INTRODUCTION TO MACROECONOMICS
INTRODUCTION TO MACROECONOMICS
MEANING OF AN
ECONOMY-
An economy is a system which provides people with the means to work and earn a living.
DEFINITION OF ECONOMICS-
Economics studies human behavior as a relationship between means i.e. resources and ends i.e. human wants. Economics aims to make sure that limited resources are optimally utilized in the best possible manner.In other words, Economics is a social science concerned with proper use and allocation of resources for the achievement and maintenance of growth stability.
BRANCHES OF ECONOMICS-The study of economics can be broadly divided into two branches – Microeconomics and Macroeconomics.
An economy is a system which provides people with the means to work and earn a living.
DEFINITION OF ECONOMICS-
Economics studies human behavior as a relationship between means i.e. resources and ends i.e. human wants. Economics aims to make sure that limited resources are optimally utilized in the best possible manner.In other words, Economics is a social science concerned with proper use and allocation of resources for the achievement and maintenance of growth stability.
BRANCHES OF ECONOMICS-The study of economics can be broadly divided into two branches – Microeconomics and Macroeconomics.
MEANING
OF MICROECONOMICS-The
term “micro” has been derived from the Greek word “mikros” which means
small. Microeconomics is that branch of economic theory that studies
the behavior of individual units of an economy. Individual income,
individual output, price of a commodity etc. are examples of micro economic
concepts.
MEANING OF
MACROECONOMICS-The
term “macro” has been derived from the Greek word “makros” which means large.Macroeconomics
is that part of economics which studies the behavior of aggregates of the
economy as a whole.National income, aggregate output, aggregate
consumption etc are examples of macroeconomic concepts.
SCOPE / AREA OF STUDY / VARIABLES /COMPONENTS OF MACRO-ECONOMICS
(1) THEORY OF NATIONAL INCOME : Macro-Economics studies the concept of national income ,its method of measurement, related concepts and social accounting
(2) THEORY OF EMPLOYMENT : Its studies problem relating to employment and unemployment ,different types of unemployment, factors determining level of employment like aggregate demand, aggregate supply, agg. saving and consumption, aggregate investment.
(3) THEORY OF MONEY : In this function of money, supply of money and various concept and theories related to money is studied.Banking structure of the country form part of this study
(4) THEORY OF GENERAL PRICE LEVEL : Problem concerning inflation or general rise in price and deflation or general decrease in price are studied.Causes for change in price level is also studied
(5) THEORY OF ECONOMIC GROWTH : Study of problem relating to fuller utilisation and growth of economics (increase in per capita income) ,welfare of public is done .Monetary and Fiscal policies of the government are also studied therein
(6) THEORY OF INTERNATIONAL TRADE : Under this trade relation of country , foreign exchange rate determination , BOP situation , Tariff and protection issue is studied
NORMATIVE ECONOMICS-Normative economics as a science answers the questions ‘What ought to be?’, ‘What should happen?’or ‘What should have happened?’. Normative economics does not base its argument on empirical and scientific data or evidence, but it talks about what should the ideal situation be like. Economic statements which are normative in nature cannot be verified or tested for factual values or legitimate cause and effect.
For example, “We should cut taxes in half to increase disposable income levels”, “Laborers should receive greater parts of capitalist profits”.
POSITIVE ECONOMICS-A positive economic statement is a statement that can be verified true or false.It is concerned with analyzing real things that can be supported with evidence.Example-In India maximum people are dependent upon agriculture for employment.
TWO SCHOOL’S OF THOUGHT RELATING TO MACRO ECONOMICS STUDY
(1) CLASSICAL SCHOOL :: It includes economist like Ricardo, Mill, J.B Says.They believe in “Supply creates Demand” and thus conclude that unemployment will disappear automatically in a free economy. According to them Full employment is an automatic phenomenon and thus there is no need of govt interference . In other words (i) Unemployment and (ii) Disequilibrium will be of temporary nature Note: The classical economists thus believed that free economy is the best economy as it offers maximum employment , highest level of income and automatically reaches the state of equilibrium
(2) KEYNESIAN SCHOOL :: Great Depression of 1929-33 (when prices/ profit and investment falls drastically) has shown that classical approach was not practical.Lord Keynes then advocated a new theory in his book “General Theory of Employment , Interest and Money” published in 1936 which says that “Demand Creates Supply” and thus unemployment will not automatically disappears Govt. must interfere and undertake invest. and production to generate employment Note: Thus J.M.Keynes believed that a market economy / free economy needs to be regulated by the government . Otherwise it might suffer the cycle of inflation and deflation , causing economic instability in the country.
The Great Depression:
The Great Depression was the worst economic downturn in the history of the industrialized world. It began after the stock market crash of October 1929, which sent Wall Street in panic and wiped out millions of investors. In 21 st century, the Great Depression is commonly used as an example of how far an economy can decline. The main cause behind this crisis was the fall in aggregate demand due to under consumption and over investment. Aggregate supply was greater than aggregate demand which resulted into depressing activities. Due to under consumption and over investment the stock of finished goods started piling up, which resulted in low price level and consequently the low profit level. The money in the economy was converted into unsold stock of finished goods that lead to an acute fall in employment and hence income level fell drastically. The demand for goods in the economy was so low that the production was lowered leading to the unemployment. In USA, the rate of unemployment increased from 3% to25%.
The Great depression has its own implications and importance in economics, as it leads to the failure of the classical approach of economics. Those who believed in the market forces of demand and supply, paved the way for emergence of the Keynesian approach.
It was this incident that provided the economists with sufficient evidence to recognize macroeconomics as a separate branch of economics.
The cause and effect relationship of the Great Depression can be summed up in this flow chart
Low demand —» Overinvestment —» Low level of employment —» Low level of output —» Low income —» Low Demand
SCOPE / AREA OF STUDY / VARIABLES /COMPONENTS OF MACRO-ECONOMICS
(1) THEORY OF NATIONAL INCOME : Macro-Economics studies the concept of national income ,its method of measurement, related concepts and social accounting
(2) THEORY OF EMPLOYMENT : Its studies problem relating to employment and unemployment ,different types of unemployment, factors determining level of employment like aggregate demand, aggregate supply, agg. saving and consumption, aggregate investment.
(3) THEORY OF MONEY : In this function of money, supply of money and various concept and theories related to money is studied.Banking structure of the country form part of this study
(4) THEORY OF GENERAL PRICE LEVEL : Problem concerning inflation or general rise in price and deflation or general decrease in price are studied.Causes for change in price level is also studied
(5) THEORY OF ECONOMIC GROWTH : Study of problem relating to fuller utilisation and growth of economics (increase in per capita income) ,welfare of public is done .Monetary and Fiscal policies of the government are also studied therein
(6) THEORY OF INTERNATIONAL TRADE : Under this trade relation of country , foreign exchange rate determination , BOP situation , Tariff and protection issue is studied
NORMATIVE ECONOMICS-Normative economics as a science answers the questions ‘What ought to be?’, ‘What should happen?’or ‘What should have happened?’. Normative economics does not base its argument on empirical and scientific data or evidence, but it talks about what should the ideal situation be like. Economic statements which are normative in nature cannot be verified or tested for factual values or legitimate cause and effect.
For example, “We should cut taxes in half to increase disposable income levels”, “Laborers should receive greater parts of capitalist profits”.
POSITIVE ECONOMICS-A positive economic statement is a statement that can be verified true or false.It is concerned with analyzing real things that can be supported with evidence.Example-In India maximum people are dependent upon agriculture for employment.
TWO SCHOOL’S OF THOUGHT RELATING TO MACRO ECONOMICS STUDY
(1) CLASSICAL SCHOOL :: It includes economist like Ricardo, Mill, J.B Says.They believe in “Supply creates Demand” and thus conclude that unemployment will disappear automatically in a free economy. According to them Full employment is an automatic phenomenon and thus there is no need of govt interference . In other words (i) Unemployment and (ii) Disequilibrium will be of temporary nature Note: The classical economists thus believed that free economy is the best economy as it offers maximum employment , highest level of income and automatically reaches the state of equilibrium
(2) KEYNESIAN SCHOOL :: Great Depression of 1929-33 (when prices/ profit and investment falls drastically) has shown that classical approach was not practical.Lord Keynes then advocated a new theory in his book “General Theory of Employment , Interest and Money” published in 1936 which says that “Demand Creates Supply” and thus unemployment will not automatically disappears Govt. must interfere and undertake invest. and production to generate employment Note: Thus J.M.Keynes believed that a market economy / free economy needs to be regulated by the government . Otherwise it might suffer the cycle of inflation and deflation , causing economic instability in the country.
The Great Depression:
The Great Depression was the worst economic downturn in the history of the industrialized world. It began after the stock market crash of October 1929, which sent Wall Street in panic and wiped out millions of investors. In 21 st century, the Great Depression is commonly used as an example of how far an economy can decline. The main cause behind this crisis was the fall in aggregate demand due to under consumption and over investment. Aggregate supply was greater than aggregate demand which resulted into depressing activities. Due to under consumption and over investment the stock of finished goods started piling up, which resulted in low price level and consequently the low profit level. The money in the economy was converted into unsold stock of finished goods that lead to an acute fall in employment and hence income level fell drastically. The demand for goods in the economy was so low that the production was lowered leading to the unemployment. In USA, the rate of unemployment increased from 3% to25%.
The Great depression has its own implications and importance in economics, as it leads to the failure of the classical approach of economics. Those who believed in the market forces of demand and supply, paved the way for emergence of the Keynesian approach.
It was this incident that provided the economists with sufficient evidence to recognize macroeconomics as a separate branch of economics.
The cause and effect relationship of the Great Depression can be summed up in this flow chart
Low demand —» Overinvestment —» Low level of employment —» Low level of output —» Low income —» Low Demand
ECONOMIC AGENT :: These are those INDIVIDUAL OR INSTITUTIONS who take economic decisions . These include (a) Consumer (b) Producer and (c) Government
SECTORS OF ECONOMY::A macro economy is classified into following sectors
(1) FIRM/PRODUCERS SECTOR engaged in the production of goods and services or value adding activities This sector hires FOP (factors of production) from household for factor payment of rent, interest and wages.
(2) HOUSEHOLD SECTOR engaged in consumption of goods and services and also are the owner of FOP.
(3) THE GOVERNMENT SECTOR engaged in activities like taxation and subsidies. It also acts as Welfare agent like maintaining law and order, providing public utility services (hospitals, roads , educational institution Producer
(4) REST OF WORLD SECTOR / EXTERNAL SECTOR engaged in export and import and receipt and payment of factor and transfer earnings ( related with flow of capital between domestic and other countries )
Factors of productions & their remunerations::
CIRCULAR
FLOW OF INCOME:
Circular flow of income.
It refers to flow of money, income or the flow of goods and services across different sectors of the economy in a circular form.
There are two types of Circular flow:
(a) Real/Product/Physical Flow
(b) Money/Monetary/Nominal Flow
Circular flow of income.
It refers to flow of money, income or the flow of goods and services across different sectors of the economy in a circular form.
There are two types of Circular flow:
(a) Real/Product/Physical Flow
(b) Money/Monetary/Nominal Flow
(a) Real flow
(i) Real flow of income implies the flow of factor services from the household sector to the producing sector and corresponding flow of goods and services from the producing sector to the household sector.
(ii) Let us consider a simple economy consisting only of 2 sectors:
• Producer Sector.
• Household Sector.
(iii) These two sectors are dependent on each other in the following ways:
• Producers supply goods and services to the households.
• Household (as the owners of factors of production) supplies factors of production (or factor services) to the producers.
This interdependence can be explained with the help of the diagram given here.
(b) Money Flow
(i) Money flow refers to the flow of factor income, as rent, interest, profit and wages from the producing sector to the household sector as monetary rewards for their factor services as shown in the
flowchart.
(ii) The households spend their incomes on the goods and services produced by the producing sector. Accordingly, money flows back to the producing sector as household expenditure as shown in the flowchart.
(ii) The households spend their incomes on the goods and services produced by the producing sector. Accordingly, money flows back to the producing sector as household expenditure as shown in the flowchart.
Circular Flow Of Income In Two Sector Model:
The following assumptions with regard to a simple economy with only two sector of economics activity are:
(i) There are only two sectors in the economy; that is, household and firms.
(ii) Household supply factor services to firms.
(iii) Firms hire factor services from Household(iv) Households spend their entire income on consumption.
(v) Firms sell all that is produced to the households.
(vi) There is no government or foreign trade.
Such an economy described above has two types of markets.
(i) Market for goods and services, that is product market.
(ii) Market for factors of production, factor market.
As a result we can derive the following, in the case of our simple economy:
(i) Total production of goods and services by firms = Total consumption of goods and services by Household Sector.
(ii) Factor Payments by Firms = Factor Incomes of Household Sector.
(iii) Consumption expenditure of Household sector = Income of Firm.
(iv) Hence, Real flows of production and consumption of Firms and households = Money flows of income and expenditure of Firms and Households.
