Principles of Economics

Twelfth Edition

PART IV
CONCEPTS AND
PROBLEMS IN
MACROECONOMICS

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Why Macroeconomics?
• Macroeconomic issues are more controversial;

– Macro hits us on our pockets through its

policy prescriptions, so we want clear answer.
– Macro gets intimately involved in politically
sensitive issues.
– Media cares these macro issues and wants to
find controversy to sell those.

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Principles of Macroeconomics

• Principle 8: A country’s Standard of Living

Depends on its ability to produce goods and
Services. (Output Growth)
• Principle 9: Prices Rise when the Government
Prints Too much Money (Inflation)
• Principle 10: Society Faces Short-Run Trade Off
between Inflation and Unemployment.
(Unemployment)

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PART IV : CONCEPTS AND
PROBLEMS IN MACROECONOMICS
• When the macroeconomy is doing well, jobs are
easy to find, incomes are generally rising, and
profits of corporations are high.
• If the macroeconomy is not doing well, new jobs
are scarce, incomes are not growing, and profits
of the corporations are low.
• Given the large effect that the macroeconomy can
have on our lives, it is important that we
understand how it works.

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Principles of Economics
Twelfth Edition

Chapter 20
Introduction to
Macroeconomics

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Chapter Outline and Learning
Objectives
20.1 Macroeconomic Concerns
• Describe the three primary concerns of macroeconomics.
20.2 The Components of the Macroeconomy
• Discuss the interaction between the four components of
the macroeconomy.
20.3 A Brief History of Macroeconomics
• Summarize the macroeconomic history of the United States
between 1929 and 1970.
20.4 The Indian Macroeconomics
• Summarizes some of macroeconomic trends of the Indian
economy in the recent past.
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Chapter 20 Introduction to Macroeconomics

• Microeconomics Examines the functioning of individual

industries and the behavior of individual decision-making
units—firms and households.
• Macroeconomics Deals with the economy as a whole.
Macroeconomics focuses on the determinants of total
national income, deals with aggregates such as aggregate
consumption and investment, and looks at the overall level
of prices instead of individual prices.

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 Chapter 20
Introduction to Macroeconomics (2 of 2)
• aggregate behavior: Aggregate is used in macroeconomics
to refers to sums. This refers to the behavior of all
households and firms together in an economy.
• When we speak of aggregate consumption and aggregate
investment which is refers to total consumption and total
investment.
• sticky prices: Microeconomics works well as the prices are
flexible to quantity supply and demand. But
macroeconomics observe that prices that do not always
adjust rapidly to maintain equality between quantity
supplied, and quantity demanded. (example wage rate).

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 Macroeconomic Concerns
• Three major concerns of macroeconomics are:
• Output growth
• Unemployment
• Inflation and deflation
⮚ Government policy makers would like to have
high output growth, low unemployment and low
inflation.
⮚ Another major concern is that these goals may
conflict with one another. (Conflicting goals of
macroeconomy)
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Output Growth (1 of 2)
• Business cycle The cycle of short-term ups and downs in
the economy. The main measure of how an economy is
doing in a given period of time in terms of aggregate
output.
• Aggregate output The total quantity of goods and
services produced in an economy in a given period of time.
• Recession A period during which aggregate output
declines. Conventionally, a period in which aggregate
output declines for two consecutive quarters.
• depression A prolonged and deep recession.

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Output Growth (2 of 2)
• expansion or boom The period in the business
cycle from a trough up to a peak during which
output and employment increases.
• contraction, recession, or slump The period in
the business cycle from a peak down to a trough
during which output and employment fall.
• The expansion and contraction of business cycle
period is not uniform and may be erratic

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FIGURE 20.1 A Typical Business Cycle
• In this business
cycle, the
economy is
experiencing
expansion as it
moves through
point A from the
trough to the peak.
• When the
economy moves
from a peak down
to a trough,
through point B,
the economy is in
recession
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Unemployment
• Unemployment rate The percentage of the labor force
that is unemployed is the key indicator of economy’s
health.
• The existence of unemployment seems to imply that the
aggregate labor market is not in equilibrium.
• A major concern of macroeconomists is studying why
labour markets do not behave like most other markets
where surplus were quickly eliminated by price changes.
• There are different kinds of Unemployment; Voluntary,
frictional (change of jobs), structural (change in technology
and other structure), seasonal unemployment.
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Inflation and Deflation
• inflation An increase in the overall price level.
• hyperinflation A period of very rapid increases in the
overall price level. It is caused by increases in the quantity
of money in circulation that are far higher than needed to
finance economic growth. Inflation rate in venezuela
reached 69% in 2014 and was the highest in the world.
The rate then increased to 181% in 2015, 800%in
2016, 4,000% in 2017 and 2,295,981% in February 2019.
• deflation A decrease in the overall price level. Japan
experienced deflation for several years during their
recession of the 1990s.

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Other Macroeconomic Concerns
• Exchange Rates
• Interest rates
• Budget Deficits

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Exchange Rates

• Exchange rate is the rate at which one currency

is exchanged with another currency.
• Exchange rate is one of the monetary policy
tool of the economy.
• Depreciation and Appreciation of Currency
• Devaluation and Revaluation of currency
• Real and nominal exchange rates

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Interest Rates
• Interest rate is one of the monetary policy tool of the
economy.
• High interest rate is the symptom of tight monetary
policy
• Low interest rate is the easy monetary policy
• Different types of interest rates; benchmark, call
money rate, deposit rate, treasury bill rate etc.

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Government Budget Deficit
• An existence of Govt. spending more than
Taxes is called budget deficit
• Deficit has to be financed by borrowings
• Deficit raises national debt
• Fiscal deficit, Current account deficits etc.

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The Components of the Macroeconomy
• Understanding how macroeconomy works is complicated
due to many interconnections.
• To see the big picture of the macroeconomy, we divide the
participants in the economy into four broad groups:
1. Households
2. Firms
3. The government
4. The rest of the world
• Households and firms make up the private sector, the
government is the public sector, and the rest of the world
is the foreign sector.

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The Circular Flow Diagram
• A useful way of seeing economic interconnections
among four groups in the economy is circular flow
diagram, A diagram showing the flows in and out of the
sectors in the economy.

• Every payment made by the government to people do have

supply goods, services, or labor in exchange for these
payments except transfer payments.
• Transfer payments Cash payments made by the
government to people who do not supply goods, services, or
labor in exchange for these payments. They include Social
Security benefits, veterans’ benefits, and welfare payments.

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FIGURE 20.3 The Circular Flow of Payments

• Households receive
income from firms
and the government,
purchase goods and
services from firms,
and pay taxes to the
government. They
also purchase
foreign-made goods
and services
(imports).

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FIGURE 20.3 The Circular Flow of Payments

• Firms receive
payments from
households and the
government for
goods and services;
they pay wages,
dividends, interest,
and rents to
households and
taxes to the
government.

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FIGURE 20.3 The Circular Flow of Payments
• The Government
receives taxes from
firms and households,
pays firms and
households for goods
and services—including
wages to government
workers—and pays
interest and transfers to
households.
• Finally, people in other
countries purchase
goods and services
produced domestically
(exports).
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The Components of the Macroeconomy –
Alternative Approach (1 of 6)
• Another way of looking at the ways households,
firms, the government, and the rest of the world
relate to one another is to consider the markets in
which they interact. (Three Market Arena)
• We divide the markets into three broad arenas:
• The goods-and-services market
• The labor market
• The money (financial) market

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The Three Market Arenas (2 of 6)
Goods-and-Services Market
• Households and the government purchase goods and
services from firms in the goods-and-services market.
• Firms purchase goods and services from each other and
also supply to the goods-and-services market.
• Households, the government, and firms demand from this
market.
• The rest of the world buys from and sells to the goods-and-
services market.

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 The Three Market Arenas (3 of 6)
Labor Market:
A labour market is the place where workers and employees
interact with each other.
In the labour market, employers compete to hire the best, and
the workers compete for the best satisfying job.
A labour market in an economy functions with demand and
supply of labour.
• In the labor market, households supply labor, and firms and
the government demand labor.
• Labor is also supplied to and demanded from the rest of the
world (Foreign Sector).

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The Three Market Arenas

• A financial market is a broad term describing any

marketplace where trading of securities including equities,
bonds, currencies, and derivatives occur.

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The Three Market Arenas (4 of 6)
Money (Financial) Market
• Households supply funds to the money market (or financial
market) in the expectation of earning income in the form of
dividends on stocks and interest returns on bonds.
• Households also demand (borrow) funds from this market
to finance various purchases.
• Firms borrow to build new facilities in the hope of earning
more in the future.

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The Three Market Arenas (5 of 6)
Money (Financial) Market
• The government also borrows by issuing Government
bonds.
• The rest of the world borrows from and lends to the Money
or Financial market.
• Much of this borrowing and lending is coordinated by
financial institutions, which take deposits from one group
and lend them to others.
• These transactions takes various forms of Financial
investments.

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The Three Market Arenas (6 of 6)
Money (Financial) Market
• Treasury bonds, notes, or bills Promissory notes issued
by the Central government when it borrows money.
• corporate bonds Promissory notes issued by
corporations when they borrow money.
• shares of stock Financial instruments that give to the
holder a share in the firm’s ownership and therefore the
right to share in the firm’s profits.
• dividends The portion of a firm’s profits that the firm pays
out each period to its shareholders.

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 The Role of the Government in the
Macroeconomy
• Fiscal policy Government policies concerning taxes and
spending.
• Government policies concerning Taxes and expenditures
(spending).
• Expansionary fiscal policy (Expenditures > Taxes)
• Contractionary fiscal policy (Expenditures < Taxes)
• Taxes: Taxes are generally an involuntary fee levied on
individuals and corporations by the government in order to
finance: Direct taxes and Indirect taxes
• Expenditures: Government expenditure refers to
the purchase of goods and services, which include public
consumption and public investment, and transfer payments
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The Role of the Government in the
Macroeconomy
Monetary Policy
The tools used by the Central Bank to control the quantity
of money in the economy.

CRR: Cash Reserve Ratio

SLR : Statutory Liquidity Ratio
REPO: Repurchase Agreement
Reverse REPO: Reverse Repurchase Agreement

The amount of money in circulation affects the overall price

level, interest rates, exchange rates, unemployment rates
and the level of output.

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Tools of the Monetary Policy

• Cash Reserve Ratio (CRR) is the share of a bank’s

total deposit that is mandated by the Reserve Bank
of India (RBI) to be maintained by the banks in the
form liquid cash. Currently it is 4%
• Statutory liquidity ratio (SLR) is the Indian
government term for the reserve requirement that
the commercial banks in India are required to
maintain in the form of cash, gold reserves, RBI
approved securities before providing credit to the
customers. Currently it is 18%

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Tools of the Monetary Policy

• Repo rate (REPO) is the rate at which the central

bank of a country (Reserve Bank of India in case
of India) lends money to commercial banks in the
event of any shortfall of funds. Currently Repo
rate is 4%
• Reverse repo rate is the rate at which Central
Bank (RBI) borrows money from the commercial
banks. Currently Reverse Repo rate is 3.35%

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A Brief History of Macroeconomics
• Great Depression The period of severe economic
contraction and high unemployment that began in 1929
and continued throughout the 1930s.
• In 1920s were the prosperous years of the U.S.
All were employed. Income rose substantially.
Prices were stable.
• In 1929 there was a sudden turn in the U.S. economy.
1.5 million people were unemployed.
• In 1933, Unemployment increased to 13 millions out of the
51 million people in U.S.
• Production decreased by 27% within 2 years.

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Roots of Macroeconomics and
Keynesian Revolution.
• Classical economists applied microeconomic models, or “market
clearing” models, to economy-wide problems.
• They believed that recessions (downturns in the economy) were
self-correcting.
• Simple classical models failed to explain the prolonged
existence of high unemployment during the Great Depression.
• This provided the impetus for the development of
macroeconomics.
• In 1936, John Maynard Keynes published The General Theory
of Employment, Interest, and Money.
• According to Keynes, it is not prices and wages that determine
the level of employment, as classical models had suggested,
but instead the level of aggregate demand for goods and
services.

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Macroeconomy Since 1970s
• Learning Objective: Describe and Understand the
fluctuations in macroeconomic variables around
the world.
• GDP/ Aggregate Output volume and its growth
rate
• Unemployment rate and Recession
• Inflation rate in India and abroad.

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FIGURE 20.4 Aggregate Output (Real GDP), 1970 I–2014 IV

MyEconLab Real-time data

Aggregate output in the United States since 1970 has risen

overall, but there have been five recessionary periods: 1974
I–1975 I, 1980 II–1982 IV, 1990 III–1991 I, 2001 I–2001 III,
and 2008 I−2009 II.
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 INDIA GDP

The Gross Domestic Product (GDP) in India was worth 2597.49 billion US dollars
in 2017 (2.6 lakh crores USD (2017)). The GDP value of India represents 4.19
percent of the world economy. GDP in India averaged 545.81 USD Billion from
1960 until 2017, reaching an all time high of 2597.49 USD Billion in 2017 and a
record low of 36.54 USD Billion in 1960.

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India is the 6th Largest Economy in the
World (2018)
USA 19.39 lakh crores USD
China 12.24 lakh crores USD
Japan 4.87 lakh crores USD
Germany 3.68 lakh crores USD
United Kingdom 2.62 lakh crores USD
India 2.6 lakh crores USD
France 2.58 lakh crores USD

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Growth Rates of GDP

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FIGURE 20.5 Unemployment Rate, 1970 I–2014 IV

MyEconLab Real-time data

The U.S. unemployment rate since 1970 shows wide variations.

• The five recessionary reference periods show increases in the
unemployment rate.

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India has lower Unemployment rate?

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FIGURE 20.6 Inflation Rate (Percentage Change in the GDP
Deflator, Four-Quarter Average), 1970 I–2014 IV

MyEconLab Real-time data

• Since 1970, inflation has been high in two periods: 1973 IV–1975 IV and 1979 I–1981
IV.

• Inflation between 1983 and 1992 was moderate.

• Since 1992, it has been fairly low.

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Inflation Rate – India

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Investment and Fiscal Deficits – India

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India’s Inflation Rate Forecast

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