MACROECONOMICS (ECU_07202)

TOPICS TO BE COVERED
1.INTRODUCTION
2.NATIONAL INCOME ACCOUNTING
3.NATIONAL INCOME DETERMINANTION
4.MONEY AND BANKING
5.MACROECONOMIC INSTABILITY
6.INTERNATIONAL TRADE
7. ECONOMIC GROWTH AND
DEVELOPMENT
 1.Introduction to
Macroeconomics
1.1 What is Macroeconomics?
1.2 Nature and Scope of Macroeconomics
1.3 Differences between Macroeconomics
and Microeconomics
1.4 Significances of Macroeconomics
1.5 Tools of Macroeconomics
1.6 Evolutions of Macroeconomics
1.7 Limitations of Macroeconomics
 What is Macroeconomics?
• Macroeconomics is the study of the
structure and performance of national
economies and of the policies that
governments use to try to affect economic
performance.
• Macroeconomics study the interaction of
the economy as a whole such as
aggregate demand, aggregate supply and
national income.
Why Macroeconomics and not
Microeconomics?
• The two reasons for it as follows:
(1) What is good at the micro level may
not be good for the economy as a whole.
Accordingly, separate theories are
needed to discuss micro and macro
issues.
(2) The macroeconomic problems, e.g.,
inflation, deflation, BOP disequilibrium
and unemployment can be solved only
through macro level programmes.
 Scope of Macroeconomics
• Macroeconomics as a subject has a
wider scope than microeconomics. The
study of macroeconomics extends to the
following areas:
• Theory of National Income;
• Theory of Employment;
• Theory of Money and Banking;
• Theory of General Price Level;
• Theory of International Trade; and
• Theory of Economic Growth.
Difference between Macro and
Microeconomics.
Microeconomics is the study of economic
actions of individuals and small groups
of individuals.
Macroeconomics deals with aggregates
of these quantities, not with individual
incomes but with the national income,
not with individual prices but with the
average price levels, not with individual
output but with the national output
 Difference between Macro and
Microeconomics.
• The objective of microeconomics on
demand side is to maximize utility
whereas on the supply side is to
maximize profits at minimum cost.
• The main objectives of macroeconomics
are full employment, price stability, stable
economic growth and favorable balance
of payments (BOP).
 Difference between Macro and
Microeconomics.
• The basis of microeconomics is the price
mechanism which operates with the help
of demand and supply forces. These
forces help to determine the equilibrium
price in the market.
• The basis of macroeconomics is national
income, output and employment which are
determined by aggregate demand and
aggregate supply.
 Difference between Macro and
Microeconomics.
• Microeconomics is based on different
assumptions concerned with rational
behaviour of individuals.
• Macroeconomics bases its assumptions
on such variables as the aggregate
volume of output of an economy, with the
extent to which its resources are
employed, with the size of the national
income and with the general price level.
 Difference between Macro and
Microeconomics.
• Microeconomics is based on partial
equilibrium analysis which helps to explain
the equilibrium conditions of an individual,
a firm, an industry and a factor.
• Macroeconomics is based on general
equilibrium analysis which is an extensive
study of individuals and their interrelations
and interdependences for understanding
the working of the economic system as a
whole. (e,g CGE model, Leontief Model)
 Interdependence of Micro and
Macroeconomics
• The difference between the microeconomics
and macroeconomics is very vivid but these
two branches cannot be taken as totally
independent of each other. The changes in
one influence the other.
• For example, increased savings by individual
households shall definitely cause a fall in
aggregate consumption in the economy.
• This is known as paradox of thrift.
Significance of Macroeconomics
1. It helps to understand the functioning of a
complicated modern economic system.
2. It helps to achieve the goal of economic
growth, higher level of GDP and higher
level of employment.
3. It helps to bring stability in price level and
analyses fluctuations in business
activities. It suggests policy measures to
control Inflation and deflation.
Significance of Macroeconomics
4. It explains factors which determine
balance of payment. At the same time, it
identifies causes of deficit in balance of
payment and suggests remedial
measures.
5. It helps to solve economic problems like
poverty, unemployment, business cycles,
etc., whose solution is possible at macro
level only, i.e., at the level of whole
economy.
Significance of Macroeconomics
6. With detailed knowledge of functioning of
an economy at macro level, it has been
possible to formulate correct economic
policies and also coordinate international
economic policies.
7. Macroeconomic theory has saved us from
the dangers of application of
microeconomic theory to the problems of
the economy as a whole (national
economy).
 Tools of Macroeconomics
• Fiscal Policy: Uses of taxation and
government expenditure to stabilize the
economy.
• Monetary Policy: relates to the
management of money supply and credit
to step up business activities, promote
economic growth, stabilize the price level.
• Income Policy: through this policy direct
control is exercised over prices and wages
(EWURA, LATRA & TASAC)
 Evolutions of Macroeconomics
• Classical Macroeconomic Model
• Price Adjustment: Prices adjust quickly
to equilibrate demand and supply. General
equilibrium prevails, as demand equals
supply simultaneously in all markets.
• Full Employment: The economy
produces at capacity, on the production
possibility frontier. There is no waste of
capital and labor. There is no
unemployment.
 Classical Macroeconomics
• Neutrality of Money: Money is neutral,
that is money has no effect on real
variables. Money serves only to set the
overall price level. Doubling the money
supply doubles the price level.
• Supply: The classical model focuses on
supply, in the sense that the economy
produces with full employment of capital
and labor. (Supply creates its own
demand)
 Classical Macroeconomics
• Efficient Allocation of Resources: In a
general equilibrium with perfect
competition, the allocation of resources is
Pareto efficient.
• No Role for Countercyclical
Government: since the allocation of
resources is efficient, there is no role for
countercyclical fiscal or monetary policy
by the government (invisible hand).
 Keynessian Macroeconomics
• John Maynard Keynes rejected the
classical model. In 1930s the world was in
depression. The allocation of resources
was not efficient, with much idle capital
and labor. Instead the economy was in
crisis.
• Rejection of General Equilibrium:
Recession is not just a change in the
general equilibrium allocation of resources
rather we have partial equilibrium.
 Keynesian Macroeconomics
• Aggregate Demand: Keynes introduced
the concept of aggregate demand, the
overall demand for goods and services in
the economy. Deficient aggregate demand
is the cause of recession.
• Countercyclical Macroeconomic Policy:
In recession, the government should take
action to raise production and employment
by using expansionary fiscal policy.
 Keynesian Macroeconomics
• Persistent Unemployment: Keynes
believed that unemployment might persist
indefinitely.
• Money is Not Neutral: With
disequilibrium and unemployment, money
is not neutral. Increasing the nominal
money supply will reduce the real interest
rate. Investment demand will then
increase, and national income and product
expands.
 Neoclassical Macroeconomics
• Neoclassical economic theory believes
that markets will naturally restore
themselves. Prices and therefore wages
will adjust on their own response to
changes in consumer demand.
• Keynesian economic theory does not
believe markets can adjust naturally to
these changes.
 Neoclassical Macroeconomics
• Neoclassical emerged in around 1900s to
compete with the earlier theories of
classical macroeconomics.
• Classical economists assume that the
most important factor in products’ price is
its cost of production.
• Neoclassical economists argue that
consumers’ perception of a product value
is the driving factor in its price.
 Neoclassical Macroeconomics
• Assumptions underpin neoclassical model:
1. Rational thinking: people make rational
choices between options based on the
value that they identify in each choice.
2. Maximizing: consumers max utility while
firms max profits.
3. Information: people act independently
based on having all the relevant
information to a choice or action.
 Limitations of Macroeconomics
1. Fallacy of Composition: In
Macroeconomic analysis the “fallacy of
composition” is involved, i.e., aggregate
economic behaviour is the sum total of
individual activities. But what is true of
individuals is not necessarily true of the
economy as a whole. For instance,
savings are a private virtue but a public
vice. Paradox of saving
 Limitations of Macroeconomics
2. To Regard the Aggregates as
Homogeneous: The main defect in
macro analysis is that it regards the
aggregates as homogeneous without
caring about their internal composition
and structure. The average wage in a
country is the sum total of wages in all
occupations, i.e., wages of clerks, typists,
teachers, nurses, etc
 Limitations of Macroeconomics
3. Aggregate Variables may not
be Important Necessarily: For
instance, the national income of a
country is the total of all individual
incomes. A rise in national income
does not mean that individual
incomes have risen.
Limitations of Macroeconomics
4. Indiscriminate Use of
Macroeconomics Misleading: For
instance, if the policy measures
needed to achieve and maintain full
employment in the economy are
applied to structural redundancy in
individual firms and industries, they
become irrelevant.
 Limitations of Macroeconomics
5. Statistical and Conceptual Difficulties:
These problems relate to the
aggregation of microeconomic
variables.
• If each data unit is different, it
becomes difficult to judge. The
aggregate tendency may not affect all
sectors equally. (e.g subsistence
output)
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