Economic Environment of Business Understanding the course content

Scope of Study
An Overview of macroeconomics and its impact on business An overview of growth and developmental economics National income accounting Various financial markets Indian economy : an overview The world economy : International monetory system Balance of payment India and the world

Internal Assessment Pattern

Attendance/ Class Participation 5 Test 5 Project/ Presentation10

Chapter-1
Macroeconomics: An overview
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The Essence of Macroeconomics

Macroeconomics vs. Microeconomics

MICROECONOMIC QUESTION Go to business school or take a job? What determines what salary to be given to a new MBA What determines the cost to a university or college of offering a new course? What determines whether a bank opens a new office in Shanghai?
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Macroeconomics
MACROECONOMIC QUESTION 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 the our country. and the rest of the world?
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Macroeconomics vs. Microeconomics

Microeconomics focuses on how decisions are made by individuals and firms and the Click to consequences of those decisions. edit the outline text format Ex.: How much it would cost for a university Second Outline Level or college to offer a new course the cost of the instructors salary, the classroom Third Outline Level facilities, the class materials, and so on.

Having determined the cost, the school can then decide Fourth Outline whether or not to offer the course by weighing the costs Level and benefits.
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Macroeconomics vs. Microeconomics

Macroeconomics examines the aggregate behavior of the economy how the actions of all the individuals and firms in the economy interact to produce a particular level of economic performance as a whole.

Ex.: Overall level of prices in the economy how high or how low they are relative to prices last year rather than the price of a particular good or service.

Macroeconomics Differs from Microeconomics:

In macroeconomics, the behavior of the whole macro economy is, indeed, greater thanClicksum ofthe outline the to edit individual actions and market outcomes. text format Macroeconomics is widely viewed as providing a rationale Second Outline Level for continual government intervention to manage shortThird Outline term fluctuations and adverse eventsin the economy. Level fiscal policy, control of government spending and taxation, and Fourth Outline monetary policy, control over interest rates and the Level quantity of money in circulation Fifth Outline

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Macroeconomics Differs from Microeconomics

Macroeconomics is the study of long-run growth: What factors lead to a higher long-run edit the outline And Click to growth rate? are there government policies capable of increasing the text format long-run growth rate? Second Outline Level

A distinctive feature of modern macroeconomics is that both its theory and policy implementation focus Third Outline on economic Level aggregates -- economic measures that summarize data across many different markets for goods, services, workers and assets. Fourth Outline Level Fifth Outline Level 1111 Sixth Outline

Economistsand society at largeagree on three important macroeconomic goals

Economic growth Full employment Stable prices

Macroeconomic Goals

Why is there such universal agreement on these three goals?

Because achieving them gives us opportunity to make all of our citizens better off
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Economic Growth
Economists monitor economic growth by keeping track of real gross domestic product (real GDP)
Total quantity of goods and services produced in a country over a year

Real GDP has actually increased faster than the population

During this period (1929 to 2002), while U.S. population did not quite triple
Quantity of goods and services produced each year has increased more than tenfold Indias GDP grew from 200 M in 1950 to 3912991 M US Dollars at market prices
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Economic Growth
Although output has grown, rate of growth has varied over the decades Over long periods of time small differences in growth rates can cause huge differences in living standards Economists and government officials are very concerned when economic growth slows down Macroeconomics helps us understand a number of issues surrounding economic growth

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High Employment (or Low Unemployment)

Unemployment affects distribution of economic well being among our citizens
People who cannot find jobs suffer a loss of income

Joblessness affects all of useven those who have jobs

A high unemployment rate means economy is not achieving its full economic potential

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High Employment (or Low Unemployment)

Unemployment rate
Percentage of the workforce that would like to work, but cannot find jobs Used to keep track of employment

All nations commitment to high employment has been been written into law
With memory of Great Depression still fresh, the US Congress passed Employment Act of 1946 Indian Govt has also passed the employment act many times

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Employment and Unemployment

Discouraged workers are non-working peopleedit the outline of Click to who are capable working but are not actively looking for a job. text format Underemployment is the number of people who work during a Second recession but receive lower wages than they would Outline during an expansion due to smaller number of hours Level lower-paying jobs, worked, or both. Third Outline The unemployment rate is the ratio of theLevel of people number unemployed to the total number of people in the labor force, either Fourth Outline currently working or looking for jobs.

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Employment and the Business Cycle

When firms produce more output, they hire more workers when they produce less output, they tend to lay off workers
We would thus expect real GDP and employment to be closely related, and indeed they are

Business cycles
Fluctuations in real GDP around its long-term growth trend

Expansion
A period of increasing real GDP

Contraction
A period of declining real GDP

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Employment and the Business Cycle

Recession
A contraction of significant depth and duration

Depression
An unusually severe recession

In the twentieth century, United States experienced one decline in output serious enough to be considered a depressionthe worldwide Great Depression of the 1930s
From 1929 to 1933, the first four years of Great Depression, U.S. output dropped by more than 25%
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Figure 3: The Business Cycle

Re GD al P Long-run upward trend of real GDP

Expansi on
Lieberman & Hall; Introduction to Economics, 2005

Recessi on

The business cycle fluctuation of actual output around its longExpansi run trend. on Ti me 2020

Stable Prices
With very few exceptions, inflation rate has been positive During 1990s, inflation rate of US averaged less than 3% per year
An extreme case was the new nation of Serbiaprices rose by 1,880% in
August 1999 The inflation rate in India was last reported at 9.7 percent in October of 2010. It was 5.58 % in Jan 2008. The highest inflation rate is of Zimbabwe, As om Jan 1, 2009 the inflation is 533%.

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The term inflation is from the Latin term inflare, meaning to blow up or inflate The inflation rate is the percentage increase in the price of goods per year. For example, if the inflation rate is 2%, then a $1 candy will cost $1.02 this year.
The movie Cleopatra cost $44 million to make in 1963. With inflation taken into account, the same movie would cost $300 million to make today

Some interesting facts about Inflation

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Stable Prices
Why are stable pricesa low inflation ratean important macroeconomic goal?
Because inflation is costly to society With annual inflation rates in the thousands of percent, the costs are easy to see
Purchasing power of currency declines so rapidly that people are no longer willing to hold it

Economists regard some inflation as good Price stabilization requires not only preventing inflation rate from rising too high
But also preventing it from falling too Lieberman & Hall; Introduction to Economics, 2005 dangerously close to turning negative low, where it would be
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The Macroeconomic Approach

In macroeconomics, we want to understand how the entire economy behaves
Thus, we apply the steps to all markets simultaneously

How can we possibly hope to deal with all these markets at the same time? The answer is aggregationprocess of combining different things into a single category and treating them as a whole
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Aggregation in Macroeconomics
Aggregation plays a key role in both micro- and macroeconomics In macroeconomics, we take aggregation to the extreme
Because we want to consider the entire economy at once, and yet keep our model as simple as possible
Must aggregate all markets into broadest possible categories

By aggregating in this way, can create workable and reasonably accurate models that teach us a great deal about how overall economy operates
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Macroeconomic Controversies
Macroeconomics is full of disputes and disagreements
Modern macroeconomics began with publication of The General Theory of Employment, Interest, and Money by British economist John Maynard Keynes in 1936 Which held that the macroeconomy worked very well on its own

Keynes was taking on conventional wisdom of his time

Best policy for the government to follow was laissez faire

This new school of thought held that the economy does not do well on its own and needed guidance
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Macroeconomic Controversies
While some of the early disagreements have been resolved, others have arisen to take their place For examplethe controversy over the Bush administrations $330-billion ten-year tax cut Because of such political battles, people who follow the news often think that there is little agreement among economists about how the macroeconomy works
In fact, the profession has come to a consensus on many basic principles, and we will stress these as we go
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The Great Depression

The Great Depression precipitated a thorough rethinking of macroeconomics which gave rise to modern macroeconomics.

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The Business Cycle

The business cycle is the short-run alternation between economic downturns, recessions, and economic upturns, Click to edit the outline expansions. text format A depression is a very deep and prolonged downturn. Second Outline Level Recessions are periods of economic downturns when output Third Outline and employment are falling. Level Expansions, or recoveries, are periods of economic Fourth Outline upturns when output and employment are rising. Level

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FOR INQUIRING MINDS: Defining Recessions and Expansions

In many countries, economists adopt the rule that a recession is a period of at least 6 months, or two quarters, during which aggregate output falls.
n the United States, the task of determining when a recession begins and ends is assigned to an independent panel of experts at the National Bureau of Economic Research (NBER). This panel looks at a number of economic indicators, with the main focus on employment and production, but ultimately the panel makes a judgment call.

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In general, the unemployment rate rises during recessions and falls during expansions. It moves in the direction opposite to aggregate output, which falls during recessions and rises during expansions.

The effects of recessions and expansions on unemployment and aggregate output:

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Taming the Business Cycle

Although recessions are temporary phenomena, they produce a considerable amount of economic pain for an economys Click to edit the outline members. So one of the key missions of macroeconomics is text format to understand why recessions happen, and what, if anything, Second Outline Level can be done about them.

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Taming the Business Cycle

Policy efforts undertaken to reduce the severity of recessions are called stabilization policy. One type of stabilization policy is monetary policy, changes in the quantity of money or the interest rate. The second type of stabilization policy is fiscal policy, changes in tax policy or government spending, or both.
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ECONOMICS IN ACTION: Has the Business Cycle Been Tamed? Has progress in macroeconomics made the economy more stable? Answer: Sort of
Clearly, nothing like the Great Depression the huge surge in unemployment that dominates the figure has happened since. But economists who argued during the 1960s that the business cycle had been completely tamed were proved wrong by severe recessions in the 1970s and early 1980s.

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Long-Run Economic Growth

Secular long-run growth, or long-run growth, is the Click to edit the outline sustained upward trend in aggregate output per person over text format several decades. Second in the Level A country can achieve a permanent increase Outlinestandard of living of its citizens only through long-run growth. So a Third Outline Level central concern of macroeconomics is what determines longrun growth. Fourth Outline

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Aggregate Price Level

A nominal measure is a measureClick to edit the outline that has not been adjusted for changes in prices over time. text format A real measure is a measure that has been Outline Level Second adjusted for changes in prices over time. Third Outline The change in real wages is a better measure of changes in Level workers purchasing power than the change in nominal Fourth Outline wages. Level The aggregate price level is the overall level ofOutline in Fifth prices the economy. Level

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Inflation and Deflation

A rising aggregate price level is inflation. A falling aggregate price level is deflation. The inflation rate is the annual percent change in the aggregate price level. The economy has price stability when the aggregate price level is changing only slowly. Because inflation and deflation can cause problems, price stability is generally desirable. In reality, the inflation rate has mainly been positive for decades, though we are not too far 3737 from price stability today.

ECONOMICS IN ACTION: A Fast (Food) Measure of Inflation

McDonalds opened in 1954: Hamburgers cost only 15 cents 25 cents with fries. Today a hamburger at a typical McDonalds costs five times as much between 70 and 80 cents.
Too expensive?

No in fact, a burger is, compared with other consumer goods, a better bargain than it was in 1954. Burger prices have risen about 400 percent, from 15 cents to about 75 cents, over the last half century. But the overall consumer price index has increased more than 600 percent.
If McDonalds had matched the overall price level increase, a hamburger would now cost between 90 cents and a dollar.

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The Open Economy

A closed economy is an economy that does not trade goods, services or assets with other countries; an open economy Click to edit the outline trades goods, services and assets. text format The U.S. has become increasingly open, so that openSecond Outline Level economy macroeconomics has become increasingly Third Outline important. Level Open-economy macroeconomics is the study of those Fourth Outline aspects of macroeconomics that are affected by movements Level of goods, services and assets across nationalboundaries. Fifth Outline

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The Open Economy

One of the main concerns introduced by open-economy macroeconomics is the exchange rate, the price of one currency in terms of another. Click to edit the outline Exchange rates can affect the aggregate price level. They can also affect aggregate output through their effect on the trade text format balance, the difference between the value of the goods and services it sells Second Outline Level to other countries and the value of the goods and services it buys in return. Economists are also concerned about capital flows, movements of financial Third Outline assets across borders.

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GDP Growth in India a comparison

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