Institute of Business Administration

Macroeconomics
MACROECONOMICS
Definition: Macroeconomics is the branch of economics that studies the
behavior and performance of an economy as a whole. It focuses on the
aggregate changes in the economy such as unemployment, growth rate,
gross domestic product and inflation.

Description: Macroeconomics analyzes all aggregate indicators and the

microeconomic factors that influence the economy. Government and
corporations use macroeconomic models to help in formulating of economic
policies and strategies.

 Macroeconomics is a branch of economics concerned with the

behavior and performance of the economy as a whole.
 It stands in contrast with microeconomics, which focuses on the impact
at an individual, group, or company level.
 Macroeconomics primarily studies large-scale economic phenomena
like inflation, price levels, rate of economic growth, national income,
gross domestic product (or GDP), and changes in unemployment.
 Macroeconomics in its modern form is thought to have originated from
John Maynard Keynes (pronounced “Canes”) and his 1936 book The
General Theory of Employment, Interest and Money.

WHAT IS A BUSINESS CYCLE?

A business cycle is a cycle of fluctuations in the Gross Domestic Product
(GDP) around its long-term natural growth rate. It explains the expansion
and contraction in economic activity that an economy experiences over time.

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A business cycle is completed when it goes through a single boom and a

single contraction in sequence. The time period to complete this sequence
is called the length of the business cycle. A boom is characterized by a period
of rapid economic growth whereas a period of relatively stagnated economic
growth is a recession. These are measured in terms of the growth of the real
GDP, which is inflation-adjusted.

Stages of the Business Cycle

In the diagram above, the straight line in the middle is the steady growth line.
The business cycle moves about the line.

Below is a more detailed description of each stage in the business cycle:

1. Expansion

The first stage in the business cycle is expansion. In this stage, there is an
increase in positive economic indicators such as employment, income,
output, wages, profits, demand, and supply of goods and services. Debtors
are generally paying their debts on time, the velocity of the money supply is
high, and investment is high. This process continues as long as economic
conditions are favorable for expansion.

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2. Peak

The economy reaches a saturation point, or peak, which is the second stage
of the business cycle. The maximum limit of growth is attained. The
economic indicators do not grow further and are at their highest. Prices are
at their peak. This stage marks the reversal point in the trend of economic
growth. Consumers tend to restructure their budgets at this point.

3. Recession

The recession is the stage that follows the peak phase. The demand for
goods and services starts declining rapidly and steadily in this phase.
Producers do not notice the decrease in demand instantly and go on
producing, which creates a situation of excess supply in the market. Prices
tend to fall. All positive economic indicators such as income, output, wages,
etc., consequently start to fall.

4. Depression

There is a commensurate rise in unemployment. The growth in the economy

continues to decline, and as this falls below the steady growth line, the stage
is called a depression.

5. Trough

In the depression stage, the economy’s growth rate becomes negative.

There is further decline until the prices of factors, as well as the demand and
supply of goods and services, contract to reach their lowest point. The
economy eventually reaches the trough. It is the negative saturation point for
an economy. There is extensive depletion of national income and
expenditure.

6. Recovery

After the trough, the economy moves to the stage of recovery. In this phase,
there is a turnaround in the economy, and it begins to recover from the

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negative growth rate. Demand starts to pick up due to low prices and,
consequently, supply begins to increase. The population develops a positive
attitude towards investment and employment and production starts
increasing.

Employment begins to rise and, due to accumulated cash balances with the
bankers, lending also shows positive signals. In this phase, depreciated
capital is replaced, leading to new investments in the production process.
Recovery continues until the economy returns to steady growth levels.

WHAT IS UNEMPLOYMENT?

Unemployment is a term referring to individuals who are employable and

actively seeking a job but are unable to find a job. Included in this group are
those people in the workforce who are working but do not have an
appropriate job. Usually measured by the unemployment rate, which is
dividing the number of unemployed people by the total number of people in
the workforce, unemployment serves as one of the indicators of a country’s
economic status.

UNDERSTANDING UNEMPLOYMENT

The term “unemployment” is often misunderstood, it as it includes people

who are waiting to return to a job after being discharged, yet it does not
include individuals who have stopped looking for work in the past four weeks
due to various reasons such as leaving work to pursue higher education,
retirement, disability, and personal issues. Also people who are not actively
seeking a job but do want to work are not classified as unemployed.

Interestingly, people who have not looked for a job in the past four weeks but
have been actively seeking one in the last 12 months are put into a category
called the “marginally attached to the labor force.” Within this category is
another category called “discouraged workers,” which refers to people who
have given up looking for a job.

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The categories mentioned above sometimes causes confusion and debate

as to whether the unemployment rate fully represents the actual number of
people who are unemployed. For a full understanding, one should juxtapose
“unemployment” with the term “employment,” which the Bureau of Labor
Statistics (BLS) describes as individuals aged 16 and above who have
recently put hours into work in the past week, paid or otherwise, because of
self-employment.

TYPES OF UNEMPLOYMENT

There are basically four types of unemployment:

1) Demand deficient unemployment OR Cyclical

Demand deficit unemployment is the biggest cause of unemployment that

typically happens during a recession. When companies experience a
reduction in the demand for their products or services, they respond by
cutting back on their production, making it necessary to reduce their
workforce within the organization. In effect, workers are laid off.

2) Frictional unemployment

Frictional unemployment refers to those workers who are in between jobs.

An example is a worker who recently quit or was fired and is looking for a job
in an economy that is not experiencing a recession. It is not an unhealthy
thing because it is usually caused by workers trying to find a job that is most
suitable to their skills.

3) Structural unemployment

Structural unemployment happens when the skills set of a worker does not
match the skills demanded by the jobs available, or alternatively when
workers are available but are unable to reach the geographical location of
the jobs.

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An example is a teaching job that requires relocation to China, but the worker
cannot secure a work visa due to certain visa restrictions. It can also happen
when there is a technological change in the organization, such as workflow
automation that displaces the need for human labor.

4) Underemployment

In this type the person are employed but not their on the basis of their skills
or degree. They are unable to find the job according to their skills and
experience

CONCEPT OF NATIONAL INCOME

The National Income is the total amount of income accruing to a country from
economic activities in a years’ time. It includes payments made to all
resources either in the form of wages, interest, rent, and profits.

The progress of a country can be determined by the growth of the national

income of the country

National Income Definition

The definition of National Income if of two types

I. Traditional Definition of National Income

According to Marshall: “The labor and capital of a country acting on its natural
resources produce annually a certain net aggregate of commodities, material
and immaterial including services of all kinds. This is the true net annual
income or revenue of the country or national dividend.”

II. Modern Definition

This definition has two sub-parts

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i. Gross Domestic Product

Gross Domestic Product, abbreviated as GDP, is the aggregate value of

goods and services produced in a country. GDP is calculated over regular
time intervals, such as a quarter or a year. GDP as an economic indicator is
used worldwide to measure the growth of countries economy.

Goods are valued at their market prices, so:

 All goods measured in the same units (e.g., dollars in the U.S.) on
 Things without exact market value are excluded.

Constituents of GDP-

 Wages and salaries

 Rent
 Interest
 Undistributed profits
 Mixed-income
 Direct taxes
 Dividend
 Depreciation

The Formula for Calculation-

GDP = CONSUMPTION + INVESTMENT + GOVERNMENT SPENDING + EXPORTS - IMPORTS.

ii. Gross National Product

Gross National Product (GNP) is an estimated value of all goods and

services produced by a country’s residents and businesses. GNP does not
include the services used to produce manufactured goods because its value
is included in the price of the finished product. It also includes net income
arising in a country from abroad.

GDP = C + I + G + NX

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C = consumption or all private consumer spending within a country’s

economy, including, durable goods (items with a lifespan greater than three
years), non-durable goods (food & clothing), and services.

I = sum of a country’s investments spent on capital equipment, inventories,

and housing.

G = total government expenditures, including salaries of government

employees, road construction/repair, public schools, and military
expenditure.

NX = net exports or a country’s total exports less total imports.

Components of GNP

 Consumer goods and services

 Gross private domestic income
 Goods produced or services rendered
 Income arising from abroad.

Formula to Calculate GNP

GNP = GDP + NR (NET INCOME FROM ASSETS ABROAD OR NETINCOME RECEIPTS)
‑ NP (NET PAYMENT OUTFLOW TO FOREIGN ASSETS).

REAL VS NOMINAL

 Nominal Gross Domestic Product takes the current market price

to calculate the GDP of the year. Real GDP takes the market price
of the base year and the quantity produced for the current year
and then finds out the GDP of the year.
 Nominal Gross Domestic Product is not so popular among
economists because it just scratches the surface. Real GDP is very

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popular among economists because it goes deep into the

concept.
 Nominal Gross Domestic Product is much higher in value since the
current market price is taken into account. Real GDP is much lower
in value since the base market price is taken into account.
 Analyzing the economic growth through Nominal Gross Domestic
Product isn’t easier since it just scratches the surface. Analyzing
economic growth through Real GDP is significantly and
comparatively easier.

WHAT IS INFLATION?

Inflation is the decline of purchasing power of a given currency over time. A quantitative
estimate of the rate at which the decline in purchasing power occurs can be reflected in
the increase of an average price level of a basket of selected goods and services in an
economy over some period of time. The rise in the general level of prices, often expressed
as a percentage, means that a unit of currency effectively buys less than it did in prior
periods.

Inflation can be contrasted with deflation, which occurs when the purchasing power of
money increases and prices decline.

WHAT IS DEFLATION?

Deflation is a general decline in prices for goods and services, typically associated with a
contraction in the supply of money and credit in the economy. During deflation, the
purchasing power of currency rises over time.

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Basis for
Nominal GDP Real GDP
Comparison

Nominal gross domestic product is the
sum-total of the economic output
Meaning
produced in a year valued at the current
market price.
Real GDP is the sum-total of the
economic output produced in a year’s
values at a pre-determined base market
price.

Based on Current Market Price. Base Year’s Market Price.

How inflation The nominal gross domestic product Real GDP takes inflation into account;
affects it? doesn’t take inflation into account. it’s called inflation-adjusted GDP.

It is much lower since the market price

It is much higher since the current
Value of GDP of the base year is taken into
market changes are taken into effect.
consideration.

Nominal gross domestic product is less

Popularity Real GDP is more popular.
popular.

Nominal gross domestic product is very

Complexity Real GDP is a bit complex to ascertain.
easy to be calculated.

Comparison The real gross domestic product can be

The nominal gross domestic product can
with earlier compared with the previous financial
be compared with the previous quarters.
GDPs years.

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Growth of the From the nominal GDP, economic From real gross domestic product,
economy growth can’t be analyzed easily. economic growth can be analyzed easily.

CAUSES OF INFLATION

An increase in the supply of money is the root of inflation, though this can
play out through different mechanisms in the economy. Money supply can
be increased by the monetary authorities either by printing and giving away
more money to the individuals, by legally devaluing (reducing the value of)
the legal tender currency, more (most commonly) by loaning new money into
existence as reserve account credits through the banking system by
purchasing government bonds from banks on the secondary market.

In all such cases of money supply increase, the money loses its purchasing
power. The mechanisms of how this drives inflation can be classified into
three types: demand-pull inflation, cost-push inflation, and built-in inflation.

Demand-Pull Effect

Demand-pull inflation occurs when an increase in the supply of money and

credit stimulates overall demand for goods and services in an economy to
increase more rapidly than the economy's production capacity. This
increases demand and leads to price rises.

Cost-Push Effect

Cost-push inflation is a result of the increase in prices working through the

production process inputs. When additions to the supply of money and credit
are channeled into a commodity or other asset markets and especially when
this is accompanied by a negative economic shock to the supply of key
commodities, costs for all kinds of intermediate goods rise.

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Built-in Inflation

Built-in inflation is related to adaptive expectations, the idea that people

expect current inflation rates to continue in the future. As the price of goods
and services rises, workers and others come to expect that they will continue
to rise in the future at a similar rate and demand more costs or wages to
maintain their standard of living. Their increased wages result in a higher
cost of goods and services, and this wage-price spiral continues as one
factor induces the other and vice-versa.

WHAT IS THE CONSUMER PRICE INDEX (CPI)?

The Consumer Price Index (CPI) is a measure that examines the weighted
average of prices of a basket of consumer goods and services, such as
transportation, food, and medical care. It is calculated by taking price
changes for each item in the predetermined basket of goods and averaging
them. Changes in the CPI are used to assess price changes associated with
the cost of living.

The CPI is one of the most frequently used statistics for identifying periods
of inflation or deflation. It may be compared with the producer price index
(PPI), which instead of considering prices paid by consumers looks at what
businesses pay for inputs.

How Is CPI Used?

CPI is an economic indicator. It is the most widely used measure of inflation

and, by proxy, of the effectiveness of the government's economic policy. The
CPI gives the government, businesses, and citizens an idea about price
changes in the economy and can act as a guide in order to make informed
decisions about the economy.
Costs of Inflation

There are many costs associated with inflation; the volatility and uncertainty can lead to
lower levels of investment and lower economic growth. For individuals, inflation can lead

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to a fall in the value of their savings and redistribute income in society from savers to
lenders and those with assets. At extreme levels, inflation can destabilise society and
destroy confidence in the economic system.

Term Definition
when the price level increases at a faster pace
unanticipated than expected; for example, if you think that the
inflation rate of inflation will be 5%, but it turns out to be
8%.

when the price level increases at a slower pace

unanticipated
than anticipated; for example, if you think the rate
disinflation
of inflation will be 5%, but it turns out to be 2%.

when the price level decreases when it was

unanticipated expected to increase; for example, if you think the
deflation rate of inflation will be 2%, but it turns out to be -
2%.

when the real value of wealth is transferred from

wealth one agent to another; when inflation is higher than
redistribution borrowers and lenders expected, wealth is
transferred from lenders to borrowers.

an agent (usually a bank) or a person (for

example, a holder of a bond) who makes money
lender
available to another agent, with the agreement that
the money will be repaid (usually with interest)

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Term Definition
an agent that has received money from another
borrower agent with the agreement that the money will be
repaid (usually with interest)

an agent that is not spending some of their

income; usually if money is saved it is put in some
saver sort of interest-earning asset (like a savings
account or a bond) or purchasing some other
financial asset (such as stocks and bonds).

an asset that is a promise to pay a fixed amount at

some point in the future; for example, the
government sells Tony a bond
bond
for \$100$100dollar sign, 100 with the promise of
paying him back \$104$104dollar sign, 104 in one
year, which allows Tony’s savings to earn interest.

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