Unit 1: Introduction to Macroeconomics

Meaning:

The word macro is derived from the Greek word ‘makros’ means large. It is the
study of economy as a whole. It is concerned with study of aggregate economic
variable like national product, general level of price, aggregate consumption and
investment, etc..

R.G.D Allen rightly remarks,” The term macroeconomics applies to study of

relation between broad economic aggregates.”

In the word of P.A. Samuelson,” Macroecnomics is the study of behavior of the

economy as a whole. It examines the overall level of national output, employment,
price and foreign trade.”

It deals with

How national income of a country is determined?

How employment is determined?

How productivity capacity of a country increase overtime?

What cause general price level to rise in an economy?

Role of government policy regarding expenditure and taxation and money supply?

Scope of Macroeconomics
The study areas of macroeconomics includes

1. Theory of income and employment:

Macroeconomics studies the factors that determine level of national income
and employment of a country. It deals with the causes that reduce in national
income and increase in unemployment.

2. Theory of general price level and inflation:

It studies the factors that affect general level of price and how such general
level of price increase over time. It studies the causes and consequences of
 the problem of inflation. It gives government certain policy measures to
stabilize such price level or continue their expenditure for growth.
3. Theory of economic growth:
Another distinct and more important branch of macroeconomics is theory of
economic growth or growth economics. The problem of growth is long run
problem. It studies how an economy’s productivity capacity grows over long
period of time. It shows the factors that determines economic growth of a
country and explains why some nation grow faster than others.
4. Theory of international trade:
Macroeconomics studies issues relating to international trade. Export and
Imports, exchange rate and balance of payment are the main topic covered in
macroeconomics.
5. Theory of Money:
Theory of money studies what determines the money supply and money
demand in an economy. It shows how price and supply of money is related?
How money market is injected to real market of an economy.
6. Macro Theory of distribution:
This part of branch of macroeconomics studies distribution of national
income among various sectors of economy and various classed of people.

Importance of Macroeconomics

1. It helps to understand the functioning of a complicated modern economic

system. It describes how the economy as a whole functions and how the
level of national income and employment is determined on the basis of
aggregate demand and aggregate supply.

2. It helps to achieve the goal of economic growth, higher level of GDP

and higher level of employment. It analyses the forces which determine
economic growth of a country and explains how to reach the highest state
of economic growth and sustain it.

3. It helps to bring stability in price level and analyses fluctuations in

business activities. It suggests policy measures to control Inflation and
deflation.
 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.

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. Last but not the least, is that macroeconomic theory has saved us from the
dangers of application of microeconomic theory to the problems of the
economy as a whole.

Limitation of Macroeconomics
1. Most macroeconomic conclusion is based on aggregates of individual
behavior. But, what is true for individual might not be true for economy as a
whole.
2. The aggregates of macroeconomic variables are heterogeneous in nature and it
is very difficult to sum such variables in reality. And result based on aggregate
is not accurate.
3. Aggregate doesn’t tell about internal composition of the economy.
4. Due to heterogeneous nature of variables it is statistically difficult to measure
such variables in aggregate.
5. Variables of macroeconomics are calculated within specific time period but
due to randomness of behavior of individual in reality there may arise error in
aggregation.
6. The aggregate variables which form the economic system may not be of much
significance. 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.
Difference between Macroeconomics and Microeconomics
Microeconomics Macroeconomics
It deals with individual
It deals with aggregates or averages
decision making.
of entire economy.
Takes into account of small
components of whole Takes into consideration of economy
economy. as a whole.
Areas of study of
Areas of study of macroeconomics
microeconomics include
include theory of income and
consumer behavior, price
employment, theory of economic
theory, and theory of
growth, theory of price level and
production.
inflation.

It studies how individual firm It studies how economic growth is

and consumer optimize his/ optimized over a period of time.
her goal with limited
resources.
Government policies Government policies regarding
regarding microeconomics are macroeconomics are fiscal policy and
pricing policy, tourism policy, monetary policy.
industrial policy, etc.
Interdependence Between Micro and Macro
Micro on macro dependence
1. When aggregate demand rises during a period of prosperity, the
demand for individual products also rises.
2. Macroeconomic change brings about changes in the values of
microeconomic variables in the demands for particular goods, in
the wage rates of particular industries, in the profits of particular
firms and industries, and in the employment position of different
groups of workers.
3. The overall size of income, output, employment, costs, etc. in the
economy affects the composition of individual incomes, outputs,
employment, and costs of individual firms and industries.
Macro on micro dependence
1. Total is sum of different parts, if income of all individual
increases this leads to increase income of nation as whole.
2. Interest rate of particular financial institute depends on aggregate
variable that is total income, total saving, aggregate stock of
money.
3. Profit of particular firm depends on macroeconomic condition of
the country. For example during period of boom business person
earns high amount of profit whereas during recession low profit.
4. Prices of particular product depend on general level of prices.
When general level of prices is raising then prices of a commodity
is also increasing.
Macroeconomic concepts:

Stock variables:
A stock is measured at one specific time, and represents a quantity
existing at that point in time. For example, total amount of wealth of an
individual on 2075 B.S. such variable are accumulated in past.
A flow variable is measured over an interval of time. Its value is
represented in per unit of time per week, per hour, per day, etc.
For example rate of speed, GDP per year, consumption, saving, etc.
Variables like stock of capital goods, money supply, price level, are
stock variables and investment, GDP, inflation, and consumption are
flow variables.
Sometimes change in value of stock over different time period is a flow
variables like change in stock of capital goods is investment of a period.
Similarly, change in flow variables causes accumulation of value of
stock variable.

Macro static
Macro-statics analysis explains the static equilibrium position of the
economy. Value of macro static analysis relates to particular point of
time. Economic statics refers to a timeless economy. It neither develops
nor decays. It is like a snapshot photo from a ‘still’ camera which would
be the same whether the previous and subsequent positions of the
economy were subject to change or not. For example the two sector
Keynesian model equation is given by
Y=C+I
Here the value of income(Y), consumption(c), and investment(I)
resembles same particular point of time and equilibrium level of income
is determined at that time. This macro-static model is illustrated in
Figure 1.
Here aggregate demand (C+I) is interacted with 45 degree of income
line at ‘E’. And OY is equilibrium level of income. It is timeless
adjustment of equilibrium position.

Comparative Statics:
Comparative statics is the method of analysis in which different
equilibrium situations are compared. In economics, comparative statics
is the comparison of two different economic outcomes, before and after
a change in some underlying exogenous parameter. In static equilibrium
relates to particular determining factor which is often called data in
economics are held constant. But in comparative static comparison of
different equilibrium that relates to different set of data is compared.
It’s like taking two snap shots of moving car at different time and then
compared.
Here in above figure, aggregate demand and aggregate supply model,
initially equilibrium position is at e1 now due to certain exogenous
change aggregate demand shifts upward and new equilibrium is formed
at e2. Now comparative static compare price change and quantity
change at two different equilibrium.

Macro Dynamics
Dynamic analysis traces the path from one equilibrium position to
another equilibrium position. One variable relation of a particular time
period depends on value of another variable of different time period it is
called dynamic relationship between the variables or time lag relation. It
is also a state of disequilibrium.
In the figure E0 is initial equilibrium where C+I is equal to 45 degree
line. If investment(I) increases c+I shifts upward and intersect at En.
Macro dynamic studies how this new equilibrium position is obtained.
It traces the time path of all disequilibrium within two equilibrium.