Narsee Monjee Institute of Management Studies

University

Macroeconomics
Introduction

Dipankar De
Mumbai, October 2007
 Economic Fundamentals
- An Integrated Perspective
 Framework

Policy/
Macro economic
Regulatory
scenario ECONOMIC scenario
ENVIRONMENT

Operating Activities
FIRM’S BUSINESS Investment Activities
ACTIVITIES Financing Activities

OWN BUSINESS
STRATEGY
Corporate Business
Strategy Strategy
 Framework
Policy/
Macro economic International
Regulatory
scenario ECONOMIC & Domestic
scenario
ENVIRONMENT
National Income Domestic macro
Accounts policy
•Real Sector • Fiscal Policy
•Monetary Sector • Monetary Policy
•Financial Sector FIRM’S BUSINESS Industrial policy
ACTIVITIES
Macro Aggregates
• Inflation Trade policy
• Interest rate
• Exchange rate

OWN BUSINESS
STRATEGY
Corporate Business
Strategy Strategy

Vertical integration
Diversification
Cost leadership
Mergers & Acquisitions
Product differentiation
International strategies
Tacit collusion
 What is Macroeconomics?
 Macroeconomics is the study of aggregates

 Macroeconomics is concerned with the behaviour of the

economy as a whole – with booms & recessions,
economy’s total output of goods & services, the growth of
output, the rate of inflation & unemployment, the balance
of payments, & exchange rates

 Macroeconomics deals with the long-run economic growth

and with the short-run fluctuations that constitute the
business cycles
Macroeconomics is a policy-oriented part of economics. The subject
matter of Macroeconomics includes factors that determine both the
level of these variables and how the variables change over time.
 Focus of Macroeconomics
 Macroeconomics focuses on the economic behaviour &
policies that affect

– Consumption & investment

– Trade balance (exports – imports)
– Currency & exchange rates
– Determinants of changes in wages & prices
– Money, interest rates & Monetary policy
– Taxation, union budget, Govt. deficit, govt. debt &
Fiscal policy, etc.
 Central Issues in Macroeconomics?
 Three central issues addressed by Macroeconomics are:

1. How do we explain periods of high & persistent

unemployment ?

1. How do we explain periods of inflation ?

1. What determines economic growth ?

Another important issue: Should the govt. fix exchange

rates or should exchange rates be market determined ?

Non exhaustive list of macroeconomic research agenda…

 Policymakers & health-checkup…
 Macroeconomic policymakers focus on improving the
health of the economy

 Crucial is the ‘thermometer’ readings of their key goals –

– High & sustainable rates of economic growth
– Low inflation
– Low unemployment

 Common economic yardsticks to measure these goals

are:
– Gross Domestic Product (GDP)
– Consumer Price Index (CPI) or Wholesale Price Index
(WPI)
– Unemployment rate
 Economic Database…
 Important & relevant websites
Get
– www.rbi.org.in & various publications
acquain
– www.mospi.nic.in ted
with
– www.eaindustry.nic.in the
– Ministry of Finance, Ministry of Commerce website
s&
 CMIE Monthly, Economic Survey their
various
 Official website of the World Bank & IMF publicat
– www.worldbank.org ions
– www.imf.org
 The Economist, London
– www.economist.com
 Pacific Exchange Rate
Macroeconomic Fluctuations
 Introduction to Business Cycles

 Business cycle is the more or less regular pattern of

expansion (recovery) and contraction (recession) in
economic activity around the path of trend growth

 Trend line provides an estimate of the path of potential

output, which is the productive capacity of the economy.

 The potential output is the output that the economy could

produce at full-employment given the existing
resources. It is determined by fixed capital & technology

 At cyclical peak, economic activity is high relative to the

trend. At cyclical trough, economic activity reaches the
low point
 Business Cycles

 During a recession, output declines significantly and

during an expansion, real GDP grows & along with it
employment of factors of production/ resources in the
economy
 Thus, output is not always at its trend level, rather
Business Cycles – 4 Phases

1 = Peak 2 = Recession
3 = Trough 4= Recovery
 Business Cycles – 4 Phases
 Phase I: Prosperity suggests an increase in the level of
economic activity above the normal level till it reaches a ‘peak’
 Phase II: Recession suggests a slow but steady decline in
economic activity towards the normal level
 Phase III: Depression suggests a further rapid decline in
economic activity below the normal level till it reaches a
‘bottom’
 Phase IV: Revival means a slow recovery in economic activity
& business conditions towards the normal level

Phases IV & I together constitute the upswing of a business cycle,

where as Phases II & III together constitute the downswing of a
business cycle
 Business Cycles
 The percentage deviation of actual GDP (or output) and the
potential output is called output gap. It allows to measure the
size of the cyclical deviations of output from potential output.

Output gap Ξ Actual output – Potential output

 These fluctuations in economic activity are called Business

cycles
 A negative output gap implies under employment of resources and
a positive output gap means there is over-employment, overtime
for workers more than usual rate of utilization of machinery
 Business cycles differ in both its length and severity
In popular usage, the economy is usually considered to be in a
recession if real GDP declines for two consecutive quarters
 Business Implication of Business Cycles

 Business implication of an overall economic slowdown is harmful

for any economy
 Production and sales decline, impacting profits of the
companies; in extreme scenario may lead to bankruptcy
 Business cycles follow irregular patterns & predicting when an
expansion will end & recession will begin is often difficult
 Business cycle exhibits simultaneous upswings in output,
employment, sales, and income, followed by similarly general
downswings. It is the co-movement of the variables that
generates the cycle