MTP

Session 1
Reading
1. Slides
2. Class notes
MACROECONOMIC THEORY & POLICY (BMJ 2021-23 Term 2)
Instructor: Arundhati Sarkar Bose
Primary Issues of Macroeconomics

Mostly move in the same

direction as output

Output growth Inflation Employment

How are they affected?

How to affect them by policy?

COVID-19
and
The World Economy
15

10

0
ia SA ina K c e ny
aly zil sia eru ina
d U h U an a It r a us P ent
-5In C r r m B R
F e r g
G A
-10
Growth rates:
-15
January – June 2020
-20

-25

-30

-35

Jan - Mar 2020 Mar - Jun 2020

India: Quarterly GDP growth rate 2018-2021 India: Monthly inflation rate 2021
India: Monthly unemployment rate 2018-2021
India: employment scenario 2021
India lost 22.7 million jobs during
April‒May 2021, with the
workers in the low- and semi-
skilled and informal sectors
bearing the brunt. 
Close to 17.2 million daily wage
earners lost jobs as against 3.2
million salaried employees.
Why do we need to learn Macroeconomics?

Because the subject deals with the

wellbeing of people and business.
Do Managers need Macroeconomics?

COVID- Annua Demonitisatio Trump’s Crude inflation Wa Real Tsunami /

9 and l n trade Oil price r estate Katrina /
lockdow Budget war hike bubbles Amphan
n

Consumer’s ability to earn & their decision to

buy

Business profitability & decisions of production, cost and

pricing
Two view points in economics
Micro and Macro
Microeconomic issues
How much will a consumer spend on food?
How much time a worker is willing to work?
How much output will a firm produce?
Which quality to produce?

choices made by Individual agents

Macroeconomic issues
How much income will the country save?
What is the appropriate exchange rate between currencies?
What will happen to employment if taxes are raised?

Aggregate outcome of all the decisions made by individual agents

Or government’s policy response to that.
Some typical macroeconomic questions:

•Should the government raise income tax?

•Should the budget deficit be reduced?
•Should the interest rate be cut down?
•Should the exchange rate be fixed?
•Should the import tariff be withdrawn?
•Should Biden follow the same trade policy as Trump?
•Should Europe have a common currency?
•Is consumerism good for the economy?

……………. Changes in the economy or government policies

– domestic and international
 Why should we worry about issues that we can not alter?
because we are affected by domestic and international macroeconomic events
/ policies positively or adversely
Growth in other nations may make us lose our market share
Growth in other nations may help us grow as well
 Do we need another
subject/ approach?

Can we not add up all the individual (micro) choices, and find out the aggregate ?

Yes… for a particular product market

No…. for the entire economy
The aggregation problem

Can you add oranges to apples?

Only if they are measured in the same unit…. That is, in money
Rs.10 * 60 + Rs.8 * 45

Can you add breads to wheat that the country produces?

No. Value of bread includes a part of the value of wheat produced.
Rs.10 * 2 + Rs.16 *15

Choices are not made in isolation. Say, Everyone decides to saves more.
Should savings in the country increase?
In microeconomic analysis, when a consumer makes a choice, she
takes prices and income and other parameters as given. No
Product market aggregation : summation of isolated individual Everyone wants to saves more
choices Þ Everyone spends less
Þ Every firm gets less revenue
But her choice affects prices and hence others’ choices and in Þ Firms layoff employees
effect her own choice. Hence simply adding up individual choices Þ People’s income falls
will give misleading results for the aggregate. Þ They cannot save as much as they did
 Aggregation of individual decisions
in order to find the economy wide
outcome
makes sense if
individual decisions do not affect each
other.

But they do.

Hence we need a different point of view

– a macro-economic point of view.
Macro-economic policies

Fiscal policy
Monetary policy
Exchange rate policy – fixed / flexible
Policies on international capital mobility
Course outline
Introduction :
General equilibrium of the macro economy: (closed economy)
Macroeconomic issues • Money , bonds and money market equilibrium and LM;
Aggregation problem Goods market equilibrium and IS

Circular flow of income involving households, firms, • Credit creation and instruments of monetary policy
governments and financial institutions. • General equilibrium and introduction to fiscal and monetary
Measuring income and inflation policy

Introduction to national income accounting • Interest sensitivity of money demand and policy effectiveness

3 approaches to measuring aggregate income • Case History : Japan

Measuring inflation: GDP deflator, CPI and WPI. • Macroeconomic crises of COVID 19
Income determination and multiplier • Medium term, Price flexibility and policy effectiveness
Macroeconomic equilibrium The open economy
Multiplier – under different parametric conditions.
• Balance of payments and exchange rates
Paradox of thrift
• Fiscal and monetary policy under fixed and flexible
Balanced Budget multiplier
exchange rates: The Mundell Fleming approach
Deficit financing of the budget
• Trillema of macroeconomic policy objectives
Limitations in the operation of multiplier.
 
Reading:

Blanchard, Olivier – Macroeconomics 7th edition

Evaluation
• Quiz 1 – 30 marks – (on session 1-7)
• Quiz 2 – 30 marks – (on session 8-14)
• End term – 40 marks - (on session 1-20)

• Quiz dates will be fixed after discussion with the CRs.

• Quiz dates will not be changed once fixed.
 Grading

Less than 10 F
11 – 20 D
21 – 30 D+

F, D and D+ are fail grades. To pass you need at least 30.

At most first 30% of those who pass will get A or A+

Grade cuts:

If two of the (subjective) answer scripts carry identical mistakes, or if there is any
other proof of cheating in the quizzes / exams, the students’ manual will be
followed to decide the penalty.
For doubt-clearing

Office: Room number 4, 2nd floor, Library building.

Contact numbers: 9771469737
Office: 0657-665-3158
Email : arundhatisb@xlri.ac.in
How does the economy function?
Let us begin with a simple picture of the economy – with the households and
the firms.

The real economy is more complex.

We shall gradually introduce other aspects to the picture and see how the real
economy works.
 Households Firms

NOTE:
• The economy is divided into sides playing two functional roles.
• The distinction between HOUSEHOLDS and FIRMS is functional.
• An individual belongs to both sectors.
For example:
As an employee when we work for the employer, we play the role for the
FIRM. As consumers we belong to the HOUSEHOLDS.
Circular flow of Income

Wages w, rent r,
profit Π, interest
payments i etc.

Labour, land, Capital

etc.

Households Firms

Goods and services

Consumption expenditure on
goods and services ‘C’
Introducing the Government

Government

Corporate
Govt. profit
Consumption taxes CT
G
Excise /
Subsidy indirect
SB taxes Ti
w, r, Π,
Πi
Households Firms
C
Introducing the Government

Government
Household
Net Debt
direct taxes
interest
HDT
NDI
Transfer
payments
TR
w, r, Π,
Π i
Households Firms
C
Net Debt Interest : Interest payments from govt. to household – interest payment
from household to govt.
Transfer payments : govt.’s spending on scholarships, relief funds etc.
Introducing the Government

Government

Househol Net Debt Corporate

d direct Govt.
interest taxes CT
taxes Consumption
NDI
HDT G Excise /
Transfer indirect
Subsidy taxes Ti
payments
SB
TR
w, r, Π, i
Households Firms
C

Budget surplus of the government

= Taxes earned + Disinvestment income, if any– [G+SB+TR+NDI]
 Government is not just the PSU.
Law and order and governance are essential government activities.

Government may or may not provide healthcare, education,

infrastructure, transport etc.

PSUs are the firms owned and run by government. But

Government is much more than the PSUs. Government may not
own any PSUs at all.
Government is
not a firm
Firms seek profit. Government’s seek sustainable growth
and development.
Government may or may not run a budget surplus. But running a
budget surplus is not a necessity. Governments may run a budget
deficit if that helps growth and development.
Introducing the Financial Institutions (Banks etc.)

Financial
Institutions

Retained
Earnings of
Firms RE
Government Investment
CT funds I

G Ti
NDI S
HD
+TR B
T
w, r, Π, i
Households Firms
C
Introducing the Financial Institutions (Banks etc.)

Financial
Institutions
Govt.’s Savings (when govt.
earns more than it spends)

Govt.’s borrowings (when govt.

spends more than it earns)
Government
CT

G Ti
NDI S
HD
+TR B
T
w, r, Π, i
Households Firms
C
Introducing the Financial Institutions (Banks etc.)

Personal Financial
savings S Institutions
Household
loans

Government
CT

G Ti
NDI S
HD
+TR B
T
w, r, Π, i
Households Firms
C
Introducing the Financial Institutions (Banks etc.)

Personal Financial
savings S Institutions
Household Govt.’s
loans Savings

Govt.’s Retained
borrowings Earnings of
Firms RE
Government Investmen
CT t funds I

G Ti
NDI S
HD
+TR B
T
w, r, Π, i
Households Firms
C
S = Savings
= income earned but not spent
(money put in the savings
account, fixed deposits, equity)

I = Investment
= addition to capital stock
= money spent by firms to add
to capital used for production,
wage payment etc.
 Introducing the Rest of the world

st ic y
e
o m
n om Financial
D co
E S Institutions

Govt.’s
Savings
Govt.’s Re
borrowings the st o
wo f
rld
Government I
CT
RE Exports
Ti
X
NDI +TR
HD G
T Imports
M
w, r, Π, i
Households Firms
C
 Introducing the Rest of the world

s tic
e y
m o m
Do con Financial
E S Institutions
Capital
Govt.’s inflows
Savings Capital
Govt.’s Re
borrowings outflows the st o
wo f
rld
Government I
CT
RE
Ti
NDI +TR
HD G
T
w, r, Π, i
Households Firms
C
Balance of payments
= Current account balance + Capital account balance

Current account balance

= export revenue– import bill
(See slide 37)

Capital account balance

= capital inflow – capital outflow
(See slide 38)
Exercise

How would the Tata Iron and Steel Company

fit in to the economic structure given above?

The Reserve Bank of India?

Exercise

The Deutsche Bank?

Delhi University?

XLRI?

Indian Railways?

A government funded primary school?

A church?
 Exercise

A school that is situated in India but funded by a Belgian church?

Television channels?

Facebook?