Assignment

Subject: MACRO ECONOMICS

Submitting Date: March 2, 2009

Topics
Evolution of macroeconomics
SCOPE OF MACROECONOMICS
INTEGRATION OF MICRO & MACRO ECONOMICS
Separation of micro & macro economics
Macroeconomics variables & functions
Economic model
Macroeconomic problems
 MACROECONOMICS
Evolution of Macroeconomics:
Classical Macroeconomics:

Till 1930 the Great Depression regarding working of the economy

was presented by classical economists like Smith, Ricardo, Say and
Marshall.
According to the classical economists in the real sector of the economy
“Supply creates its own demand”
Thus we see the classical economists on the basis of
• Flexibility of prices
• Flexibility of rate of interest
• Flexibility of wages
• Constancy of velocity of circulation of money proves that
there is always full employment in the economy

J. M Keynes Macroeconomics:
In 1936, Keynes rejected the classical theory of full employment and
he also presented his own theory of income and employment.
According to the Keynes

Submitted To: Submitted By:

Mr. Shiahid Hassan Syed Hassan Askari – 073605-098
Abdul Haseeb - 073605-063
Section: B
Batch: 36
“The level of income and employment is determined where the
aggregate demand is equal to the aggregate output”
Keynes identified the inflation and unemployment.

Hicksian Macroeconomics:
Keynes didn’t consider the role of rate of interest in the determination
of national income. So John Hicks presented the concept of
“IS Curve”
“In such curve he established the relationship between rate of
interest and national income through equality of saving and
investment.”
He also presented the concept of
“LM Curve”

In such curve he established the relationship between the rate of

interest and national income through equality of demand for money
and supply of money.
Thus with the help of IS and LM Curves, Hicks presented the
stimulation equilibrium in goods and money markets.

Modern Macroeconomics:
In Keynes theory, the concept of AD and AS has been presented
without any relation to the level of prices.
So Modern Macroeconomics linked AD and AS to the level of
prices.

Macroeconomics for Stabilization:

In 1960 the major macroeconomic problem was that of inflation. Thus
following theories were presented regarding inflation

• Demand pull inflation

• Cost Pull inflation
• Phillips curve approach to inflation

Scope of Macroeconomics:

http://www.econ.iastate.edu/classes/econ102/wang/documents/S07LectureNotes1.
pdf

The study of macroeconomic theory is important for several reasons.

• It provides us with tools by which we can judge the performance

of an economy. The performance of an economy is judged by the
Gross National Product (GNP) of the economy.
• It is generally assumed that the objective of the government in
any country is to raise the material well being of the country.
Now the question is how to define the material well being of the
country. These questions are discussed in welfare economics
which forms a part of macroeconomics theory.
 • Macroeconomic theory is also useful to the government for
formulating appropriate policies such as monetary policy, fiscal
policy, income policy, etc.
• In many developing countries the objective of the government is
to promote economic development. For this the government
should know the factors influencing the process of economic
development so that these factors can be manipulated. For this
reason also the knowledge of macroeconomic theory is essential.

• For any business firm the knowledge of macroeconomic theory is

required.
• From the theoretical standpoint also the knowledge of
macroeconomic theory is necessary.

Integration of Micro & Macroeconomics:

First of all I would like to differentiate between micro and

macroeconomics. Micro means “small”, so it deals with small level. E.g.
it deals with economic terms regarding individual, firm, company or
industry. So it has narrow perspective. It deals with economic affairs of
individual, households.
Macro means “large”, so it deals with large level. E.g. it deals with
economic affairs of whole country, government, in short words we can
say it with whole world. It’s at global level. It shows overall economic
affairs of a country. So its dimension is larger than microeconomics.
As for as this topic is concerned, according to my point of view,
integration of micro and macro economics can’t be occurred. Because
both are different from each other. One deals with smaller level and
other deals with larger level. They can’t integrate because they are
different from each other. But somehow they can affect each other.
Now I’ll explain that how integration of micro and macroeconomics
can’t be occurred. Microeconomics scale is very small because it deals
with economic affairs of individual, household etc. But macroeconomics
has very larger dimension because it deals with economic affairs of
country, government. And it also includes different economic policies
like GDP, employment rate income tax So macroeconomics field is
diversified. So integration of micro and macroeconomics can’t be
occurred.

Separate Identity of Micro & Macroeconomics:

It’s very easiest to differentiate between micro and macroeconomics

because both are different from each other and both have same
identity. As a result we can say that both micro and macroeconomics
are important. Because first of all if we want to make research, then
first of all we would have to observe economic affairs of individual and
after that we would be able to study the whole economy of country. So
always start from lower level to higher level. So we can’t say that
macroeconomics is more important than microeconomics. But both are
important.
If we talk about microeconomics, it would lead us to know economic
affairs of individual, household. So it has main importance. And if we
talk about macroeconomics, it would lead us to know GDP rate.
Inflation rate, unemployment rate and other different rates regarding
economic affairs. At the end we can conclude that both are different
from each other and both have separate identity and they can’t be
integrated.

Macroeconomics Variables & functional relationship

There are some many important variables of macroeconomics. Some
are given below.
• Consumption
• Investment
• Savings
• Money Demand
• Supply of money as function of interest
a) Consumption:
Consumption depend upon income as follows
C = f (Y)
• As income grows up, consumption increases
• As income decreases, consumption decreases
General Form:
In general it is represented as
C = Co + cY
Autonomous Consumption= (Co)
Induced Consumption = (c)
Average Prospenity to consumption:
APC = c/Y
Ratio of consumption to national income is called as APC.
Marginal Prospenity to consumption:
MPC = d c/ dY
MPC = +c
Slope of consumption is greater than 0
b) Investment:
I = f (Y)
G.F:
 I = Io + eY
Autonomous Investment = Io
Induced Investment = eY
Average Prospenity to Investment:
API = I/Y
API = Io+Ey/Y
Marginal Prospenity to Investment:
MPI = Di/Dy
MPI = d/dY(Io+Ey)
MPI = 0+ edY/Dy
MPI = + e
Slope of investment function is greater than zero

C) Savings:
Savings is given as
S = f(Y)
G.F:
S = -So + dY

Average Prospenity to Savings:

APS = S/Y
APS = -So + SY/Y

Marginal Prospenity to Savings:

MPS = Ds/Dy
MPS = d/dY (-So + sY)
MPS = 0 + s
Slope of saving function is greater than zero
d) Money Demand:
Money demand depends upon income
MD = f (i)
Speculation demand for money:
Msd depends upon interest rate

e) Supply of money as function of (i):

Ms = f(i)
F) Demand for labor is function of real wages:
DL = f (W/P)

ECONOMIC Model
The economic model is used to explain the theoretical principles of
economics. This model consists of equations and functional relations
which explain of an economy or some economic unit. The economic
model consists of mathematical equations, diagrams and computer
programs which make the forecasting’s regarding the behavior of
economic variables. According to:
Ackly Gardener
An economic model consist of set of economic functional
relationship and in each function relation there is at least one variable.
Mac Dougal
An economic model represents an economic reality

The economic models are classified into two categories

• Microeconomic
• Macroeconomic

Microeconomic Model
In microeconomic model study the individual units of economy
like consumer, firms and factors of production and study the working of
a firm , behavior of customer and determine the prices of goods. In
this model we see the consumer’s demand model, the model of
consumer behavior, the model of demand, supply and the model of
equilibrium.

Macroeconomic Model
In macroeconomic model we study the aggregate consumption,
aggregate investment, national income and the general price level etc.
This model is used study the working of the whole economy and
mostly employed in economic paining. Acceding to:

Keynesian Models (1936-1969)

The Simple Keynesian Model, a vastly oversimplified view of the

economy, constructs an equilibrium without referring to the labor
market. The point of this exercise is to shows that the economy can
be in an equilibrium that is far from full employment.

http://www.ask.com/bar?q=Types+of+Economic+Models&page=1&qsr
c=6&zoom=Definition+%3CKW%3EEconomic+Model%3C%2FKW%3E
%7CGeneric+%3CKW%3EEconomic+Model%3C%2FKW%3E%7CHow
+Does+the+Government+Use+%3CKW%3EEconomic+Models%3C%2
FKW%3E&ab=2&u=http%3A%2F%2Fwww.econmodel.com%2Fclassic
%2F
The economic model is divided into two categories
1. Partial equilibrium model
2. General equilibrium model

Partial equilibrium model

In this model, two or few variables are selected while the rest
are kept fixed. Then the functional relationship is estimated between
the selected variables of the model.

General equilibrium model

The general equilibrium model is composed of all the variables of the
economy. The general equilibrium model establish the relationship
between all the variables of the economy (eg) In the market model we
will observe that the price of goods, the supply of a goods, demand of
many goods influence the demand and supply of a goods. This
situation will represent a general equilibrium model.

Derivation of economic model

There are two methods to derive the economic model
1. deduction Method
2. induction Method

Deduction Method
In this method we derive the specific result from an ordinary
reality of life. When we get a conclusion from a routine fact of life this
will be a deductive method to derive an economic model. (e.g.)
consumption depends upon income and when income increase
consumption also increases but not in the same proportion.
Induction Method
In this method a simple law is derived on the basis of specific
fact of life. The fact are selected and the statistical data is collected
regarding the selected facts. After analysis that data find the
conclusion and on the basis of such special result we form an ordinary
law.

Construction of an Economic Model

Variables of the Model

When the model is constructed the variables of the model are
selected. The variables which we establish have a functional
relationship (eg) the Keynesian Law of consumption, the two
variables like C and Y where C= f(Y). C and Y are variables because
they both can change.

Assumptions
It is assumed that the normal conditions prevail in the economy,
there is no hyper inflation in the economy, there is no change in the
distribution of income and there is no change in the tastes of people
this shows that we will have to make certain assumptions (eg)
Keynesian law of consumption assumes that except C and Y all other
variables are constant.

Hypothesis
The hypothesis expresses the behavior of the variables of the
model. In the law of demand we see hypothesis that a result of
increase in price, the quantity demanded falls (e.g.) Keynesian
consumption function the hypothesis is that along with increase in
income, the consumption also increase, the hypothesis of this law
suggests the positive relationship between income and consumption.

Prediction
On the basis of above elements and facts we can deduce a
result, As the case of law of consumption (Keynesian) predicts that
there exists a non-proportional relationship between income and
consumption.
Macroeconomic Problems:
Unemployment

Unemployment refers to the condition of being unemployed, or to the

number or proportion of people in the working population who are
unemployed

Unemployment, especially involuntarily can cause big problems in our

modern world. But how does one measure such an enormous
prospect? When measuring unemployment it is first necessary to
measure the working population, as not every person is able to work.
Looking at the elderly and young children as labor resources would be
a waste of time. Therefore the first step to controlling unemployment
would be to first measure the size of the scale we are working with.
We must also look at current unemployment problems, more
specifically the costs of unemployment, what causes unemployment as
well as examining the various types of unemployment including
voluntary and in-voluntary unemployment. Would 100% employment
benefit the economy? Overall we must discuss the consequences
unemployment bring and the means by which it may be controlled.

Unemployment rate
The unemployment rate is a ratio, obtained by dividing the number of
unemployed persons by the number of persons in the labor force.

Unemployment as a problem

Several circumstances contribute to the problem of unemployment. For

example, the constant changes in the modes of production, which
today sees the advancement of automation and technology in many
areas, and the rationalization of production management practices
aimed at maximizing profit and reducing maximum cost.

Many people end up losing their work or they just can’t find it because
by age or level of education they are unable to adapt new technologies
and sectors. All this has an impact on the quality of life on large
sections of the population, which expects income and also feel
threatened by often achieved fatigue. Some people argue that in order
to enjoy life, it is necessary to consider your aim.

Above all it will be necessary to empower individuals, ensuring that

they own the idea of continuing education, caring for their talents, and
autonomy in the development of appropriate training. Important
education will be a widespread, but more importantly the willingness to
learn independently throughout your life.

Each of us needs occupations sufficiently attractive, well-remunerated,

to alternate periods of work with periods of study, rely more productive
within organizations, workplaces healthy and stimulating.
Unemployment benefits are needed to prevent the development of
pockets of poverty, give all training opportunities and change, give the
people the chance to express their talents.

Inflation

Inflation is defined as an increase in the average price level in the

economy. Thus, if the price of each good or service in the economy
were to rise by 5% from one year to the next, we could say without
hesitation that the average price level has risen by 5%, and there has
been 5% inflation. But, in general, prices do not all rise at the same
rate, some rise rapidly, some rise slowly, and some prices even drop.
Thus, we express the overall price level by a price index, that is, an
average of these different rising and falling prices. But a simple
average won't do. Some prices are more important than others. In the
economy of the 1990's computers are more important than buggy
whips, so it doesn't make sense to add the price of computers to the
price of buggy whips and divide by two. Instead we use a weighted
average with weights that reflect the importance of the different
products in production. Since a lot more computers are produced than
buggy-whips, we would give computers a heavier weight. Such a
weighted index of prices is known as a "price index.