1Macroeconomics: Problems and Issues

Macro is sum of micro:

Agg. Output = Sum of all output i.e. Qi Agg. Price = Sum of all prices ( generally price indices) i.e. Pi Agg Employment= Sum of all employment in all sector i.e. Ei

But since apple and orange can not be added we add themonetary value of this to obtain total output.

Output MacroYear Apple Orange Car TV Total Output2008 50 40 10 12 1122009 80 70 20 15 185

MacroeconomicAggregates:TheoryofAggregation

2Macroeconomic fallacy:

However due to fallacy of composition, whatever relationship istrue for an individual may not be true at aggregate level.Ex. ( Rs. 000)

- Whatever is true for household in not true for economy.- Aggregates are not a reality but a picture or approximation of

reality.- Conclusion drawn from aggregates are misleading.

Household I Household II MacroYear income Consumption income Consumption income Consumption2009 50 40 90 80 140 1202010 100 70 50 45 150 115

MacroeconomicAggregates:TheoryofAggregation

MacroeconomicAggregates:ASADa. Aggregate Supply AS refers to the total quantity of goods and

services that the nations business willingly produce and sell ina given time. AS depends upon price level, the productivecapacity of the economy, and the level of costs

AS=f(L,N,K,O)

b. Aggregate Demand: AD refers to the total amount thatdifferent sectors in the economy willingly spends in a givenperiod. AD equals total spending on goods and services. Itdepends on the level of prices, as well as monetary, fiscal policyand other factors.

AD=C+I+G+NX

3Equilibrium: The interaction between AD and AS determinesthe general price level ( called as price indices)

MacroeconomicEqulibrium:ASAD

MacroeconomicEquilibrium:Outcome

P

Q

P

P

Q

Q

4MainObjectives:1.Output:HighandrapidEconomicGrowth (ofoutput).

>Sustainableeconomicgrowth>Inclusivegrowth

2.Employment: HighlevelofEmploymentwithlowinvoluntary3.PriceLevelStability: Lowinflationratewithstablepricelevel

MajorMacroeconomicGoals/Objectives

SubsidiaryObjectives:1.SocialWelfareandEquitableJustice2.ComplementaryandConflictingGoals

1.MacroeconomicGoals:EconomicGrowth Actual Output ( GDP):

The output actually produced in a country mostlyGDP at time period t.

GDP at FC at Constant Price:To measure the Growth Rate of output for a country.

Growth Rate= (GDPtGDPt1/GDPt1)*100

>Sustainableeconomicgrowth>Inclusivegrowth

5RealGDPLevelvsGrowthRatei.e.GDPatFC(constantprice)baseyear(200405)

0.00

10000.00

20000.00

30000.00

40000.00

50000.00

60000.00

70000.0019

50-51

1953

-5419

56-57

1959

-6019

62-63

1965

-6619

68-69

1971

-7219

74-75

1977

-7819

80-81

1983

-8419

86-87

1989

-9019

92-93

1995

-9619

98-99

2001

-0220

04-05

2007

-0820

10-11

2013

-14

GDP at Factor Cost

TrendLine

-6.000

-4.000

-2.000

0.000

2.000

4.000

6.000

8.000

10.000

12.000

1950

-5119

53-54

1956

-5719

59-60

1962

-6319

65-66

1968

-6919

71-72

1974

-7519

77-78

1980

-8119

83-84

1986

-8719

89-90

1992

-9319

95-96

1998

-9920

01-02

2004

-0520

07-08

2010

-1120

13-14

GDPatFCgrowthrate

(RupeesBillion)

1.MacroeconomicGoals:EconomicGrowth

1.MacroeconomicGoals:EconomicGrowtha. Actual Output ( GDP). Actually produced

GDP at time t period.Also Known as Demand for Output (AD)

b. Potential Output (GDP)Maximum sustainable output the economycan produce with full utilisation ofresources.Also Known as Supply for Output(AS)

Calculation of Potential Outputa. Usually when unemployment rate is 4 tor

6%, OR,b. Trend line growth, ORc. Hodrick Prescott Filtering Techniques

Output Gap = Actual Output Potential Output= ADAS

6OutputGapandInflationRate

NaturalRealGDP isthelevelofGDPatwhichtheinflationrateisconstant,withnotendencytoaccelerateordecelerate.ThetermPotentialRealGDPandnaturalRealGDPareinterchangeablyused

Lowoutputhighunemploymentlowincomelowdemandlowprices.

If Output Gap > 0 Economy is heading towards Inflation as AD>ASIf Output Gap < 0 Economy is heading towards deflation as ADu* Inflation rises Ifu 0 =>low unemployment as AD>ASIf Output Gap < 0 => high unemployment as AD

72.MacroeconomicGoals:PriceStability

Jan1969 Jan2011AnnualchangesinCPI From1969until.2010,theaverageinflationrateinIndia was7.99percent

4to5%inflationrateisgoodforeconomicgrowth

3. Macroeconomic Goals: Low Unemployment

U.S.

1973 1975recession

1981 1982recession

1990 1991recession

GreatDepression(1929 1933)

WorldWarII(1941 1945)

Source:BureauofLaborStatistics(www.bls.gov)

83.MacroeconomicGoals:LowUnemployment

UnemploymentRatein%oflaborforce

4.SubsidiaryMacroeconomicGoalsa. ComplementaryGoals

Lowunemploymentandhigheconomicgrowth

b. ConflictingGoals Lowunemploymentandlowinflation

c. SocialWelfare Health,education,sanitationetc.

d. EquitableJustice Lawandordercondition Equaljusticetoeverybody

9CentralMacroeconomicIssues1. Why do NATIONAL OUTPUT some time fluctuates?

How can a nation increase its rate of Economic Growth withstability over long run.

2. Why does EMPLOYMENT sometimes fall?How can unemployment be reduced?

3. What are the sources of PRICE FLUCTUATION ( INFLATIONS)and its consequences?

CentralMacroeconomicIssues Short Run

1. Business Cycle2. Unemployment3. Inflation

Long Run1. EconomicGrowth2. PovertyandOverall

LivingStandards3. Interest Rates4. HighRatesofSavings

andInvestment5. Governmentbudget

deficits6. ExchangeRate7. BOPDeficits

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1.BusinessCycles

Business Cycle implies a swing in total national output, income, andemployment, usually lasting for a period of 2 to 10 years, markedby a widespread expansion or contraction in most sectors of theeconomy Samuelson. (e.g.) 1930: Great Depression; GlobalRecession of 200709.

During the period of prosperity there is high growth rate of nationaloutput above the potential growth rate.

NBER determines and declares the dates of business cycle but wellafter the recession has begun and recovery has started.

MacroeconomicIssues

BusinessCyclePotentialorNaturalRealGDPgrowthrate

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Trough: High unemployment, low demand, unused productive capacity,low profits, low investments and lack of confidence about economicprospects

Peak: top of cycle high capacity utilisation shortage of skill labour andraw material excess demand, etc

Recovery or Expansion: employment, income, consumer spending,demand, etc. increases Business opinions changes from pessimism tooptimism

Recession or contraction: is downturn in economic activity. Recession is fallin real GDP for two quarters.

Depression Recession that is deep and long lasting is Depression. Demand,production and employment falls

Boom and Slump: Non technical but descriptive terms. Falling half of cycle isslump. Rising half of cycle is often called boom.

PhasesofBusinessCycles

2.HighGrowthRatesoftheEconomyAchievingandmaintainingahighsustainablegrowthrateinlongrun.

DCsgrowthrate46%,LDCsstillstrivingforit

India: designed5yearplan:1951753.5%growthrate(average):Mid1980sgrowthrateisslightlyhigherthan3.5%:Strivingfor9%growthrateperannum

FactorsAffectingLongrunGrowth:1. IncreasesinCapitalperHourWorked2. TechnologicalChangeGrowthModels:

Harrod DomarModelKaldorModelSolowModelSamuelsonModelRobertLucasModeletc.

MacroeconomicIssues

GrowthModelsInIndiaNehru- Mahalnobis ModelEconomic Planning5 Year PlansNitii Ayog

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3.InflationPersistentriseinthegeneralpricelevelsoveraperiodoftime.DC:23%inflationisgoodLDCs :45%inflationisgoodPolicyproblem: Howtostimulateeconomicactivitywithout

causinginflation.Inflation tighteningmonetarypolicythatraisesinterest

ratesbutbringsslowdownintheeconomy

4.UnemploymentandPovertyUnemploymentiscentralconcernofeconomics.(e.g.)In1930s,IncreaseinGovernmentspendingandreducingtaxes.UnemploymentleadtoPoverty.1/3ofIndianpopulationBPLIncomeInequality:

Kuznets'sCurve,LorenzCurve

MacroeconomicIssues

5.OverallLivingStandards QualityofLife Environment Health EducationLongtermincreaseintotaland/orpercapitaoutputisthepredominantdeterminantoflivingstandards.

6.HighRatesofSavingsandInvestment Requiredforexpandingproductionsandeconomicactivities Avoidparadoxicalsituation:Highsaving,lowconsumption,

lowdemand,leadtorecession7.InterestRates

Highinterestrateissymptomoftightmonetarypolicy.>Borrowingbecomescostlier.Businessexpansionstops.Consumersreduceexpensesandsalesfall.

Lowinterestratestendtostimulatedemand

MacroeconomicIssues

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8.GovernmentbudgetdeficitsDeficits=Expenditure>RevenueGovernmentspendingcreatesjobs.ButburdenofdebtandinterestpaymentburdenwillincreasetaxburdenFirmsworryaboutdeficitsinthreeways: Increaseininterestrates Increaseintaxes(forinterestanddebtburden) Governmentpreemptingfundsthatcouldflowtofirms

9.ExchangeRateExchangeratechangescanaffectrelativepricesandtherebycompetitivenessofdomesticandforeignproducers.

Ex.USsubprimecrisisanditsspilloveracrossglobe10.BOPDeficits

Highbalanceofpaymentsdeficitleadstohighborrowingandfurtherdetoriationinnationaleconomicactivities

MacroeconomicIssues

Inadequatesupplyofinfrastructure

Corruption Inefficientgovernmentbureaucracy

Policyinstability Inflation Accesstofinancing TaxregulationsandTaxrates

MacroeconomicProblemsFacingIndia Restrictivelabour

regulations

Insufficientcapacitytoinnovate

Governmentinstability/coups

Poorworkethicinnationallabourforce

Security:Crimeandtheft Foreigncurrencyregulations Poorpublichealthand

education

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MainPolicy:1. MonetaryPolicy:RBI2. FiscalPolicy:CentralGovt.

SubsidiaryPolicy1. ExchangerateorTradePolicy: FERA(orFEMA).2. EmploymentPolicy :

MGNREGA,JawaharRozgarYojna,PMGSYetc.3.PriceandIncomePolicy:

MSP,minimumagestotheworkers.4.InternationalTradePolicy: EXIMpolicyin1997

SEZ, etc.

MacroeconomicPolicies

DemandManagementPolicies: GivenSupplyfixedhowtomanagedemandi.e.C,I,G,Nx (XM) ObjectiveinShortrun:controlinflationandunemployment Instrument:MonetaryPolicyandFiscalPolicy

SupplyManagementPolices Howtoboosteconomicgrowth(Percapita income):L,La,K,E Obj:Longrun increaseinoutput Instruments:Innovations,Technology,R&D,Percapitaproductivityetc.

MacroeconomicPolicies

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MacroeconomicTheory

Theory of Income and Employment

Theory of Price and Inflation

Theory of Economic Growth

Theory of Distribution

MacroeconomicTheory

Economists use economic models to understand the world. Model is a formalstatement of a theory which describes relationship between two or morevariables. In other words model means abstraction of reality.1. Economic Theory

Relation bt. MS and Inflation, Relation bt. unemployment and inflation etc. Relation bt. Consumption and disposable income

2. Variables: something which can be measured Endogeneous Exogeneous

3. Assumptions: always present in a model Taken for given or granted. Ex. Ceteris paribus

4. Model: C=C0+cYd Estimation Validation Policy Decision

MacroeconomicModels

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MajorWorksinMacroEconomics Mercantilists(from15th18thcentury)Europe:Wealth=f(Trade)ThomasMun,JeanBodin,DavidHume

Physiocrats (Late17th andearly18th Century)France,Wealth=f(Productivity)FrancoisQuesnay

Classical (18th and19th Century 1770sto1930s),UK,USA,Wealth=f(ProductivityandDivisionofLabour)AdamSmith,JBSay,Ricardo,JSMill.

London School of Economics(1895) by Sidney Webb, Beatrice Webb, George Bernard Shaw and R.G.D. Allen

Keynesian (20th Century,1030s)UK: EconomicFluctuations(Y)GD,FP,Shortrun ,JMKeynes(1936),ISLMModelbyHicksandHansen(1937),mathtoKeynesianmacromodels

Monetarist(late1940sand1960s)USA: PriceFluctuations(P),MP,ShortrunandLongrun MiltonFriedman,AnnaSchwartz(1956s)

PhillipsCurve(1958) NewZealand:Inflation(P)andUnemployment(U)tradeoffinshortrunA.W.BillPhillips

MajorWorksinMacroEconomics Fiscalists:(late1950s early1970s)USA,FP,RoleofGovt.Inflation(P)andUnemployment(U)notradeoffinlongrunJamesTobinandPASamuelson

RationalExpectations(NewClassicalEconomic)(during1970s(1972))USA:Rationalbehavior,failureofMP,JohnMuth andRobertLucas,ThomasSargent,EdwardPrescott

SupplySideEconomics(1975)USA,LafferCurve,RobertMundell,RonaldRaganandArthurLaffer

RealBusinessCycles(1982):USA Businesscycleduetorealvariablesfluctuations Kydland andPrescott,

DSGEmode(1982) microeconomicequationscombinedintomodelsofthegeneraleconomyKydland andPrescott:

InstitutionalEconomics(during1980sand1990s)USA, Informationasymmetry,RonaldCoase,GAkerlof

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MajorWorksinMacroEconomics Neoclassical(19thandearly20thCentury)foundedin1870s:micro(foundationsof)economicsD&S>P

Cambridge school (1871):Stanley Jevons, Alfred Marshall, and Arthur Pigou: partial equilibrium and market failuer

Austrian School(1871):Carl Menger, Eugen von Bhm-Bawerk, and Friedrich von Wieserdeveloped capital theory and explin economic cisis

Lausanne School (1874):Lon Walras and Vilfredo Pareto, general equilibrium and pareto efficiency

NewClassical(1970s(1973))USA:neoclassicalmicroeconomicfoundationsformacroeconomics, rationalexpectations,failureofMPandFP JohnMuth andRobertLucas,ThomasSargent,EdwardPrescott

NeoKeynesian(alsoNeoClassicalSynthesis)(1940to1960s):synthesisbetweenneoclassicalmicroandKeynesianmacro, Stagflation,Hicks,Samuelson,Modigliani,

NewKeynesian(late1970s 1980s)USA:microfoundationtoKeynesianeconomics,EPhelps,JBTaylor,GAkerlof

PostKeynesian(1975s)USA:TaxbasedIncomepolicyforantiinflation,Wintraub andDavidson.Micha Kalecki,JoanRobinson,NicholasKaldor,PaulDavidson andPiero Sraffa.

MacroeconomicDebates ClassicalvsKeynesian KeynesianvsMonetarists FiscalistvsMonetarists RationalExpectationswithOthers

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Macroeconomic data base RBI Handbook of statistics on Indian Economy Economic Survey, Govt of India CMIE prowess India Stat EPW Research Foundation database CRISIL data base CEIC Indian Economy database IMF CDROM World Bank data base OECD database BIS CSO, NAS Govt of India, Ministry of Statistics and Programme

Impementations

References: Ch1,2,3 of Principles of Macroeconomics

by N G Mankiw, 6th edition.

Ch1 of Macroeconomics by D N Dwivedi

Any macroeconomic book Introductory part.

History of Economic thought in wikipedia.

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Thanks!!!!!!!!