1. OVERVIEW OF MACROECONOMICS

2.  Essentially the study of the behaviour and performance
of the economy as a whole
 Deals with the functioning of the economy as a whole,
including how the economy’s total output of goods and
services, the price level of goods and services and the
total employment of resources are determined and
what causes these magnitudes to fluctuate.
 Studies the relationship and interaction between the
factors and forces that determine the level and growth
of output and employment, general price level and
balance of payment position of an economy.
MACROECONOMICS

3. Macroeconomics has both theoretical and policy orientations
Theoretical Orientation
Macroeconomic theories use macroeconomic models to
explain the bahaviour of macroeconomic variables and
specify the nature of relationship between them
Policy Orientation
Macroeconomics as a policy science provides a
framework and instruments, i.e., fiscal and monetary policy
etc. for restructuring the economy and guiding it on the path
of growth and stability
MACROECONOMICS

4.  Observe of Macroeconomics
 Study of the economic actions of individuals and small
groups of individuals
 The study of particular firms, particular households,
individual prices, wages, incomes, individual industry,
particular commodities.
 In its approach, microeconomics proceeds to examine
how output and employment are allocated among individual
industries and firms with industries and how the prices
of various products of these individual firms are
established assuming the total output, total employment and
spending for all goods and services as given.
MICROECONOMICS

5. MACROECONOMICS &
MICROECONOMICS
Item Given Variable
Total
output
Micro Total output of the economy as a
whole
Distribution of output, employment
and total spending among
particular goods and services of
individual firms and industries
Macro Distribution of output, employment
and total spending among particular
goods and services of individual
firms and industries
Total output of the economy as a
whole
General
price
level
Micro General Price level Relative price or exchange ratios
among individual goods and
services
Macro Relative price or exchange ratios
among individual goods and services
Determination of general price level

6. Macroeconomics and Microeconomics are not separable
 Analysis of the economy is not conducted separately in two water
tight compartments
 Macroeconomic theory has a foundation in Microeconomic theory
and Microeconomic theory has a foundation in Macroeconomic
theory
 Macroeconomics – Nation’s material well-being will be greater,
the closer the economy comes to full-utilisation of its total
resources, given the allocation of resources
 Microeconomics – Material well-being will be greater, the closer
the economy comes to optimal allocation of resources, given the
degree of utilisation of total resources, partial to full
 Common basic goal – Maximum well-being for the population as a
whole which can only be attained with both full utilisation and
optimum allocation of all available resources
MACROECONOMICS &
MICROECONOMICS

7. Classical Macroeconomics - Before 1930
 Had not developed any coherent macroeconomic theory or model
 Macroeconomic thoughts were in the form of certain postulates
 If market forces of demand and supply are allowed to
have free play then
(i) There will always be full employment in the long-run
(ii) There will neither over-production nor under-
production
(iii) The economy will always be in equilibrium in the
long-run
 Government spending crowds our private investment
 But the great depression of 1930’s exposed the inadequacy of the
theoretical foundations of the laissez-faire doctrine
GROWTH OF MACROECONOMICS

8. Keynesian Macroeconomics - 1930 –1960
 Revolutionary Book – “ General theory of Employment, Interest
and Money” – 1936
 Keynesian macroeconomic theories are associated mainly with
employment, growth and stability.
 Level of output and employment in an economy is determined by
the aggregate demand.
 Unemployment is caused by lack of aggregate demand.
 Economic fluctuations are caused by demand fluctuations.
 The demand deficiency can be removed through compensatory
government spending.
 Started showing signs of its failure during 1970’s - Stagflation
GROWTH OF MACROECONOMICS

9. Post Keynesian Macroeconomics - include growth of
 Monetarism – Milton Friedman – A Monetary History of the
United States
 Role of money is central to growth and stability of national output
 Shift in the emphasis from aggregate demand for real output to money
demand and supply and its policy orientation from demand
management to monetary management
 Difference between the monetarists and Keynesians in
 Relationship between money supply and inflation
Inflation is caused by rapid expansion of money supply in
the economy and in order to control in inflation there should be
constant growth of money supply
 Role of Government
A free market economy is inherently stable
Govt. or its Central bank should not adopt active
discretionary monetary policy, rather it should pursue a policy of
stable rate of growth of money supply
GROWTH OF MACROECONOMICS

10.  Supply side Economics – Arthur Laffer
 Change in aggregate demand will either increase inflation or
unemployment rate
 Emphasised the role of the factors operating in the supply side of the
market
 Contraction in supply, given the aggregate demand curve, results in rise in
price level and inflation on one hand and fall in aggregate output and rise in
unemployment on the other
 In crease in aggregate supply, given aggregate demand, will lead to
increase in employment and reduction in inflation
 More work or labour, and higher investment will lead to increase in
aggregate supply
 Reduction in income tax
 Encourages more saving, work and investment
 In crease in Govt. revenue to reduce budget deficit
GROWTH OF MACROECONOMICS

11.  Neo-Classical Macroeconomics – Robert E. Lucus
 Consumers, workers and producers behave rationally to promote their interest and
welfare
 Emphasises the role of individual’s rational expectations about future economic
events, especially those on the supply side of the economy, and about the future
government policies
 People’s expectations about government’s monetary and fiscal policies
determine the behaviour of aggregate supply and aggregate demand
 When Govt. makes a deficit budget, people expect that rates of interest will rise
 They will attempt to take new loans when rates of interest are lower and
therefore, the interest rates rise immediately rather than in future
 If Central bank of a country increases money supply, consumers, workers and
producers will expect rationally a rise in price level
 On the basis of rational expectations, workers get their wages raised, producers
raise their profits, lenders and bankers raise interest etc.
 As a result, the effect of expansion in money supply on these persons get cancelled
 There is no need for the Govt. to intervene in the economy through macroeconomic
policies
GROWTH OF MACROECONOMICS

12. To find a reasonable answer and a feasible solution to the following
Macroeconomic problems
 What determines the levels of economic activity and employment
in a country?
 How is the equilibrium level of national income determined?
 What causes fluctuations in the national output and employment?
 What determines the general level of prices in a country?
 What causes inflation and unemployment?
 What determines the levels of foreign trade and trade balance?
 What causes trade deficits and disequilibrium in the balance of
payments of a country?
 How do the monetary and fiscal policies of the government affect
the economy?
IMPORTANCE OF
MACROECONOMICS

13.  Macroeconomic Paradoxes – (Boulding) Results obtained from
the study of the behaviour of individual firms or industries may lead us to
misleading conclusions about the working of the macroeconomy.
 Paradox of Thrift -
Saving is a virtue for an individual but not for the economy as whole.
Efforts to save more, reduces consumption demand and thus national
output and income and also increases unemployment
 Wage – Employment Paradox –
Cut in money wages in an individual industry will lead to more
employment in that industry.
But for the society or economy, reduction in money wages will create
more unemployment.
Fall in money wages  Decline in aggregate demand  Decline in
employment since demand for labour is a derived demand
IMPORTANCE OF
MACROECONOMICS

14.  Understanding the Working of the Economy –
Macroeconomics explains the causes of important problems of the
economy such as unemployment, inflation, instability in foreign
exchange rate.
 Prescribing Policy Measures –
Working of the macroeconomic concepts is a bare necessity in
bringing solutions to important problems like overpopulation,
inflation, balance pf payments, underproduction etc.
 Accelerating Economic Growth –
Economic growth helps in solving the problems of poverty and
unemployment.
Economic growth can be obtained through increase in the rate of
saving and investment and improvement in technology (Harrod-
Domar and Solow growth model)
IMPORTANCE OF
MACROECONOMICS

15.  Understanding Business Cycles -
No unanimity in macroeconomic theory about the proper
explanation of business cycle.
However, fluctuations in aggregate demand due to volatile nature
of investment demand together with the interaction of multiplier
and accelerator provides an adequate explanation for business
cycle (Keynes).
 Individual Decision Making –
Fall in the demand for an individual product can only be
understood, if the causes of deficiency of aggregate demand are
analysed.
Knowledge about macroeconomics helps an individual to assess
the impact of Government’s economic policy.
IMPORTANCE OF
MACROECONOMICS

16. SOME CONCEPTS USED IN MACROECONOMIC ANALYSIS
 Stock
 Refer to the quantity of a variable at a point of time
 Example
 Water stored in a lake
 Fixed deposit in a bank
 Number of persons employed
 Assets like plant, building, machinery etc.
 Supply of Money
 Accumulated Savings
Flow
 Expressed per unit of time
 Example
 Water flowing in or out per unit of time (per day / per week)
 Interest earned on the fixed deposit
 Annual return from fixed assets such as plant, building, machinery etc.
 Gross National Product
 Consumption Expenditure
 Change in Inventories
STOCK AND FLOW VARIABLES

17. PARTIAL AND GENERAL EQUILIBRIUM
 Equilibrium
 Position of rest characterized by absence of change
 Position in which forces working in opposite directions are in balance
and there is no in- built tendency to deviate from this position
Partial
 Analysis of a part of an economy, isolated and insulated through
assumptions from the influence of the changes in rest of the economy
 Based on assumption of ceteris paribus
 Concerned with two types of economic problems
Pertaining to only particular aspects economic behavior of a certain
individual , firm or industry
Studies only the first-order consequences of the economic events it
analyses

18. PARTIAL AND GENERAL EQUILIBRIUM
 General
 Theory of interrelationship among all parts of the economy.
 Only if all consumers, all firms, all industries and all factor services
are in equilibrium simultaneously and they are interlinked through
commodity and factor prices
 Exists when
• All prices are in equilibrium
• Each consumer gets maximum satisfaction
• All firms in the industry are in equilibrium at all prices and outputs
• Supply and demand for productive resources are equal at equilibrium
prices
 Partial equilibrium analysis is encompassed in the general equilibrium
analysis

19. STATIC AND DYNAMIC ANALYSIS
 Static
 Macro-economic phenomenon studied under static conditions.
 Static macro-model assumes no change in the size of the economy, national
output, prices and employment
 Basic forces of change like, stock of capital, technology, population, nature of
business organisation, tastes and preferences of the people remain constant
 Variables used in this analysis have no time frame - All variables belong to
the same time frame
 Abstraction from reality
Dynamic
 Macro-economic phenomenon studied under changing or dynamic conditions
 Studies the factors and forces that set an economy in motion and lead or do not
lead it to a new equilibrium
 Takes into account the time lag involved in the process of adjustment
 Studies the nature and magnitude of changes and finds whether they are
oscillatory (convergent or divergent) or dampening.

20. ALTERNATIVE ECONOMIC SYSTEMS
Economic System refers to the mode of production and the distribution of
goods and services within which economic activity takes place.
Broader sense – The way different economic elements., i.e., individuals,
firms and government agencies are linked together to form an organic whole
Market Economy
Private Property
Profit Motive
Price Mechanism – No control by central authority
Consumers sovereignty
Freedom of enterprise
Competition
Limited role of State

21. ALTERNATIVE ECONOMIC SYSTEMS
Command Economy
Public ownership
Central planning-
Definite objectives and price - Authoritarian methods to
determine resource use and price
Mixed Economy
Price mechanism and economic planning working side by side
Public sector
Private sector
Joint sector
Freedom and control

22. THREE PROBLEMS OF ECONOMIC
ORGANISATION
WHAT, HOW and FOR WHOM to produce
What goods and services are to produce and in what quantity
How to produce these goods and services
How these goods and services so produced are distributed
among the households

23. MARKETS SOLVING THE THREE ECONOMIC PROBLEMS
What goods and services are to produce and in what quantity
 Solved through price mechanism that works through supply and
demand for goods and services
 Problem of nature of commodities and their quantities is decided by
the preferences of the consumers
 Price of a commodity reflects the tastes & preference of the consumer
High price – Urgency of desire for certain commodity & vice-versa
 Price acts simultaneously as a beacon light and a warning signal for
the producer or the consumer as the case may be.
 Consumer sets the price and producers manufacture those
commodities which he wants more

24. MARKETS SOLVING THE THREE ECONOMIC PROBLEMS
How to produce these goods and services
 Price also determines the techniques to be used for production
 Every producer aims at using the most efficient production process or
producing goods at minimum cost
 Choice of production process depends on relative prices of the factor
services and quantity of goods to be produced
 Producer uses expensive factor services in less quantities relative to
cheap resources
 Capital expensive to labour – Labour intensive technique
 Capital relatively cheaper – Capital intensive technique
 Production of capital goods in larger outputs – complicated &
expensive machines and techniques

25. MARKETS SOLVING THE THREE ECONOMIC PROBLEMS
For whom to produce these goods and services
Three main activity of the economy- Production, Consumption, & Exchange
 Production leads to consumption
 Consumption necessitates production
 These two flows interrelated
and interdependent through exchange
 Households
 Firms
 Real Flow
 Financial Flows

26. Economic Role of Government
 Capitalist Economy – Limited role
Maintenance of law & order, Protection from external aggression
 Socialist Economy – Owns and regulates the entire consumption and
production process
 Mixed Economy – Strengthens market system
 Household & Government
Household sector outflows - Taxes
Household sector inflows - Transfer Payments in shape of old age
pension, unemployment relief etc & purchase
of services of household
Firms and Government
Firm sector outflows - Corporate and other taxes
Firm sector inflows – Subsidies and transfer payments to firms and
purchase of goods

27. Economic Role of Government

28. The circular flow of income
Two Sector Model

29. FIRMS
(suppliers of goods and services,
demanders of factor services)
HOUSEHOLDS
(demanders of goods and services,
suppliers of factor services)
The interdependence of goods and
factor markets

30. Q1
P1
QF2
PF2
Q2
P2
PF1
QF1
D2
D2
The interdependence of goods
and factor markets
P
Q
P
Q
Rs.Rs. RsRs..
RsRs..RsRs..
Factor
services
Goods
Goods
Factor
services
S S
D1 D1
(1)
Consumer
demand
(4)
Factor
supply
(3)
Factor
demand
(2)
Producer
supply
OO