Macroeconomics 19 nov

November 19 2011

Macroeconomics

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Introduction

Scarcity, Choice and Real Cost

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Opportunity Cost

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

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”

»Money is just a claim to the final output5

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

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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

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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

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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

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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

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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

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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

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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

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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)

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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

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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

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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

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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

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»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

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»Problems of arriving at an estimate:

»Consumer goods Vs. Industrial goods

»Police force, defense

»Goods produced and consumed within the

same household

»Price effect

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same household

»Price effect

»GDP and GNP are also treated as a way to

estimate the value added to a process

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same household

»Price effect

»GDP and GNP are also treated as a way to

estimate the value added to a process

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»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

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»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

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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)

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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 + S26

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?

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Industrial and Agricultural Production

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»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

Wholesale, Consumer Prices and Inflation

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»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)

Employment

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»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

Balance of Payments (BoP)

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»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


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»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


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»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?

Rate of Growth

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»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?

Business Cycles and Circular Flow of Income

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»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

Concept of National Product

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»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

Relationship

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GNPMP

NNPMP GNPFC

GDPFC

NDPFC

NDPMP

NNPFC

GDPMP

- Dep- Net indirect taxes

- Net indirect

taxes

- Net indirect taxes - Dep

- Dep

- Dep

- Net income from abroad

- Net in

com

e

from

abro

ad

- N

et

inco

me

from

abro

ad

- Net indirect

taxes

- Net income from abroad

Real Vs. Nominal GNP

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»“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


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»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?


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»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)

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

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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

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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

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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

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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

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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

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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) above47

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

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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

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Questions???

Have a happy Sunday!

Macroeconomics 19 nov

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Transcript of Macroeconomics 19 nov