Macroeconomic Analysis and Policy What is Macroeconomics?

Session-1

Macroeconomics Deals with the economy as a whole. Macroeconomics focuses on the determinants of national income, deals with aggregates such as aggregate consumption and investment, and looks at the overall level of prices instead of individual prices. Macroeconomics may be defined as that branch of economic analysis which studies the behaviour of not one particular unit, but of all the units combined together. The following are the fields covered by macroeconomics: Fields of Macroeconomics Theory of Income, Output and Employment with its two constituents, namely, the theory of consumption function, the theory of investment function and the theory of business cycles or economic fluctuations. Theory of Prices with its constituents of the theories of inflation and deflation. Theory of Economic Growth dealing with the long-run growth of income, output and employment. Macro Theory of Distribution dealing with the relative shares of wages and profits in the total national income. Macroeconomists... Try to figure out why overall economic activity rises and falls Try to understand what determines the level and rate of change of overall prices Study other variables that play a major role in determining the overall levels of production, income, employment, and prices Microeconomics vs. Macroeconomic The words Micro and Macro have Greek origins Mikros and Makros. Mikros implies small and Makros large. Microeconomics is concerned with the most Elemental economic units, like consumer, firm, input, market and industry. Microeconomics vs. Macroeconomic The micro-macro distinction in economics is not based solely on size. Ex: Studying pricing policy of GE- Realm of microeconomics Studying inflation in a small country like Rwanada or Burundi - Realm of Macroeconomics Microeconomics focuses on decisions of individual units however large they may be; Macroeconomics concentrates on behaviour of entire economies, no matter how small. Macroeconomics studies the overall price level, unemployment rate and other things that we call economic aggregates. What are Economic aggregates then ? Economic aggregates are an abstraction that people use to describe some salient features of the economic life. Although we observe process of individual products, we never see the price level. Domestic product/national output is is also an abstract notion, though it represents the total production in an economy, it is unobservable. The process by which real objects such as computers, wheat, wine are combined into an abstraction called total domestic product is aggregation.

Biswa Swarup Misra

September 16, 2009

Macroeconomic Analysis and Policy

Session-1

Limitations of Aggregation Ignores distinction amongst the different products. Although composition of demand and supply in different markets matters, it may be of little consequence for the economy wide issues such as growth, inflation, unemployment etc. - the issues that concern macroeconomics During economic fluctuations, markets for different products tend to move up or down together. Macroeconomics vs. Microeconomics MICROECONOMIC QUESTION MACROECONOMIC QUESTION Go to business school or take a job? What determines the cost to a university of offering a new course? What government policies should be adopted to make it easier for low-income students to attend university? What determines whether Scotia bank opens a new office in Shanghai? How many people are employed in the economy as a whole? What government policies should be adopted to promote full employment and growth in the economy as a whole? What determines the overall trade in goods, services, and financial assets between Canada and the rest of the world? What determines the overall salary levels paid to workers in a given year?

Macroeconomics vs. Microeconomics In macroeconomics, the behavior of the whole macroeconomy is, indeed, greater than the sum of individual actions and market outcomes. Example: Paradox of thrift: when families and businesses are worried about the possibility of economic hard times, they prepare by cutting their spending. This reduction in spending depresses the economy as consumers spend less and businesses react by laying off workers. As a result, families and businesses may end up worse off than if they hadnt tried to act responsibly by cutting their spending. Why Macroeconomics Matters Cultural Literacy Ability to follow and participate in public debates and discussions Ability to understand news reports on changes in the economy Why Macroeconomics Matters Self-Interest Effects of the macro economy on our daily lives Understanding of changing opportunities as the economy fluctuates Why Macroeconomics Matters Civic Responsibility more informed voting more responsible macroeconomic policy

Biswa Swarup Misra

September 16, 2009

Macroeconomic Analysis and Policy

Session-1

Fundamentals Distinction between stock and flow Goods are not produced instantaneouslyproduction takes time. Therefore, we must have a period of time in mind when we think about GDP. For example, it does not make sense to say a bakery produces 2,000 loaves of bread. If it produces that many in a day, then it produces 4,000 in 2 days, 10,000 in a (5-day) week, and about 130,000 in a quarter. Because we always have to keep a time dimension in mind, we say that GDP is a flow. If we measured GDP at any tiny instant of time, it would be almost zero. Other variables can be measured independent of time-we refer to these as stocks. Economists pay a lot of attention to the factories and machines that firms use to produce goods. This is known as the capital stock. In principle, you could measure this at any instant of time. Over time this capital stock will change because firms purchase new factories and machines. This change in the stock is called investment; it is a flow. Flows are changes in stocks; stocks change as a result of flows. In understanding the macro economy, it is often crucial to keep the distinction between stocks and flows in mind. A classic example of the stockflow relationship is that of water flowing into a bathtub. The amount of water in a bathtub is a stock as it is a quantity measured at a given moment in time. The amount of water flowing to the tub is a flow as sit is a quantity measured per unit of time. Output and wealth - Which is important? Output is a flow where as wealth is a stock concept. Endogenous vs. Exogenous variables Endogenous variables are determined by and within the macro economy - Policy makers can not simply have a meeting, vote to increase growth from 2% to 3% and expect national output to conveniently comply. National output is an endogenously determined variable and the final change is instead, a result of simultaneous interactions of consumer and investor expectations, domestic and foreign disturbances (shocks) and of course, macroeconomic policies. Example of endogenous variables - Output, Employment, inflation etc. The policies that influence the endogenous variables are deliberately implemented and directly controlled by policy makers. These policies are considered exogenous, determined independently outside the model. Exogenous Variables
Fiscal Policy Changes in tax rate and Government spending Government Controlled Monetary Policy Changes in Money Supply and in short term interest rates Controlled by Nations central Bank Shocks Wars. Weather, Oil shocks Terrorism

What Is Investment? In Macroeconomics, the term investment is used in a very precise sense. Investment means the purchase of newly created goods and services to add to the capital stock. It does not apply to the purchase of already existing assets, since this simply changes the ownership of the capital stock.

Biswa Swarup Misra

September 16, 2009