UNIT 1

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INTRODUCTION OF MACROECONOMICS

1.1 Meaning and Definition of Macro Economics.

Meaning:

The terms Macro is derived from the Greek terms ‘Makros’ meaning
large. Macro economics studies the behaviour of the economy as
whole. Thus Macro economics study of aggregates covering the whole
economy such as national income, employment, aggregates Demand
and Supply, Total investment & General Price level.

Definition:

1) According to Boulding, “Marco economics deals not with

individual quantity but with aggregate if these quantities not with
individual incomes bit with national income not with individual
prices but with price levels, not with individual outputs but with
the national output.”

2) Gardener Ackley, “It looks at the total size and shape and
functioning of the elephant if economic experiences, rather the
working or articulation or dimensions if the individual parts. It
studies the character of the forest, independent of the trees
which compose it”.
 3) According Prof.Marshall, “Macro economics views the forest as a
whole independent of the individual trees composing it.”

1.2 Nature of Macro Economics.

1) Study of aggregates: Macro economics is a study of the

aggregates. It is also known as aggregates economics. It studies
the economics system as a whole covering all condition of the
economy such as total production, total consumption, total
saving and total investment. In the words of Prof. McConnell,
“Macro economics examines the forest, not the tree.”

2) Lumping method: Macro economics deals with macro quantities

and macro variable. Unlike macro economics, it does not split up
the economy into small slice but studies in big lumps. Therefore
it is called the method of lumping.

3) General Equilibrium: Macroeconomic is based on general

equilibrium. Whole economy is called general equilibrium. The
technique of general equilibrium is applied to study the
determination of the general price level, total employment and
output.

4) Vision: It gives the overall view of the whole economy i.e.it give a
bird’s eye view of the whole economy.

5) Interdependence: Macro analysis stresses inter relationship

between the different Market and sectors in the economy.
According to general equilibrium analysis, a change in any one
 market or sector will have its impact on the other markets or
sectors of the economy.

6) Income theory: Macroeconomics is known as income theory. It

studies the factors determining national income and employment
and the causes offluctuations in income and employment.
According to Edward Shapiro, the major task of Macro economics
is the explanation of what determines the economy’s income.

7) Policy-oriented: Macro economics, according to Keynes’ is a

policy-oriented science. Macro-economic analysis helps in
formulating suitable economic policies to promote economic
growth, to generate employment, to control inflation, to pull the
economy out of depression etc.

1.3 Scope of Macro Economics.

Scope and Subject Matter of Macro Economics:-

1) Theory of Income and Employment: Macro Economic analysis

explains what determines the level of national income and
employment and what causes the fluctuations in the level of
national income for a long period of time. So Macro economics is
known as “Income Theory”. He showed how the equilibrium level
of national income and employment was determined by the
aggregate demand and aggregate supply. Aggregate demand
constitutes consumption demand and investment demand. Both
consumption function and investment functions interact to
determine income, employment interest and general price level.
2) Theory of General Price- Level and inflation: Macro economics
also explain show the general prices level is determined .Keynes
has explained that it is total Ways that increase in supply of
money that brings rise in price. But also explained that just as
unemployment and depression were caused due to deficiency of
aggregate demand, inflation was due to excessive aggregate
demand. The problem of fluctuation is a serious problem faced
these days, both by the developed and under developed countries
of the world. Theory of price level, studies cause and effect to
inflation and depression and suggests policies to tackle these
problems.

3) Theory of Economic Growth and Development: The problem of

growth is a long run problem. It was Harrod and Domar who
extended the Keynesian analysis to the long-run problem of
growth with stability. If growth with stability is to be achieved,
income or demand must be increase at a rate sufficient enough to
ensure full utilization of increase capacity. General growth theory
applies to both the developed and under developed economies.
Special theories have been developed, which explain the causes
of under- development and poverty in under developed countries
and also suggests strategies for initiating and accelerating grow
thin them.

4) Macro Theory of Distribution: The Macro economic theory also

explains the factors determining the relative shares of various
social classes, workers and capitalist in the form of total rent,
total wages, income, total interest and total profit in the total
national income.
1.4 Significance of Macro Economics.

Importance of Macroeconomics:-

1) Function of the Economic: The study of individual items will not

help in understanding the working of an economic system. Only
an aggregative approach can make it possible to understand the
functioning of complex system.

2) Formulation of Economic policies: Study of macroeconomic is an

essential requirement for farming economic policies. Modern
government depends upon reliable statistics of aggregate
variable as the basis for the formulation of government policies.
For e.g.-The data collected on national income, general price
level, wage rate,saving, investment, interest rate is very useful in
farming sound economic policies.

3) Dynamic science: Macroeconomics studies and suggests solution

to the issue and problems from the dynamic view point. It gives
importance to the changes in the economy.

4) Understanding of National income: Macroeconomics studies the

computation, use and application of National income data. The
national income data enable us to understand & evaluate the
performance of economy.

5) International comparison: Macro economics Facilitates

international comparison by providing information about
aggregate demand, national income, consumption and saving for
different countries.
 6) For understanding Micro-theory: Since Macro economics deals
with the group behaviour its study is important in understanding
the behaviour of Individual units.

1.5 Limitations of Macro Economics.

There are however, certain limitations oo

Macroeconomic analysis. Mostly, these stem from attempts to yield
macroeconomic generalisations from individual experiences.

(1)Fallacy of Composition:
In Macroeconomic analysis the “fallacy of composition” Is involved,
i.e., aggregate economic behaviour is that the sum of individual
activities. But what’s true of people isn’t necessarily true of the
economy as an entire. For instance, savings are a personal virtue but a
public vice. If total savings within the economy increase, they’ll initiate
depression unless they’re invested. Again, if a personal depositor
withdraws his money from the bank there’s no danger. But if all
depositors do that simultaneously, there’ll be a run on the banks and
therefore the banking industry are adversely affected.

(2)To take the Aggregates as Homogeneous:

The main defect in macro analysis is that it regards the aggregates as

homogeneous without caring about their internal composition and
structure. The average wage in an exceedingly country is that the sum
of wages altogether occupations i.e., wages of clerks, typists, teachers,
nurses, etc. But the amount of aggregate employment depends on the
relative structure of wages instead of on the typical wage. If, as an
example, wages of nurses increase but of typists fall, the typical may
remain unchanged. But if
The utilization of nurses falls a touch and of typists raises much,
aggregate employment would increase.

(3)Aggregate Variables might not be Important Necessarily:

The aggregate variables which form the financial system might not be
of much significance. As an example, the value of a country is that the
total of all individual incomes. An increase in value doesn’t mean that
individual incomes have risen. The increase in value could be the results
of the rise. With in the incomes of some rich people within the country.
Thus an increase within the national income of this kind has little
significance from the purpose of view of the community.
Prof. Boulding calls these three difficulties As Macroeconomic
paradoxes which are true when applied to one individual but which are
untrue when applied to the economic system as an entire.

(4)Indiscriminate Use Misleading Of Macro Economics :

An indiscriminate and uncritical use of macro economics in analysing

the issues of the important world can often be misleading. As an
example, if the policy measures needed to realize and maintain full.
Employment within the economy are applied to structural
unemployment in individual firms and industries, they become
irrelevant. Similarly, measures aimed toward controlling general prices
cannot be applied with much advantage for controlling prices of
individual products.
(5)Statistical and Conceptual Difficulties:

The measurement of macroeconomic concepts involves variety of

statistical and conceptual difficulties. These problems related the
aggregation of microeconomic variables. If individual units are almost
similar,
Aggregation doesn’t present much difficulty. But if micro economic
variables related are similar individual units, their aggregation into one
macroeconomic variable could also be wrong and dangerous.

1.6 Macro Economic Objectives.

Microeconomics and macroeconomics-the two major divisions of

economics-have different objectives to be pursued. The key
microeconomic goals are the efficient use of resources that are
employed and therefore the efficient distribution of output. These two
goals of microeconomics are encapsulated as ‘efficiency’ and ‘equity’.
But macroeconomic goals are quite different because the general
response of the economy must not match. With the individual units. As
macroeconomics looks at the overall economy, its objectives are
aggregative in character. In other words, due to different level of
aggregation, these two branches of economics focus on different
economic objectives.

1. Macroeconomic Policy Objectives: The macroeconomic

policy objectives are the following:
(i) Full employment,
(ii) (ii) Price stability,
(iii) Economic growth,
 (iv) Balance of payment equilibrium and rate of
exchange stability, and
(v) Social objectives.

i. Full employment:

Performance of any government is judged in terms of goals of achieving

full employment and price stability. These two could also be called the
key indicators of health of an economy. In other words, modern
Governments aim at reducing both unemployment and inflation rates.
Unemployment refers to involuntary idleness of mainly other
productive labour force and other productive resources.
Unemployment (of labour) is closely associated with the economy’s
aggregate output. Higher the unemployment rate, greater the
divergence between actual aggregate output (and GNP/CDP) and
potential output. So, one among the objectives of macroeconomic
policy is to make sure full employment.
The objective of full employment became uppermost amongst the
policymakers in the era of Great Depression when unemployment rate
in all the countries except the then socialist country, the USSR, rose to
a great height. It should be noted here that a free enterprise capitalist
economy always exhibits full employment.
But, Keynes said that the goal of full employment could also be a
desirable one but impossible to attain. Full employment, thus, doesn’t
mean that no-one is unemployed. Even if 4 or 5 p.c. Of the entire
population remain unemployed, the country is claimed to be fully
employed. Full employment, though theoretically conceivable, is
difficult to achieve in a market-driven economy. In view of this, full
employment objective is usually translated into high employment’
objective. This goal is desirable indeed, but ‘how high’ should it be?
One author has given a solution in the following way; “The goal for high
employment should therefore be to not seek an unemployment level
of zero, but rather A level of above zero according to full employment
at which the demand for labour equals the availability of labour. This
level is named the natural rate of unemployment.”

ii. Price stability:

No longer is the attainment of full employment taken into account as a

macroeconomic goal. The emphasis has shifted to price stability. By
price stability we must not mean an unchanging price level over time.
Not Necessarily, increase is unwelcome, particularly if it’s restricted
within an affordable limit. In other words, price fluctuations of a higher
degree are always unwelcome.
However, it’s difficult again to define the permissible or reasonable
rate of inflation. But sustained increase in price level also as a falling
price level produce destabilising effects on the economy. Therefore,
one among the objectives of macroeconomic policy is to ensure
(relative) price level stability. This goal prevents not only economic
fluctuations but also helps within the attainment of a steady growth of
an economy.

iii. Economic growth:

Economic growth during a market economy isn’t steady. These
economies experience ups and downs in their performance. This
objective became uppermost in the period following the World War II
(1939-45). Economists call such ups and downs within the economic
performance as trade cycle/business cycle. Within the short run such
fluctuations may exhibit depressions or prosperity (boom).
One of the important benchmarks to calculate the performance of an
economy is the rate of increase in output over a period of time. There
are three major’ sources of economic growth, viz.
(i) The growth of the labour force,
(ii) Capital formation, and
(iii) Technological progress. A country seeks to attain higher
economic growth over a long period so that the standards
of living or the quality of life of people, on a mean,
improve. It should be noted here that while talking about
higher economic growth, we take into account general,
social and environmental factors so the wants of people
of both present generations and future generations is
met.
However, promotion of higher economic growth is usually hampered
by short run fluctuations in aggregate output. In other words, one finds
a conflict between the objectives of economic growth and economic
stability (in prices). In view of this conflict,
It’s said that macroeconomic policy should promote economic growth
with reasonable price stability.

iv. Balance of payments equilibrium and rate of exchange

stability:
From a macro- economic point of view, one can show that a global
transaction differs from domestic transaction in terms of (foreign)
currency exchange. Over a period of time, all countries aim at balanced
flow of products, services and assets into and out of the country.
Whenever this happens, total international monetary reserves are
viewed as stable. Country’s exports exceed imports, it then Experiences
a balance of payments surplus or Accumulation of reserves, like gold
and foreign Currency. When the The country Loses reserves, it Country
loses Experiences balance of payments deficit (or imports Exceed
exports). However, depletion of reserves reflects The unhealthy
performance of an economy and thus. Creates various problems. That’s
why every country Aims at building substantial volume of exchange
Reserves. Anyway, the accumulation of exchange reserves is essentially
conditioned by the rate of exchange the rate at which one currency is
exchanged for another currency to carry out international transactions.
The exchange rate should be stable as far as possible. This is often what
one may call it external stability in price. External instability in prices
hampers the smooth flow of products and services between nations. It
also erodes the confidence of currency. However, maintenance of
external stability is no longer considered because the macroeconomic
policy objective also as macroeconomic policy instrument. It Is,
however, due to growing inter- connectedness and interdependence
between different nations within the globalised world, the task of
fulfilling this macroeconomic policy objective has become more
Problematic.

v. Social objectives:

The list of objectives that we’ve referred here is by no means an

exhaustive one; one can add more within the list. Even then we’ve
incorporated the major ones.
Macroeconomic policy is additionally used to attain some social ends
or social welfare. This suggests that income distribution must be fairer
and more equitable. In a capitalist market-based society some people
get more than others. So as to make sure social justice, policymakers
use macroeconomic policy instruments.