
U×100%
Types of Unemployment
 Frictional unemployment: It occurs when people move
between jobs in the labour market, as well as when people
transition into and out of the labour force. It occur when
people who have left job that didn’t work out and are
searching for new employment
 Structural Unemployment: refers the unemployment due to
structural change (introduction of new technology or
invention) in the economy.
 Cyclical Unemployment: is the type of unemployment
resulting from declines in real GDP during the period of
contraction.
 Cont…
I. Business Cycle:
 It refers the fluctuation in aggregate production as
measured by the ups and downs of real GDP.
 It is more or less regular pattern expansion (recovery) and
contraction (recession) in economic activity around the path
of the trend growth.
 There are four parts of business cycle.
 Recovery (Expansion)
 Recession (Contraction)
 Depression
 Boom (Peak)
 Cont….

Peak recession

expansion depression

Fig 1: Business cycle

 Methods of analysis in Economics

• Macroeconomics analyzed by Aggregate demand and aggregate

supply.

• Aggregate demand: is the total demand for goods and services

in the economy.

• Aggregate supply: is the total output that the producers in an

economy are willing and able to produce and sell in a given

period of time
 Macro economics Goals and Instruments

• Goals Macroeconomics

• The following are the basic macroeconomic goals a

country:
Higher rate of economic growth
Stability of the economy- stabilize the general price
level/reduce level of inflation and exchange rate.
Achieving a favorable (positive ) balance of payment
Reducing budget deficit
 Cont….

Reduce unemployment/achieving full

employment level
Equity in income and wealth distribution
among people
Efficiency in resource allocation
 Macroeconomic instruments

• To achieve the above objectives economic policy makers use

mix of macroeconomics instruments. The most important

instruments among others include monetary policy, fiscal

policy, income policy, and labor policy, trade policy.

Fiscal policy: is a policy by which a government adjusts its level

of
 Cont…

spending and revenue to monitor and influence a nation’s

economy.

• Depending on the prevailing economic condition the

government may apply either expansionary fiscal policy or

tight (contractionary) fiscal policy.

 Cont…

Monetary policy: is regulation of money supply and

the control of the cost (interest) and availability of

credit by the central bank of the country.

Income policy: is a policy of government used to

control wage/salary.
 Cont..
Labor policy indicates policies concerned with relation ship
between employers and employees and those concerned with the
employment , training and distribution of workers in the labor
market.
Trade policy: refers the agreements and regulation surrounding
imports and exports between different countries.
 The evolution of macroeconomics Schools of Thoughts

• Economic thinking has begun since the cradle/birth of man

kind/human being. This is because archeological

excavations evidenced that our ancestors (ancient man kind)

were having some economic thinking such as saving due to

scarcity of resources and division of labor.

 Cont…

 However, Macroeconomics as a branch of economics was emerged around

246 years back with the writing of Adam Smith “The wealth of Nation” in
1776.

A. The classical school of thought (1776 – 1870)

The dominant idea of this school of thought was the invisible hand

or lassies fair, which means leave the market free (free market)

advocated by Adam Smith. The reason for their argument was that

because supply will create its own demand (say’s law).

 Cont….
 According to this school of thought government intervention
is not necessary/the disequilibrium can be corrected by
market.
B. The neo-classical school of thought(1870-1936)
 The idea of this school of thought was not different from the
classical. The only different contribution that can be
mentioned of this school of thought was the idea “absolute
and comparative advantage” of nations in international
trade.
 Cont….
C. The Keynesian macroeconomics (1936-1975)

• Keynes believes that markets are not always self-regulating.

The main idea of the Keynesian school is that economy is

subjected to failure as markets are not efficient and economy

may not achieve full employment level. The Keynesian thinkers

believed that government intervention is inevitable (neccessay).

• He criticize the classical economist during the great

depression (1929-1935) on their idea of “supply creates its

own demand”
• The great depression was caused by excessive or
overproduction of wheat and coffee with less level of demand
, ultimately results price become low. This negatively affect
producers who seek less revenue.
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