Macro-Economics:

Basic Concepts
Lecturer
Abba Aminu (PhD)
Associate Professor of Agricultural Economics
Department of Agric. Economics and Extension.,
Faculty of Agriculture
Bayero University, Kano, Nigeria
Phone +2348024042308
Email: abbasron@yahoo.com

2012/2013 Academic Session

 Macro-Economics
 Economic theory is traditionally
divided into two broad categories;
Macro and micro economics
 Macroeconomics is further subdivided
into; theory and applied. Applied
economics is also subdivided into
policy and econometrics.
 Theory
 There are various terminologies that
are normally used for
macroeconomics, sometimes referred
to as INCOME THEORY and also
referred to as AGGREAGATE
ECONOMICS ANALYSIS or
ECONOMICS OF THE TOTAL.
 Nature of macro-economic theory
 By nature it deals with aggregates
and seek to explain the function and
performance of an economy as a
whole.
 It does this by using what is referred
to as economic indicators such as
national income, employment,
general price level etc.
 Methodology
 By methodology macroeconomics uses the
aggregation method (i.e. economic aggregates).
 This method is very convenient since we are
dealing with the whole economy.
 The assumption underlying this methodology (i.e.
the rational ) is that the groups or the aggregates
would be so selected that each group or
aggregate is sufficiently uniform that we can
make generalization.
 This method was borrowed from the French
classical economist in the 19th century who used
this method of aggregation in the study of their
national income.
 Methodology contd
 The word ‘macro’ is a Greek word
 which means large.

 Macro economics focus on the

magnitude (i.e. aggregates ) not on
the composition. i.e. the forest as a
whole not the individual trees that
make up the forest.
General economic methodology
 Generaleconomic methodology can
be divided into two broad groups;
- Deductive method
- Statistical method
 Deductive method
 This method is commonly used in the
formulation of analytical frameworks
or theories and it has three main
elements;
-Abstraction
-Logical reasoning and
-Deduce conclusion
 Abstraction
Abstraction i.e. abstraction from the real
world through the creation of simplified
form (model) from the real world. This
is generally done by the use of axioms or
assumptions. Axioms usually focus on
those few and significant variables that
are of interest to the problem situation
under
consideration. Those not important to
the
current situation are kept constant.
 Logical reasoning
 Axioms or assumptions are subjected
to logical reasoning
 Deduce conclusion
 The conclusion inferred by subjecting
axiom to logical reasoning are the
economic laws or theories.
 The deductive method was
introduced by classical economist
and such method is not based on
observation or use of data.
 Statistical method
 This method is based on data
collection and observation.
 The primary objective is to
statistically test out the theory.
 Statistician are users and not
formulators of theory. They use what
is already there.
 Dimensions of Macro-Economics
 Monetary economics
 International economics

 Consumption economics

 Investment economics etc

 Why study macroeconomics
 It is necessary to study
macroeconomics in order to
understand;
- the determinants of income
- the effect of government policy on
income
- the performance and
consequences of an economy.
 Contd
 Why is national income high or why is it
low?
 Why is it required that income should be
high enough?
 If government takes X action what is
going to be the effect on income?
 In order to understand or answer all these
we must to know how the economy
function (i.e. linkages and relationships
between variables or aggregates.)
 Why study Contd
 There are two basic method of
studying macroeconomics;
- construction of theory or model
- the determination of equilibrium
Note: We would treat these in greater
detail in the latter part of our
discussion.
 Historical perspectives
 Macroeconomics originated from classical
economist, most of which were from
Britain and some from France and other
part of Europe.
 Before the coming of Keynes in
1896,macroeconomics consist primarily of
theory of output and employment.
 With the coming of Keynes
macroeconomics turn a new leaf, he took
the classical economist to task.
 Keynes replace their concept with his own
broad and new concept of
macroeconomics.
 Historical perspectives contd
 Keynes was a revolutionist to classical and
neoclassical economists.
 Then there was another revolution to Keynes, i.e.
the monetary school ,after which came the
growth theory.
 But macroeconomics is still 90% Keynes.
 The monetary did not succeeded in replacing
Keynes theories.
 Therefore the counter-revolution is not so much
of theoretical superstructure but a matter of
policy.
 What is economy
 There is one to one relationship
between the economy and the
government; infant government is
economy. Macroeconomic theory
goes hand in hand with policy.
 Traditionally three types of economy
are identified
- Free-enterprise economy
- Command economy
- Mixed economy
 Free enterprise economy
 In a free market economy there is a free
mechanism of the forces of supply and demand.
 In this type of economy the market basic
overriding economic institution. The government
is democratic and the ownership of resources is
predominantly private.
 The macro-economic theory we are going to
study is based on the economies of democracies
(i.e. the free market economies) e.g. U.S.A,
Japan, German, Britain etc. and this because the
pioneering of this theory came largely from this
part of the world.
 Macro economic theories are mostly founded by
keynes in the 20th century.
 Command economy
 The socialist economy is a typical of
the command economy.
 In command economic system, the
roles of demand and supply is
restricted.
 Ownership of resources is
predominantly by government.
 Mixed economy
 Inmixed economy, different degree
of the forces of demand and supply
to the extent by which the market is
allowed to perform.
 Examples of Major macro-
economic problems
 Low level of income
 Inflation

 Unemployment

 High rate of interest

 Trade imbalance which lead to

shortage of foreign exchange supply.
This is an important problem in
nigeria.
 Macro-economic objectives
 The objective is to simply deal with the
macro-economic problems. For example,
we want to have;
- high income level
- high growth rate
- supply trade balance as to have
high
foreign exchange.
- low interest rate
 These are usually the objectives specify in
national development plans.
 Indicators of economic
performance
 Level of employment
 Level of interest rate

 Level of income

 Level of trade imbalance

 National debt
 Model and theory

 An economic model is a deliberately simplified

analytical framework. A very rough skeletal
representation
of the economy.
 An economic model is a theoretical framework. It
is an abstraction from the real world.
 A theoretical framework and model work can be
mathematical or otherwise.
 When it is specified in mathematical framework,
it is called mathematical model.
 When it is specified in prose it is called theory.
 The mathematical model is the best, it can enable
u have a number of variables in problems.
 Mathematical model
 It consists of equations which describe
the structure of the model.
 The equations will relate the variables to
each other in a particular way.
 This equations are the assumptions or the
axioms of the model.
 When the equations are subjected to
mathematical operation, we get the model
solution.
 Economic Management
 The basic task of economic management
is to move the economy in the path of
achieving stated objectives.
 Which means the task start with setting
the objectives.
 Then one question arises, are the
objectives appropriate? Once the
objectives are not appropriate the task is
likely to be difficult.
 The task of economic management is the
responsibility of the government of the
day.
Problems of the Nigerian Economy
 Import dependence
 Dependence on single economic sector(?)
 Weak industrial base
 Low level of agricultural production
 Weak private sector
 Dependence on foreign loan
 Regional inequalities
 Rural-urban migration
 Sluggish economic growth
 Inefficient public utilities
 con’td
 Low quality of social services
 Unemployment
 Low capacity utilization
Most of these problems arises from the
structural characteristics of the
economy. The task of government is
to set objectives and use approariate
methods in managing the economy
to solve this problems.
Methods of managing economy
 Traditionally , the methods available for
government in managing economy are
classified into two;
1. Fiscal policy
2. Monetary policy. This approach is
derived from macro-economic theories
which prescribed either or both of this
method in managing the economy.
 Contd
 However in recent times and more
particularly within the developing
countries a broad-spectrum of measures
or methods are now in use for economic
management.
 These measures are as follows;
1. Fiscal policies
2. Monetary policies
3. Programmes
4. Reforms
 Economic mgt condt
Budget
 Each year the government map out how it
intends to manage the economy and it came out
with details of how to do that.
 Traditionally, a budget is defined as an estimate
of the expenditure and revenue per year by the
government.
 Now the budget is more than that, the estimate
of expenditure and revenue is now just one
element.
 Budget is now a comprehensive government
statement of its plan of managing the economy
for a year.
 Budget con’td
 Budget, also include rolling plan i.e.
beyond a year.( e.g. 2 year rolling
plan,..)
A case of economic Management:
2012 Budget , Nigeria
Study under the following;
 Problems of the economy
 Objectives stated
 Performance assessment of the
economy
 Estimated expenditure and revenue
 Policies (with emphasis on
agricultural and financial systems
policies), programme and reforms.
 Fiscal and Monetary policies
 Theories are formulated and the
whole idea of theory in macro-
economics is to suggest policy.
 Policy is an integral method of
economic management.
 Fiscal and monetary policies are used
in managing economy
 Fiscal policy
 The principal objectives of fiscal policy is
to influence the level of spending i.e. the
amount of income available to consumers
and there by influence aggregate demand.
 If the government decide to raise the level
of income such can be done by; reduction
in income tax, reduction in indirect tax,
rise in subsidies, rise in government
expenditure, rise in transfer payment.
 Fiscal policy contd
 Normally fiscal policy are divided into two; fiscal
incentives and fiscal disincentives.
 Fiscal incentives measures include; capital
consumption allowance, tax holiday, reduction in
company tax and reduction in income tax.
 Fiscal disincentives measures include; capital
gain tax (i.e. a tax on profit or sale of share.),
control on dividends payment (e.g subjecting
dividends paid to shareholders to withholding
tax)
 Basically, the instrument of fiscal policy are either
to grant incentives or disincentives to individuals
or companies.
 Fiscal policy condt2
 Tax is fiscal instrument and a fiscal
instrument is one that can be control and
impose only by the authority.
 Types of taxes include; income tax,
education tax, VAT etc
 Apart from tax government can also
impose levies or border prices i.e tariffs.
 There can also be direct government
control such as control on prices and
wages.
 Fiscal policy contd3
 There are four major variables or instruments for fiscal policy and
these are;
- income tax
- indirect tax
- government expenditure
- transfer
 Any of these four variables can be used as an instrument of fiscal
policy.
 Government can decide to use any of them or all in managing the
economy.
 Each of these instrument has a multiplier effect. So we have
income tax multiplier, indirect tax multiplier, government
expenditure multiplier and transfer multiplier.
 Fiscal policy is a direct instrument in that it has effect directly on
consumption , investment, national income, prices and
employment.
 Monetary policy
 Monetary policy is an indirect approach to
influence and manage the economy.
 The CBN is a regulator of money. It has
the basic function of managing money
supply.
 This function is done by restraining and
directing credit expansion through the use
of monetary instruments
 Monetary policy contd
 For monetary policy to have profound impact in
the economy there are some basic underlying
assumptions;
- a highly monetized economy
- a well developed banking system
- a developed money market with a
variety of money market instrument
- a high degree of financial intermediation
- an independent Central Bank
- a diversified asset holding of individual
especially in financial asset
 Monetary policy instruments
 Monetary policy instruments are the tools available to the
Central Bank in managing money supply
 Such instruments include;
- interest rate structure
- reserve requirement also called liquidity ratio
- discount rate
- bank charges
- Open Market Operation
- Moral suasion
- selective credit control
- special deposit from commercial banks
- stabilization securities
- cash ratio
 The most utilized of all these instrument are interest rate
structure and selective credit control mechanism
 Monetary policy institutions
 The Central Bank
 Federal Treasury
 Financial intermediaries
 Commercial banks
 Merchant banks
 Development banks
 Mortgage banks
 Insurance companies
 Investment companies
 Stock brokers
 Savings banks
 Pension fund
 Transmission mechanism
 That is the mechanism by which
these policies affect income and
employment.
 The question is how and where
money gets to influence national
income and employment
 To understand this we have to
discuss the general equilibrium
approach.
Transmission mechanism contd
 e.g. output as a function of bank credit, is this a
realistic hypothesis?
 If all other things held constant and assume a
proper utilization then the hypothesis becomes
realistic.
 The hypothesis is saying that economic activities
are dependent on increase in bank credit
especially in the private sector, therefore credit
restrain could reduce output.
 Also through selective credit control consumer
credit can be reduced to reduce pressure on
spending and therefore reduce inflation. At the
same time we can increase producer credit
thereby enhancing production.
 Therelationship between
employment and output is direct.
 Any business activity no matter how
small generate employment and any
contraction in economic activities
brings unemployment.
 LS and LM curves
 The general principle for describing these
requires the use of complete keysian model. This
model require equilibrium in output and money
market.
 The assumptions of this model:
- one single output X
- Price of X (P) which is an aggregate price
- two sectors of the economy real ( output) and
financial sector( money)
 the apparatus used to combined these two
sectors is the LS and LM analytical framework.
 LS and LM Contd
 We shall continue from here in the
next series ..
 We may probably change the lecture
time ( 2pm-5pm instead of the 9pm-
12pm)
 Macro-economic Aggregates
There are 3 groups of macro-economic
aggregates;
- Aggregates Variables

- Aggregates Markets

- Aggregates Sectors
 Aggregates Variables
Aggregates Variables include;
1. Aggregate Output which is all commodities and services
produce in the economy over some period of time, all
added together by taking their monetary value. GNP is the
official name for aggregate output. GNP = GDP + Net
Income from abroad. GDP = production within the
boundary of the country. Valuation of GNP or GDP is
either at market price or at factor cost. There is also NNP
( Net National Product) i.e. if depreciation is deducted
2. Aggregate Income which is the income of the nation as a
whole. The income recipient in an economy include;
individuals, business firms and governments. The official
name of Aggregate Income is NI ( which is either GNI or
NNI)
 Aggregate Variables Contd
3. Aggregate Expenditure which is the sum of all final
expenditure by residents in the country. They consist of
consumer expenditure, government expenditure, gross
capital formation, difference between export and import all
these constitute GNE (Gross national expenditure)
GNP, GNI and GNE are all identical in value if depreciation is
deducted they become NNP, NNI and NNE. This r/ship is
shown in what is called the circular flow
4. Other aggregate variables include; Price Level (P), Interest
Rate (R) and Employment (N).
Of all the aggregates, the National Income is one of the
major or principal indicator of the performance of the
economy. But an indicator which we have to use with
caution because it is aggregate.
 Aggregates Markets
Market Aggregates include;
 Output market

 Labour market

 Money market

 Bond market

 Foreign exchange market

 Aggregate Sector
Aggregate sectors are obtained through aggregation of the
markets. Two major sectors include;
1. The Real sector which consist of the output and labour
markets
2. The Financial sector consisting of money and bond
markets.

Note: It is from all these aggregates the models

and theories of the economy are based such as
the National Income Model, Consumption
Function model, the Investment Function Model,
the Aggregates Market Models ( Output, Labour
and money market), etc
 Market Models
1. Partial linear Market. This is an isolated market that has
no relation with other markets. The variables are quantity
demanded, price and quantity supplied. If we assume linear
behavioral equation and only one commodity.
Qd= a-bp and Qs= -c +dp

For Qd the condition for equilibrium is that there sholud be

no excess demand . In Qs the intercept –C implies that
there should a minimum price that can induce the supplier
to supplier.
 Market Models Contd
The indigenous variables in the equations are Qd, Qs and P.
To solve for this variables then ;
Qd =Qs ( no excess demand at equilibrium)

a-bp = -c+dp
P= a+c/d+b and Q = a-b(a+c/d+b) = ab-bc/b+d

Compute the equilibrium values in the following equations;

1. Qd = 4-P and Qs = 4p-1

2. Qd= 5-p and Qs= 2p-3

 Market Models
General Market Equilibrium
In this we recognize two commodities that are
related and thus their prices should be part of the
model. The equilibrium condition is that Qd= Qs
for both the commodities. If solution exist, there
should be a set of values of P and Q that would
simoultanessly satisfy the condition of equilibrium
in all the markets.