January 2020, MEPA

Course

Introduction to
Macroeconomics

Ananda Vadivelu
 Economics
 “Economics is the science which studies human
behavior as a relationship between given ends
and scarce means which have alternative uses.”

(Lionel Robbins, An Essay on the Nature and

Significance of Economic Science)
 Micro and Macro
 Microeconomics examines the behavior of
individual decision-making units—business
firms and households.

 Macroeconomics deals with the economy as a

whole; it examines the behavior of economic
aggregates such as aggregate income,
consumption, investment, and the overall level
of prices.
 Macroeconoimcs
 Macroeconomics is concerned with the
behaviour of the economy as a whole with
booms and recessions, the economy’s total
output of goods and services and the rates of
inflation and unemployment, the balance of
payments and exchange rates.
 Economic Booms

 A boom is a period of rapid economic expansion resulting

in higher GDP, lower unemployment, a higher inflation
rate.

 Booms usually suggest the economy is overheating

creating a positive output gap and inflationary pressures.

 A positive output gap commonly spurs inflation in an

economy because both labor costs and the prices of goods
increase in response to the increased demand.
 GDP
 GDP = private consumption + gross investment +
government investment + government spending +
(exports – imports).

 The nominal GDP is the value of all the final

goods and services that an economy
produced during a given year. It is calculated
by using the prices that are current in the
year in which the output is produced.

 The real GDP is the total value of all of the final goods
and services that an economy produces during a given
year, accounting for inflation.
Economic Booms
 Recession
 A period of temporary economic
decline during which trade and
industrial activity are reduced,
generally identified by a fall in GDP
in two successive quarters.
 Balance of
Payments
 The balance of payments (BOP), also known as balance
of international payments, summarizes all transactions
that a country's individuals, companies and government
bodies complete with individuals, companies and
government bodies outside the country.

 These transactions consist of imports and exports of

goods, services and capital, as well as transfer payments,
such as foreign aid and remittances.
 The Roots of Macroeconomics

 Classical economists applied microeconomic

models, or “market clearing” models, to
economy-wide problems.

 The market clearing model is a model where

prices adjust to equilibrating demand and supply
meaning the quantity supplied equals the
quantity demanded.
 The Roots of Macroeconomics

 The failure of simple classical models to explain

the prolonged existence of high unemployment
during the Great Depression provided the
impetus for the development of
macroeconomics.
 The Economy on a Roller Coaster
The Great Depression, 1929-1933

 Decline in economic activity

 Rapid deflation
 Production – declined 30%
 Unemployment rate
o Increased from 3% to 25%

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 Keynes

 In 1936, John Maynard Keynes published The

General Theory of Employment, Interest, and
Money.

 Keynes believed governments could intervene in

the economy and affect the level of output and
employment.
 The Economy on a Roller Coaster
 From WWII to 1973

 WWII: increased government spending

o Increased aggregate demand
o Price controls
o Shortage: consumer goods

 1960s – strong growth

 Vietnam war – increased spending

o Inflation (5-6%) & high unemployment
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 The Economy on a Roller Coaster

 The Great Stagflation,

Stagflation 1973-1980

 OPEC – 1973 oil prices quadrupled

(1st Oil Shock)

 Poor harvests in 1973 rose food prices

 Stagflation
o Inflation rate: 12%
o High unemployment (9% in 1st quarter 1975)

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 An explanation of stagflation

Keynesian economists blame supply shocks for causing

stagflation. They cite surging energy costs or surging food
costs, for example, as the cause of economic woes.

http://www.investopedia.com/articles/economics/08/stagflation
.asp
Components of the
Macroeconomy
The Three Market
Arenas
 Households, firms, the government, and
the rest of the world all interact in the
goods-and-services, labor, and money
markets.
 Market Arenas
 Households and the government purchase goods
and services (demand) from firms in the goods-
and services market, and firms supply to the
goods and services market.

 In the labor market, firms and government

purchase (demand) labor from households
(supply).

 The total supply of labor in the economy

depends on the sum of decisions made by
households.
Three Market Arenas
 In the money market—sometimes called the financial
market—households purchase stocks and bonds from
firms.

 A bond is a fixed income instrument that represents a loan

made by an investor to a borrower (typically corporate or
governmental).

 A bond could be thought of as an I.O.U. between the

lender and borrower that includes the details of the loan
and its payments. Bonds are used by companies,
municipalities, states, and sovereign governments to
finance projects and operations. Owners of bonds are
debtholders, or creditors, of the issuer.
 Three Market Arenas
 Households supply funds to this market in the
expectation of earning income, and also demand
(borrow) funds from this market.

 Firms, government, and the rest of the world

also engage in borrowing and lending,
coordinated by financial institutions.
Macroeconomic
Concerns
 Three of the major concerns of
macroeconomics are:

 Inflation
 Output growth
 Unemployment
 Inflation
 Inflation is an increase in the overall price level.

 Hyperinflation is a period of very rapid

increases in the overall price level.
Hyperinflations are rare, but have been used to
study the costs and consequences of even
moderate inflation.
 Inflation in
India
 At wholesale level: The index used to
calculated wholesale inflation is known as
Wholesale Price Index (WPI). This inflation rate
is often known as headline inflation. WPI is
released by the Ministry of Commerce and
Industry.

 Consumer level: The CPI measures price change from

the perspective of the retail buyer. It is the real index for
the common people. It reflects the actual inflation that is
borne by the individual.  CPI is designed to measure
changes over time in the level of retail prices of selected
goods and services on which consumers of a defined
group spend their incomes.
 Inflation in India
 Consumer prices in India rose 5.61 percent year-
on-year in December of 2015, accelerating for
the fifth straight month and reaching the highest
since September 2014, in line with market
expectations. Food inflation was 6.4 percent, up
from 6.07 percent in November.

Source:
http://www.tradingeconomics.com/india/inflation-cpi
 Inflation in India
 In India, the index which shows the inflation rate at retail
level is known as Consumer Price Index (CPI). CPI is
based on 260 commodities, but includes certain services
too.

 There are four Consumer Price Indices covering different

socio-economic groups in the economy.

 These four indices were Consumer Price Index for

Industrial Workers (CPI-IW); Consumer Price Index for
Agricultural Labourers (CPI-AL); Consumer Price Index
for Rural Labourers (CPI -RL) and Consumer Price Index
for Urban Non-Manual Employees (CPI-UNME).
Rising Dal Prices!?
 Inflation trends in
India
 Output Growth
 The business cycle is the cycle of short-term ups
and downs in the economy.

 The main measure of how an economy is doing

is aggregate output:

 Aggregate output is the total quantity of

goods and services produced in an
economy in a given period.
 Output Growth
 A recession is a period during which
aggregate output declines. Two
consecutive quarters of decrease in
output signal a recession.

 A prolonged and deep recession

becomes a depression.

 The size of the growth rate of output

over a long period is also a concern of
macroeconomists and policy makers.
 Unemployment
 The unemployment rate is the percentage of the
labor force that is unemployed.

 The unemployment rate is a key indicator of the

economy’s health.

 The existence of unemployment seems to imply

that the aggregate labor market is not in
equilibrium.
 Unemployment
measurement in India

 The NSSO defines following three broad

Activity Status

 (i) Working (engaged in an economic activity)

i.e. ‘Employed’

 (ii) Seeking or available for work i.e.

‘Unemployed’

 (iii) Neither seeking nor available for work.

 Unemployment measurement
in India
 Unemployment rate = (Unemployed Workers /
Total labor force) X 100

 Work Participation Rate = (Total Workers

(Main+Marginal) / Total Population) X 100

 Main Workers are those workers who had worked

for the major part of the reference period i.e. 6
months or more.

 Marginal Workers are those workers who had not worked for
the major part of the reference period i.e. less than 6 months.
 Government in the
Macroeconomy
 There are three kinds of policy that the
government uses to influence the
macro economy:

1. Fiscal policy
2. Monetary policy
3. Growth or supply-side policies
Government in the
Macroeconomy
 Fiscal policy refers to government policies
concerning taxes and expenditures.

 Monetary policy consists of tools used by the

Reserve Bank of India to control the money
supply.

 Growth policies are government policies that

focus on stimulating aggregate supply instead of
aggregate demand.
Demand and Supply in
Macroeconomics
 Aggregate demand (AD)
AD curve

 Quantity of domestic product –

demanded
 Each possible value of price level

 Aggregate supply (AS)

AS curve
 Quantity of domestic product –
supplied
 Each possible value of price level
Figure 1
interpretations of a shift in the demand curve

D1
S S
D D0

Price
Price

A
P1
E E
P0 P0

S S
D1
D D0
0 Q0 0

Quantity Quantity

(a) (b) 37
Figure 2
An economy slipping into a recession
D0 S

D2
E
P0
Price Level

B
P2

S D0
D2
0 Q2 Q0

Domestic Product
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Questions, comments, doubts??

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