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.

Macroeconomics is the study of whole economies--the part of

economics concerned with large-scale or general economic
factors and how they interact in economies.

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 Importance of Macroeconomics
Consumers want to know how easy it will be to find work,
how much it will cost to buy goods and services in the
market, or how much it may cost to borrow money.

Businesses use macroeconomic analysis to determine

whether expanding production will be welcomed by the
market. Will consumers have enough money to buy the
products, or will the products sit on shelves and collect
dust?

Governments turn to macroeconomics when budgeting

spending, creating taxes, deciding on interest rates, and
making policy decisions.
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 Primary Macroeconomic Goals
Economic Growth: Growing economies create jobs and
raise living standards by increasing production and demand.

Full Employment: It aims to provide jobs for all, reducing

poverty and ensuring economic stability.

Price Stability: Maintaining stable prices preserves the

purchasing power of money, benefiting consumers and
businesses.

Balance of Payments Equilibrium: Trade imbalances, like

deficits or surpluses, can impact a country's economy by
affecting debt and industries.
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 Theories of
Macro Economics
 Classical Economics Theory

Classical economics is a school of economic thought that

emerged during the 18th and 19th centuries, primarily
associated with economists like Adam Smith, David Ricardo,
and John Stuart Mill. It laid the foundation for modern
economics and emphasized certain key principles:

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Key Elements of Classical Economics

Laissez-faire: Minimal government intervention in the

economy, advocating for free-market principles.

Say's Law: Suggests that supply creates its own demand,

implying no overproduction or general glut in a well-
functioning market.

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Key Elements of Classical Economics

Belief in Self-Correction: Classical economists believed

that markets naturally tend toward equilibrium and self-
regulate.

Historical Context: Classical economics emerged during

the Industrial Revolution in the 18th and 19th centuries,
addressing the shift to industrial and capitalist economies.

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Keynesian
Economics
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 Principles of Keynesian Economics:
1. Aggregate Demand:

Keynesian theory emphasizes that aggregate demand is a driving force for the economy due
to its direct influence on economic output, employment, and overall economic well-being.

An economy's total demand for goods and services determines its overall economic activity.

2. Aggregate Supply:

Aggregate Supply is the total amount of goods and services that all firms in an economy
are willing and able to produce at a given overall price level during a certain time period.

It is divided into three distinct ranges based on the price levels and their effects on
production: Short-run, Long-run and Medium-run Aggregate Supply

3. Multiplier Effect:

Where an initial increase in spending (e.g., government spending) leads to a larger overall
increase in national income due to the successive rounds of spending and re-spending in
the economy.
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 Role of Government Intervention During
economic downturn
1..Stabilizing Aggregate demand:

Economic downturn will lead to a cycle of reduced spending, lower

production, and increased unemployment.

The govt should intervene to break this cycle by boosting demand using
Fiscal policy and monetary policy.

2. Addressing Unemployment and Underutilization of Resources:

In times of economic downturns, there can be significant unemployment

and underutilization of resources.

The Government should intervene and solve the problem by introducing

projects that will increase employment opportunities and utilize the
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underutilized resources.
 Fiscal Policy
Fiscal policy is defined as the policy under which the government uses the
instrument of taxation, public spending, and public borrowing to achieve
various objectives of economic policy.

Components of Fiscal Policy:

- Government Spending
- Taxation

To stabilize the economy during an economic downturn:

The government can increase its spending on public projects,

infrastructure, and social programs.

Provide tax cuts to individuals and businesses.

During inflation and Overheating of Economy:

During periods of high inflation or when the economy is overheating, the

government can reduce spending or increase taxes to decrease aggregate 12
demand.
Historical Context (Great Depression)
During the Great Depression, traditional economic theories and policies
were ineffective in addressing the crisis.

John Maynard Keynes, influenced by the failure of classical economic

theories to provide solutions, introduced his revolutionary ideas
advocating for active government intervention to manage demand and
stabilize the economy.

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Monetarism
 Monetarism is an economic theory and school of thought that emphasizes
the role of money supply and its management in influencing economic
activity, particularly the overall level of prices and inflation.

Key Principles of Monetarism:

Money Supply and Inflation

Quantity Theory of Money
Monetary Policy's Role
Long-Term Neutrality of Money
Rational Expectations
Active Monetary Policy

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 Money Supply
Monetarists believe that changes in the money supply, influence the overall price
level in the economy directly.

The reasons why monetarists believe that controlling the money supply is
essential for economic stability:

Inflation Control:
By managing and restraining the growth rate of the money supply,
central banks can keep inflation in check and maintain price stability in
the economy.
Price and Economic Stability:
Fluctuations in the money supply can lead to volatility in prices and
economic activity.
Interest Rates and Investment Decisions:
A controlled money supply growth will lead to stable and
predictable interest rates.
Rational Expectations and Policy Effectiveness:
By signaling a consistent and predictable approach to money supply 16
growth, monetary policy becomes more effective in influencing economic
behavior and expectations.
 Quantity Theory of Money
The theory establishes a direct relationship between the quantity of
money in an economy and its price level. It is usually given by the
equation MV = PQ
where:
M = Money supply
V = Velocity of money
P = The price level
Q = quantity of goods and services produced

1. Direct Proportional Relationship: Assuming the velocity of money and

the quantity of goods and services produced (VQ) remain relatively
constant in the short term, an increase in the money supply (M) will lead
to a proportional increase in the price level (P).

2.Inflation: If the money supply grows faster than the economy's ability to
produce goods and services (Q), it can lead to inflation.
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Role of central banks in implementing
monetarist policies
Setting Monetary Policy Instruments:
Monetarist principles guide instruments (such as open market operations,
reserve requirements, and discount rates that the central banks have at
their disposal) to achieve a targeted growth rate of the money supply
consistent with their inflation goals.
Influencing Interest Rates:
Central banks use interest rates as a tool to manage the money supply and
implement monetarist policies
Setting Money Supply Targets:
Central banks, following monetarist principles, set specific targets for
the growth rate of the money supply.
Analyzing Economic Indicators:
The analysis of the economic indicators can result in economic and
price stability.
Communicating Policies and Objectives:
C e n t r a l b a n k s c o m m u n i c a t e t h e i r o b j e c t i v e s , s t r a t e g i e s , a n d d e c i s i o n s t o 18
the public transparently.
New Classical
Economics
 New Classical Economics is an economic thought that emerged in the
1970s as a response to perceived shortcomings of traditional Keynesian
economics.

Rational Expectations:

Rational expectations theory posits that individuals and firms make

predictions about the future based on all available relevant information.

They use this information to form expectations about economic variables

such as prices, output, and inflation.

Market Clearing:

New Classical economics assumes that markets clear continuously.

If there is an excess supply of a good or labor, prices and wages will

a d j u s t d o w n w a r d , a n d i f t h e r e i s e x c e s s d e m a n d , t h e y w i l l a d j u s t u p w a r d . 20
 Efficient Markets Hypothesis
The Efficient Markets Hypothesis (EMH) is a fundamental concept in
finance that asserts that financial markets are efficient in processing
and incorporating all relevant information into security prices.

Information Efficiency: The core idea of the EMH is that markets are
efficient in processing information.

Three Forms of Efficiency:

1. Weak Form Efficiency
2.Semi-strong Form Efficiency
3.Strong Form Efficiency

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 Influence on Policies

The new classical economics theory emphasis on market efficiency, rational

expectations, and skepticism toward active government intervention has
shaped policy discussions in several ways:

1. Limited Government Intervention

2.Critique of Countercyclical Policies

3.Focus on Market-Friendly Policies

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New Keynesian
Economics
New Keynesian Economics extends John Maynard Keynes' ideas, aiming to
clarify short-term output and employment fluctuations. It differs from
classical economics by introducing 'sticky' prices and wages, which adjust
slowly, challenging the notion of immediate market equilibrium.

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Main Principles of New Keynesian Economics,
Emphasizing Sticky Prices and the Role of
Government:
Sticky Prices and Wages: Prices and wages resist quick adjustments,
causing unemployment and suboptimal output in the short term.

Imperfect Competition: Firms have market power, slowing price

adjustments compared to perfect competition.

Role of Government: Advocates government intervention, using fiscal and

monetary policy to combat market failures during downturns.

Synthesis of Views: Strives to reconcile Keynesian and neoclassical ideas

by respecting long-term market forces while endorsing short-term
government intervention for stability."

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Real Business
Cycle (RBC)
Theory
RBC Theory explains economic fluctuations as stemming primarily from
changes in the supply-side factors, like technology and productivity. It
shifts away from Keynesian demand-side explanations, highlighting the
importance of real, non-monetary factors in business cycles.

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 Key Concepts of RBC Theory

Supply-Side Focus: RBC theory attributes economic fluctuations mainly to

supply-side shocks like tech advancements or productivity changes,
leading to output and employment swings.

Voluntary Unemployment: It claims unemployment is mostly voluntary,

driven by personal choices, not involuntary or cyclical labor market issues.

Limited Government Role: RBC advocates minimal government

intervention during downturns, as it sees real factors as the main drivers
of fluctuations, making demand management policies less effective.

Critiques: Critics argue RBC theory neglects demand-side forces,

financial markets, and market imperfections, limiting its policy relevance.
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Post-Keynesian
Economics
Post-Keynesian Economics is a heterodox economic theory that diverges
from mainstream economic thought. It builds upon the ideas of John
Maynard Keynes but extends them in various ways to provide alternative
explanations for economic phenomena.

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Central Concepts of Post-Keynesian Economics,
Heterodox Approach: Post-Keynesian economics challenges mainstream
economics by questioning ideas like perfect competition and market
balance. It's like saying, "Hey, not everything works the way they say it
does!"

Endogenous Money Supply: Post-Keynesians believe that banks create

money when they lend it out, kind of like magic. This is different from the
mainstream idea that money is controlled by central banks.

Financial Instability: Post-Keynesians worry that financial markets are

like a rollercoaster – they can go wild and crash suddenly. They think
speculation and risky moves can cause financial disasters.

Income Distribution Focus: Post-Keynesians care about how money is

shared. They say, "Let's make sure everyone gets a fair piece of the pie!"
because they think it affects how much stuff we can buy and how stable
the economy is.
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 Quick recap
Classical Economics: Minimal government intervention, self-
correcting markets, and the idea that supply creates its own demand.
Rooted in the Industrial Revolution.

Keynesian Economics: Focus on boosting aggregate demand to drive

economic activity. Government policies can influence output and
employment. The multiplier effect is crucial.

Monetarism: Emphasis on managing money supply to control

inflation. Rational expectations and long-term neutrality of money
are core principles.

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New Keynesian Economics: Extends Keynesian ideas, introducing
"sticky" prices and advocating for government intervention during
downturns.

Real Business Cycle Theory: Attributes economic fluctuations to

supply-side factors like technology, minimizing the role of
government during downturns.

Post-Keynesian Economics: Heterodox approach challenging

mainstream economics, with a focus on endogenous money supply,
financial instability, and income distribution.

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Macroeconomics remains a vibrant field characterized by ongoing debates
and discussions. These dialogues revolve around critical topics such as
fiscal policy effectiveness, the role of central banks, and the impact of
globalization on economic stability, highlighting the field's dynamic
nature.

Macroeconomic theories have continually adapted to shifting economic

conditions, reflecting the field's resilience and responsiveness to real-
world challenges. This evolution underscores the importance of dynamic
economic thought in addressing the complexities of our ever-changing
global economy.

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Thank
you!!