MACROECONOMICS

Dr. Muhammad Usman

Senior Assistant Professor
Bahria Business School
Let’s Recap!
What is Economics?

– Scarcity
– Choice
– Opportunity Cost
Scarcity and Choice

– What should be produced?

– How should goods and services be produced?

– For whom goods and services be produced?

How do people make choices?

– Maximizing value

– Budget Contraints

– Choices are made at the margin

– Little more or little less of something
Opportunity Cost

– Opportunity cost is the value of the best alternative forgone in making any choice

– “One of the most important concept of economics”

– Not to be confused with purchasing price of an item!

Macroeconomics
Macroeconomics

Macroeconomics (Greek makro = ‘big’) describes and explains

economic processes that concern aggregates

Macroeconomics is the study of the structure and performance of

national economies and of the policies that governments use to try to
affect economic performance.
 Mircroeconomics vs. Macroeconomics

choices made by individual decision-making units in the economy Micro

choices on the total or aggregate, level of economic activity Macro

Why do designer clothes costs so much? Micro

Why do senior citizens gets discount on transport? Micro

Is the total level of economic activity rising or falling? Macro
Is the rate of inflation increasing or decreasing? Macro
 Background

Adam Smith – The Wealth of Nation

– Classical School of Thought

– David Ricardo and James Mill –
– later on, Marshall, J.S. Mill Pigou and Edgeworth

– The Keynesian Economics

– The Post-Keynesian Economics
Classical School of Thought

– There are free markets;

– Individuals act in their own best interest.

– Markets must function without impediments.

– Wages and prices should be flexible.

– Thus, according to the classical approach, the government should have a limited
role in the economy.
The Keynesian Economics

– The Great Depression

– High unemployement
– Low spendings
– Low consumption

– Keynes (1936): The General Theory of Employement, Interest and Money

– What causes depression and how?
– How consumption and investments levels are determined?
– Role of central bank in managing money and interest rates
– Why some nations prospoer while others stagnate?
The Post-Keynasian Economics

– Issues with Keynasian Economics:

– mainly focus on demand side economics
– Desgined for controlling aggregate demand
– Neglected supply side economics

– An extension of classical theory ~ role of money as a major factor in determining

whatever happens in the economy | Monetarism (Milton Friedman)
– Rational Expectations: emphasize on the role of individuals’ rational expections
regarding future economics events
– Supply side of economics
Why Study Macroeconomics?

ü“To help Individuals, businesses and governments in making their decision”

ü“To assess economic performance”

ü“Increasing economic stability and growth”

“To help Individuals, businesses and governments in
making their decision”

– Consumers’ Interest: How easily can they find job? Prices of goods and services?
Cost of borrowing?

– Businesses’ Interest: Whether to expand production or not? Demand and supply?

Purchasing power of consumers?

– Governments’ Interest: planning budgets and taxes? Deciding interest rate?

Making policy decisions?
“To assess economic performance”

– National Output (GDP, GNP, NI…)

– Rate of unemployement
– Inflation rate
– trade performances

– Governments role: Fiscal Policy, Monetary Policy

– Macroeconomics helps to evaluate the success and failure of economic policies
and the Central Bank
“Increasing economic stability and growth”

– The Business Cycle:

– Analyze short-run fluctuations in the national income that leads to business cycle

– Increase in the National Income:

– Determinants of long-term economic growth

– Both, businesses and the governments, use macroeconomic models and their
forecasts to foster their development process and evaluation of policies. This helps
in maintining stability and growth.
Some Concepts in
Macroeconomics
Positive vs. Normative Economics

– Positive economics
– describes and explains various economic phenomenon
– “what is” scenario
– Objective and fact-based
– Precise, descriptive and clearly measureable

– Normative economics
– Reflects people’s desireability
– “what should be” or “ what ought to be” scenario
– Subjective and based on perceptions, opinion and value judgements
 Business Cycle and Recession

Business Cycle:
“short-run contractions and expansions of economic activity”

Recession:
“the downward phase of a business cycle when national
output is falling or growing slowly”

– Hard times for many people

– A major economic and political concern
Unnemployement

– Recessions are usually accompanied by high unemployment:

– Unemployment: The number of people who are available for work and are
actively seeking it but cannot find jobs.

Unemployed
Unemployme nt Rate = ´ 100%
Labour Force
Inflation

– When prices of most goods and services are rising over time it is
inflation. When they are falling it is deflation.

– The inflation rate is the percentage increase in the average level of

prices.
Effects of Inflation

– High Inflation rate = poor functioning of the economy

– The purchasing power of money declines quickly, which forces people to spend
their money as soon as they receive it.
The International Economy

– An economy which has extensive trading and financial relationships with

other national economies is an open economy.

– An economy with no relationships is a closed economy.

– International trade and borrowing relationships effects business cycles

from country to country.
Exports and Imports

– Pakistani exports are goods and services produced in Pakistan and

consumed abroad.

– Pakistani imports are goods and services produced abroad and

consumed in Pakistan.
Trade Imbalances

– Trade imbalances (trade surplus and deficit) affect output and employment.

– Trade surplus: exports exceed imports.

– Trade deficit: imports exceed exports.

The Exchange Rate

– The trade balance is affected by the exchange rate

– “the amount of Pakistan Rupees that can be purchased with a unit of foreign
currency”
Macroeconomic policies

– Fiscal policy: government spending and taxation at different government levels.

– Monetary policy: the central bank’s control of short-term interest rates and the
money supply.
Economics Model

– Economic theory: a set of ideas about the economy to be organized in a logical

framework.

– Economic model: a simplified description of some aspects of the economy.

Stock vs. Flow

– Stock and/or flow variables of an economic model

– Stock: quantity measured at a point in time
Currency in circulation, number of people employed, total labour force etc.
– Flow: quantity measured over a period of time
Savings, investments, number of people leave jobs or get new jobs, etc.

– Static vs dynamic relationship of variables

– Same time period vs. different time period
– Equillibirum vs disequilibirum solution
– comparative statics
 – Equillibirum: Balance or state where there is no change in the net
effect of the change
– Disequillibirum: State of imbalance

Equillibirum vs.
Disequillibrium
Partial vs. General Equillibrium

– Partial Equillibrium
– Determination of equillibirum price and output in each market, Ceteris Paribus
– Ignores interdependacne and linkages between different markets

– General Equillibrium
– Analysis involved a state where all the markets and the decision making units in the
economy are in simulatenous equilibrium
– Studies equillibria in a group of inter-related markets, emphasizing inter-dependence
between different economic unit
GDP vs. GNP

Two major measures of total output in the economy

1. Gross Domestic Product (GDP)

– Total value of goods and services produced in the country in a certain period of time
2. Gross National Product (GNP)
– Total value of goods and services produced by nationals of the country in a certain period of time

For instance, the cars produced in a Suzuki plant in Karachi would count towards the
GDP of the Pakistan but the GNP of Japan.
Measuring Output

– Suppose we had the following production process

Wheat Flour Cake

– Farmer ------------→ Miller -----------→ Baker ------------→ Consumer

– The economy has produced wheat, flour, and cake, which is eventually consumed
by the consumer.
– But a large part of the Rupee value of cake is made up of flour. Counting both
would overstate the amount of output people actually consume.
– Thus we only count the Rupee value of the end use (cake) in GDP.
Q&A
Session
 – While the study of economic activities of individuals, households,
and business at the sub-national level is the concern of
____________________ the study of economic activities of the
national and global level is the concern of ___________________.
– Questions about facts or “how things are” are ________________
while questions about values and “how things should be” are
________________ questions.
– The fluctuations in the level of production, including recessions on
Class Activity the one hand and booms on the other hand, is called
________________.
– The school of economics that is associated with the idea that
individual self-interest is a positive force and that governments
should let markets function without interference is called _______.
– The economist who argued that the market mechanism can fail by
leaving insufficient demand and that governments could intervene
by increasing aggregate demand was named _______________.
– What are the “three basic economic questions” that economists
often address when examining how much economic output is
produced?
– Why is the goal of stability and security important to many
people? What problems typically emerge during periods of
instability?
– Explain how the classical school, Keynasian economics and
Monetarist views the role of markets and government
intervention in fighting business cycles.