Session 01

MACROECONOMICS
An Introduction

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 Learning Objectives

• Objective of Macroeconomics
• Distinction b/w Micro- and Macroeconomics.
• Instruments of macroeconomic policy.
• Tools of macroeconomic analysis.
• Time frame in macroeconomic analysis.
• Positive and normative analysis.
• Short-run Vs long-run economics.

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 What Macroeconomics is about?

• Study of the structure and performance of

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

• It deals with long-run economic growth

(growth theories), and short-run
fluctuations (business cycles).
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 Main Issues in Macroeconomics
• Inflation: What are the causes, consequences
and remedies?

• Unemployment: How can it be reduced?

• Output and Growth: How to increase it?

Macroeconomics tries to answer:

HOW TO ACHIEVE HIGHER ECONOMIC GROWTH
WITH STABILITY?
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 What is Economic Growth?
GDP Growth Rates: 1951-2017
12

10

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Growth Rate of Real GDP

4
Growth rate of GDP
2
Linear (Growth rate of GDP)
0
1951
1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
-2

-4 Year

-6

The growth of the economy is measured in terms of the rate at which the
output (i.e., GDP) increases.
How output/supply changes?
• Change in amount of resources (capital + labor)
• Changes in productivity of resources
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 Fluctuations in growth: Business Cycles
The business cycle is the short-term tendency for output
and employment to fluctuate around their long-term trend
path.
C

C
Output
D
Actual output
C B
D
A
A: Slump
A B: Recovery
B
C: Boom
A D: Recession

Time
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Indicators of Economic Success

• High Output (GDP)

• Low Unemployment
• Stable Prices

Instruments of Macroeconomic Policy

• Fiscal policy
• Monetary policy
• Trade policy

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 F-3 GDP=
M-5
C+I+G+X-M
External
Households Firms Government
Sector
(C) (I) (G)
(X-M)

Goods Market Assets Markets Labor Market

Aggregate Demand Money Bond (Wages)
M-1 market Market
(C+I+G+X-M) & Demand Demand
Aggregate supply & & F-5 Debt
F-2 M-4
F-1 M-3 Supply Supply (Domestic/Foreign)
F-4
Employment M-2 F-6
Employment
Prices & Inflation
Fiscal
Monetary Interest Rate Policy
Policy (the Budget)
Exchange Rate
Centre, States &
RBI/Banks, FIs Local Govts 8
 Tools of Macroeconomics

• Aggregate Supply: Prices and costs, potential

output, resources (K,L,l and T) determine total
production.

• Aggregate Demand: Money and prices, spending

and taxes, other forces determine demand.

AS ≡ AD
An ideal economic condition
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 AD and AS schedules

P
AS0

P1
Price level

P0
AD1
AD0
Y0 Y1
Output

The interaction of AS and AD determines output, employment,

prices, inflation, foreign trade and overall economic situation in
a country. 10
 Time frame in Macroeconomic Analysis

Behavior of the economy as reflected in output

and prices vary depending on time span.

 The short run model

 (The very short run model)
 The long run model
 (The very long run model)
 The medium run model
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 The Short run Model
P

Price level

AS
P0

AD1
AD0
Y0 Y1

Output

• The level of output does not affect prices in the short run.

• In the short run output is determined by AD alone and prices are

unaffected by the level of output.

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 The Long run Model
P AS

P1
Price level

P0
AD1
AD0
Y0

Output

• In the long run output is determined by aggregate supply (AS) alone and
prices are determined by both AS and aggregate demand (AD).

• Very high inflation rates are always due to changes in AD

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 The Medium run Model

P
AS0

P1
Price level

P0
AD1
AD0
Y0 Y1
Output

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 Why disagreement among Economists?
Positive and Normative Analysis

A positive analysis examines the economic consequences of policy but

doesn’t address the question of whether those consequences are desirable
(“What is”)
E.g., evaluation of the effect of a 5% reduction in the income tax

A normative analysis of policy tries to determine whether a certain policy

should be used (“what should be”)
E.g., examine whether the income tax should be reduced by 5%

Normative analysis involves not only the economist’s objective and scientific
understanding but also personal value judgments.

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 Long-run Vs Short-run Economics

 Classical School, since 1776

 Led by Adam Smith (An Inquiry into the Nature
and Scope of the Wealth of Nations)

 Keynesian School, since 1936

 Led by John Maynard Keynes (The General Theory
of Employment, Interest and Money)

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 Reference
• DFS, Chapter 1

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