MACROECONOMICS

Dr.Prashanth Rao
NMIMS School Of Commerce
Email: Chinthapatla.prashanth@nmims.edu
Mobile: 9959876779

1-01-2024 to be used only for lecture purpose at NMIMS SOC 1

Module 1: Introduction

to be used only for lecture purpose at NMIMS SOC 2

What is Economics?
• Economics studies as to how the society can allocate its limited
resources most efficiently.

Economics has two main branches : ??

• Microeconomics
• Macroeconomics
 Microeconomics
• Microeconomics is that branch of economics which analyses the market
behaviour and decision-making process of the individual consumers and
firms.
• Microeconomics focuses on the demand, supply, and equilibrium, and
the price and output determination in individual markets.
• Microeconomics is the study of how individuals (households) and firms
(producers/suppliers) make decisions and how they interact in markets
 What is macroeconomics?

Macroeconomics is the study of the behavior of the economy as a whole and

the policy measures used to influence factors like total output, rates of
unemployment, inflation, and exchange rates, government deficit/debt etc
• Macroeconomics, studies how the national economy as a whole grows and
the changes that occur over time .
• Gives a bigger picture
• Concerns with how well an economy performs and how to improve it

to be used only for lecture purpose at NMIMS SOC

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Point out the differences between Micro and Macro Economics ???

Macro deals with aggregates, Micro deals with specific product or market or
decision of a particular consumer or firm

Microeconomics and Macroeconomics are the two sides of same coin – explain.
 Main objectives of Macroeconomic policies
 To maintain a high level and increasing rate of growth in national income along with stable prices
and low unemployment

A High and sustainable economic growth

Full Employment
Price stability
Addressing inequality
Sound Government finances
External balance/Stability

to be used only for lecture purpose at NMIMS SOC 7

Why is it important for managers?
A manager has to be perform within the boundaries of macroeconomic environment

Macroeconomic Environment
• Demand
• Interest rates
• Prices
• Stability
• Exchange rate fluctuations

to be used only for lecture purpose at NMIMS SOC 8

Are these important for Managers?
A manager has to be perform within the boundaries of macroeconomic environment
• To understand how economy functions-what causes fluctuation in
demand
• Direction of government policies
• To arrive at a decision on timing of fresh investment
• To get the best return on investment

to be used only for lecture purpose at NMIMS SOC

 Macroeconomics: Functions
• Help to ‘formulate policies by anticipating economic conditions’ for
consumers, firms and the government
 For consumers, the concern is how
 easily one can get work,
 prices of goods and services and
 cost of borrowing.
 For firms, it is important
 whether to expand production,
 whether consumers have purchasing power,
 how to get finance for production activities etc
 The government is concerned with
• taxes,
• decision on interest rates,
• formulating policies for better economic performance and
• regulation of markets for the benefit of the economy
• Continuously explaining the macroeconomic scenario and
looking for appropriate actions
• Evaluate Performance of the economy is very important.
• We measure performance of an economy by variables like
GDP growth, unemployment, inflation etc
• In this connection, the stability and growth are equally
important
Containing the fluctuations in business cycles
How to increase growth
Using macroeconomic forecasts for sustainable growth
 Macroeconomics and three models
• Very Long run
Growth theory explains the very long run behavior of the economy
through understanding how productive capacity grows.
• Long run
In the long run, productive capacity can be taken as given. ‘Output
depends on aggregate supply, and prices depend on both aggregate
supply and aggregate demand.
• Short run
In the short run, the price level is fixed and output is determined by the
level of aggregate demand.
 To maintain a high level and increasing rate of growth in national income
along with stable prices and low unemployment

Conflicts between the objectives

• A healthy growth and a low rate of inflation
• A healthy growth and equilibrium in the balance of payments
• A low rate of inflation and low unemployment
• A healthy growth and an equal distribution of income and wealth
• A healthy growth and a healthy environment
A healthy growth and a low rate of inflation

• If an economy grows too quickly and that too

due to an excessive increase in the consumer
demands,
• then there will be an increase in the prices.
Thus, there will be growth but accompanied by
inflation.
A healthy growth and equilibrium in the balance of
payments

• In a growing economy consumer spending is

high, especially on foreign goods in comparison
to domestic goods.
• This leads to the trade deficit and disequilibrium
in the balance of payments.

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A low rate of inflation and low unemployment

• Downward sloping Philips curve

inflation and unemployment have an inverse relationship.
Higher inflation is associated with lower unemployment
and vice versa.

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A healthy growth and an equal distribution of income and wealth
• It is difficult to achieve equality in the distribution of
income and wealth ‘side by side’ with growth because
forcing equality can have an adverse effect on the
incentives for work and, thus, lead to inefficiencies.

A healthy growth and a healthy environment

The faster is the growth the higher is the pollution
because of the smoke emanating from the factories and
cars, disappearance of forests to make way for the new
factories and houses, etc.
 Some macroeconomic policy challenges…..(think and
answer)

• How to reduce unemployment in the economy?

• How to foster and stabilize economic growth?
• How to control inflation?
• How to control money supply in the economy?
• How to correct balance of payment difficulties?
Tools of Macroeconomic policy
Tools

Fiscal policy- Exchange rate

operation by the policy
government Monetary policy- operation
by the monetary authority,
central bank

Currency exchange
rate, foreign exchange
Government
reserve
expenditure,
taxation
Open market operations, CRR,
interest rate, exchange rate

SLR- Statutory Liquidity Ratio

Fiscal policy
The policy of government taxation and spending to achieve sustainable
growth.
The government’s choice regarding levels of spending and taxation.

 Tax cut
 Tax rise
 Increase in government expenditure and investment
 Decrease in government expenditure and investment
 Disinvestment
 Monetary Policy
Monetary policy is a set of tools used by a nation's central bank to
control the overall money supply and promote economic growth and

 Inflation targeting
 Controlling long term interest rate
 Exchange rate policy
• Exchange rate policy involves choosing an exchange rate system and
determining the particular rate at which foreign exchange transactions will
take place.
• A country’s exchange rate policy affects its relative price structure in
domestic currency terms between goods which are traded internationally
(tradables) and goods which are produced for the domestic market (non–
tradables or home goods). (IMF)
 Withdrawals and Injections
• Withdrawal/ Leakage: income that is generated in the production of
national output and is not part of the circular flow
3 types: Savings, Taxes and Import
• Injection: Amount of money spent by different sectors in addition to
their incomes generated in the circular flow of income
3 types: Investment, Government expenditure and exports
• In equilibrium, leakages are equal to injections and the circular flow
remain the same
• If Injection > Leakage, economy will grow
• If Injection < Leakage, economy will shrink/ recession
 The Circular-Flow of Income - Two Sector Economy
• A simple circular flow model of the macro economics containing two sectors (business
and household) and two markets (goods and services) that illustrates the continuous
movement of the payments for goods and services between producers and
consumers.
• It shows the real flows and the money flows.
• money flows from households to firms as consumption expenditure made by the
households on the goods and services produced by the firms.
• Money flows from households to firms as consumption expenditure made by the
households on the goods and services produced by the firms.
• Money flows from business firms to households as factor payments and then it flows
back from households to firms. This circular flow of money or income continues year
after year. This Is how the economy functions.
• In the figure, the resources flow from households to firms as indicated by the arrow
mark. In opposite direction to this, money flows from business firms to the households
as factors payments such as rent, wages, interest and profit.
Understanding GDP: The Circular Flow of Income (Two Sector Economy)
Injections: Govt.(G)/Exports(X)/Investment(I)

FIRMS National Output/GDP

Investment • Inner loop describes money flow

rent Payment Goods
Land
for
• Outer loop depicts real flow
Labor wages Capital and
Capital profit/ Goods Services • The diagram also describes how
market and
interest
Services
GDP is calculated
Saving Income approach (incomes of
Expenditure factors of production)
approach Expenditure approach (total expenditure
HOUSEHOLDS
of g and s)
Income
approach
Leakages: Taxes(T), Imports(M)
 Assumptions of Circular Flow Model:
• There are only two sectors in the economy, household sector and business sector.
• The business sector hires factors of production owned by the household sector
and it is the sole producer of goods and services in the economy.
• The household sector is the sole buyer of goods and services. It spends its entire
income on the goods and services produced by the business sector.
• The household are also suppliers of labor and various of other factors of
production.
• The business sector sells the entire output to households. It does not store. There
are, therefore, no inventories.
• There are no savings and investment in the economy.
• Government does not exist for all such practical purposes (No public
expenditures, no taxes, no subsidies, no social insurance contribution, etc.).
• The economy is closed one having no international trade relations.
Understanding GDP: The Circular Flow of Income (Three Sector Economy)
Government Spending What will happen if
G>T
taxes
(Government spending >
Taxes)
FIRMS
- Government follows a
Investment Budget deficit
Land
Rent
Wages Payments Goods - Borrowing from capital
Government Labor Profit/ Capital market for final and
Capital Interest goods and
services
Services
market (rise in interest
Saving rate)
- Taxes are (direct and
HOUSEHOLDS indirect taxes)
taxes imposed on individuals
and corporates
- capital formation is not
Government Spending
happening then GDP will
shrink/fall
to be used only for lecture purpose at NMIMS SOC
What will happen if T>G (Taxes > Government spending )
• Budget Surplus
Budget Surplus :- administration, defence, justice, development, social welfare,
subsidies etc.
• Payments to households (as salaries, in army, civil services etc)
• Payments to firms for goods and services bought
• Subsidies to firms
• Transfer payments – for social security and welfare, e.g. pensions,
unemployment benefits etc

Govt Expenditure

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Understanding GDP: The Circular Flow of Income (Four Sector Economy)
Government Spending Payment for Imports

taxes Payment for

Exports
FIRMS

Investment
Rent Payments
Goods
GOVERNMENT
Land Wages for final
and FOREIGN
Labor Profit/ Capital market goods and
Capital Interest services
Services
SECTOR

Saving
X(exports) < M(imports) X>M
- trade deficit - Trade surplus
HOUSEHOLDS - Leakages are more - Injections are more
than injections
taxes
hence this will
than leakages
reduce income hence this will increase
- Leads to foreign income
borrowing - Leads to foreign lending
Government Spending
- Rupee will - Rupee will appreciate
depreciate (dollar (dollar will depreciate)
will appreciate)
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Gross Domestic Product
GDP is the Market Value of all Final Goods and Services Produced on
Domestic Soil During a Given Time Period