MACRO ECONOMICS

AND BUSINESS

By:
Prof. Vani Dhawan

Why to study
Macroeconomics?
To understand the functioning of an economy as a whole.

What determines a nations long-run economic growth ?

What causes unemployment ?

What causes prices to rise ?

Can government policies (Fiscal and Monetary) be used to improve

a nations economic performance ?

What causes a nations economic activity to fluctuate ?

How does being a part of a global economic system affect nations

economies ?

So, Macro economics is both a Theoretical science and a Policy

science.

Meaning of Macro-Economics
Macroeconomicsis a branch ofeconomicsdealing with the
performance, structure,behavior, and decision-making of
aneconomy, rather than individual markets.
It is often called as Aggregative Economics and mainly it deals
with the theory of Income, Employment, Prices and Money.

According to M.H. Spencer,

Macro Economics is concerned with the economy as a large
segments of it. In macro economics, attention is focused on
such problems as the level of unemployment, the rate of
inflation, the nations total output and
other matters of
economy wide significance.

Functions of an Economy
An economy is a complex arrangement of closely linked
sectors households, businesses, financial institutions,
government and the rest of the world.
An economy employs various resources to produce a
variety of goods and services for domestic and world
consumption and provides income for the resources.
The CIRCULAR FLOW OF INCOME AND OUTPUT
diagram shows the income received and payments made
by each sector of the economy

Two Sectors Circular Flow

Income
Labor, land,
capital,
entrepreneurship

Households

Saving

Goods &
Services bought
Spending

Factor
Market

Financial
Sector

Product
Market

Wages, rent,
interest, profit
Inputs for
production

Investment

Business/
Firms

Goods &
Services sold
Revenue

Three Sectors Circular Flow

Factor
Market
Direct taxes

Households

Wages, rent, interest, profit

Direct/Indirect taxes

Government

Govt. expenditure
(G)
Financial

Business/
Firms

Govt. expenditure
(G)

Financial
Market

Saving = Investment (S=I)

Product
Market

Consumption Spending (C)

Four Sectors Circular Flow

External
Sector

Remittances

Receipts from exports

Export of services

Payments for imports

Wages, rent, interest, profit

Direct taxes

Direct/Indirect taxes

Households

Government

Govt. expenditure (G)

Govt. expenditure (G)

Saving = Investment (S=I)

Consumption Spending (C)

Business/
Firms

Main Macroeconomic
Indicators
Macroeconomic indicators are statistics that indicate the current
status of the economy of a state depending on a particular area
of the economy (industry, labor market, trade, etc).
These statistics are published regularly at a certain time by
governmental agencies and the private sector.
In truth, these statistics help Forex traders monitor the economy's
pulse, thus it is not surprising that these are religiously followed by
almost everyone in the financial markets.
After publication of these indicators we can observe volatility of
the market. The degree of volatility is determined depending on
the importance of an indicator. That is why it is important to
understand which indicator is important and what it represents.

Cont..
1. Interest Rates Announcement::
Interest rates play the most important role in moving the
prices of currencies in the foreign exchange market and
central bank are the most influential actors.
When central banks change interest rates they cause the
forex market to experience movement and volatility.
2. Gross Domestic Product (GDP)::
The GDP is the broadest measure of a country's economy,
and it represents the total market value of all goods and
services produced in a country during a given year.

Cont..
3. Consumer Price Index::
CPI is probably the most crucial indicator of inflation. It
represents changes in the level of retail prices for the basic
consumer basket.
If the economy develops in normal conditions, the increase in
CPI can lead to an increase in basic interest rates. This, in turn,
leads to an increase in the attractiveness of a currency.
4. Employment Indicators::
It reflect the overall health of an economy or business cycle.
In order to understand how an economy is functioning, it is
important to know how many jobs are being created or
destructed, what percentage of the work force is actively
working, and how many new people are claiming
unemployment.

Cont..
5. Retail Sales::
The retail sales indicator is released on a monthly basis and
is important to the foreign exchange trader because it is a
timely indicator of broad consumer spending patterns that
is adjusted for seasonal variables.
6. Balance of Payments::
The Balance of Payments represents the total foreign trade
operations, trade balance, and balance between export and
import, transfer payments. If coming payment exceeds
payments
to
other
countries
and
international
organizations the balance of payments is positive.

Cont..
7. Government Fiscal and Monetary Policy::
Stabilization of the economy (e.g., full employment, control
of inflation, and an equitable balance of payments) is one of
the goals that governments attempt to achieve through
manipulation of fiscal and monetary policies.
Fiscal policy relates to taxes and expenditures, and
Monetary policy to financial markets and the supply of
credit, money, and other financial assets.
There are many economic indicators, and even more private
reports that can be used to evaluate the fundamentals of
forex. It's important to take the time to not only look at the
numbers, but also understand what they mean and
how they affect a nation's economy.

Gross Domestic Product

A measure of a countrys economy.
Commonly the Expenditure Method is used for
measuring and quantifying GDP. So the formula is ::

GDP = C + I + G+(X-M)
Where

C = consumption,
I = gross investment,
G = government spending,
X = exports, and
M = imports.

BUSINESS CYCLE

What is Business Cycle ?

According to Keynes,
"A Business cycle is composed of periods of Good Trade,
characterized by rising prices and low unemployment
percentages, shifting with periods of bad trade characterized
by falling prices and high unemployment percentages."
Pattern of the Business Cycle::

The pattern of that of a period of growth, called expansion,

which hits a peak.
The growth is followed by a fall in the economy, called a
contraction.
The bottom of the fall is called the trough.

Phases of Business Cycle

Prosperity - highest
period of economic
growth.
Recession - economic
slowdown
Depression prolonged recession
Recovery - renewed
economic growth.

Phase 1 : Prosperity
When there is an expansion of output, income, employment, prices
and profits, also a rise in the standard of living termed as Prosperity
phase.
Features of prosperityare : High level of output and trade.
High level of effective demand.
High level of income and employment.
Rising interest rates & large expansion of bank credit.
Inflation and Overall business optimism.
A high level of MEC (Marginal efficiency of capital) and investment.
Due to full employment of resources, the level of production is
Maximum and there is a rise inGNP. There is an upswing in the
economic activity and economy reaches itsPeak. This is also called
as aBoom Period.

Phase 2 : Recession
The turning point from prosperity to depression is termed
as Recession Phase.
During a recession period, the economic activities slow
down.
When demand starts falling, the overproduction and future
investment plans are also given up. There is a steady decline in
the output, income, employment, prices and profits. The
businessmen lose confidence and become pessimistic
(Negative). It reduces investment.
The banks and the people try to get greater liquidity, so credit
also contracts. Expansion of business stops, stock market falls.
Orders are cancelled and people start losing their jobs. The
increase in unemployment causes a sharp decline in income and
aggregate demand. Generally, recession lasts for a short period.

Phase 3 : Depression
When there is a continuous decrease of output, income, employment,
prices and profits, also fall in the standard of living and depression sets
in.
Features of depressionare : Fall in volume of output and trade.
Fall in income and rise in unemployment.
Decline in consumption and demand.
Fall in interest rate.
Deflation and Overall business pessimism.
Contraction of bank credit.
Fall in MEC (Marginal efficiency of capital) and investment.
In depression, there is under-utilization of resources and fall in GNP. The
aggregate economic activity is at the lowest, causing a decline in prices
and profits until the economy reaches itsTrough(low point).

Phase 4 : Recovery
The turning point from depression to expansion is termed as Recovery or
RevivalPhase.
During the period of revival or recovery, there are expansions and rise in
economic activities. When demand starts rising, production increases and
this causes an increase in investment. There is a steady rise in output,
income, employment, prices and profits. The businessmen gain confidence
and become optimistic (Positive). This increases investments. The
stimulation of investment brings about the revival or recovery of the
economy.
The banks expand credit, business expansion takes place and stock markets
are activated. There is an increase in employment, production, income and
aggregate demand, prices and profits start rising, and business expands.
Revival slowly emerges into prosperity, and the business cycle is repeated.
Thus, during the expansionary or prosperity phase, there is inflation
and during the contraction or depression phase, there is a deflation.

FORECASTING OF
BUSINESS

What is Business
forecasting?
Business forecasting is an estimate or prediction
of future developments in business such as sales,
expenditures, and profits (usually are made by
past events).
It is the activity of estimating the quantity of a
product or service that consumers will purchase
in the future period of time.

Why do we need Business

forecasting ??

Reduces the cost .

Reduces the investment risk.
Know about the market (have a general idea
of market).
Reduce the problem of decision in the times
of uncertainty.
To provide information for optimum decision
making.
Change the strategies of company in time.

Business Cost Benefit

Forecasting
Benefits:
Aids

decision making
Informs planning and
resource allocation
decisions
Increased revenue
and efficiency
Increased customer
retention
Decreased costs

Cont...........
Costs:

Data not always reliable or accurate,

Data may be out of date,
The past is not always a guide to the future,
Qualitative data may be influenced by peer pressure,
Difficulty of coping with changes to external factors
out of the businesss control,
For Example: change in economic policy, political
developments (9/11?), natural disasters
hurricanes, earthquakes, etc.

INPUT-OUTPUT
ANALYSIS

Meaning of Input Output

Analysis
Input-output analysis explains that the output of one sector
can in turn become an input for another sector, which
results in an interlinked economic system.
It is also known as Analysis of Inter Industry Relations.
According to Wassily Leontief,

The input output analysis, seeks to analyze inter

industry relationship in order to understand the
interdependences and complexities of the system and to
find the conditions for maintaining the balance between
demand and supply of each industry.

ASSUMPTIONS
Each industry produces only one homogenous
product. No two commodities are produced
jointly.
Production technology is assumed to be static.
The use of inputs are employed in rigidly fixed
proportion.
Inputs & outputs of industries are expressed in
terms of money value and are technical in
nature.
All producing firms are competitive in nature.
There is pure competition in producing sector.

Examples of Inter-relationships
Between Sectors
Consider an economy with several industries. Each industry
has a demand for products from other industries i.e. internal
demand. There are also external demands from the
outside. Find a production level for the industries that will
meet both internal and external demands.
The IO model is centered on the idea of inter-industry
transactions:
Industries use the products of other industries to produce
their own products.
Outputs from one industry become inputs to another.
When you buy a car, you affect the demand for glass,
plastic, steel, etc.

Basic Input-Output Logic

Steel

Glass

Tires

Plastic

Automobile Factory

Other
Components

From the Tire

Producers
Perspective

Individual
Consumers

School
Districts

Tire Factory

Final
Demand
For Tires

Trucking
Companies

Automobile
Factory

InterMediate
Demand
For
Tires

Importance of Input Output

Analysis
This model is powerful tool of economic analysis for the
firms as well as for economy:

Helpful for producer to make necessary adjustments in

production process and improve his position.
Helpful for Business Forecasting.
It is the master chart of the economy (or macro economic
balance sheet) which depicts the inter-dependence of the
various sectors and their money flow.
To study the effects of consumption, investment,
expenditure etc. with reasonable accuracy.
It is quite helpful for providing information for the
formulation of economic policies in the developing
economies.

Limitations of Input Output

Analysis
This technique suffers from various limitations
are as follows:

Ignores the fluctuations in price level of goods and

services.
Based on linear equations which is unrealistic (increase
in output do not always require proportionate increase
in inputs).
It is very expensive in terms of time and money.
The assumption constant returns to scale will not hold
for long period of time (in reality, economy faces
dynamic economic conditions).
Errors in forecasting final demand will have grave
consequences.