macroeconomic environment: major issues

7/31/2019 Macroeconomic Environment: Major Issues

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INTRODUCTION

Having discussed the nature and scope of business

environment.

Major macroeconomic issues considered while taking

business decisions.

The important macroeconomic issues :

Rate economic growth of the country

Magnitude of employment generation in the economy

Foreign exchange rate of the national currency

Balance of payments situations of the country


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ECONOMIC GROWTH

Meaning

Economic growth has been defined in two ways:

First

It is defined as increase in an economys real national income or gross

national product (GNP).

Second

Second and better way to define is to do so in terms of per capita income.


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ECONOMICGROWTH & ECONOMIC

DEVELOPMENT

Since 1970 s

Necessary to distinguish between economic growth & Economicdevelopment.

Two Views :

Traditional View

In this view share of agriculture in both national product andemployment of labor force declines and that of industriesand services increases.

C.P. Kindelberger writes, Economic growth means moreoutput and economic development implies both more outputand changes in the technical and institutional arrangementsby which it is produced


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Thus according to this view economic development implies growth

plus structural change.

Modern View

The problems of poverty, unemployment and income

inequality further worsened instead of getting reduced

during the process of growth in the fifties and sixties in the

developing countries.

Thus due to failure of traditional strategies of development

in solving the problems of poverty, unemployment and

inequality..

This led to view that economic development should not be

judged on the basis of growth in GNP alone.


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POVERTYAND ECONOMIC GROWTH

Despite significant economic growth achieved

during the last half a century, there still prevails

widespread poverty in developing countries.

Drastic changes in seventies.

India declined during nineties.


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TOTAL FACTOR PRODUCTIVITY & ECONOMIC

GROWTH

Y=AF(L,K,N)

Where,

Y=GDP

A=Total factor productivity

L=Quantity of labor input

K=Size of capital stock

N=Quantity of natural resources

Now in studies of growth N=constant & Human capital (H)is added

Y=AF(L,K,H)


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ARE NATURAL RESOURCES A LIMIT TO

GROWTH???

Economic Growth

living standards

Club of Rome Non-renewable natural resources

restricts the economicgrowth

2 saving factors

1) Technological Progress

2) Discovery & Use of the substitute

resources


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ASIAN TIGERS & ECONOMIC GROWTH

Hong Kong, Singapore, South Korea, Taiwan

Per capita GDP growth rate is 5.7 to 6.8 & they claim SpecialTricks

Economists like Alwyn Young say that no special tricksItsjust increase in inputs like labor, human capital etc & increasein TFP

Outward-looking economic strategy (promotion of exports togenerate growth) & lissez-faire free market policies

China & India too have registered a higher growth rate & havebecome the two fastest growing economies of the world.


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INFLATION & ITS MEASUREMENT

Persistent rise in general price level

Measured by % change in WPI & CPI

It makes the rich richer & the poor poorer

Pt - Pt-1Pt-1

Where

Pt=Price level of the current year

& Pt-1=Price level of the previous year

Similarly can be found out by the CPI where price

of a basket of goods is taken in account


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WHAT CAUSES INFLATION??

Quantity Theory of Money

1. Demand-pull Inflation : Keyness View

2. Cause of Inflation : Monetarists View3. Cost-Push Factor


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EMPLOYMENTAND UNEMPLOYMENT

An important macroeconomic issue is whatdetermines the level of employment in the economyand what causes involuntary unemployment.

Involuntary unemployment is defined as the

situation when in the country there are a largenumber of workers who are willing to work at thecurrent wage rates but are unable to getemployment.

In times of depression, the level of employment

declines very low with the result that a largenumber of persons become involuntarilyunemployed.


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SAYSLAWAND EMPLOYMENT

According to Says Law, there is always enough

expenditure or aggregate demand to purchase the

total output produces with full-employment or

resources.

In other words, in their theory, the classical

economists neglected the problem of deficiency of

demand for purchasing goods produces at full-

employment level of resources.

Even if deficiency of demand arises, according tothem, prices and wages would change in such a

way that real production, employment and income

will not decline.


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Says Law is based on the fact that every

production of goods also creates incomes for the

factors of production equal to the value of goods

produced by them.

Income earned by the factors are spent on

purchasing goods produces.

Supply creates its own demand, as a result,

the problem of general overproduction and

unemployment of resources do not arise.


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According to classical economists, savings by the

individual are automatically spent on investment or

capital goods.

Therefore, since saving becomes another form of

expenditure (that is, investment expenditure), in

classical theory the whole income is spent, partly

on consumption and partly on investment.

That is why, there is no reason for any leakage in

the income stream and therefore supply creates itsown demand.


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Another reason is that, according to classical theory, it isthe rate of interest which makes investment equal tosaving.

When saving of the people increases, rate of interestdeclines. As a result, the demand for investmentincreases and in this way investment expenditurebecomes equal to the increases savings.

In other words, it is changes in the rate of interest due towhich the withdrawal of some money from the incomestream as a result of savings automatically comes backto it in the form of investment expenditure and thereforeincome flow continues unchanged and supply goes oncreating its own demand.


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FLEXIBILITYIN PRICESAND WAGESAND FULL

EMPLOYMENT: THEVIEWOF CLASSICAL ECONOMISTS

According to Classical Economists, if changes in

rate of interest somehow fail to bring about equality

between savings and investment and as a result

deficiency of aggregate demand or expenditure

arises, even then the problem of overproductionand involuntarily unemployment will not arise.

This is because they thought that the deficiency in

aggregate demand would be made up by change

sin the price level.


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When, due to the increase in savings by the people,

the expenditure of the people declines, therefore, it

will affect the prices of products. As a result,

aggregate expenditure or demand will fall and

therefore, the prices of products would declines andat reduced prices their quantity demanded will

increase.

Therefore, all the quantity of goods produced will be

sold out at lower prices.


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Thus, Classical economists thought that a free-market capitalist economy works in a self-correctingmanner and when aggregate expenditure on goodsor aggregate demand for them declines, then

various sellers and producers will reduce prices oftheir products so as to avoid the excessiveaccumulation of stocks of goods with them.

Hence, according to them, when aggregatedemand declines due to investment expenditure

falling short of saving, the prices of products willdecline, the level of production and employmentremaining unaffected.


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VOLUNTARILY UNEMPLOYMENT

If some workers do not want to work at the lower

wages, they will not get any job or employment and

therefore will remain unemployed.

But, according to classical economists, those

workers who do not want to work at lower wages

and does remain unemployed are only voluntarily

unemployed.

This voluntarily unemployment is not real

unemployment. According to the classical thought,it is involuntarily unemployment which is not

possible in a free market capitalist economy.


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J.M. KEYNES

During the period 1929-33, Keynes challenges the

classical theory and put forward a new theory of

income and employment.

He brought about a basic change in economic

thought regarding the determination of income and

employment. Therefore, it is often said that Keynes

brought about a revolution in economic theory.

Keynes made a genuine break and a basic

departure from the Classical economics. His macro-economic theory is therefore called Keynesian

revolution or New Economics.


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KEYNESON EMPLOYMENTAND

UNEMPLOYMENT

Keynes challenged the correctness of Says law

that supply creates its own demand.

According to him, if aggregate demand is not

sufficient to purchase the entire supply of goods

then the producers would be unable to sell their

whole output. As a result, their inventories of goods

will increase beyond their desired level.

This will cause the producers to reduce their level

of production giving rise to unemployment in theeconomy.


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Keynes showed that there was no guarantee that

investment expenditure by entrepreneurs would be

equal to the desired savings by people.

While savings are done by individuals and

households, investment expenditure is made by

entrepreneurs.

Saving depend on various subjective factors such

as willingness to save for old age, for periods of

sickness and unemployment, for education andmarriage of their children, for amassing wealth to

leave behind a large estate etc.


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Apart from this, savings also depends on level of

prices, rate of inflation, rate of interest, taxation

policy of the government, distribution of income,

and wealth in the society and expectations of future

income.

Investment by the entrepreneurs are determined by

rate of interest and expected rate of profits in the

short run and progress in technology, growth in

population in long run.As a result, problem of demand deficiency arises

which causes involuntarily unemployment.


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Keynes also challenged the classical viewpoint

regarding the impact of all-round cut in money

wages on output and employment of labor.

According to him, while in case of the analysis of

process and output determination of an individual

industry, it is justified to assume that a cut in wages

by the industry would not significantly affect the

demand for the product of that industry because

most of the demand for the product of that industrycomes from the workers and persons employed in

other industries.


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Keynes explained that the level employment was

determined by aggregate demand and aggregate

supply.

He showed that equilibrium level of income and

employment could well be established at less than

full-employment level of national income.

Thus, according to him, lack of aggregate demand

can cause involuntarily unemployment of labor and

unutilized productive capacity.


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EMPLOYMENT STRATEGIESTO

REDUCE UNEMPLOYMENT

IN ORDER TO REDUCE UNEMPLOYMENT


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INORDERTOREDUCEUNEMPLOYMENT

PROBLEMIN INDIAFOLLOWINGMEASURES

SHOULDBEADOPTED :

Use of Labour-Intensive Technology :

In order to generate employment both the ruraland urban sectors must adopt these steps.

The decline in employment elasticity of output

growth is due to the increasing trend in capitalintensity in organised sector as well asagriculture.

Due to enhancement of technology theemployment elasticity of growth of agricultural

output has to discourage use of capitalintensive technology

So there must be proper trade off betweenemployment and growth of outputs


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ACCELERATING INVESTMENTIN AGRICULTURE:

Due to shortfall in investment or capital formation inagriculture the unemployment problem is faced.

Both the public and private sector investment in

agriculture has declined. So this problem could beovercomed by investing in infrastructure whichoperates through backward and forward linkages.

Government has announced to furnish more creditto farmers at lower than market rates of intrestwhich will lead to growth of agricultural sector.


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LABOUR INTENSIVE INDUSTRIAL GROWTH:

For solving employment problems in the urban areas

organized industrial sector must absorb sufficient

number of workers.

The cause for failure is capital intensive technology

imported from abroad which tries to improvecompetitiveness to face imported commodities.

Also factor- price distortions like cheap capital and

relatively higher wages of workers is the cause for such

issue.

Capital has become cheaper due to liberal fiscal

consessions which leads to use of capital intensive

technology so there must be proper trade off between

employment and output.


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SERVICEAND EMPLOYMENT GROWTH

Growth of service has a large employment

potential.

For eg. Software and BPOs.

It must be noted that growth of such sector is

dependent on industrial and agricultural growth in

the economy.


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EDUCATION, HEALTH & EMPLOYMENT

GENERATION

Lastly expansion of education and health care not

only promotes accumulation of human capital and

thereby contributes to growth of output it will also

generate a good deal of employment opportunities.

Working of these sectors will provide employmentof both skilled and unskilled persons.


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BALANCEOFPAYMENTS :

The balance of payments is a systematic record of

economic transactions of residents of a country with

the rest of the world during a given period of time.

It is prepared to measure various components of a

countrys external and economic transactions.

This helps to find out international economic

position of a country which helps the Government in

decision making on monetary and fiscal policies of

a country.


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BALANCEOF TRADEAND BALANCEOF

PAYMENTS :

It refers to difference in values of imports and

exports of commodities only.

During a given period of time, the exports and

imports may be exactly equal in which case

balance of trade is said to be in balance.

If value of exports exceeds the value of imports

than it is regarded as export surplus.

And if the value of its imports exceeds the value of

exports it is regarded as deficit balance of trade.


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BALANCEOF PAYMENTSONCURRENT

ACCOUNT :

Two types of balance of payments are

distinguished- (a) Balance of payments on current

account (b) Balance of payment on capital account.

Balance of payment on current account is more

comprehensive in scope than balance of trade. Innot only includes imports and exports of a country

which are visible items but also invisible items such

as foreign travel ,insurance etc.


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BALANCEOF PAYMENTON CAPITAL ACCOUNT :

In balance of payments of capital account theimportant items are borrowings from foreigncountries and lending funds to other countries.

This takes two forms - (a) External assistance

which means aid from foreign countries atconcessional rates of intrest. (b) Commercialborrowings under which the Indian Government andthe private sector borrow funds from world moneymarkets at the market rates of intrest.( c )Short term

debt which is incurred on short term borrowing ontrade account. ( d ) In addition, non residentdeposits made by NRIs. (e) and by investmentdone by foreign companies in India.


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DISTINCTIONBETWEEN CURRENT ACCOUNT

AND CAPITAL ACCOUNT

The major diffrence is that current account deals

with payment for currently produced goods and

services on the other hand capital account deals

with capital receipts and paymenst of debts and

claims. The current account of balance paymenst has a

direct effect on the level of income in a country

where as capital account does not have any such

direct effect on the level of income; it influences thevolume of assets which a country holds.

DOES BALANCE OF THE PAYMENTS MUST


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DOES BALANCE OF THE PAYMENTS MUST

ALWAYS BALANCE?

The individuals and business firms of an economy

have to pay for the imports and if exports are not

sufficient to pay the imports than how the balance

of payment will be in balance?

Here is a example,

The balance of payments on current account of

india has been in deficit for most the years. Deficit

on current account implies that the residents are

paying more on imports than the incomes they areearning from exports.


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For the overall balance of payment to be inbalance, this deficit in the current account of thebalance of payments must be financed by sellingcapital assests such as shares. Both selling assests

or by borrowing from abroad, foreign capital flowsinto the country as has been happening in the lastseveral years in India. These foreign capital inflowsare shown in the capital account of the balance ofpayments which must be in surplus to finance the

deficit in the current account. Current account + capital account surplus = 0


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CAPITAL FLOWS AND GLOBALIZATION

The globalization of the Indian economy has an

important consequence with regard to capital flows

into the economy.

Suppose India faces given prices of its imports and

a given demand for its exports. So, if domestic rateof interest is higher as compare to what exists

abroad, then given the mobility of capital, capital

will flow into Indian economy to a very large extent.


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BP = NX ( Yd, Yf, R) + CF(If Id)

BP= balance of payments, NX= net exports, CF=

surplus ( Capital flows)

An increase in the domestic income due to higher

industrial growth or fall in real exchange rate of

rupee will adversely affect the trade balance

inflows.


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FOREIGN EXCHANGE RATE

Exchange Rate is the value of national currency in

terms of a foreign currency. Change in foreign

exchange rate effect the price of exports and

imports which is turn determine there volume and

there by determine balance of payments of acountry.

In the long run the foreign exchange rate between

the two currencies is determined by the purchasing

powers of the two currencies in the domesticeconomies.


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In the short run, the demand for imports and

exports of goods and services, magnitude of capital

flows between the countries effect demand for and

supply of foreign exchange and there by determine

the exchange rate between the currencies. The system of exchange rate in which the value of

a currency is allowed to adjust freely or to float as

determine by demand for and supply of foreign

exchange is called as flexible exchange rate.


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If foreign exchange rate instead of been determine

by demand for and supply of foreign exchange is

fixed by the govt. its is called the fixed exchange

rate system.

In a fixed exchange rate system the govt has to buyor sell foreign exchange in order to maintain the

rate at the controlled level. However under the fixed

exchange rate system the value of once currency

can be changed.


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A one time lowering of value of its currency in terms

of foreign exchange by a country is called

Devaluation.

With the fixed rate exchange system if a country

raises the value of its currency in terms of foreigncurrency, it is called Revaluation.


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macroeconomic environment: major issues

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