BEC 20225:Macroeconomics

Week 01 : An introduction to Macroeconomics

Semester I
School of Accounting and Business
Institute of Chartered Accountants of Sri Lanka
 Intended Learning
Outcomes
• Explain the overview of economics
• Differentiate macroeconomics from
microeconomics
• Identify macroeconomics variables
• Discuss macroeconomic policies
• Analyze and explain the business cycle
• Know the role of the government
 Content

Introduction,
01 Macroeconomic Variables

02 Macroeconomic Policies

Business Cycle and Its

03 Behavior

Role of Government in
04 Macroeconomy
Introduction
 What is Economics
• Several definitions

Scope of the economics Methodology of economics

 Scope of the Economics

Economists

Alfred Marshall Lionel Robbins Paul Samuelson

Marshall defines economics as
“a study of men as they live and
move and think in the ordinary
business of life.”
Robbins, "Economics is the science which
studies human behavior as a relationship
between ends and scarce means which have
alternative uses."
Samuelson, “Economics is the study of how men
and society choose with or without the use of money,
to employ the scarce productive resources which have
alternative uses, to produce various commodities over
time and distribute them for consumption now and in
future among various people and group of society
Methodology of Economics
John Maynard Keynes defines economics as “the science which study
price, output and employment of the entire economy.”

Main Principles
• Scarcity
• Opportunity cost of capital
• Rational self-interest
• Marginality
 Positive Statements Vs Normative Statements

Positive statements Normative statements

Deals with questions such as :
why?, what has happened?,
what will happen?
Examples : There is a positive
relationship between money
supply and price levels, There is
a positive relationship between
education level and the income
Deals with questions such as :
what have to be done?
Examples : minimum wages level
must be increased,
Free medical services have to be
provided to each and every
person.

• Can be right or wrong • Used for policy making

• Although these may be difficult questions to
answer, they all can be resolved by reference
to analysis and empirical evidence.
 Macroeconomics
Macroeconomics is essentially the study of the performance and the behavior of the
economy as whole.

Gardner Ackley: “Macroeconomics is the study of forces or

factors that determine the levels of aggregate production,
employment and prices in the economy, and their rate of
changes over time”

J. M.Culbertson: “Macroeconomics theory is the theory of

income, employment, prices and money”

P. A. Samuelson and W .D. Nordhaus: “Macroeconomics is

the study of the behavior of the economy as a whole. It
examines the overall level of a nation’s output, employment,
and prices.
 Macroeconomics Cont.….
Macroeconomics looks at the economy as a whole,
dealing with such aggregate phenomena as growth
in total output and living standards, commonly
called ‘economic growth', business cycles, inflation,
unemployment, productivity, and the balance of
payments.
In macroeconomics we look at the broad
range of opportunities and difficulties
facing the economy as a whole.
Macroeconomics is concerned with the
nature, relationship, and the behavior of
national economic aggregates such as
national income, total consumption
expenditure, savings and investments,
total employment, and the general price
level.
We need a separate subject called
macroeconomics because there are
forces affecting the economy as a whole
that cannot be fully or simply understood
by analyzing individual markets and
individual products.
In order to comprehend the subject matter of macroeconomics, let us look at the basic
questions that macroeconomics seeks to answer
• What determines the levels of economic activities, total output, the general price level, and
the overall 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 determines the level of foreign trade and trade balances
• What causes disequilibrium in the balance of payments of a country.
Macroeconomics
Variables
 Macroeconomic Variables
The behavior of the economy as a whole is studied on the basis of the behavior of the
aggregate variables, i.e., macroeconomic variables. Macroeconomic variables are, in
general, interrelated and independent. Macroeconomics provides the framework for
analyzing the nature and extent of relationship and interactions between the aggregate
variables, which leads to the formulation of macroeconomic theories.

It is, therefore, important to have a view of macroeconomic variables. For analytical

purpose, macroeconomic variables can be classified under two categories: (i) Goods
market macro variables, and (ii) Money market macro variables.
 Macroeconomic Variables Cont.….
Goods Market Macro Variables
Gross Domestic Product (GDP)
Aggregate consumption
expenditure
Aggregate savings
Aggregate investment
Total tax revenue
Total government expenditure
Total exports
Total imports
Employment
Money Market Macro Variables
Aggregate money supply
Aggregate money demand
Transaction demand for money
Speculative demand for money
Interest rate
Exchange rate
Balance of payments
Macroeconomics
Policies
Macroeconomic Policies
Economic policy is the deliberate attempt to generate increases in economic
welfare. Since the late 1920s, when many advanced economies were on the
brink of complete collapse, economists have recognized that there is a role
for government and monetary authorities in steering a macro-economy
towards increased economic welfare.

The three main types of government macroeconomic policies are fiscal

policy, monetary policy and supply-side policies. Other government
policies including industrial, competition and environmental policies. Price
controls, exercised by government, also affect private sector producers.
 Macroeconomic Policies Cont.….Objectives
Stable prices A balance of payments with the rest of the world
Stable prices mean average prices rising This means that a country is able to ‘pay its way’ in the world.
by only a small amount, such as 2% per
year.
A sound structure to public
An equitable (fair) distribution of finances
income In short, if an economy was in
An equitable distribution of income recession, it did not matter who
means that the gap between rich and injected the money - the public sector
poor is not excessive, but still enough was just as productive as the private
to create incentives to work. sector. However, as public
(sovereign) debt has spiraled over
Full employment the last decade, the control and
Full employment occurs when the labour reduction of debt levels has become
force is fully employed in productive a major policy objective.
work.
Care for the environment
Care for the environment means protecting
the environment from misuse and overuse.
Macroeconomic Policies Cont.….
Monetary Policy

Monetary policy is the process by which a Central Bank manages the

supply and the cost of money in an economy mainly with a view to
achieve the macroeconomic objective of price stability.

Central Bank of Sri Lanka is responsible for conducting monetary policy in Sri
Lanka, which mainly involves setting the policy interest rates and managing
the liquidity in the economy. The monetary operations of the Central Bank
influences interest rates in the economy, affecting the behavior of borrowers
and lenders, economic activity and ultimately the rate of inflation. Therefore,
the Central Bank uses monetary policy to control inflation and keep it within a
desired path.

At present, the Central Bank conducts monetary policy within an enhanced

monetary policy framework with features of both monetary targeting and
flexible inflation targeting (FIT).

Source : Central Bank of Sri Lanka

Macroeconomic Policies Cont.….
Fiscal Policy

The fiscal policy is the government’s budgetary policy of spending, revenue,

deficit and deficit-financing to drive the economy. All government policies
decide the magnitude and the quality of the budget. As the influence of the
government on the economy is excessive through both budget and public
services, any changes in fiscal policy or stability of the government adversely
affect the national economy.

A government sets out the amount it plans to spend and raise in tax revenue
in a budget statement. A budget deficit is when the government’s expenditure
is higher than its revenue. In this case, the government will have to borrow to
finance some of its expenditure.

In contrast, a budget surplus occurs when government revenue is greater

than government expenditure. A balanced budget, which occurs less
frequently, is when government expenditure and revenue are equal. A
government may deliberately alter its expenditure or tax revenue to influence
economic activity.
Business Cycles
 Business Cycles
The economy tends to move in a series of
ups and downs, called business cycles,
rather than in a steady pattern.

During recessions many business go bust,

while profits fall for the survivors. In
contrast, during a boom demand for most
products rise, profits rise, and most
business find it easy to expand.
Understanding the business cycle is
therefore important for successful
businesses.

Macroeconomics as a subject was invented

to help produce policies that could
ameliorate economic fluctuations. Much of
what follows is devoted to explanations of
why the economy goes through these ups
and downs, and what, the government can
do about them.
Role of the
Government
Role of the Government: Objectives

To protect life and property by exercising a

monopoly of force and establishing property rights.

To improve economic efficiency by addressing the

various causes of market failure.

To protect the environment

To achieve some accepted standards of equity

To influence the rate of economic growth

To stabilize the economy against income and

price level fluctuations
 Policies for Equity
The distribution of income

An important characteristic of any

market economy is the distribution of 100
income that it determines. People
80
whose skills are scare relative to supply

Income (cumulative)
earn large incomes, whereas people
whose skills are plentiful relative to 60

supply earn much less.

40
Concepts about equity have two Lorenz
dimensions; horizontal and vertical. 20 Curve
Horizontal equity means that people in
similar circumstance should be treated
similarly. Vertical equity means treating 0 20 40 60 80 100

people in different economic situations Individuals (cumulative)

differently in order to reduce inequalities
between them.
 Policies for Equity Cont.….

The distribution of wealth Equity versus efficiency

Wealth confers economic power, and Problems arise when government

wealth is more unequally distributed than
is income. There are two main ways in
which in the distribution of wealth
inequalities an be reduced. The first is to
levy taxes on wealth at the time that
wealth is transferred from one owner to
another, either by gifts during the lifetime
of the owner or by bequest after death.
The second method is can annual tax on
the value of each person’s wealth.
measures designed to improve equity
seriously inhibit the efficient operation of
the price system.
Often the goal of a more equitable
distribution conflicts with the goal of a
more efficient economy.
 Policies for Economic Growth
Macroeconomic policy was largely assumed to be aimed at keeping the
economy as close to potential as possible. In this respect traditional
stabilization policy has emphasized the need to reduce cycles in the
economy, and especially to avoid both recessionary gaps, which are
associated with high unemployment, and inflationary gaps, which generate
inflation.

Economic growth is the most powerful determinant of living standards.

Whatever their policies concerning efficiency and equity, people who live in
economies with rapid rates of growth find their living standards rising on
average faster than those of people who live in countries with low rates of
growth.
Thank You