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 TM

SELF–LEARNING MANAGEMENT SERIES

MACROECONOMICS
ESSENTIALS
YOU ALWAYS WANTED TO KNOW

Learn the concepts of macroeconomics and the logic behind various

economic policies adopted at national and global levels.

DR. AMLAN RAY

Macroeconomics Essentials
You Always Wanted To Know
First Edition

© 2023, By Vibrant Publishers, USA. All rights reserved. No part of this publication
may be reproduced or distributed in any form or by any means, or stored in a database
or retrieval system, without the prior permission of the publisher.

Paperback ISBN 10: 1–63651–181–3

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 About the Author
Dr. Amlan Ray is currently the Assistant
Vice President at Sunstone Edtech Pvt. Ltd,
one of the leading Edtech ventures in India.
Previously he has been Director & Dean of
various higher education institutions across
India. His corporate stints include A.V. Birla
Group and TATA Group in India. Amlan’s
consulting experience and research areas
include Economic Analysis, Digital Transformation, and
International Business. He has also been an advisor to Infinite Sum
Modelling Inc., a U.S.-based multinational consulting firm in the
area of International Trade. Amlan has authored several articles in
Management and Economics journals.

Amlan has executed various training and consulting assignments

sponsored by organizations like AICTE, World Bank, Ph.D.
Chamber of Commerce, Grafoventure, Italy, MasterCard
Foundation, and Data Science Network, Nigeria. He has been
instrumental in designing National Occupational Standard
(NOS) in the area of Digital Transformation for National Skill
Development Corporation (NSDC), India.

Amlan is a B.Tech., MBA, M.A. (Economics), and Ph.D. from

Amrita Viswa Vidyapeetham, India in the area of International
Trade.
 Other Contributors
We would like to thank our editor Nicole Carmichael for her
contribution to making this book the best version possible.
Nicole is a writer and economist with a master’s degree from the
University of Pennsylvania. She works with governments and
nonprofits to design an economy that better serves all people. She
has authored government reports, copyedited books and papers,
and managed a variety of programs and projects.
 What experts say about this book!
In my opinion, there is no doubt about the content, course, and delivery
of the subject. This is absolutely excellent and easy to understand for
students, professionals, and entrepreneurs. The beauty of the book is
that it delivers different aspects of knowledge executed by experts in this
domain.

– Dr. Rajeev Johari, Associate Professor (Management),

Institute of Technology and Science

Conceptually simple and pedagogically sound, this introductory textbook

is meant for beginners and undergraduate students of management,
economics, commerce, and other disciplines. It provides detailed insights
into the theoretical, empirical, and policy implications of various concepts
of macroeconomics, thereby equipping students with a working
knowledge of the subject.

– Dr. Partha Pratim Sahu, Associate Professor,

National Institute of Rural Development and Panchayati Raj
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 Table of Content
1 Macroeconomics: Fundamentals 1
1.1 Overview of Macroeconomics 2
1.2 Factors of Production 3
1.3 Circular Flow of Macroeconomic Activities 5
1.4 Measurement of Economic Activity 7
1.5 Economic Growth 8
1.6 Growth and Development 9
1.7 Economic Success 10
Quiz 13
Chapter Summary 16

2 Measurement of National Income 19

2.1 National Income Accounting 20
2.2 Gross Domestic Product (GDP) 21
2.3 Gross National Product (GNP) 23
2.4 Measurement of GDP 24
2.5 Product or Value Added Method 25
2.6 Expenditure Method 27
2.7 Income Method 29
Quiz 30
Chapter Summary 34

3 Consumption and Savings 35

3.1 Consumption, Income, and Savings 36
3.2 Consumption Function and Marginal Propensity to
Consume 37
3.3 Savings Function 39
3.4 Marginal Propensity to Save 40
3.5 National Savings Across the Globe 41
3.6 National Debt 42
Quiz 44
Chapter Summary 48
4 Investment 51
4.1 What is Investment? 52
4.2 Gross and Net Investment 53
4.3 Methods of Investment 54
4.4 Determinants of Investment 55
4.5 Domestic Private Investment 58
4.6 Foreign Direct Investment 59
4.7 Foreign Portfolio Investment 60
4.8 Investment Demand Curve 61
Quiz 64
Chapter Summary 68

5 Business Cycles 71
5.1 Concept of Business Cycles 72
5.2 Features of the Business Cycle 73
5.3 Peak and Trough 75
5.4 Reasons behind Business Cycles 77
5.5 Seasonality and Business Cycle 80
5.6 Recession 80
5.7 Policy Measures for Stability 82
Quiz 84
Chapter Summary 88

6 Money and Banking 91

6.1 Concept and History of Money 92
6.2 Demand and Supply of Money 93
6.3 Central Banks 95
6.4 Commercial Banks 96
6.5 The Modern Financial System 97
6.6 Evolution of the Banking System 98
6.7 The Modern Banking System 99
6.8 Central Bank of a Country 100
Quiz 102
Chapter Summary 105
7 Macroeconomic Policies 107
7.1 Policy Tools 108
7.2 Monetary Policy 109
7.3 Fiscal Policy 111
7.4 Fiscal Deficit 114
7.5 Inflation and Policy Measures 116
7.6 Unemployment and Economic Policy 117
Quiz 119
Chapter Summary 122

8 External Trade 125

8.1 Trade 126
8.2 Trade Balance 127
8.3 Balance of Payments 128
8.4 Current Account 131
8.5 Capital Account 132
8.6 Effect of BOP on the Economy 133
Quiz 135
Chapter Summary 138

9 Foreign Exchange Market 141

9.1 Bretton Woods Agreement and Gold Reserve System 142
9.2 Foreign Exchange Market 144
9.3 Determination of Currency Rate 145
9.4 Role of the Central Bank in the Forex Market 147
9.5 Fixed Rate vs Flexible Rate 148
9.6 Currency Rate and Foreign Trade 151
Quiz 153
Chapter Summary 157
10 Multilateral Institutions and Macroeconomic Policy 159
10.1 Importance of Multilateralism 160
10.2 Role of IMF 161
10.3 The World Bank 163
10.4 GATT and WTO 164
10.5 Regional Trade Agreements and Trade Blocks 167
Quiz 170
Chapter Summary 173
 Preface
Economics has influenced policy–making across the globe, and
the world of finance and trade are completely dependent on
this subject. Despite the tremendous practical application of
the subject, it is often perceived as obscure and theoretical. This
book attempts to make the readers understand the practicalities
of the subject. Examples taken from various industries in this
book demonstrate how economics can be applied. The book
tries to acquaint the readers with the practical applications of
macroeconomics, unraveling the economics jargon. At the end of
each chapter, the reader should be able to appreciate the practical
application of macroeconomics in business and policymaking.
The purpose of the book is to make people without an economics
background comfortable with the subject. As a learning outcome,
the readers should be able to understand business articles or get
engaged in discussions on economic issues. The book will also
help students of economics in undergraduate level and executive
MBA programs in following their academic curriculum
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 Introduction to the book
Macroeconomic policies govern the world of trade and finance.
The knowledge of macroeconomics is essential for students and
professionals who want to understand the impact of various
policies formulated by the government or central banks. A
knowledge of macroeconomics is a must to participate in business.
The relevance of macroeconomics has increased with its ability
to forecast based on big data and analytics. Often, economics
textbooks become a bit complex due to more emphasis on theories,
and the readers do not become fully aware of its applications.
This book attempts to explain various macroeconomic theories
with examples so that readers can understand its utilities. The
book introduces the readers to macroeconomic concepts like the
circular flow of an economy, gross domestic product, savings,
income, consumption, investments, and their respective roles in
a country’s economy. The book also explores the evolution of
the monetary system, the concept of a banking system, foreign
exchange mechanisms, and the roles that the central banks play in
an economy. The book takes the readers through policy–making
at the country level and multilateral levels. At the end of the book,
the readers will be able to appreciate the following concepts of
macroeconomics:

● Concept of circular flow of income

● Economic growth and development

● Concepts and calculation of GDP

● Income, consumption, savings, and investment

● The banking system and the modern financial system

● Concept of business cycles

● Monetary policy

● Fiscal policy

● The mechanism behind forex rate determination

● International trading system

● Balance of trade and balance of payments

● Multilateralism and policy–making

Finally, the readers will be able to comprehend how

macroeconomic policies are formulated for economic growth
and better living conditions for the people.
 How to use this book?
The book can help various segments of readers. Based on the
readers’ need, it can have multiple usages:

1. Students can use this to understand the basics of

macroeconomics.

2. This can be used as a reference book by various UG–level

students like Engineering, Management, Commerce, Law,
etc. for understanding the concepts of macroeconomics and
policy–making.

3. Readers may look at the book as a guide for a better

understanding of policy issues. Readers may follow various
news related to economics and business and can appreciate
them better by referring to various issues explained in the
book.

4. Students may try to create their own examples and case

studies based on various macroeconomic events happening
around the world.

5. Entrepreneurs can use this book to understand various

policy decisions which may affect their businesses.

6. Instructors may design capstone projects based on various

issues dealt with in this book.
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Who can benefit from this book?
1. Undergraduate students, who can use this as a prescribed
textbook to follow their syllabus.

2. Students at the master’s level in programs like MBA, who

are from non–economics backgrounds, will find this book
useful to understand the basics of economics.

3. Business professionals can use this book to follow policy

issues that will affect their business decisions.

4. Entrepreneurs can learn the basics of macroeconomics to

understand policy matters and appreciate their effect on the
future of business.
This page is intentionally left blank
Chapter 1

Macroeconomics:
Fundamentals

T his chapter introduces the concept and core issues

of macroeconomics and its importance in policy
making. The chapter discusses the circular flow of income
and the complementary role of household and industry.
It also introduces the concept of output, unemployment,
and inflation. It exhibits the importance of measurement of
economic activity. It outlines the concept of economic growth,
the importance of growth in development, and vice versa.
The chapter also discusses the objective and the reasons
behind economic success.

Key learning objectives should include the reader’s

understanding of the following:

● The concept of macroeconomics, its evolution, and how

it differs from microeconomics

● The concept of circular flow of income

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2 Macroeconomics Essentials You Always Wanted To Know

● The concepts of output and GDP

● How to measure economic activity

● What is economic growth?

● Economic growth and development and their

complementary nature

● How to define economic success

1.1 Overview of Macroeconomics

Economics is segregated into Microeconomics and

Macroeconomics. Macroeconomics evolved as a new field in the
1930s with the publication of the famous title ‘The General Theory
of Employment, Interest and Money’ by John Maynard Keynes
. As the field of macroeconomics is concerned with the whole
1

economy, it is useful in shaping countries’ economic policies.

The major issues covered by macroeconomics are Employment,
National Output, Interest Rate, Balance of Payments, International
Trade, Price Level, Currency Valuation, and more.

Macroeconomics is a field of study concerned with economic

growth and business cycles. It can be defined as the study of
the economy as a whole. Contrary to microeconomics, it deals
with market, labor, and consumptions in aggregate for the
entire economy. The word ‘macro’ is derived from the Greek
word ‘macro’ which means large, indicating an economy–wide

1. Vines, David. "John Maynard Keynes 1937–1946: the Creation of International

Macroeconomics: A Review article on John Maynard Keynes 1937–1946: Fighting for
Britain by Robert Skidelsky." The Economic Journal 113, no. 488 (2003): F338–F361.
www.vibrantpublishers.com
Macroeconomics: Fundamentals 3

perspective 2. The usage of large datasets or big data is prevalent

in macroeconomics. Databases for multiple years for a large
number of variables for multiple countries are considered when
crafting macroeconomic policy analysis with global implications.

The COVID pandemic and the recent war between Russia

and Ukraine have familiarized common people with various
types of macroeconomic predictions like the fall in GDP, loss of
livelihoods, crash in stock markets, price rises, etc. However, we
must not consider macroeconomic indicators only as naysayers
or predictors of human catastrophes! Macroeconomics also
deals with the rise in a country’s national income, growth of
employment, economic success stories of emerging economies,
and finally, shows the path for being economically prosperous.
After all, macroeconomics evolved with Keynesian theories
of stimulating the U.S. economy in the backdrop of the Great
Depression. Its contribution is seen in addressing issues like global
poverty, unemployment, and welfare.

1.2 Factors of Production

In the discussion of macroeconomics, we first need to

understand the concept of aggregate output. Now, output is the
total production of goods and services. For the production of
goods and services, we need various resources like land, labor,
capital, and entrepreneurial skills. These are termed as factors of
production.

2. Mitchell, W., Wray, L. R., & Watts, M. ”Macroeconomics”. Macmillan International

Higher Education (2019).
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4 Macroeconomics Essentials You Always Wanted To Know

The first factor of production is land. Land was the primary

requirement for agriculture and for setting up factories. In the
modern service–driven economy, land may not be as essential to
business success, but the term is used to represent different kinds
of resources.

The next factor considered is labor. Labor in economics is

employees’ efforts that lead to the manufacturing of goods and
services. A software engineer programming code, a chef cooking
in a restaurant, an air hostess serving as part of the cabin crew,
and a farmer’s activities are all considered to be labor– one of the
factors of production in macroeconomics. The earnings of the
laborers are termed as wages.

Capital is a crucial factor of production in the production

process. Capital enables farmers to buy their seeds, tractors,
or fertilizers. Factory owners can set up their workshops by
buying machinery with capital. Capital is needed by diagnostic
labs to buy image processing machines, spectrometers, and
echocardiogram machines.

Finally, the entrepreneur utilizes land, labor, and capital to

convert all resources or inputs into the final output. Without
the entrepreneur, labor, capital, or other resources cannot be
combined for the purpose of production.

Economists often simplify the analysis by considering land

(L) and capital (K) as the only factors of production, which is
known as the two–factor production function. This function is
represented mathematically as f(L, K) = O, where output (O) is
dependent on labor (L) and capital (K) as independent variables.

Countries with a strong capital base, such as France,

Switzerland, and the UK, tend to adopt capital–intensive

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Macroeconomics: Fundamentals 5

production methods due to available capital, low–interest rates,

and high wages. Developing countries like India, China, or
Vietnam are more likely to adopt labor–intensive industries
as they have an abundance of low–cost manpower. In the next
section, we explore how firms mobilize these resources to produce
output.

1.3 Circular Flow of Macroeconomic Activities

Households are the suppliers of factors of production like

land, labor, or capital. Households keep their savings in banks
and financial institutions. These savings are given out as loans
to companies, who borrow from households to invest in their
production activities. Similarly, people from households work
in various types of firms, including industrial factories and
agricultural farms, providing the labor supply to these firms.
In return, firms pay wages and rent to the households for their
supply of labor or land. Households earn interest and dividends
from their investments in financial institutions.

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6 Macroeconomics Essentials You Always Wanted To Know

Figure 1.1 Circular flow of macroeconomic activities

Goods and Services

Consumer expenditure

Wages, rent, dividends

Households Firms

Factors for production

The upper circle of Figure 1.1 shows that households are

supplying factors of production to the firms, and in exchange,
firms are supplying goods and services to households. Money is
spent on these goods of consumption by the households, which
is how revenue circles back to the firms. This is the consumption
expenditure incurred by the firms. The wage, rent, and dividends
(See Figure 1.1., inner circle in red) are the source of income for
households which again goes back to the firms as consumer
expenditure.

The above concept helps in the measurement of national

income, as we will explore further in the next chapter.

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Macroeconomics: Fundamentals 7

1.4 Measurement of Economic Activity

Output, price, and employment are three key dimensions

of macroeconomic activity. Output measures the total value of
all goods and services produced by an economy. Price level is
the weighted average of prices of different goods and services
produced in an economy. Employment measures the number of
people in an economy who have jobs.

Output, also called real Gross Domestic Product (GDP), is a

measure of the total quantity of goods and services produced in
the economy. Real GDP is the monetary value of the final goods
and services produced by the country during a year. We will
learn how GDP is calculated in detail in Chapter 2. GDP is also
a measure of the income generated by the total production of
goods and services in the economy. Employees work for a certain
number of hours to produce this output, and the number of hours
worked helps to calculate the level of employment in an economy.

Price or the price level is the weighted average of the market

prices of all final goods and services produced. Price level is
representative of the cost of production in the economy. Inflation
is when there are increases in the level of prices of goods
and services across the economy. The economic performance
indicates how these measures of output, price level, and
employment change over time 3. Countries aim to see increases
in growth in output and reductions in unemployment. Economic
policy–makers try to reduce unemployment by increasing the
engagement of the laborers.

3. Curtis, D., & Irvine, I. Principles of Microeconomics, 2021A version (Lyryx). Lyryx
Learning
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8 Macroeconomics Essentials You Always Wanted To Know

1.5 Economic Growth

Countries prosper when their economies grow. Economists

used to believe that there was a limit to how much wealth a
person or economy could accumulate. In fact, some cultures used
to consider making bundles of money as sinful4. If the supply of
money is limited, then any money you make is technically taken
from someone else's share. However, the scientific revolution
busted this myth, and it is now understood that the economy
can grow and everybody can be better off. Many of the problems
faced by people, like poverty, illiteracy, and conflicts, can be
solved by expanding the economy. Hence, countries primarily
try to grow their economies for the betterment of most of their
citizens. Economic growth cannot exist at the cost of degrading
the environment as a result of global warming and pollution.
Economic growth needs to occur in a way that benefits the planet
and society at large.

Real Growth in GDP is calculated as follows:

Suppose,
Real GDP for the year 2019–20 is GDP20
Real GDP for the year 2018–19 is GDP19
Real GDP growth for the year 2019–20 is Growth20

Now, Growth20 = (GDP20 – GDP19)/ GDP19

Growth is usually expressed as a percentage.

4. Harari, Y. N., & Sapiens, A. A brief history of humankind (2014). Chapter 16

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