1/31/2022

Introduction to Macroeconomics and its relevance to Business

Macroeconomics is a study of ‘big’ economic issues that determine well-

being of all.
It affects all businesses irrespective of their nature.
- Recall the impact of 2008 Global Economic Crisis
- Recall the impact of 2011 economic recession
- Understand the ongoing Global Recession accentuated by the Covid-19
Virtually all political leaders of capitalist countries want their economies
to grow rapidly at full employment with low and stable inflation and
rising stock prices.

What would you want to become ?

– Smart Managers or Clever Managers!
Smart managers create opportunities from risks but clever managers avoid risk
“no man is unto himself an island” – John Donne’s poem (1964)
nor is any business
however, “Forewarned is forearmed”
What is forewarned or forearmed?
- To increase ability to manage global macroeconomic risks,
need to become your own chief risk officer.
Study of macroeconomics equips you the methods of analyzing the
risks coming your way and fortify your business.

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Entrepreneurs often, “swim like swans” and form “swarm like clusters”
It is apparently true that all entrepreneurs flock together, they aggressively invest in boom
(period of optimism) and hold back new investments during recession (period of pessimism).

But, what would you prefer:

swimming with the tide; or, swimming against it?
Is it a right thing or wrong thing to do?
(at times, majority opinion is right, sometimes wrong).
but, if enough people act on a wrong thinking, it actually becomes right (ex.
stock prices, political decisions like demonetization).
So, how can you, as a manager of different mind, tell majority is wrong.
(assuming the majority is wrong is a recipe for disaster. But assuming the
majority is never wrong is equally disastrous).

Telling that difference is an art – can come through intelligent use of macroeconomic
tools and analyses.

3 Big Concepts of Macroeconomics:

Growth, unemployment and inflation

The current values of these 3 variables and their forecasts are key
for managers to plan their business

Managers must understand how much to produce and when, how

much to borrow and when, how much to advertise and when?.

Therefore, a clear understanding of macroeconomic factors is

essential for successful business management.

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To a certain extent, all social sciences are a blend of ‘‘art’’ and ‘‘science.’’

The ‘‘science’’ consists of various relationships that hold if other things remain the same,
often known as ceteris paribus.

For example, if personal income rises, consumers will spend more, ceteris paribus – that is,
assuming no change in monetary conditions, the stock of wealth, or consumer attitudes.
If interest rates decline and expectations about future sales and profitability remain the same, firms
will invest more.
If the cost of production rises and demand does not decline, prices will also rise, and so on.

However, economics is not a laboratory science, and in most cases, other things are changing.
If personal income rises because workers receive bigger pay increases, then that might
boost inflation, hence raising interest rates, which would offset the gain in income. Under
those circumstances, consumption might not rise at all.

Thus, macroeconomics will never be an exact science because of the critical role of
expectations.

What is Macroeconomics ?

Macroeconomics is a study of aggregate relationships among its big

issues: Growth, unemployment and inflation.

The relationship, in turn, explain the behavior of economic agents –

individuals and firms
(for various levels of income, assets, liquidity, interest rates, relative
prices, and other economic variables).

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The big-3 concepts of macroeconomics

1. The unemployment rate:

The higher the unemployment rate, the harder it is for graduates to

seek jobs.
Many people have had lost their jobs, salary cuts, full-time workers
become part-time workers, etc. during recession 2008, 2011, 2016
(demonetization), 2018 (trade war, economic recession), 2020-22.

In contrast, during 2004-08, there was a boom, jobs were on rise,

pays were on rise, businesses were on rise. This was also partly true
during 2009-2011 and 2016-18 (in formal sector).

2. The inflation rate:

A high inflation rate means that prices are rising rapidly, while a low inflation rate
means that prices are rising slowly. An inflation rate zero means that prices
remain essentially same, month after month.
In inflationary periods, retired people or those about to retire lose the most, since
their hard-earned savings buy less as prices shoot up. On the other hand, it
rewards those who have borrowed. People want their lives to be predictable, but
inflation makes it uncertain.

3. Productivity Growth:
Productivity is the aggregate output an average worker produces per hour. Faster
the aggregate productivity grows, easier it is for each member of society to
improve his or her standard of living. It makes the nation possible to have more
houses, cars, hospitals, roads, schools, etc. but if the growth rate of productivity
was zero, to have more houses and cars, we would have to sacrifice some
hospitals and schools. Such an economy with no productivity growth, has been
called the “zero-sum society.”

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Macroeconomic Objectives:

To achieve highest sustainable long-term growth, low unemployment

and low inflation.

Rapid sustainable real GDP growth can make a profound contribution to

economic well-being.
For example, if with an annual real growth rate of 2 percent, it takes 30
years for production or standard of living to double.

With a growth rate of 5 percent a year, production or standard of living

more than doubles in just 15 years.

And with a growth rate of 10 percent a year, production or standard of

living doubles in just 7 years.

Circular Flow of Income

Fig: Two-sector model (with no HH-savings and no Firm-profits)

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Fig: Four-sector model