4. Macroeconomic theory
» Furnishes with a set of tools from basic
postulates of human behavior
» Economic analysis ALWAYS establishes
reference points
» Helps in understanding complex relationships –
How?
» Can unrelated activities be related
economically?
» What do you think are the problems in
macroeconomic analysis?
4
5. If money is the root cause…
» What is the concept of money?
» Is money actually a scarce commodity?
» By printing more money, can the Government
solve the problem of scarcity?
» If we can print more money, do we need
economists?
» Periods of Hyperinflation
» “Too much money chasing too few goods”
5
» Money is just a claim to the final output
6. Positive Economics
» Always a scenario of facts Vs. what should have
been…
» Positive Economics: Scientific approach to the
analysis of economic events; talks about what
currently is happening
» Example: If the price of cloth is higher, people
will but less of it
» Should be reducible to some form which is
testable
6
7. Normative Economics
» What ought to be!
» Normative Economics: Economic science that
encompasses statements involving value
judgments
» Involved prescriptions or statements about how
things should ideally be
» Example: Monopolies should be regulated
» Advocates specific policy prescriptions, because
it uses ethical judgments
7
8. Interdependence
» Microeconomics assumes that t he total output,
price, quantity, employment, general price level,
spending etc. are fixed, given or known
» Determines how resources can be optimally
allocated
» What microeconomics takes as given, is what
macroeconomics seeks to explain and vice versa
» Macroeconomic theory has a foundation in
microeconomic theory and vice versa
8
9. Economic Analysis and Managerial Decisions
» Demand Forecasting
» Pricing and Marketing Decisions
» Cost Analysis
» Investment Appraisal
» Specific Industry Analysis
» Government, Regulation and Policy Impact
Analysis
» Strategic Planning
9
10. Schools of Thought
» Classical Theory
» Laid the basics of Macroeconomic thinking
» Keynesian Theory
» Built on Classical theory to explain large scale
unemployment
» Neoclassical Theory
» Combination of the two above
» Monetarism
10
11. Macroeconomic Policy Goals
» Full employment
» High living standards
» Price Stability
» Reduction of economic inequality and removal of
poverty
» Rapid economic growth
» External balance Vs. Overall balance
11
12. Problems of setting macroeconomic goals
»Choice of goals for an economy is a
controversial matter
»Goals can be mutually incompatible
»Universally acceptable operational
definitions for all goals cannot be
formulated
12
13. Revised Goals
» High and rising per capita incomes
» Avoiding excessively high inflation
» Efficient use of human and non-human
resources with minimum possible
unemployment of labor
» Avoidance of persistent imbalances in foreign
trade and excessive resort to foreign capital
13
14. Basic Concepts
» Stocks and Flows:
» Both variables have a time dimension
associated
» Stock variables: Measured at a period of time
» Flow Variables: Measured over a period of
time
» Some flow macroeconomic variables have a
direct stock counterpart variable (investment
and capital stock)
14
15. Basic Concepts
» Stocks and Flows:
» Stocks can change only as a result of flows
» What are the following:
» Inflation
» Unemployment
» Exports and Imports
» Consumption and Investment
» Money supply
15
16. Basic Concepts
» Equilibrium and Disequilibrium
» State of balance between two opposing
forces is called equilibrium
» Absence of equilibrium is called
disequilibrium
» State of no change over time Vs. constant
change
» Even during a state of disequilibrium, market
constantly tries to move towards equilibrium
16
17. Basic Concepts
» Statics and Dynamics
» Economic variables can be either stock or
flow
» They can be in either equilibrium or
disequilibrium
» If they are in equilibrium and tend to repeat
themselves – stationary equilibrium
» If they are in disequilibrium, possibility of the
values varying in the next period also
17
18. National and Domestic Product
» Thousands of outputs produced in an economy
» Some products act as inputs, others act as
facilitators, ultimately they are churned out as a
final product
» GNP and GDP are measures of aggregate
production of all goods and services which
either lend to consumption or add to productive
capacity
18
19. National and Domestic Product
» Can we add the physical outputs of all the goods
and services produced in an economy? Why or
why not?
» The units of measurement of each product
varies
» Usually multiplied with their monetary values to
arrive at an aggregate
19
20. National and Domestic Product
» Problems of arriving at an estimate:
» Consumer goods Vs. Industrial goods
» Police force, defense
» Goods produced and consumed within the
same household
» Price effect
20
21. National and Domestic Product
» Problems of arriving at an estimate:
» Consumer goods Vs. Industrial goods
» Police force, defense
» Goods produced and consumed within the
same household
» Price effect
» GDP and GNP are also treated as a way to
estimate the value added to a process
21
22. National and Domestic Product
» Problems of arriving at an estimate:
» Consumer goods Vs. Industrial goods
» Police force, defense
» Goods produced and consumed within the
same household
» Price effect
» GDP and GNP are also treated as a way to
estimate the value added to a process
22
23. National and Domestic Product
» Value added in a productive process equals the
incomes paid out to suppliers of these inputs
which economists call primary factors of
production
» Thus, GDP and GNP are measures of total
economic activity during a specific period of
time
» This influences a variety of stick and flow
macroeconomic variable
23
24. National and Domestic Product
» Most importantly, Income (Y) is affected as the
level of employment depends on the national
and domestic products
» Increase in Y signifies increase in jobs, output,
better standard of living
» Y is determined by the level of aggregate
demand (AD)
» For equilibrium to exist: Y = AD
24
25. Aggregate Consumption
» Aggregate of all expenditures on current
consumption goods and services
» Living standards correlated to per capita
consumption of goods and services
» Can be related to either national income or
disposable income
» Consumption function establishes the
relationship between aggregate consumption
expenditures and aggregate income; C = C(Y)
25
26. Gross Domestic Savings (GDS)
» Do households and productive sector spend all
the money they make (Y)?
» Income that is not spent on current
consumption contributes to the savings function
» Do all households spend or save the same
amount?
» GDS = GDP – Aggregate Consumption
» What is the saving of productive sector known?
»Y = C + S
26
27. Gross Domestic Capital Formation (GDCF)
» Role of fixed assets in production process
» GDCF consists of:
» Making good the depreciation
» Adding to the stock of fixed assets
» Adding to inventories
» Depreciation and addition to fixed assets is called
gross fixed investment
» What is meant by investment?
» Should GDS equal GDCF?
27
28. Industrial and Agricultural Production
»For Indian economy, agriculture is primary
and industry output is secondary. Remaining
are called tertiary services
»Changes in Industrial Production is
measured via IIP
»Concept of base year and current year
»Variety of agricultural produce way lesser
»Same UoM; indices can be constructed
28
29. Wholesale, Consumer Prices and Inflation
»Who is most affected by change in prices?
»Can we monitor the price changes of every
product or service?
»Need for an index was felt as each product
or service displayed a different pattern of
price fluctuation
»Wholesale Price Index (WPI) and Consumer
Price Index (CPI)
29
30. Employment
»Is full employment possible?
»What is the definition of unemployment?
»Problems of estimating unemployment rates
»Is everybody willing to work?
»Does everybody who is willing, have a
job?
»People is transition phase
»People looking for better jobs
30
31. Balance of Payments (BoP)
»Existence of economic transactions with
other countries
»Lending and borrowing functions
»Double-entry accounting system with
transactions that increase the availability of
foreign exchange recorded as ___ and those
that use up foreign exchange recorded as __
»Current Account, Capital Account and
Official Reserve Account
31
32. Balance of Payments (BoP)
»Current Account
»Records imports & exports of goods and
services and unilateral transfers
»Exports and gifts received are __; imports
and gifts made are __
»Capital Account
»Records inflows and outflows of capital
»Inflows are __ and outflows are __ items
32
33. Balance of Payments (BoP)
»Official Reserve Account
»Records changes in foreign exchange
reserves and reserves of monetary gold
»What is meant by Balance of Trade?
»Concept of surplus or deficit
»BoP account has to tally always
»What happens during surplus or deficit?
33
34. Rate of Growth
»Every country desires a healthy rate of
growth in its National and Domestic
products
»2 essential rates of growth: Growth rate of
GDP and growth rate of per capita GDP
»Both these growth rates are measured in
real rates, for a year.
»What is meant by ‘real’ rates?
»How is it related to population?
34
35. Business Cycles and Circular Flow of Income
»Every economy goes through various phases
in the business cycle
»Circular flow of income:
»In a simple economy where all income is
consumed
»In a closed economy
»In an open economy
»Building the model
35
36. Concept of National Product
»Capacity to produce goods and services over
a period of time
»GNP growth rate is a powerful indicator of
the growth rate of an economy
»Sum of all final goods and services produced
during a specified time period
»Output can be measure at Market Prices of
Factor Cost
»Concept of value addition
36
38. Real Vs. Nominal GNP
»“Real” refers to prices or values that have
been adjusted for inflation or price level
fluctuations
»Real GNP is the GNP in current rupees
deflated for changes in the prices of items
included in GNP
»Nominal GNP is just expressed as current
rupees
»Doesn’t indicate change in price levels
38
39. Real Vs. Nominal GNP
»Over time Nominal values reflect changes in
»Real size of an economic variable
»General level of prices
»For example, if nominal GNP in 1998-99 was
16 crores compared to 7 crores in ’93-94.
Does this mean output has doubled?
»Real GNP for ‘93-94 is only 10 crores. What
does this imply?
39
40. Real Vs. Nominal GNP
»What are the situations in which Nominal
GNP increases?
»If more output is produced
»If prices rise
»What are we more interested in and why?
»Concept of GNP Deflator
»Real GNP = Nominal GNP *(GNP deflator for
base year/GNP deflator for current year)
40
41. Practice Problems
» Which of the following variable(s) will come
under stock variable(s)
1. Consumer Price Index
2. GDP
3. Money Supply
4. Exports
5. Both (1) and (2) above
41
42. Practice Problems
» The relationship between aggregate
consumption expenditure and aggregate income
of household sector is known as _____ function
1. Consumption
2. Expenditure
3. Saving
4. Income
42
43. Practice Problems
» Gross Domestic Savings is the difference
between
1. GDP and GNP
2.GDP and GDCF
3.National Disposable Income and GDP
4.GDP and Aggregate Consumption
5.National Disposable Income and GDP
43
44. Practice Problems
» Which of the following will come under flow
variable(s)?
1.Unemployment
2.Foreign Exchange Reserves
3.Consumption
4.Money Supply
5.Both (1) and (2) above
44
45. Practice Problems
» The act of replacing worn out assets and
creating new assets is capital formation. Then
GDCF consists of
1.Making good the depreciation on existing
fixed assets
2.Adding to the stock of fixed assets
3.Adding to inventories
4.Both (1) and (2) above
5.All of (1), (2) and (3) above
45
46. Practice Problems
» If GDP is growing at g% per annum and
population at p% per annum, then per capita
GDP must be growing at ____ %
1.(g+p)/2
2.(g-p)/2
3.(p-g)
4.[(1+g)/(1+p)]-1
5.None of the above
46
47. Practice Problems
» The circular flow model of a free enterprise
economy shows
1.How competition achieves economic
efficiency under capitalism
2.How the prices of resources, goods and
assets are determined
3.How resources are distributed
4.How production and household sectors
interact through markets
5.Both (2) and (4) above
47
48. Practice Problems
» Which is the best indicator of economic
development of a developing country?
1.National Income Deflator
2.GNP at current prices
3.Real National Income
4.Per Capita Real National Income
5.GDP Deflator
48
49. Practice Problems
» Which of the following is not true with respect
to stock and flow variables?
1.Both variables have time dimension
2.Flow variables are always determined by
stock variables
3.Stock variables are usually affected by flow
variables
4.All flow variables need not have stock
variable counterparts
5.Flow variables are partly determined by
stock variables
49
