Unit One

Introduction to Macroeconomics
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Meaning of Macroeconomics
 The term “macro” is derived from Greek word

“makros” meaning “very big.”

 It was coined by Ragnar Frisch in 1933.
 It is the study of the economy as a whole.
 The unit of the study in macroeconomics is

the entire economy rather than a part of it

and it deals with the problems faced by the
entire economy.
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 According to K.E. Boulding, macroeconomics
deals not with individual quantities as such
with aggregates of these quantities, not with
individual income but with national income,
not with individual prices but with price
levels, not with individual output but with
national output.
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 Macroeconomics was popular after Keynesian
revolution.
 That is why, it is popularly known as Keynesian
Economics.
 Macroeconomics shows the nature, relationship
and behaviour of economic aggregates,
 Macroeconomics explains the process of
determining income and employment,
 Therefore, it is also known as Income and
Employment Theory.
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Growth of Macroeconomics
 The Classical Macroeconomics: The classical

economists had not developed any systematic

macroeconomic theories or models.
 Their macroeconomic thoughts were in the

form of certain postulates which can be

summarized as follows:
 If market forces of demand and supply are

allowed to work freely, then,

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i. there will always be full employment in the
long run and unemployment, if any, will be
a short run phenomenon;
ii. their will be neither over-production nor
under production at the aggregate level;
and,
iii. the economy will always be in equilibrium
in the long run.
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The Keynesian Revolution
 Keynesian macroeconomics was born out of
Keynes’ attempt to find the solutions to
economic problems associated with the Great
Economic Depression in 1930s.
 The Keynesian macroeconomic theories are
mainly associated with employment, growth and
stability.
 The central theme of the Keynesian
macroeconomics may be summarized as follows:
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i. The level of output and employment in an
economy is determined by aggregate
demand given the resources.
ii. The unemployment in any country is caused
by the lack of aggregate demand and
economic fluctuations are caused by
demand deficiency.
iii. The demand deficiency can be removed
through compensatory government
spending.
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Monetarism
 A group of economists called “monetarists”

led by Milton Friedman claimed that

Keynesian theory had failed to predict
national output, price level, rate of
employment and interest rate.
 According to monetarists, the role of money

is central to growth and stability of national

output, not the role of aggregate demand for
real output as advocated by Keynes.
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 In their opinion, money supply is the main
determinant of output and employment in the
short run and price level in the long run.
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Types of Macroeconomic Variables
 Macroeconomic variables are divided into two

types: Stock and Flow Variables.

Stock Variables
 Refer to the quantity or value of certain

economic variables at a point in time.

 Stock variables do not have any time restriction.
 For example, the water stored in a tank at a

point in time and the number of books in a

library on a particular date are stock variables.
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 In economics, money supply, number of
persons employed, deposits in the bank etc.
at a particular time are stock variables.
Flow Variables
 Refer to the quantity which is measured with

reference to a specific time period (length of

time) like hours, days, weeks , months or
years.
 Flow variables have time dimension.
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 For example, the water accumulated in a lake
may be a stock variable, whereas water
flowing out per day is a flow variable.
 In economics, national income, saving,

investment, exports, imports etc. are flow

variables as they describe the flow of
macroeconomic variables during given period
of time.
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Equilibrium and Disequilibrium
 Concepts of equilibrium and disequilibrium

are broadly employed in economics.

 In microeconomics, we basically deal with

partial equilibrium, while we deal with the

general equilibrium in macroeconomics,
Equilibrium
 It is defined as a situation in which the two

opposite forces of demand and supply are

equal.
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 In Keneysian macroeconomics, equilibrium in the
economy takes place when aggregate demand
and supply are equal.
 In an open economy, aggregate demand consists
of the sum of consumption demand (C),
investment demand (I), government demand for
goods (G) and net exports (X-M).
 Hence, aggregate demand is the sum of demand
for all consumer goods and capital goods in an
economy.
 On the other hand, aggregate supply is the
sum of supply of all consumer and capital
goods in an economy.
 In other words, aggregate supply is the total

output (Y) produced in an economy.

 The Keynesian equilibrium in an open

economy can be presented as follows:

AS = AD
Y = C + I + G + (X-M)
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Disequilibrium
 It is a situation of imbalance between the two

opposite forces of demand and supply.

 In Keynesian macroeconomics, disequilibrium

arises when aggregate demand is not equal

to aggregate supply.
 Due to interrelated and interacting forces,

continuous balance between demand and

supply can not be expected.
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 If aggregate demand is less than aggregate
supply, business inventories increase causing
overproduction.
 On the other hand, if aggregate demand is

more than aggregate supply, business

inventories decrease causing
underproduction.
 Figure
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Types of Macroeconomics
(A) Simple Macro static
 It explains the aggregate relation in a

stationary state.
 It deals with the final equilibrium of the

economy at a particular point of t of time.

 It shows the still picture of the economy as a

whole.
 It does not explain the process of adjustment

of the final equilibrium.

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 It only explains the condition required for
equilibrium.
 Figure

(B) Comparative Macro static

 It makes the comparative study of different

equilibria attained by the economy.

 It makes comparison between new and old

equilibria.
 However, it does not provide the answer about

the cause of disequilibrium and final adjustment

to the new equilibrium.
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 Figure
(C) Macro dynamic
 It traces out the whole path through which the

system passes over time to reach the new

equilibrium.
 The macro dynamic method enables one to see a

motion picture of the functioning of the

economy.
 It explains the whole process of disturbance in

one equilibrium and the attainment of other

equilibrium.
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