INTRODUCTION TO MACROECONOMICS 11 Meanin: | ‘Ss cet EDUCATION, 505) 1.2 Schools of Thought Sa LON S LIBRARY yo $§ cuemaue mumaalao007s. + 2 Ay ence 8 1.3 Scope/Subject Matter 1.4 Importance 1.5 Limitations 4 63596 been ea omes (3A MBANING So | croeconomics studies the economy as a whole and analyses its ioning. It deals with the behaviour of aggregates such as national income, employment level, general price level, investment level and balance of payments. These aggregates are the result of activities in different sectors of the economy and they form the collective behaviour pattern of decision makers such as consumers, governments, firms and industries, oO ‘According to K. E. Boudling*, “Macro economics is that part of economics which studies the overall averages and aggregates of the economic system. It does not deal with individual incomes but with national income; Hot with individual prices but with the general price level, not with individual output, but with national output”. ne yo ane Cece of has Sei ° Kenneth Boulding, British Economist (1910-1993).3 introduction to Macroeconomics a that modern macroeconomics began with the publication of y John Maynard Keynes's General Theory of Employment, Interest and Money in 1936. © post Keynesian Developments: Later in 1950s, economists like Poul Samuelson, James Tobin, Robert Solow, Franco Modigilani, combined Keynesian economic theories with neo-classical microeconomics to develop theories of consumption, investment and money. Another important post-Keynesian development in macroeconomics was the emergence of Monetarism, led by Milton Friedman. Monetarists focus on the role of money supply and central bank in determining price level in an economy. [All of these, along with Keynesian models, form the subject matter of modern macroeconomics. ‘The following is the scope of macroeconomics: 1, Determination of National Income: The primary focus of macroeconomics is the study of the factors that determine a country’s national output and income. These factors include consumption, investment, government expenditure and net exports. Macroeconomics analyses each of these factors. Several concepts of national income accounting are used in macroeconomics, such as, gross domestic product (GDP), gross national product (GNP), net national product (NNP), per capita income. Alll these measures are used to analyse the performance of an economy. The growth of the national income is a very important part of macroeconomic study as itis used to compare « the relative performances of different countries. Per capita income is used to understand how national income is distributed among people. onomic Fluctuations or Business Cycles: Free-market e€onomies experience business cycles which refer toBs 4. 5y 4 Business Economics-III (S.Y-B.Com. : SEM. jroctuations in ne and employment wig siternating periods of prosperity a a ms fluctuations cause large scale involus ary ployment well as inflation. Analysis of the effects of economic fluctuation has been the main focus of macroeconomics, partic baay tin the Great Depression of 1929. Macroeconomic models provid, the basis for policy design stabilisation measur, national incom makers to through fiscal and ‘monetary policies. ly: The theor ‘Aggregate Demand and Aggregate Supply’ heory of fens and employment explains what determines the national income and what causes fluctuations in the level ot e. During the Great Depression, the national income over tim ess Ievels of employment and income were very low. This could not be successfully explained with the classical economic principles which believes that whatever is supplied will always Pederanded (Say’s Law) and that in the long run, the economy will achieve full employment equilibrium. But Keynes explained that the level of employment and national income is determined by aggregate demand and an economy can be in equilibrium even at less than full employment level. The focus of macroeconomics then shifted to analysing components of aggregate demand like, consumption, investment, government expenditure and net exports. Aggregate supply can be ‘increased in the long run through irfiprovement in productivity, investments, technological changes and policies. Employment and Unemployment: Macroeconomics studies the level of and nature of employment in an economy. During recession, due to lack of aggregate demand, the economy especies large scale involuntary unemployment. This is Cea ae eee developed economies. n onomie: problem of unemployment i Ca ae that of developed economies. In agen guised unemployment, underemployment and mass ie ae place due to structural problems which eee: sided. Macroeconomics studies the causes ‘unemployment and provides the basis ence at wrong) a Price Level: Macroeconomics studies the role of economy by analysing the demand for and suppla well ; \. Suep of money. Macroeconomics is concerned with the study of nent a, inflation, deflation and more recently, stagflation. Inflation is ® faced by both developed and developing economies. It has far Introduction to Macroeconomics 5 uatio, ly si he reaching impact on people's welfare and an economy's growth. >rovide Classical economists believe that general price level is easuires determined by the quantity of money and price level rises in proportion with money supply. This is explained by the ‘Quantity Theory of Money. On the other hand, Keynes showed 20ry of that it is not quantity of money, but rise in aggregate demand es the that causes inflation. Keynes put forward the concept of evel of demand-pull inflation. In 1970s, developed economies on, the experienced a situation which could not be explained by the 3 could existing macroeconomic models. This was stagflation (stagnant momic inflation), a period where there is unemployment as well as always rapid rise in price level. This was explained as cost-push onomy inflation by supply-side economic models. seymes 6 Economic Growth and Development: Theories of economic fomeis growth and development have been a recent area of interest in 0 be in macroeconomics. The problem of economic growth is a long e focus term problem and Keynesian economics did not deal with it. ents of Therefore, in the 1950s and 1960s, a branch of economics called ment Development Economics emerged to study the development creased process in low-income economies. The main areas of study of tivity, this branch of macroeconomics are economic growth, economic development and structural changes in developing economies. r One of the first models to explain growth theory was the fiesthe ——_Yarrod-Domar Model. Other economists who have contributed During’ significantly to theories of growth and development are Arthur onomy Lewis, W.W. Rostow, Robert Solow, James Meade and in more This 1s recent times economists like Amartya Sen, Paul Romer and romies. Robert Lucas. nent is nomies 7. Balance of Payments and Exchange Rate: As foreign income is i mass a determinant of national income, macroeconomics studies the which » impact of trade on national income. Macroeconomics explains iuses of the factors which determine a country’s balance of payments solicies’ and identifies the causes of deficit. It suggests policy measures Pi to correct such deficits. Exchange rate between different role %* currencies is one of determinants of balance of paymentsSES Economics-IIl (S.¥-B.Com. SEMA usiness EO? : y, The central bank plays a role j, Introd’ ‘| position of an economy seems dei subject matter rate of ir Ss exchange ** S pate of Franaging exch ws spoeconomics: rn a pusiness U that arise Understa taking ef! to Me tion to cance t0 Policy 5 of great Vendy of macroecononnt is of gent SF interruion| g. Forecast mencies like the World bank ‘sons why a good understanding economi aperraiowing are some of the To tate, pri of macroeconomics 6 important: pee forecast isnt onomy: ? | 1, Understanding the functioning of bane Ba tre 2 formul macroeconomics helps Ons Th Oot action between different 6. Makin; aneconomy. Ithelpstostucl Tir seholds, business and Stone, sectors of an economy like: (vr arkets interactwith choice’ government and analyse how ee | Berner Macroeconomics also focuses On he St yor gover economic systems that exist, like different forms of capitalism, as ae al socialism and mixed economy systems. = sel 2. Understaniling and evaluating, economlcyPeHOnaense: 9 AnGoy Undersieigrowth and development are considered to bethe and most important indicators of an economy's performance. The funct ta income forms the basis for impa analysis of national and per capil evaluating and comparing different economies on their performance. 451 3. Formulating government policies: Macroeconomic analysis and models form the base on which governments formulate their economic and social policies. Keynesian theory has been Thought the foundation of counter-cyclical fiscal and monetary policies that were put in place by most developed economies to deal with recession, unemployment and inflation. The developing economies have formulated long term plans and policies '© promote growth . dayne aa development on the basis of th® Followi the func makers, limitatic need of ig the economic envir et Eo are: ‘onment of business: affected by the macroeconomic environment. be 4. Understandin; Business unitsin, | Introduction to Macroeconomics oF Rate of interest, the general price level, the phase of business cycle, exchange rate, level of employment, investment and expenditure levels, all have major impact on performance of business units. Businesses have to be prepared to face challenges that arise out of changes in the macroeconomic environment. Understanding of macroeconomics is extremely important in taking effective business decisions. Nal 5, Forecasting future trends: Macroeconomics provides the ‘ns, foundation to economic analysts to forecast future trends in Ing economic indicators like interest rate, exchange rate, growth rate, price level, income and employment levels. Such trend forecasts are used by governments as well as businesses to of ici tof formulate policies. ent 6. Making political choices: Economics and politics have very nd strong inter-linkages. In most cases, people make political ith choices on the basis of macroeconomic indicators and judge of governments on the basis of their achievements in areas’ like im, employment generation, control of inflation and welfare generation. Political parties and leaders in democracies try to win votes by promising economic benefits like employment, ce: income, price control and social welfare. One can make a good the and wise political choice if one has an understanding of the ‘he functioning of an economy. Study of macroeconomics becomes for important for making good political choices. eir \ {a5 narations 45° I SI sis ate ten Though macroeconomics provides the foundation for understanding ies the functioning of an economy and is very important to policy eal Makers, macroeconomic theories and models do suffer from certain ing limitations. They need to be adapted and modified according to the | to need of the situation. th Following are some of these limitations: 1. Emphasis on aggregates: Macroeconomic analysis is based on excessive reliance on aggregate values, sometimes ignoring =~ the differences that exist at the micro level. At times, changesConflic tors. For é : some sec < a Ignores welfare: Classical 2 ae nly de i mena as prescribe but only describe economic phenom Keynesian approach to macroec c the ie overcome this criticism by advocating that the governments _ need to take care of economic and social welfare throw budgetary policies Role of money:Since macroeconomics deals v quantities like consumption, income, savings and inv the common measuring rod used is money. The value depends on factors like inflation and interest rate w both subject to change. Thus, the value of money itself kee changing. This makes it difficult to measure and compare ® macroeconomic aggregates. At best, the measurements # averages of individual quantities, which limit their usefuln& - A E 1 »Introduction to Macroeconomics 9 Mismatch with reality: Macroeconomic models based on unrealistic assumptions are criticised for being far removed from reality and therefore have limited application. It is often argued that the models are too abstract and mathematical to be able to provide a solution to real world problems. The models assume linear cause-effect relationship between variables. However, in the real world, such precise and liner relationships may not be seen Limited application to developing economies: Most macroeconomic models are based on assumptions that are applicable to developed, industrialised, free-market economies. Therefore, their application to underdeveloped, developing and emerging economies is limited. For example, the theory of business cycle assumes that the economy is an industrialised, . free-market economy. Such a theory cannot explain the ’ movement of national income in an agrarian, non-capitalist economy. Sometimes, when policymakers try to replicate policies of a developed economy ina developing economy, the result may lead to economic disaster. However, Development Economics branch of macroeconomics deals with the specific problems of developing economies. Define macroeconomics. Discuss the various schools of thought of macroeconomics. Discuss the scope of macroeconomics. Discuss the importance of the study of macroeconomics. What are the limitations of macroeconomics ?