Economic Environment and Policy

(Macro Economics)
 Macro economics is part of our everyday
lives.
 If the macro economy is doing well, it is easy
for new entrants into the labour force,
 such as students who have just graduated, to
find jobs.
.
 ON the other hand,

 if the macro economy is in a slump, new jobs are

hard to find,

 incomes are not growing well, and profits are low.

.
 Until the Great Depression of the 1930s, the scope
of economics was essential limited to Micro
economics.
 Macro came into existence in 1936, the year John
Maynard Keyes published his revolutionary book,
the General Theory of Employment, Interest and
Money.
 This book laid the foundation of Macro economics.
.
 Macro Economics is divided under three sub-
sections:
 1. Classical Macroeconomics – market forces of
demand and supply are allowed to work freely.
 Full employment in the long run and unemployment if any will be in
short run,
 neither over production or under production,
 economy will always be in equilibrium
 Great Depression of 1930s proved all the classical postulates are
wrong.
.
 2.Keynesian Revolution and Macro
economics – associated mainly with --------
 “employment, growth and stability”
 1. level of output and employment determined by aggregate demand.

 2. Unemployment in any country is caused by lack of aggregate

demand and economic fluctuations caused by demand deficiency.

 3. demand deficiency is removed through compensatory government

spending.
.
 3.Post-Keynesian developments:
 Keynesian economics started showing signs of its failures in the
early 1970s.
 Especially Keynesian fiscal measures failed to provide
solution to economic problems of -------- low growth, high
unemployment with high rate of inflation faced by most
developed countries, especially by US.
 This led to growth of new school of macroeconomic
thought called “monetarists”.
.
 Monetarism (Counter –Revolution): The monetarists
came out with a new revolutionary thought -------

 Role of money not the role of aggregate demand for real output
as Keynesians believe.

 “Money supply is the main determinant of output and

employment in the short run and price level in the long
run.”
.
 Macro-economy can have impact on our
lives, it is important to understand how it
works.

 NOW we begin by discussing the differences

between microeconomics and
macroeconomics.
Micro Economics
 Microeconomics examines the functioning of
individual industries and the behavior of individual
decision-making units, typically business firms and
households.
 WITH a few assumptions about how these units
behave( firms maximize profits, households maximize
utility)--------------how markets work, how resources
are allocated, and so forth.
Macro Economics
 Macro economics, instead of focusing
on the factors that influence the
production of particular products and
the behavior of individual industries,
focuses on the determinants of total
national output.
.
 Macroeconomics studies not household
income but national income, not individual
prices but the overall price level.
 It does not analyze the demand for labour in
the automobile industry but instead total
employment in the economy.
.
 Micro economics deals with individual
decisions; macroeconomics deals with the
sum of these individual decisions.
 AGGREGATE is used in macroeconomics to
refer to sums.
 When we speak of aggregate behaviour, we
mean the behaviour of all households and
firms together.
.
 Macro economics deals with the economy
as a whole.

 Macro economics focuses on the determinants of

total national income,
 deals with aggregates such as --------aggregate
consumption and aggregate investment which refer
to -------total consumption and total investment in the
economy and looks at the overall level prices
instead of individual prices.
Macro economic Concerns
 Macroeconomic Concerns :
Three of the major concerns of
macroeconomics are -----------
 1.Inflation
 2.Output growth
 3.Unemployment
.
 Government policy makers would like to
have --------------------------
 low inflation,
 high output growth, and
 low unemployment.
.
 1.INFLATION:
 Inflation is an increase in the overall price
level. Keeping Inflation low has long been a
goal of government policy. Especially
problematic are hyperinflations.
 Hyperinflation :
 A period of very rapid increases in the overall price
level.
.
 Most Americans are unaware of what life is
like under very high inflation.
 In some countries at some times people were
accustomed to prices rising by the day, by
the hour or even by the minute.
.
 Hyperinflations are rare.
 Nonetheless, economists have devoted much
effort to identify the costs and
consequences of even moderate inflation.
.
 Inflation :
 Inflation refers to a persistent rise in prices.
 Simply put, it is a situation of too much money and
too few goods.

 Thus, due to scarcity of goods and the presence of

many buyers, the prices are pushed up.

 Inflation occurs when most prices are rising by some

degree across the whole economy.
.
 This is caused by four possible factors, each of which
is related to basic economic principles of changes in
supply and demand: 
 Increase in the money supply.
 Decrease in the value of money.
 Decrease in the aggregate supply of goods and
services.
 Increase in the aggregate demand for goods and
services.
.
 Look at what inflation is and how it works,
 we will ignore the effects of money supply on
inflation and concentrate specifically on the effects
of aggregate supply and demand: cost-push and
demand-pull inflation.     

 COST-PUSH INFLATION:
When there is a decrease in the aggregate supply of
goods and services stemming from an increase in
the cost of production, we have cost-push
inflation. 
.
 Cost-push inflation basically means that prices
have been “pushed up” by increases in costs of
production.
 Demand-Pull Inflation :

 Demand-pull inflation occurs when there is an

increase in aggregate demand, categorized by the
four sections of the macro economy:
 1.households, 2. businesses, 3.governments and
4.foreign buyers
.
 When these four sectors concurrently want to
purchase more output than the economy can
produce, they compete to purchase limited amounts
of goods and services.
 Buyers in essence “bid prices up”, again, causing
inflation.
 This excessive demand, also referred to as “too
much money chasing too few goods”, usually
occurs in an expanding economy.  
.
 Demand-pull inflation is a product of -------an
increase in aggregate demand that is faster than
the corresponding increase in aggregate supply.

 The converse of inflation, (i.e.) deflation, is the

persistent falling of prices.
 RBI can reduce the supply of money or increase
interest rates to reduce inflation.
.
 Bank interest rate depends on many other
factors, out of that the major one is
inflation.

 Whenever you see an increase on inflation,

there will be an increase of interest rate
also.
.
 Who gains from inflation? Who loses?
 What costs does inflation impose on society?
How severe they? What causes inflation?
 What is the best way to stop it?
 These are some of the main concerns of
macro-economists.
.
 2.OUTPUT GROWTH: (Short run and long run)
Instead of growing at an even(smooth) rate at all
times, economies tend to experience short-term ups
and downs in their performance.
 THE technical name for these ups and downs is the
business cycle.
 BUSINESS CYCLE -------- 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:
The total quantity of goods and services produced in
the economy in a given period.
 When less is produced (in other words, when
aggregate output decreases), there are fewer goods
and services to go around, and the average standard
of living declines.
.
 When firms cut back on production, they also lay
off workers, increasing the rate of unemployment.
 RECESSION:
 A period during which aggregate output declines.
It has become conventional to classify an economic
downturn as a “recession” when aggregate output
declines for two consecutive quarters.
 A prolonged and deep recession is called a
depression.
 SINCE the beginning of the twentieth century, the
United States has experienced one
depression(1930).
.
 3.UNEMPLOYMENT :
The unemployment rate ------ the percentage
of the labour force unemployed --- is a key
indicator of the economy’s health.
 The unemployment rate is usually closely
related to the economy’s aggregate
output.
Government in the Macro Economy

 Much of our discussion of macroeconomics

concerns the potential role of government
in influencing the economy.
 There are three kinds of policy that the
government has used to influence the macro
economy.
 1.Fiscal policy
 2.Monetary policy
 3.Growth or supply-side policies.
.
 1.FISCAL POLICY:
 “Decisions on taxes and government spending.”
 Government policies concerning taxes and
expenditures.
 The Government affects the economy through its
tax and expenditure decisions or fiscal policy.

 Fiscal policy can play an important role in

stimulating the rate of growth of an economy.
.
 Expansionary fiscal policies--------Here
the government should cut taxes and/or
raise spending----------to get the economy
out of slump.
 Contractionary fiscal policies---------Here
the government should raise taxes and/or
cut spending ----------to bring the economy
out of an inflation.
.
 2.MONETARY POLICY:
“Control of money supply.”
 The tools used by the Federal Reserve to control
the money supply.
 Taxes and spending are not the only variables the
government controls.
 Through the ------- Federal Reserve, the nation’s
central bank, the government can determine the
quantity of money in the economy.
.
 Monetary policy is one of the two principal
means (the other being fiscal policy) by which
government authorities in an economy
--------------------------regularly influence the
pace and direction of the overall economic
activity but also the general rate at which
prices rise or fall.
.
 HERE we discuss how the central bank
influences the money supply
--------------------------------------by using different
tools and how this mechanism works in ----------
 controlling the trade-offs between inflation and
 real aspects of economic activity like output and
employment.
.
 3.GROWTH POLICIES (supply-side
policies): “Policies that focus on increasing
the long-run growth rate.”
 Focus of government policy should be to
stimulate aggregate supply ----- to stimulate
the potential growth of aggregate output
and income.
.
 A host(multitude) of policies have been
aimed at increasing the rate of growth.

 Many of these are targeted at specific

markets and are largely discussed in
microeconomics.
.
 COMPONENTS OF MACROECONOMY
Macroeconomics focuses on four groups:
 Households and Firms( the private sector)
 The Government (the public sector)
 Rest of the world( the international sector).
 These four groups interact in a variety of ways.
INDIAN ECONOMY (Introduction)

 In this chapter we study the broad profile of

the Indian economy as it will help us in
understanding the scope for business
activity in the country.
 The Indian economy is often characterised as
underdeveloped which means that the
national income being low in the country,
the size of the market is rather limited.
.

 Hence, a business firm cannot plan to expand its

activity easily. Unlike a firm in a developed country.

 The Indian economy, however, no longer suffers from

stagnation as it did under the British.

 The country’s economy is now in the process of

development which is continuously creating
opportunities for increased business activity.
.
 Having missed the opportunity to develop
along the capitalist path during the colonial
period,
 after independence India opted for a planned
capitalist development and accordingly
built-up a mixed economy.
.
 Characteristic features of the Indian
economy:
 1.The Indian economy still remains underdeveloped.
 2.The Indian economy has been growing both in
terms of an increase in its per capita income and
in terms of structural changes.
 3. From its pre capitalistic form, the Indian economy
has evolved into a mixed economy.
India--- an Underdeveloped Economy

The Indian economy is presently an underdeveloped

economy.
 Almost all important characteristic features of an
underdeveloped economy are present in the Indian
economy even after 58 years of independence.
.
 Underdeveloped economy is primarily an
agricultural economy,
 as 60 to 70 per cent of the country’s
population seeks employment in agricultural.
.
 REASONS:
 1.Low Per-Capita Income and the rate of
capital accumulation is also very low.
 2. Predominance of Agriculture: We find
64.8% of working population was employed in
agriculture in 2001, as against 69.7% in 1951.
 Thus the dependence on agriculture seems to have
declined only marginally.
.
 For instance, 65% of India's working population
seeks employment in agriculture, only 2% of the
USA’s working population is engaged in agricultural
operations.
 The Indian economy thus is essentially agrarian.
 In the agricultural sector productivity is low and, as
a result, a large number of farmers have virtually no
purchasing power to buy industrial goods.
.
 3. Due to widespread poverty most people
have virtually no ability to save. (Sixth five year plan
1980-85 acknowledged the fact)

 4. Rapid population of growth.

 5. Widespread Unemployment
.
 6. Scarcity of Capital.

 7.Technological Backwardness.

 8.Lack of Entrepreneurs (Growth arresting

factor).
 Therefore, if some society possesses people
who are gifted with entrepreneurial skill, it
is bound to grow rapidly.
.
 Some economic historians contended that the
presence of this class(entrepreneurial class) in
England, Germany and the USA had a major role in
their development.
 SUCH a class did not exist during the British period
in India.
 Even after independence for about four decades the
Indian business class did not show much
entrepreneurial skill as it operated under a
protective umbrella.
.
 This situation has, however, changed
since 1990-91 due to economic
liberalization.
India --- a Developing Economy
India’s economy had suffered a long period of
stagnation under the British. After independence,
this long spell of stagnation was broken.
With the beginning of economic planning, an era of
economic development was observed.
Economic Development in India has broadly
two facets -----
1.Quantitative.
2. Structural.
.
REASONS:
1.National income trends --- The new economic
policy which was adopted in 1991, temporarily put
the Indian economy on a high growth path.
2.Structural changes– Apart from the growth in
quantitative terms, there have been significant
changes in India's economic structure since
independence.
.

 The Indian economy is no longer a subsistence

(survival of) agrarian economy.

 Now its structure provides beyond any doubt a far

more congenial environment for business
activities as compared to about two decades ago.
.
 3.Growth of basic capital goods industries.
 4.Development of Infrastructure-------
 It includes transport facilities, energy production, and
telecommunication system.
 Their development creates favorable conditions for
business growth and also for better living.
 5. Progress in the Banking and Financial
Sector.
ECONOMIC SYSTEM

Every country in this world has an economic system to

facilitate the production, trade and consumption of
goods.
Countries across the world have evolved through
various ideologies to follow a mix of different
thoughts and systems.
The economic systems of the USA, Japan, Germany,
France and the UK as capitalistic.
Likewise, despite differences between the economic
systems of the former Soviet Union and China, they
can both be called socialist.
.

CAPITALISTIC ECONOMY:
In the broad sense, is a system of private
property in both producer and consumer
goods,
 freedom of contract and competition,
 with limited Government intervention in
economic affairs.
.
CAPITALISM has existed in a limited form in
the economies of all civilizations.

CAPITALISM is an economic system which is

usually closely related to market economies.
BY definition, marker economy is an economic
system that operates in a free market and is
not planned or controlled by a central
authority.
.
 Although market economy is often identified
with capitalism, it is possible to have
government intervention in such an
economy.
 The key difference between market
economy and planned economies lies not
in the degree of government influence but in
how that influence is used.
 EX---1. in a market economy, if the govt
wants more steel, it collects taxes to buy steel
at market price.
.
 EX--2. However, in a planned economy, the govt
would simply order more steel production.
 In contrast, on the other hand, an economy
where both central planning and market
mechanisms of production and distribution are
present is known as a mixed economy.
 However, governments role in a market economy
remains debatable (controversial).
.
 THOUGH most supporters of the market
economy believe that government has a
legitimate role in defining and enforcing the
basic rules of the market,
 there has long been a debate on how strong
a role the government should have in
both guiding the economy and addressing
the inequalities the market produces.
.
 IN Soviet Union , this process was known as
‘perestroika’
 while in China , the creation of a “socialist
market economy” was one element of
Chinese economic reform.
.
 A capitalistic economy is characterized by
three fundamental features:
 1.Free Private Enterprise
 2.Market Mechanism --- Prices are determined by
operation of the forces of Demand and Supply.
 (i.e.) the relative pressure of buyers and sellers on
the market, will ultimately maximize consumer
welfare.
 3.Profit Motive.
.

 We find that even in the USA, which is a leading

capitalist economy, production takes place in the
private and the public sectors side by side.

 BESIDES this, the government through its fiscal

policy and various restrictive policies tries to control
the activities of the private sector.
.
 INDIA, which is an underdeveloped country, does not
differ significantly from the USA in the organization of
its economy.
 In India too, both private and public sectors co-
exist.

 Capitalism of today is a mixed economic system

in which the private as well as the public sectors
co-exist side by side.
.

 The Government, in order to ensure a certain

level of social welfare for its people,
intervenes in various ways in the functioning
of the economy.
.
 SOCIALISTIC ECONOMY( Centrally Planned):
 The planned socialist economic system is
characterized by social ownership of means of
production, central planning and social welfare
objective.
 Under socialism, property, (i.e.) the means of
production are owned, controlled, allocated, directed
and managed by the state.
.
 Economic planning is an integral part of a socialistic
economy.

 Unlike in a capitalist economy where all important

decisions are taken by autonomous business units.

 In a socialistic economy the responsibility of taking all

decisions related to production and economic
development lies with the state.
.
 The socialist system was established first in Russia in 1917.
 After the World war II in 1949 the communists came to power
in china and thus the biggest country became a socialist
economy.

 In the early 1990s, the Soviet Union disregarded and other

east European countries abandoned the socialist economic
system.

 At this juncture some experts proclaimed that socialism has

lived its life and now it has no future. But is it really so?
.
 The Chinese Economic Miracle

Chinese economic performance since 1978……. is an

even bigger miracle than the East Asian, involving
------------------------------------Singapore, Hong Kong,
Taiwan and South Korea.
.
 China’s GDP growth averaged nearly 10% over the
two decades beginning 1978.
 But even more impressive has been its success
in reducing poverty.
 According to World Bank, it took the US 50 years
and Japan 60 years to achieve a structural
transformation similar to China’s.
 Over the last two decades, China’s share in world
trade jumped from 1% to about 4%(India’s is only
0.6%) and is projected (by the WB) to touch 10% by
2020.
.
 FDI flows into China rose from near zero in
1978 to more than $40 billion in 2000( contrast this
with India's $ 2.3 billion).
 Whichever way one looks at it, China’s
economic performance is nothing short of
a miracle.
.
 SALIENT FEATURES OF THE SOCIALIST
ECONOMIC SYSTEM:
 Marx and Engels have not given any detailed outline
of the socialist economy.
 However, they visualized the socialist system as one
in which there would not be private ownership of the
means of production.
 The practical functioning of a socialist society
became clearer after the Communist Revolution in
Russia.
.
 Salient features------
 1.Social ownership of means of production.
 2.Predominance of public sector.
 3.Decisive role of planning.
 4.Production guided by social benefit.
 5.Abolition of exploitation of labour.
.
 MIXED ECONOMY:
 Mixed economy is followed by socialist countries
where equal importance is given to both public and
private sectors.

 All economists agree that a mixed economy must be

adapted for the benefit of the vast majority of the
people rather than for a small aristocratic(upper
class) or capitalist(entrepreneurial) class.
.

 Today, in a world where many countries offer a

broader electoral franchise, open support to the
wealthy would be the equivalent to political suicide.

 Therefore, most ideologies claim to support the

interest of the greatest number, something that was
once advocated only by socialists.
Features of Mixed Economy
MIXED ECONOMY:
In contrast to the features of a free market (capitalist) economy and
a centrally-planned (socialist) economy,
 the institutional features of a mixed economy may
be listed as ------------------------
1.Co-existence of public and private sectors.

2.Combination of planning with price system.

(Decisive role of market mechanism and supportive role of
planning).

3.Profit motive and social welfare objective.

.
 4.Intervention role of the state.

 5.Public sector activities guided by social

benefit.

 6. SUPPORTIVE ROLE OF ECONOMIC

PLANNING.
.
 Private and Public Sectors:
 A mixed economic system intends to combine the
elements of private capitalism with those of state
socialism.

 The two factors in the Indian economy (i.e.) the

growth of the public sector and economic planning
made it distinctly different from the capitalist
economies of the west.
.
 A mixed economy resembles a capitalist
economy in more than one respect.
 This is not surprising because while building a mixed
economy no attempt is made to eliminate the basic
characteristics of a capitalist economy.
 Note: There was close similarities between the
characteristics of the two systems--------- the mixed
economy and capitalism.
.
Features of India's economy which
determine its character as a mixed
economy.
1.Private ownership of the means of production.
2.Predominance of the market.
3.Private sector monopolies.
4.Public sector
5.Economic planning.
.
 Private ownership production:
 At present a big segment of the industrial sector is in
private hands.
 As a matter of fact, with the exception of some basic
industries, all other industries including
----------------------------------heavy engineering,
electronics, textiles, jute, sugar, cement, leather,
detergents, consumer durables,liquor,etc. are in
private sector.
.
 Most of the sun-rise IT industry is also in the
private sector.

 Agriculture, the principal economic activity in the country, is

also in the private sector as the ownership of agricultural land
is entirely personal.

 These facts suggest that the production in such an

economy will be done for the market and the activity
of the producers will be motivated primarily by
profit.
.
 NOTE:
 It is worth noting that most of the countries in the
world have moved to the ‘market economy’ from
other economic systems in last fifteen years.

 THE private enterprises find it more comfortable to do

business in a ‘free and open economy’ because of
unlimited opportunities.
.
.