Macroeconomics

Dr. Ashok Panigrahi

What
Macroeconomics?
What is
is Macroeconomics?
Macroeconomics is the branch of economics.
Economics is the study of how scarce economic resources are
allocated to maximize production for a society. It is a social
science which deals with economic behavior of individuals
and organizations engaged in the production, distribution and
consumption of goods and services.
The study of economics is divided into two general fields:
Economics
Economics
M
Microeconomics
icroeconomics

Macroeconomics
Macroeconomics

Macroeconomics and Microeconomics

Microeconomics
Macroeconomics
analyzes individual components
analyzes the economy as
of the economy;
a whole;
whole
is concerned with the economic
studies aggregate economic
behavior of individual decisionsbehavior;
behavior
making units (individual firm or
deals with the economic issues
individual household) and their
interaction in the markets for
that affect the entire economy
particular goods and services (for
and most of society such as
wheat,bicycles, oil, computers,etc)
gross domestic product,
deals with such variables as the
national income, aggregate
amount of a firms output or of a
demand, aggregate supply,
consumers income, quantities
general price level, rate of
demanded and supplied of particuunemployment, public deficit,
lar goods and their prices, etc.
exchange rates, etc.

Using Microeconomics in Macroeconomics

Macroeconomics is based on microeconomics (has
microeconomic foundations), because macroeconomic
events are the result of the decisions of millions of
individual agents, maximizing their own welfare and arise
from the interaction of many people.
At the same time all the decisions of individual agents
are made taking into account the macroeconomic
situation.

Microeconomics

Macroeconomics

Key Questions Macroeconomists Try to Answer

Why do incomes grow? How much richer (poorer) are we

than our parents?

Why some countries are growing faster than others? Would

our children live better than we do?

Why recessions and expansions occur in the economy?

Why unemployment is low in some countries and high in

the other?
Why prices grow? What is the cost of inflation for the
society? Will inflation make us poorer by destroying our
savings or rich by eliminating our debts?

Questions Macroeconomists Try to Answer

Is it better for an economy to have budget deficit or budget surplus?

trade deficit or trade surplus? to be a lender or a borrower in the
world financial markets?

Why interest rates fluctuate? What impact have the changes in the
money and stock markets on the economy?
What are the determinants of the exchange rates? Is it good to have
a strong or a weak domestic currency?

Is government policy able to affect long-term economic growth? Can

it eliminate or at least smooth economic fluctuations during the
business cycle?

How economic changes in one country effect the situation in others?

Answer: study macroeconomics and be informed!

Key Macroeconomic Issues

Overall output
- long-run changes - economic growth
- short run fluctuations - business cycle
Unemployment
Inflation
Interest Rates
Government Budget
Balance of Payments and Exchange Rates
Macroeconomic Policy

THE ROOTS OF MACROECONOMICS

THE GREAT DEPRESSION
Great Depression The period of
severe economic contraction
and high unemployment that
began in 1929 and continued
throughout the 1930s.

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THE ROOTS OF MACROECONOMICS

Classical Models
Classical economists applied microeconomic
models, or market clearing models, to
economy-wide problems.
Simple classical models failed to explain the
prolonged existence of high unemployment
during the Great Depression. This provided
the impetus for the development of
macroeconomics.

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THE ROOTS OF MACROECONOMICS

The Keynesian Revolution
In 1936, John Maynard Keynes published The
General Theory of Employment, Interest, and
Money.
Much of macroeconomics has roots in
Keyness work. According to Keynes, it is not
prices and wages that determine the level of
employment, as classical models had
suggested, but instead the level of
aggregate demand for goods and services.

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MACROECONOMIC CONCERNS
Three of the major concerns of
macroeconomics are:
Inflation
Output growth
Unemployment

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MACROECONOMIC CONCERNS
INFLATION AND DEFLATION
inflation An increase in the
overall price level.
hyperinflation A period of
very rapid increases in the
overall price level.
deflation A decrease in the
overall price level.

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MACROECONOMIC CONCERNS
OUTPUT GROWTH: SHORT RUN AND LONG
RUN
business cycle The cycle of
short-term ups and downs in
the economy.
aggregate output The total
quantity of goods and services
produced in an economy in a
given period.

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MACROECONOMIC CONCERNS

recession A period during

which aggregate output
declines. Conventionally, a
period in which aggregate
output declines for two
consecutive quarters.
depression A prolonged and
deep recession.

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MACROECONOMIC CONCERNS
UNEMPLOYMENT
unemployment rate The
percentage of the labor force
that is unemployed.

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GOVERNMENT IN THE MACROECONOMY

There are three kinds of policy

that the government has used
to influence the
macroeconomy:
1. Fiscal policy
2. Monetary policy
3. Growth or supply-side
policies

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GOVERNMENT IN THE MACROECONOMY

FISCAL POLICY
fiscal policy Government
policies concerning taxes and
expenditures (spending).

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GOVERNMENT IN THE MACROECONOMY

MONETARY POLICY
monetary policy The tools
used by the Reserve Bank to
control the quantity of money
in the economy.

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GOVERNMENT IN THE MACROECONOMY

GROWTH POLICIES
supply-side policies
Government policies that
focus on stimulating
aggregate supply instead of
aggregate demand.

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THE COMPONENTS OF THE

MACROECONOMY
Macroeconomics focuses on
four groups:
(1) households and
(2) firms, which together
compose the private sector,
(3) the government (the public
sector), and
(4) the rest of the world (the
international sector).

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BUSINESS TRENDS AND CYCLES

EXPANSION AND CONTRACTION: THE
BUSINESS CYCLE

FIGURE 5.3
A Typical
Business Cycle
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BUSINESS TRENDS AND CYCLES

expansion or boom The period

in the business cycle from a
trough up to a peak, during
which output and employment
rise.
contraction, recession, or
slump The period in the
business cycle from a peak
down to a trough, during
which output and employment
fall.
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Aggregation
The main principle of macroeconomic analysis is aggregation.
Aggregation means putting all the units together.

The subject matter of macroeconomics is to study

aggregate economic behavior,
behavior i.e. behavior of
aggregate (macroeconomic) agents on
aggregate (macroeconomic) markets.
markets
There are four macroeconomic agents and
four macroeconomic markets.

Macroeconomic Agents

Households
the owners of economic resources
(suppliers of factors of production);
the earners of national income;
the main consumers of goods and
services (demanders for aggregate output);
the main savers (lenders).

Firms
the main producers of goods and services
(suppliers of aggregate output);
the main demanders for economic
resources;
the consumers of the part of aggregate
output (demanders for investment goods);
the main borrowers.
Households and firms form private sector of the economy.

Macroeconomic Agents

Government

the producer of public goods;

the consumer of the part of aggregate output
(purchaser of goods and services);
the redistributor of national income (through collecting taxes
and making transfer payments);
lender or borrower in the financial markets (depending on the state
of government budget);
the regulator of economic activity:
- establishing and supporting institutional basis for
the economic performance (rules of the game);
- conducting macroeconomic policy.
Private and government sectors form
the closed economy
(or the mixed closed economy), i.e.
the economy not interacting with other economies.

Macroeconomic Agents
Foreign sector
interacts with the national economy through two
channels:
international trade
exchange of goods and
services

capital flows
exchange of assets,
primarily financial (bond and shares)

Economy that interacts with other economies

(with the rest of the world) is called
the open economy

Macroeconomic Markets
Goods (or product) market
Resource (or factor) market
Financial market
consisting of two segments:
- money market;
- bonds market
Foreign exchange market
Price
Supply
Equilibrium
Price

Equilibrium:
Equilibrium:
Supply
Supply==Demand
Demand

Demand
Equilibrium
Quantity

Quantity

Market Definition
A market is an arrangement
whereby buyers and sellers interact
to determine the prices and
quantities of a commodity.

Demand and Supply Cycle

Supply
Goods &
Services sold

Market for
Goods
and Services

Demand
Goods &
Services bought

Firms

Households

Inputs for
production
Demand

Market for
Factors
of Production

Labor, land, and

capital
Supply

Model of Circular Flows

In order to understand how the aggregate economy
works and to analyze the aggregate economic behavior
economists use the model of circular flows, representing
the interaction between macroeconomic agents through
macroeconomic markets.
markets

Model of Circular Flows

with Government and Foreign Sector
(open economy)
Foreign Sector

Exports (Ex)

Imports (Im)
Consumption
Goods
Spending (C)

Market (Y)

Government
Taxes (Tx) Purchases (G)
Transfers (Tr)

Households

Financial Market

Capital inflow (if Im > Ex)

Incomes (Y)

Investment
Spending (I)
Taxes (Tx)

Government Subsidies(Tr)

Loan to the Government

(if G + Tr > Tx)
Saving (S)

Revenues

Resource
Market

Firms

Loanable
Funds (F)

Wages, Rent,
Interest, Profits

Stock and Flow Variables

Macroeconomic variables can be divided into stocks and flows.
A flow is an economic magnitude
measured per a given period of
time (a year, a week, an hour).
All the variables in the model of
circular flows (output, income,
consumption, saving, investment,
taxes, budget deficit, trade
surplus and others) are flows.

A stock is an economic
magnitude measured at a
particular point of time (on
January, 1, 2013).
Examples: wealth, savings,
government debt, capital
stock, money supply, number
of unemployed, etc.

Flows add to or diminish stocks.

For example, the flow of investment change the stock of capital,
the flow of budget deficit increases the stock of government debt.

STOCK and FLOW

Variables

FLOW

STOCK FL

OW

STOCK

The Image of the Macroeconomic System

External
Factors

Objectives

Instruments

AS
AD

Market Economy

The main objectives of government economic

policy
The key elements of the Government's strategy are:
1.

Delivering macroeconomic stability (a very broad

macroeconomic aim)- Prices, exchange rates, etc

2.

Meeting the productivity challenge (an important

supply-side target) - Growth

3.

Increasing employment opportunity for all (a labour

market objective)

4.

Ensuring fairness for families and communities

(commitment to equity)

5.

Protecting the environment (green economics has a

macroeconomic dimension)

The Macroeconomic System

It is a market economy which
is influenced by
external (exogenous) factors:
natural (weather,
earthquakes, spots
on the sun, eruptions, tsunami, etc)
social (wars,
revolutions,
overturns, etc)

has objectives
(induced variables):
economic growth;
high employment;
stable prices;
balance of payments equilibrium

use instruments
(policy variables):
fiscal policy;
monetary policy;
income policy;
foreign trade and
exchange rate
policy.
Macroeconomic Policy

Macroeconomic Policy
Economic Growth Policy
is aimed to stimulate economic
growth in the long run and to
affect productive possibilities
of the economy;
suggests changes primarily
in aggregate supply

Stabilization Policy
is aimed to smooth out
business cycle in the short run
and to diminish the depth of
recessions and the height of
booms;
suggests changes primarily
in aggregate demand

Market Economy: Key Concepts

Aggregate Demand and Aggregate Supply
Cost of Human
Resources

Consumption
Investment

Aggregate
Demand

Aggregate
Supply

Government
Spending
Net Exports

Cost of Capital
Resources
Cost of Natural
Resources

Aggregate
Output

General
Price Level

Technology

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