Macroeconomics

(Section F)

Sudip Chaudhuri
sudip@iimcal.ac.in
Room B-207; Ext 2030
 What is Macroeconomics?
Microeconomics focuses on how decisions are
made by individuals and firms and the consequences of
those decisions - on individual prices, quantities etc

Macroeconomics examines the

aggregate behavior of the economy how
the actions of all individuals and firms in
the economy interact to produce a
particular level of economic performance
as a whole.
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 Macroeconomics
The behaviour of macro economy is not a
simple summation of individual actions
It is often greater than the sum of
individual actions, e.g., as we will discuss:
Paradox of thrift

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 Topics

1. Overview of Macroeconomics
2. National Income Accounting
3. Consumption and Investment
4. Business Cycles and Aggregate Demand
5. Fiscal policy
6. Money and Financial system
7. Monetary Policy
8. Balance of payments and Foreign Exchange Rates
9. Open economy Macroeconomics
10. Selected additional topics

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 Topic 1

Overview of Macroeconomics
 Two Central themes of Macroeconomics

Business cycles
Short term fluctuations in aggregate:
output
employment
prices
Economic Growth/Development
Long term trends in output and living
standards

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 Gross Domestic product (GDP)
The notion of aggregate output lies at the
heart of macroeconomics:
Unemployment
Poverty
Standard of living
GDP per capita, the most common
economic indicator

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 Per capita GDP
(International $ 1990)

Year United States China India

1000 400 466 450
1500 400 600 550
1600 400 600 550

http://www.ggdc.net/maddison/
1700 527 600 550
1820 1,257 600 533
1850 1,806 600 533
1870 2,445 530 533
1890 3,392 540 584
1900 4,091 545 599
1913 5,301 552 673
1930 6,213 568 726
1950 9,561 448 619
1980 18,577 1,061 938
1990 23,201 1,871 1,309
2008 31,178 6,725 2,975
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 Per capita GDP
35,000

30,000
1990 international $

25,000

20,000

15,000

10,000

5,000

0
1000 1600 1820 1870 1900 1930 1980 2008
United States China India

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 Economic Growth
High standard of living in rich countries is
the result of growth of real GDP per capita
over a long period of time
The poor countries must increase real
GDP per capita to take care of
unemployment, poverty and improve
standard of living

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 Economic crises
Recession/depression
Inflation
Foreign exchange crises

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 Measuring economic success
GDP (gross domestic product)/GNI (gross
national income)
Annual growth rate
Per capita GDP/GNI
Price level:
Inflation rate
External balance:
Trade deficit as % of GDP
Current account deficit (CAD) as % of GDP
Unemployment (and poverty) rates
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 Growth rate
GDP (percent)
((GDPt GDPt-1)/GDPt-1) x 100
Inflation rate (per cent)
((Pt Pt-1)/Pt-1) x 100, where
P: Annual averages of price
indexes
Or Year-on-year

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 Recession/depression

No strict definition
Recession:
Decline in output, income and employment
lasting more than few months
Depression:
a recession that is large in both scale and
duration

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 Great Depression
The sharp fall in aggregate output and
employment levels which started in 1929 and
lasted through the 1930s
This gave rise to modern macroeconomics
Macroeconomic theory changed dramatically
with the 1936 publication of the book, The
General Theory of Employment, Interest and
Money by John Maynard Keynes
Important mission of modern
macroeconomics: to prevent anything like the
Great Depression from happening again

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The Great Depression

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 -2.0

-6.0
-4.0
0.0
2.0
4.0
6.0
8.0
10.0
1951-52 12.0
1954-55
1957-58
1960-61
1963-64
1966-67
1969-70
1972-73
1975-76
1978-79
1981-82
1984-85
1987-88
GDP growth rate

1990-91
1993-94
1996-97
1999-2000
2002-03
2005-06
2008-09
2011-12
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 Percent

0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0

Apr/13
Jul/13
Oct/13
Jan/14
Apr/14
Jul/14
Oct/14
Jan/15
Apr/15
Jul/15
Oct/15
Jan/16
Apr/16
Year on Year Inflation Rate: CPI

Jul/16
Oct/16
Jan/17
Apr/17
Jul/17
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 Foreign Exchange
Trade deficit as % of GDP
Current account deficit (CAD) as % of GDP
Foreign exchange rate

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Indias BOP Table Credit Debit Net
A) Current Account
A.1) Merchandise
A.2) Invisibles
B) Capital Account

B.1) Foreign Investment

B.2) Loans
B.3) Banking Capital

B.4) Rupee Debt Service

B.5) Other Capital

C) Errors and Omissions

D) Overall Balance

E) Monetary Movements
E.1) I.M.F

E.2) Foreign Exchange

Reserves (decrease)
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 Rupees per USD

10
20
30
50
60
70

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0
1950-51
1953-54
1956-57
1959-60
1962-63
1965-66
1968-69
1971-72
1974-75
1977-78
1980-81
1983-84
Forex Rate

1986-87
1989-90
1992-93
1995-96
1998-99
2001-02
2004-05
2007-08
2010-11
2013-14
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 Aggregate Demand
Aggregate Supply Framework

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 Potential Output
For any economy, there is a maximum
sustainable output that can be produced
It depends on:
Productive capacity
Supply of labour, human capital
Technology etc
It is not the absolute maximum output:
economy can operate with output levels
above potential output for a short time.
 Potential Output
P
Price level

Q
QP

Real Output
 Aggregate Demand
Price level AD = Consumption (C) +
Private investment (I) +
Government Expenditure (G) +
Net exports (X)
AD: Link between AD and
aggregate price level other
factors remaining the same
As P changes, AD can
changes due to several
reasons including:
When money income or money
wealth do not change with price
level

Real Demand
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 Aggregate Supply
Price level AS; link between aggregate
price level and AS other
factors remaining the same
More production and supply if
profit per unit is more
As P changes, AS can change
due to several reasons
including:
When some costs in money
terms, for example wages do not
change with the price level

Real Supply
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 Actual Output
Depends on aggregate demand and not
as such on potential output
Firms do not produce unless demand is
there and it is profitable to produce
Most of the recessions in the post World
War II can in fact be explained by
reductions in aggregate demand

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Demand constrained economy
AS
P
AD
Price level

Potential output

Q
Q QP

Real Output
Supply constrained economy
AS
P
AD
Price level

Potential output

Q
QP

Real Output
Recession/depression
AS
P
AD
Price level

Potential output

Q
Q2 Q1 QP

Real Output
 Expansion/Boom
AS
P
AD
Price level

Potential output

Q
Q1 Q2 QP

Real Output
Short run: Ideal
AS
P
AD
Price level

Potential output

Q
QP

Real Output
 Traditional Tools of Economic Policy

Short term Demand management for

avoiding recession/inflation:
Fiscal Policy:
Government expenditure and taxes
Monetary Policy:
Money, Credit, interest rates
Long term intervention for economic
development

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Policy in Demand constrained economy:
Why is D low?: What can be done to D? AS
P
AD
Price level

Potential output

Q
Q QP

Real Output
Policy in Supply constrained economy
How to manage D to contain inflation? AS
P
AD
Price level

Potential output

Q
QP

Real Output
Long run growth
Potential output
How to increase QP?
P
Price level

Q
QP

Real Output
 Successful countries
Done both
Potential output and demand management

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38
 GNI per capita, 2015
(2011 PPP $)

India 5663

China 13345

Brazil 14145

Russia 23286

Malysia 24620

South Korea 34541

USA 53245

0 10000 20000 30000 40000 50000 60000

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 Purchasing Power parity

The PPP between two countries

currencies is the exchange rate at which a
given basket of goods and services would
cost the same amount to buy in each
country
Suppose a basket of goods and services
that costs $ 100 in USA, costs Rs 2000 in
India. Then the PPP conversion factor
(local currency unit per $) is Rs 20.
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 Big Mac Index, January 2016

Local Dollar
Country Exchange rate Dollar price
price PPP
Australia 5.3 1.42 3.74 1.08
Britain 2.89 0.68 4.22 0.59
Chile 2100 715.22 2.94 425.96
China 17.6 6.56 2.68 3.57
India 127 66.80 1.90 25.76
Malaysia 8 4.39 1.82 1.62
Norway 46.8 8.97 5.21 9.49
Pakistan 300 104.89 2.86 60.85
South Africa 28 15.81 1.77 5.68
Switzerland 6.5 1.01 6.44 1.32
United States 4.93 1.00 4.93 1.00
Dollar PPP
$ 4.93 = Rs 127.00
Or, 1 $ = Rs 25.76 (= 127/4.93) 41
 Human Development Index
A composite index prepared and published
by UNDP based on three basic
dimensions of human development:
HEALTH: life expectancy at birth.
EDUCATION: Mean of years of schooling
(adults) and expected years of schooling
(children)
LIVING STANDARDS: GNI per capita PPP $

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Country HDI GNI per capita
2014 rank minus
HDI rank, 2014
Norway 0.944 5
New Zealand 0.913 23
USA 0.915 3
Singapore 0.912 -7
UAE 0.835 -34
Qatar 0.850 -31
China 0.727 -7
Sri Lanka 0.757 29
India 0.609 -4
Guinea 0.411 0
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Belgium 0.890 0
 Some useful sources of data

UNDP: http://hdr.undp.org/en/statistics/data/
http://data.worldbank.org/
www.imf.org
For India:
RBI, Handbook of Statistics on Indian Economy
(https://www.rbi.org.in/)
Min of Finance, Economic Survey:
http://indiabudget.nic.in/
CSO: http://mospi.nic.in/Mospi_New/site/home.aspx

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 Textbooks

Paul Samuelson and William Nordhaus,

Macroeconomics (some chapters photocopied)
Paul Krugman and Robin Wells,
Macroeconomics (some chapters photocopied)
Dornbusch, Fischer and Startz,
Macroeconomics
Collect your copy

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 Recommended text
(for examinations purpose)

Collect your copy of photocopied handout:

Paul Samuelson and William Nordhaus,
Chapters 4 to 7; 10 and 14
Paul Krugman and Robin Wells, Chapters 13,
14, 18 and 19

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 Examination
Closed book Mid-term and End-term
examination:
Lecture PPTs
Photocopied chapters
Class discussions
Mid-term exam:
Topics to 1 to 5
End-term exam:
Remaining topics
Separate question papers Sections (A & E),
Section B, Section F, Sections (C and D).
Grades to be normalized 47
 Grade normalization target
A plus: 10% of the students
A only: 15%
A minus: 15%
B plus: 25%
B only: 15%
B minus: 10%
C plus/F: 10%
Note: Actual distribution may vary across sections
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 Lectures
PPTs will be available in advance
Discussions in class room:
PPTs uploaded are not substitutes for class
lectures
Apart from class rooms, students may ask
questions through email (sudip@iimcal.ac.in)
Discussion sessions 2nd week onwards?
Clarifications:
Most welcome to meet me in my office room
on Mondays and Wednesdays
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