* Chapter 1: Introduction

 Economics is the study of the economy and the behavior of people

in the economy.

 Based on the scope of study, There are two main branches of

economics.

 Microeconomics; studies the behavior of economy at individual

level.

 Macroeconomics; studies the overall or the aggregate behavior of

economy.
 * Chapter 1: Introduction
*Macroeconomics is a branch of economics which concerns with the
nature, relationships and behavior of aggregate quantities such as
national income, total consumption, savings and investments, total
employment, general price level, aggregate expenditure, aggregate
demand and supply of goods and services.

*Since macroeconomics deals with aggregate quantities of the

economy as a whole, it is sometimes also called Aggregate
Economics.
Continued …….
 It deals with both long-run economic growth and the short run
fluctuations which are constituents of the business cycle
 In brief, it deals with major economic issues and problems and
therein possible solutions.
 For instance, during high unemployment the policies aim at
reducing unemployment rate.
 During high inflation it tries to stabilize price level. During trade
deficit, it tries to find the means through which export can be
expanded
 Macroeconomic issues play a central role in political debate
 Macroeconomic issues are also at the center of world politics
 * Major Elements of Macroeconomics
*Gross Domestic Product (GDP) ): is the sum of values of total
goods and services produced in a given country in a given period of
time (a year).

*Government expenditure: is the amount of resources that the

government sector of a country spends in a given fiscal year
(budget year).

*Total money supply: is the sum of total currencies in circulation.

*Inflation: represents a rise in general price level
Continued……..
 Trade Balance: is the net inflow of foreign exchange from trade (export
and import). It is the value of net export of a country. It is measured by
the difference between export from and import into a country;
 Current Account Balance (CA):)
 is the net inflow of resource from trade, services and unrepeated transfer.
 In addition to import and export items, the current account includes the
flow of payment to factors (labour, capital, land etc.) such as dividends,
profits and wage as well as payments to services such as shipping, banks
and tourism; and unrepeated transfers such as remittance from abroad.
continued…….
 Balance of Payment (BOP) )
 is the net of inflow of resources to a given country/economy from
the rest of the world.
 This includes the flow of all resources. It does not refer to flow of
resources only from trade services.
 In addition to the current account balance, the balance of payment
(BOP) includes the flow of resources from foreign investment,
borrowings from the rest of the world (short term, medium term, and
long term), and repayments of such borrowings.
 Exchange rate: refers to the rate at which domestic currency is
exchanged for foreign currency.
Continued……….
Consumer price Index (CPI):
 is the measure of weighted average of prices of goods and services
used by consumers.
 It is the measure of cost of living. Like GDP which measures or
converts all goods and services in a given economy/country to a
single figure, CPI measures prices of several goods and services into a
single price
 Per capita Income (PCI) ; GDP/ Population: is the measure of
average output of a country per person
 *1.3. Macroeconomics Schools of Thoughts
*Different macroeconomic ideas/thoughts have evolved over time
beginning from the mercantilist (1500s–1600s) period to present.

*According to Mercantilists, national development (wealth of nation)

can be achieved through accumulating precious metals, especially
gold.
*This theory is also called materialist theory.
*The Classical and Keynesians are the dominant thoughts behind the
development of these ideas.
 * Con….
*In general term these schools can be categorized either as
interventionist (similar position with Keynesians) and

* non-interventionist (similar position with classical economists).

*Interventionist believes that government intervention is necessary
for efficient functioning of the nation.

*Whereas non-interventionist believes that market are basically

efficient and hence there should not be any government intervention
in the economy.
 Classical thought(1776-1870)
*The ruling principle was the invisible hand coined by Adam Smith.
*During this time there was no government intervention in economic
activities.

*Because economists of the time i.e. classical economists believed

that the market is efficient and works the best by itself and

* There is no need of government intervention (Lassez-fair

economy).
 * Neo classical (1870-1939) Though
*The neoclassical school which criticized some of the ideas of
classical economists but more or less their ideas is the same.

*The main distinction between them is the tool of analysis, such as the
marginal analysis of microeconomics theory.

*Classical and neo-classical ideas are also now days applied under
different circumstances.

*His work is popularly known as Say’s law of market which is a well-

known non-interventionist approach.
 * Con….
*Say's Law holds that every supply creates its own demand.
*He believed that the total supply of products and the total demand
for them must be equal.

*He agreed that there may be temporarily overproduction.

*This over production will soon be corrected by supplier once they
know that there is no demand for the over production.
 * Keynesian’s (1936 - 1970) school of thought

*The first economist who developed this theory was John Maynard
Keynes.

*The economists following his trend are called Keynesian

economists.

* Keynesian’s economic theory is also known as ‘Theory of

Recession’.

*The Keynesian thinkers believed that government intervention is

inevitable.
 * Con…
* For Keynes to deal with recessions,
* the first and the most obvious thing to do is to make it possible for
people to satisfy their demand for more cash without cutting their
spending,

* thereby preventing the downward spiral of shrinking spending and

shrinking income.

* The simplest way to do this is by increasing government spending

or by increasing the supply of money.

* Therefore, one of the fundamental Keynesian answers to recessions

is monetary expansion.
 * Con….
*When monetary expansion is ineffective (“liquidty trap”) , fiscal
expansion must take its place.

*Such a fiscal expansion can break the vicious circle of low

spending and low incomes and help the economy to return back to
its normal path.

*The implications of the fundamental Keynesian thought are the

following.

The economy is inherently unstable and is subject to erratic

shocks.

 The economy can take a long time to return to being close to full
 * Con…
Government intervention is necessary for the smooth
function of the economy.

Aggregate demand is the predominant determinant of output

and employment, and it can be altered by the authorities.

Fiscal policy is preferred to monetary policy for carrying out

stabilization policies.

The access to information about the economic variables is

the key.
 Con…
In other words, a straightforward rule “keep the money supply
steady” is good enough so that there is no need for a
“discretionary’ policy of the form “pumps money in only
when your economic advisers think a recession is imminent”.
 New classical and New Keynesians
 New classical: The New Classical School, along with the New
Keynesians, is built largely on the goal of integrating microeconomic
foundations into macroeconomics in order to resolve the glaring
theoretical contradictions between the two subjects.
 The New Classical School emphasizes the importance of
microeconomics and models based on that behavior.
 New Classical economists assume that all agents try to maximize their
utility and have rational expectation which they incorporate into
macroeconomic models.
 New Classical economists believe that unemployment is largely
voluntary and that discretionary fiscal policy is destabilizing, while
inflation can be controlled with monetary policy.
Continued …………..
 New Keynesians: The new Keynesian school also attempts to add
microeconomic foundations to traditional Keynesian economic
theories.
 While New Keynesians do accept that households and firms
operate on the basis of rational expectations, they still maintain
that there are a variety of market failures, including sticky prices
and wages.
 Because of this "stickiness", the government can improve
macroeconomic conditions through fiscal and monetary policy.