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MACROECONOMICS:
THEORY AND POLICY
Anindya S. Chakrabarti
Indian Institute of Management, Ahmedabad
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Course details
• Prof. Anindya S. Chakrabarti: Sections A and B, Extn.4886

• Section A-B: Jesal Tejwani and Amrendra Kushwaha

• Email: jesalt@iima.ac.in , amrendrak@iima.ac.in

• Textbook: Dornbusch, Fischer and Startz (DFS),

Macroeconomics, latest Indian Edition, McGraw Hill
(2018).

• Additional readings:

• Mankiw, Macroeconomics, Latest Edition.

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Course details
• Evaluation

Exercises/Quizzes 10%
Presentation 10%
Mid term 35%
Term-end exam 35%
Class participation 10%

• I will have some in-class quizzes, typically very short.

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Course details
• Timing

Please do NOT be late for class.

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Introduction
• What is macroeconomics?

• Macroeconomics is the study of the behavior of the

economy as a whole
• … different policy measures that the government and the
central bank uses to influence it.
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Covid and the macroeconomy

(Source: Gay et al, https://onlinelibrary.wiley.com/doi/10.1111/1746-692X.12271)
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Introduction
• What is macroeconomics?

• Macroeconomics is the study of the behavior of the

economy as a whole
• … different policy measures that the government and the
central bank uses to influence it.

• How is macroeconomics different from microeconomics?

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Introduction
• How is macroeconomics different from microeconomics?

• Individuals and aggregates

• Micro versus macro
• Single product versus multiple products
• Single market versus multiple markets

• Macroeconomics aggregates the individual markets vs.

microeconomics examines the behavior of individual
economic units and the determination of prices in
individual markets
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Introduction
• What is macroeconomics?

• Macroeconomics is the study of the behavior of the

economy as a whole and the policy measures that the
government uses to influence it.

• Roughly what are the macro variables?

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Introduction
• What is macroeconomics?

• Macroeconomics is the study of the behavior of the

economy as a whole and the policy measures that the
government uses to influence it.

• Roughly what are the macro variables?

• We will use measures of total output, rates of unemployment and
inflation, and exchange rates
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Introduction
• What is macroeconomics?

• Macroeconomics is the study of the behavior of the

economy as a whole and the policy measures that the
government uses to influence it
• Utilizes measures including total output, rates of unemployment
and inflation, and exchange rates

• What is the time frame?

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Introduction
• What is macroeconomics?

• Macroeconomics is the study of the behavior of the

economy as a whole and the policy measures that the
government uses to influence it
• Utilizes measures including total output, rates of unemployment
and inflation, and exchange rates

• What is the time frame?

• Examines the economy in the short and long run
• Short run: movements in the business cycle
• Long run: economic growth
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Introduction

• What is the time frame?

• Examines the economy in the short and long run
• Short run: movements in the business cycle
• Long run: economic growth

• Long Run Model: domain of growth theory  focuses on growth of

the production capacity of the economy
• Short Run Model: business cycle theories
• Changes in demand determine how much of the productive
capacity is used and the level of output and unemployment
• Prices are fixed in this period, but output is variable
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Introduction
• Growth theory

• The above figure illustrates growth of income per person in the U.S.
over last century  growth of 2-3% per year
• accumulation of inputs and improvements in technology lead to
increased standards of living
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Demand-supply model

• At the macro level:

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Demand-supply model

• At the macro level: Long run

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Demand-supply model

• At the macro level: Short run

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What are we trying to model?

• Business cycle is the
• Short run fluctuations: pattern of expansion and
contraction in economic
activity about the path of
trend growth

• Trend path of GDP is the path

GDP would take if factors of
production were fully utilized
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What are we trying to model?

• Deviation of output from
• Short run fluctuations: the trend is referred to as
the output gap

• Output gap = actual output –

potential output
• Output gap measures the
magnitude of cyclical
deviations of output from the
potential level
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Some basic ideas

• The growth rate of the economy is the rate at which
GDP is increasing
• Most developed economies grow at a rate of a few percentage
points per year
• For example, the US real GDP grew at an average rate of 3.4
percent per year from 1960 to 2005
• Growth rate is far from smooth

• Growth in GDP is caused by:

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Some basic ideas

• The growth rate of the economy is the rate at which
GDP is increasing
• Most developed economies grow at a rate of a few percentage
points per year
• For example, the US real GDP grew at an average rate of 3.4
percent per year from 1960 to 2005
• Growth rate is far from smooth

• Growth in GDP is caused by:

1. Increases in available resources (labor and capital)
2. Increases in the productivity of those resources
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US economy: actual data

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US economy: actual data

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Take away:
• So we have seen a couple of snapshots of real data

• They move a lot

• Somehow connected to each other

• We will study those connections

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Plan of the course:

• Introduce components: consumption, investment etc.

• Add them up to have a first cut model of the demand

side

• Add a supply side

• Construct AD-AS model (Keynes)

• Finally study a bit of growth economics (Solow)

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• How did we end up with the

Keynesian and the Solow model?
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A brief history:

• It is not from the benevolence of the butcher, the brewer, or

the baker that we expect our dinner, but from their regard to
their own interest.

• Man is an animal that makes bargains: no other animal does

this - no dog exchanges bones with another.

• No society can surely be flourishing and happy, of which the

far greater part of the members are poor and miserable.

• The real tragedy of the poor is the poverty of their

aspirations.
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A brief history:

• Utility maximization

• Rationality

• Market as a decentralized organization

• Distribution of wealth
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Economics as a science:

• Alfred Marshall (Principles of economics, 1890)

• John Maynard Keynes (The general theory of

employment, interest and money, 1936)

• Capitalism is the astounding belief that the most

wickedest of men will do the most wickedest of things
for the greatest good of everyone.
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Economics as a science:

• Kenneth Arrow (General equilibrium theory)

• Paul Samuelson (Mathematical economics)

• John Von Neumann (Cooperative game theory)

• John Nash (Non-cooperative game theory)

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Economics as a science:
• Milton Friedman (Monetarism)

• Robert Lucas Jr. (Rational expectation)

• Amartya Sen (Social choice theory)

• Daniel Kahneman (Behavioral economics)

• Harry Markowitz (Portfolio optimization)

• Avijit Banerjee, Esther Duflo and Micheal Kremer (Experimental turn;

RCT)

• Guido Imbens, Joshua Angrist and David Card (Causal Econometrics)

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Economics as a science:

• An interesting story:

• Louis Bachelier

• The Theory of Speculation, (published 1900)

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Economics as a science:

• Fast forward to 2000

• Bonhomie about how well understood economics is!

• Then something interesting happens:

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Economics as a science:

• So we will not pretend that we understand everything.

• But we do understand a lot of things.

• Have a happy journey!