Introduction to Macro Economics

An Overview of Macroeconomics

1. What is Macroeconomics

2. Macroeconomic Goals

3. Key Principles of Economics

4. Economic Theory in Practice

 1. What Is Macroeconomics?

• Microeconomics - study of behavior of

individual economic agents.

• Macroeconomics - study of aggregate

measures of the economy
 2. Macroeconomic Goals

• Low Unemployment
• Price Stability
• Economic Growth
 2. Macroeconomic Goals
Complementary and Conflicting Goals

• Complementary Goals
– Low unemployment and high economic
growth

• Conflicting Goals
– Low unemployment and low inflation
 Recent Macroeconomic History
• Fine-tuning was the phrase used by Walter
Heller to refer to the government’s role in
regulating inflation and unemployment.
• The use of Keynesian policy to fine-tune the
economy in the 1960s, led to disillusionment
in the 1970s and early 1980s.

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 Aggregate?
• The amount or total formed from separate units.
Aggregate refers to a total, everything added up.

• Aggregate = Total

• The economy can be viewed as a series of

aggregates, flowing together to make a working
whole
 Gross Domestic Product
• the total market value of all final goods and
services produced in a given year in the
domestic territory of India.
• A Monetary Measure
 Gross Domestic Product
• the total market value of all final goods and
services produced in a given year in a country
• A Monetary Measure
• Avoiding Multiple Counting

illustrated…
 Value Added in a Five-Stage Production
Process
Table 5-2

Production Stage Sales Value Value Added

Sheep Ranch $120 $120
Wool Processor $180 $ 60
Suit Manufacturer $220 $ 40
Wholesaler $270 $ 50
Retailer $350 $ 80
Total $1140 $350
 Value Added in a Five-Stage Production
Process
Table 5-2

Production Stage Sales Value Value Added

Sheep Ranch $120 $120
Wool Processor $180good
intermediate $ 60
intermediate good
Suit Manufacturer $220 $ 40
Wholesaler $270 $ 50
Retailer $350 $ 80
Total $1140 $350
 Value Added in a Five-Stage Production
Process

Production Stage Sales Value Value Added

Sheep Ranch $120 $120
Wool Processor $180 $ 60
Suit Manufacturer
final
final good
good $220 $ 40
Wholesaler $270 $ 50
Retailer $350 $ 80
Total $1140 $350
 3 Approaches for measuring GDP
1. Expenditure Approach (upper loop) – measures
GDP as the sum of expenditures on final goods and
services.
2. Income Approach (lower loop) – measures GDP as
the sum of incomes of factors of production
(wages, rent, interest and profit.
3. Value-added Approach – measures GDP as the sum
of value added at each stage of production (from
initial to final stage)
 Expenditure Approach
• Uses the upper loop of the circular flow diagram.
• Example: Suppose the economy has only one product,
namely, rice.

Good Price per Q sold Expenditure

unit
Rice 20 1000 20,000
GDP 20,000
 Income Approach
• Uses the lower loop of the circular flow diagram: sum of payments to the
various factors of production.
• Suppose that in the production of rice the sales and expenses are as
follows:

Sales 20,000
Expenses:
Wages 8000
Rent 4000
Interest 2000
Total 14,000
Profit 6,000
GDP=Sum of Payments to 20,000 20,000
factors
 Value Added Approach

• Suppose that rice is the only final product of an economy: It

goes through several (3) stages of production.

Value of
Stage of Prod’n intermediate Value of Value-added
good Sales
Farmer - Palay 12,000 12,000
Rice Miller -Milled 12,000 15,000 3,000
Rice
Retailers - Rice 15,000 20,000 5,000
GDP= Total Value 20,000
Added
Any error in Following Chart
 The Circular Flow Model
• Shows the economic transactions that occur
between households, firms and other sectors
in the economy.

• Money flows- We will only focus money flows

as it is simpler than trying to account for the
physical flows.
 payments for goods and services

goods and services

FIRMS HOUSEHOLDS

factor services

factor payments
(wages, interest, rent, profit)

Circular flow diagram. The diagram above represents the transactions between firms and
households in a simple economy.
In the upper loop, the arrow emanating from firms to households represents the sale by firms of
goods and services to households. On the other hand, the arrow from households to firms
represents the payments.
In the lower loop, the arrow originating from the households to the firms shows that firms hire
labor and capital from households in order to produce goods and services. The arrow emanating
from the firms indicates their payments for the use of the factors of production.
 Five-sector Circular Flow of Income
Income

Household sector Firms

sector
Expenditure
I
L
N
E
Financial J
A
Savings sector Investment E
K
C
A
T
G Government
I
E sector Government
Taxation O
S expenditure N
External S
Imports Exports
sector
Real A Typical Trade Cycle
GDP

Peak

Recession Recovery

Boom

Trough/Depression

Time
 Divide into two groups
downturn peak downswing

contraction trough upturn

expansion recession recovery

depression slump boom

 economic ______ vs. economic ______

• contraction • upturn
• depression / slump • boom
• trough • expansion
• recession • peak
• downturn /downswing • recovery

Match the opposites, pls!

 economic decline vs. economic growth
• depression / slump • boom
• recession • recovery
• downturn /downswing • upturn
• contraction • expansion
• trough • peak
 Recession
• economic activity slows down
• consumers spend less money
• businesses make fewer sales
• inventories build up
• companies earn less revenue
• fewer orders are placed
• businesses cut back on output
• unemployment rate goes up
• businesses reduce the number
of people on payrolls
• eventually it reaches a trough
v. Expansion
• economic activity picks up
again
• sales improve
• excess inventories are used
up
• new orders are placed
• production is ramped up
again
• job opportunities improve
• unemployment rate comes
down
• eventually it tops out
 Macro Paradoxes
• What is true of parts is not true of the whole.

1. Paradox of Thrif
2. Wage-Employment Paradox
3. Fallacy of Composition

Footnote : H. L. Ahuja ( p.g. 13-14)

 Personal Income
Personal Income =
National Income – Social Security Contribution
– Corporate Income Taxes – Undistributed
Corporate Profits + Transfer Payment
 Disposable Income
Disposable Income = Personal Income –
Personal Taxes

Disposable Income = Consumption + Saving

Thank You