INTRODUCTION TO MACROECONOMICS

WHAT IS MACROECONOMICS?

• 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.

– Aggregate behavior refers to the behavior of all

households and firms together.
 IMPORTANCE OF MACRO ECONOMICS
• To understand the working of the economy: Macroeconomic variables like Total Income, Total Output,
Employment and General Price level help us in analysing the functioning of the economy.
• In Economic Policies – Macro economic study helps us to find a solution to complex economic problems
of modern times.
Ex. 1. General Unemployment,
Ex. 2. National Income data helps in forecasting the level of economic activity & to understand the
distribution of income among different groups of people in the economy
• In Economic Growth – To plan for economic growth, it is necessary that the macro economic variables
like income, output and employment are evaluated.
• In Monetary Problems – Frequent changes in the value of money ( ?) affects the economy adversely!!
• In Business Cycles – Macro economics began to be studied only after the Great Depression. Thus, its
importance lies in analyzing the causes of economic fluctuations and in providing remedies.
WHY STUDY MACRO ECONOMICS?

• The economic well being of consumers rich or poor is affected by movement in interest rates,
exchange rates, inflation etc.
• Businesses stand to gain or lose considerable amounts of money when their economic environment
changes, regardless of how well they are managed.
• Being prepared for such changes in fortunes can have considerable value; more generally, it makes us
all better citizens able to grasp the complex challenges that our societies face.
• Macroeconomics is relevant to voters who wonder what their governments are up to?
• Study of Macroeconomics also help governments avoid the worst economic crises that have afflicted
modern industrial societies in the past century—depressions and hyperinflations.
• These extreme situations can tear at a society’s social fabric, yet can be prevented when policy-
makers apply sound economic principles.
BASIC ECONOMIC PROBLEMS
Resources/Inputs:
• A society’s resources consist of natural endowments such as land, forests, and
minerals (traditionally referred as land);
• Human resources both physical and mental (traditionally referred as labor).
• Manufactured aids to production such as tools, machinery, and buildings
(commonly known as capital).
• Entrepreneurs: Organization of production, innovation of new goods and
technologies and the bearing of risk and uncertainty.

Resources are used to produce the outputs that people desire. These outputs are
divided into goods and services.
Goods are tangibles (car, shoes etc) and services are intangibles (e.g. haircuts, and
education).
BASIC ECONOMIC PROBLEMS ISSUE

Scarcity occurs because our limited resources and time can only yield
limited production and income, but people’s wants are virtually
unlimited.

Output is produced by using knowledge (technology) to apply energy

to a blend of resources.

Production, in turn, generates the income people spend on the

limited goods and services available.
BASIC ECONOMIC PROBLEMS ISSUE
Economic surplus: the benefit of any action, minus its cost, where benefit is
measured by the marginal willingness-to-pay to undertake that action, and the
cost is the marginal opportunity cost of undertaking that action. Also known as
"total surplus" or “social surplus.”

Economic Efficiency: the maximization of economic surplus. Economic Efficiency is

achieved when we produce the combination of outputs with the highest
attainable total value, given our limited resources.

Economic Efficiency can be decomposed into: allocative, productive, and

distributive
TYPES OF ECONOMIC EFFICIENCY (THREE BASIC
QUESTIONS)
Allocative efficiency-What: Requires the pattern of national output to mirror what
people want and are willing and able to buy

Productive efficiency-How: Requires minimizing opportunity cost for a given value

of output. Maximum output using given resources. Remember, “too many cooks
spoil the broth”

Distributive efficiency-Who: Requires that specific goods be used or who will

value the output relatively the most
MARKET EFFICIENCY

Pareto efficiency: A situation where no one can be made better-off without making
someone else worse-off (Zero sum game).

Pareto improvement: A change that actually makes someone better-off without

making anyone else worse off. Difficult!

“Potential” Pareto-improvement: A change that makes some people better-off by

enough that they could compensate any losers with money so that everyone is
better-off. Also known as "more efficient" or "economic improvement."
PRODUCTION POSSIBILITY BOUNDARY
Production possibility boundary illustrates three concepts: scarcity,
choice and opportunity cost;

Scarcity is indicated by the unattainable combinations above the

boundary;

Choice by the need to choose among the alternative attainable points

outside the boundary.

Opportunity cost by the negative slope of the boundary.

PRODUCTION POSSIBILITY BOUNDARY
The production possibility
frontier (PPF) is a curve depicting all
maximum output possibilities for two
goods, given a set of inputs consisting
of resources and other factors. The
PPF assumes that all inputs are used
efficiently.

PPF curve shows the maximum

possible production level of one
commodity for any given production
level of the other, given the existing
state of technology.

A point on the frontier indicates

efficient use of the available inputs
(such as points B, D and C in the
graph), a point beneath the curve
(such as A) indicates inefficiency, and
a point beyond the curve (such as X)
indicates impossibility.
PRODUCTION POSSIBILITY BOUNDARY
The slope of the production–possibility frontier (PPF)
at any given point is called the marginal rate of
transformation (MRT). The slope defines the rate at
which production of one good can be redirected (by
reallocation of productive resources) into production
of the other. It is also called the (marginal)
"opportunity cost" of a commodity, that is, it is the
opportunity cost of X in terms of Y at the margin. It
measures how much of good Y is given up for one
more unit of good X or vice versa. The shape of a PPF
is commonly drawn as concave to the origin to
represent increasing opportunity cost with increased
output of a good. Thus, MRT increases in absolute size
as one moves from the top left of the PPF to the
bottom right of the PPF.

The law of increasing opportunity cost states: as the

production of one good rises, the opportunity cost of
producing that good increases.
CIRCULAR FLOW OF ECONOMY
CIRCULAR FLOW OF THE ECONOMY – 2 SECTOR MODEL
CIRCULAR FLOW OF ACTIVITIES IN AN ECONOMY – 4 SECTOR MODEL
CIRCULAR FLOW OF THE ECONOMY – LEAKAGES AND INJECTIONS
JUDGEMENT OF AN ECONOMY
 PERFORMANCE OF AN ECONOMY

With the help of GDP analysis ( a macroeconomic

variable) comment on the condition of the economy

The Gross Domestic Product measures the value of

economic activity within a country. Strictly defined,
GDP is the sum of the market values, or prices, of all
final goods and services produced in an economy
during a period of time.
COUNTRY WISE GDP - 2015
COUNTRY WISE GDP PER CAPITA - 2016
WORLD’S SHARE OF GDP - 2017
 LORENZ CURVE
The Lorenz Curve, the actual distribution of
income curve, is a graphical distribution of wealth
developed by Max Lorenz in 1906. The curve
shows the proportion of income earned by any
given percentage of the population. The line at
the 45º angle shows perfectly equal income
distribution, while the other line shows the actual
distribution of income. The further away from the
diagonal, the more unequal the size of the
distribution of income.
 GINI INDEX
The Gini index is a simple measure of the distribution of income across income percentiles in a
population. A higher Gini index indicates greater inequality, with high income individuals receiving much
larger percentages of the total income of the population

The Gini Coefficient, which is derived from the Lorenz Curve, can be used as an indicator of economic development
in a country. The Gini Coefficient measures the degree of income equality in a population. The Gini Coefficient can
vary from 0 (perfect equality) to 1 (perfect inequality). A Gini Coefficient of zero means that everyone has the same
income, while a Coefficient of 1 represents a single individual receiving all the income.

The Gini Coefficient is equal to the area between the actual income distribution curve and the line of perfect
income equality, scaled to a number between 0 and 100. The Gini coefficient is the Gini index expressed as a
number between 0 and 1.

Gini Coefficient = A / A + B
 GINI INDEX

Gini Index – The darker the shade, greater is the value of GINI Index