MACROECONOMICS I

MODULE 1
Introduction to Macroeconomics

Mansoor P
Assistant Professor
Department of Economics
Amal College of Advanced Studies, Nilambur
 Introduction to Macroeconomics
• Two branches of Economics- Macroeconomics and Microeconomics-
Ragnar Frisch.
• Macroeconomics- younger branch of Economics- developed after Great
Depression of 1930s.
Subject Matters of Macroeconomics
• Determination of national income
• Study the causes and fluctuations of national output and employment.
• Determination of general price level.
• Determination of level of foreign trade.
• Study the causes of disequilibrium in BoP and BoT.
• Study the effect of monetary policy and fiscal policy.
• How to keep economy on growth path.
Origin and Growth of Macroeconomics
• Classical Macroeconomics
• Keynesian Macroeconomics
• Post-Keynesian Macroeconomics
– Monetarism
– Neo Classical Macroeconomics
– Supply-side Economics
– Neo-Keynesian Macroeconomics
Definition of Macroeconomics
• According to Samuelson, ‘Macroeconomics is the study of the behaviour of
the economy as a whole. It examines the overall level of a nation’s output,
employment, prices and foreign trade’.
 Scope of Macroeconomics
• Studies economic theories
• Study of economy as a whole
• Policy formulation, analysing and solving economic issues like
overpopulation, BoP deficit, etc.
• Macroeconomic variables- national income, output, employment,
inflation, business cycles, etc.
• National income and its calculation
• Development of growth theories and its applications
• Micro to macro.
Limitations of Macroeconomics
• Excessive generalisation – danger in generalising individual experience as the
experience of the system as a whole.
• Macroeconomics deals with national aggregates- these aggregates are not
reality.
• Differences within aggregates themselves- if national income increased by 7 per
cent, this does not mean that all people’s income increased by 7 per cent.
• The macroeconomic models have only limited applicability because of their
abstract nature.
Macroeconomic Models
• A macroeconomic model is an abstraction from the real world.
• It is a tool used to analyse an economic phenomenon and predict the values of
endogenous values used in the model.
• A hypothetical economic world.
• Establishes a set of relationships among economic variables.
• It can be a verbal statements, numerical tables, graphs, mathematical equations,
etc.
• A macroeconomic model is an analytical tool designed to replicate the operation
of the global or individual country’s economy.
• It examines the dynamics of important economic indicators like output, inflation
and unemployment.
• When looking to enter a new market, assessing current markets or considering
different policy scenarios, organisations can use this type of information to plan
ahead of major macroeconomic events.
• Macroeconomic models facilitate medium to longer term planning by serving
three primary purposes: understanding the past and present, predicting different
economic indicators and evaluating alternative “what if” scenarios.
• As a key component of market research, Macroeconomic models can help
determine the economic implications of various hypothetical economic events
and changes. This brings us to two different types of forecasts: baseline forecast
and scenario forecast.
• A baseline forecast presents the most likely outlook for a country or region.
• Scenario forecasts capture a range of alternative futures to the baseline forecast,
assigning them different probabilities.
• The use of a macroeconomic model elevates economic forecasting to a scientific
and systematic level.
• In a microeconomic model we considers interactions at the level of the individual
household or company.
• Broadly speaking, modeling can be used for three purposes;
• To understand the past and present
• To predict (forecast) the future
• To test alternative futures
Examples of Macroeconomic Model
• Law of demand (micro)
• Law of supply (micro)
• Aggregate demand function, AD =C+I+G
• Aggregate supply function, AS = C+I+S
• C = a+bY
• Graphical representations
• Circular flow of income in different sectors
Variables
• A variable is a measurable quantity which varies.
• Value will be changing.
• Macroeconomic variables are indicators or main signposts signaling the current
trends in the economy.
Stock and Flow Variables (time)
• Most of the economic variables that are studied are categorised either as stock or
flow variable.
• Stock- quantity of which can be expressed at a particular/exact point in time. Eg:
total production on January 15, 2021.
• Flow- measured over a period of time, quantity is accumulated over that period.
Eg: national income during 2018 to 2019.
Endogenous and Exogenous Variables (interdependence)
• Endogenous- affected by other variables in the model.
• Exogenous-not affected by other variables in the model.
• Eg; Qd = f(P)
Qd = endogenous variable
P = exogenous variable

Ex-ante and Ex-post Variables

• Ex- ante Ex-post are Latin words- Ex-ante means ‘before the event’ and Ex-post
means ‘after the fact’.
• Ex-ante- planned or predicted value- ex-ante is the prediction of a particular
event in the future, such as the potential returns of a company.
• It is the prediction of an event before it actually happens, and the actual outcome
is uncertain.
• Ex-ante refers to future events, such as the potential returns of a particular
security, or the returns of a company.
• Much of the analysis conducted in the markets is ex-ante, focusing on the impacts
of long-term cash flows, earnings and revenue.
• Ex-ante analysis in financial markets refers to prediction of various indicators,
economic and financial, by evaluating past and present data and parameters.
• Ex-ante analysis is not always correct because it is often impossible to account for
variables and markets are also susceptible to shocks that affect all stocks.
• Ex-post- actual or realised values- Ex-post is backward-looking, and it looks at
results after they have already occurred.
• Ex-post information is attained by companies to forecast future earnings.
• When economy is in equilibrium, ex-ante and ex-post variables will be same.
Static Analysis
• Static- economy is studied at a particular point in time as the economy is standstill
at that moment.
• Prof. Harrod, ‘an economy in which rates of output are constant is called a static’.
• Economic activities are going on in the normal rate- no change in the rate of
growth of output, employment, stock of capital, etc.
Comparative Static Analysis
• Study of economy at two different points in time.
• Study of the relationship between two variables at two different points in time.
Dynamic Analysis
• Economic phenomenon is studied under changing conditions.
• Studies those factors that put the economy in motion.
• Studies movements in the economy which are unexpected and irregular.
Equilibrium and Disequilibrium
• Latin word ‘aequilibrium’ which means equal balance.
• The word came to economics from physics.
• Equilibrium- state of balance or equality between two opposing
forces at which economy is at rest.
• At macro level-equilibrium- aggregate demand= aggregate supply
and total savings=total investment.
• Market equilibrium- total quantity of goods and services demanded
is equal to total quantity of goods and services offered for sale.
• Disequilibrium- two opposing forces are in imbalance in the
economy- creates disturbances in the economy.
 Circular Flow of Income and Output
• When various transactions take place in an economy, there will be two types of
flows –
– 1) Product Flow or real flow – goods and services flow and factor flow.
– 2) Money Flow – factor payments and expenditures on goods and services.
Circular Flows in a Two Sector Economy
• Two sectors – Households and Firms (business)
• Households provide factor services (land, labour, capital and organisation) for
which they receive factor payments (rent, wages, interest and profit) from firms.
This is the income of the factor owners.
• Firms provide products - both goods and services for which they receive income
from households in the form of product prices.
• Factor income will be equal to factor payments
• Households expenditure will be equal to total value of the products
• Households Income (Y) = Factor Payments (FP) = Value of Output Produced (V).
• Size of money flows in an economy is determined by the size of income in the
society.
• Leakages- savings
• Injections – past savings, borrowed money
Circular Flows in a Three Sector Economy
• Three sectors- households, firms and government.
• Closed economy.
• Fiscal variables are included- government expenditure, taxes, transfer payments,
public borrowings, etc.
• Injections – Government expenditures, transfer payments like social security
payments, unemployment insurance, subsidies, etc.
• Leakages – Taxes.
• Households provide factor services to the government, and get wages, salaries,
rent and interest in return.
• Firms provide goods and services to the households and government and get
price in return.
• Both households and firms pay taxes to the government.
• Government spends its revenue on various projects and the money goes to both
households and firms.
• All money flows have a counter flow in the form of output except in the case of
transfer payments.
• Government can borrow money form financial market.
• Total expenditure = C + I +G
• Total Income = C + S + T
• Income (Y) = Expenditure (E)
C+S+T = C+I+G
S+T = I+G
Circular Flows in a Four Sector Economy
• Open economy
• Foreign sector is added
• Households start exporting man power and get foreign remittance in return.
• Firms export goods and services and get foreign exchange in return.
• Firms import raw materials, intermediary goods and finished goods.
• Capital is also imported and exported.
• Leakages – Value of imports.
• Injections – Foreign remittances and value of exports.
 National Income
• National Income- total money value of all final goods and services
or output produced in a country during a year.
• The value of total output produced will be equal to the total
income generated in the economy during that period.
• Simon Kuznet, “the net output of commodities and services
flowing during the year from the country’s productive system to
the hands of the ultimate consumers”.
Gross National Product (GNP)
• Total money value of all final goods and services produced by the nationals of a
country or by the domestically owned factors of production during a financial year.
• Ownership specific.
• Income earned by citizens of a country abroad will be included.
• Income earned by foreigners inside the country will be deducted.
Nominal and Real GNP
• GNP estimated at current price- Nominal GNP.
• GNP which adjusted to inflation- Real GNP- estimated on the basis of base year.
Actual and Potential GNP
• Potential- output which could be produced using resources- full employment GNP.
• Actual- what is actually produced- actual GNP < real GNP.
• The difference between actual and potential- GNP gap.
Green GNP
• Real GNP adjusted to environmental degradation or damage.
GNP Deflator
• Converting nominal GNP into real GNP.

Net National Product (NNP)

• Net value of all final goods and services.
• NNP= GNP - Depreciation
Gross Domestic Product (GDP)
• Total money value of all final goods and services produced within the
geographical region of a country during a year.
• It included income earned by all residents of the country and foreigners residing
in the country.
• GDP= GNP – Net factor income from abroad
Net Domestic Product
• GDP – Depreciation
NNP at Factor Cost
• True representative of national income.
• NNPFC = NNPMP – Indirect Taxes + Subsidies
• National income can be calculated at market prices (current and constant) and at
factor cost (current and constant).
• National income calculated at constant prices is called real national income.
Personal Income
• Total income received by all individuals or households form all sources of income
during a year before paying taxes.
• Private income- total income earned by individuals and private corporate sector.
Disposable Personal Income
• Disposable income = Personal Income – Personal Taxes.
Percapita Income
• Average income of a person in a country during a particular year.
 National Income Estimation
• 3 Methods- income, expenditure, and Value added.
1). Income Method
• Income received by all individuals in the country.
• Summing income received by all 4 factors of production.
2). Expenditure Method
• Total of all expenditures made in the economy during one year.
• Individuals, firms and government are agencies who make expenditures in the
economy.
• Expenditure on both consumer goods and services and capital goods and services.
3). Value Added Method or Product Method
• Flow of final goods and services during a year.
• Value added at each stage of production is added together to arrive at national
income.
Difficulties in the Estimation of National Income
• Problem of double counting.
• Non-monetary transactions- services of housewife.
• Underground economy.
• Public services-evaluation of services like police, military, etc is difficult.
• Absence of accounts.
• Transfer payments- pension, unemployment allowance, etc are not for a current
services rendered.
• Additional payments in kind- cost of uniform of police, etc are included.
• Barter economy.
• Price changes- frequent price changes.
• Inventory changes- correct valuation is difficult.
• Capital gain or loss- change value of capital asset is not included.
• Illiteracy and ignorance.
• Calculation of depreciation.
• Environmental damages.
• Inadequate statistics.
• Imputation- value of self owned resources are not included.