Lecture 1: Introduction to

Macroeconomics

Dr. Amarendu Nandy

Assistant Professor
Indian Institute of Management Ranchi
[email protected]

Textbooks

Prescribed Text Book

Abel, Andrew B., Bernanke, Ben S. and Croushore, Dean
(2014), Macroeconomics,
8th Edition, New Delhi:
Pearson.

Additional Reference Textbooks

Mankiw,
Gregory
N.
(2012),
Principles
of
Macroeconomics, 6th Edition, New Delhi: Cengage
Learning.
Gordon R. J. (2012), Macroeconomics - 12th Edition
Eastern Economy Edition, New Delhi: PHI Learning
Private Limited.
Nandy,
Amarendu
(adapting
author)
(2013),
Macroeconomic Analysis for Business Decisions, New
Delhi: McGraw Hill Education (Create)

Source: Facebook Page, Grayscale (IIM Ranchi)

GDP Per Capita and Survival Rate of Newborns

Economic growth is key. Health and wealth go together. The figure shows that the higher the GDP per capita the greater is the survival rate of newborns.

Macroeconomics is a field within economics

concerned with the study of total, or aggregate,
economic activity.

studies

The study of macroeconomics investigates the

workings of the wider economy, including the
measurement and determination of:

It contrasts with Microeconomics, which

individual prices, quantities, and markets.

national income;
output and expenditure; and
the consequences for employment and prices.

The field is also concerned with developments in

the international economy with implications for
the flow of exports and imports between
countries, and international flows of capital.

 Macroeconomics affect our daily lives.

Inflation rate influences the prices we pay for goods and services, and
in turn, the value of our incomes and our savings.
Interest rates determine the cost of borrowing, and the yield on bank
accounts and bonds.
Exchange rate affects our command over foreign products, as well as
value of our foreign assets.

Understanding of macroeconomics allows business managers to

better anticipate and respond to major macroeconomic events like
a sudden depreciation of real exchange rate or steep hike in repo
rates.
Balance of Payments Mexican and Asian currency crises in 1990s
Dynamics of a Bank run & power of negative expectations Financial
crisis 2007-2009

 All market economies face three central

macroeconomic questions:

Why do output and employment sometimes fall, and how

can unemployment be reduced?
What are the sources of price inflation, and how can it be
kept under control?
How can a nation increase its rate of economic growth?

The hard fact: Inevitable conflicts or

trade-offs among these goals

Rapid growth in future living standards may mean

reducing consumption today
Curbing inflation may involve a temporary period of
high unemployment.

Why do incomes grow? Why are some countries

richer than others? Why do some grow faster than
others? Why do incomes fluctuate? Can policy do
anything about it?

Why is there unemployment? Is it a necessary part

of economic life? How is it affected by policy?

What determines inflation? Why is price stability

preferred?

What is the importance of the business cycle (shortterm fluctuations in output, employment, financial
conditions, and prices) and why policy-makers seek
to diminish the severity of business cycles?

What is long-run growth (economic growth), and how

it determines a countrys standard of living?

What is special about the macroeconomics of an

open economy. i.e. international trade?

India: Growth in Real GDP (per cent)

India: Key Economic Indicators

Source: Government of India (2014), Economic Survey 2013-14.

Divided by their stance on one central issue role of the

government in the economy.
Classical macroeconomics
A body of theory about how a market economy works and why it
experiences economic growth and fluctuations.

The classical view is that free markets work well and deliver the
best available macroeconomic performance (Adam Smiths
Invisible Hand).

The economy will fluctuate, and growth will slow down from time
to time.

But no government remedy can improve the performance of the

market.

1.
2.
3.
4.
5.
6.
7.

Says law: Supply will create its own demand

No government intervention
Economy self adjusting
recessions are temporary
wages and prices are flexible and self adjusting
against minimum wages
against welfare and government assistance

 Economists began to study economic growth, inflation, and

international payments during the 1750s

Modern macroeconomics dates from the Great Depression, a

decade (1929-1939) of high unemployment and stagnant
production throughout the world economy.
John Maynard Keynes book, The General Theory of
Employment, Interest, and Money, began the subject.
Keynes focused on the short-term - on unemployment and
lost production. In the long run, said Keynes, were all dead.

During the 1970s and 1980s, macroeconomists became

more concerned about the long-term - inflation and economic
growth.

1.
2.
3.
4.
5.
6.
7.

Economy is not self adjusting

recessions are long and can be permanent
major government intervention
wages and prices are sticky and not self adjusting
put a floor and support to the economy a free falling economy
support welfare and government assistance
interest rates are not effective during recession

The Great Depression

The Great Depression precipitated a thorough rethinking of macroeconomics

which gave rise to modern macroeconomics.

Much of the framework of modern

macroeconomics comes from the works
of John Maynard Keynes, whose General
Theory of Employment, Interest and Money
was published in 1936.
Keynes twofold argument:
1. It is possible for high unemployment
and underutilized capacity to persist
in market economies.
2. Government fiscal and monetary
policies can affect output, and
thereby reduce unemployment and
shorten economic downturns.

Macroeconomics and macroeconomic

policy post-Keynes:
Supply factors; expectations; alternate
views of wage and price dynamics

Monetarism is an economic school of thought

that stresses the primary importance of the
money supply in determining nominal GDP
and the price level.

The Founding Father of Monetarism is

economist Milton Friedman.

Characteristics of Monetarism

The theoretical foundation is the Quantity

Theory of Money.

The economy and financial markets are

inherently stable.

The central bank should be bound to fixed

rules in conducting monetary policy.

Fiscal Policy is often bad policy. A small role

for government is good.

Output is determined by:

Demand in the short run, say, up to a few years.
The level of technology, the capital stock, and
the labour force in the medium run, say, up to a
decade or so.
Factors such as education, research, saving,
and the quality of government in the long run,
say, a half century or more.

1. In macroeconomics, the behavior of

the whole macroeconomy is, indeed,
greater than the sum of individual
actions and market outcomes (e.g.
Paradox of Thrift)

3. Macroeconomics is the study of

long-run growth: What factors lead to a
higher long-run growth rate? And are
there government policies capable of
increasing the long-run growth rate?

2. Macroeconomics is widely viewed as

providing a rationale for continual
government intervention to manage
short-term fluctuations and adverse
events in the economy.

4. A distinctive feature of modern

macroeconomics is that both its
theory and policy implementation
focus on economic aggregates economic measures that summarize
data across many different markets
for goods, services, workers, and
assets.

fiscal policy, control of government

spending and taxation, and

monetary policy, control over interest

rates and the quantity of money in
circulation

growth policy, stimulating aggregate

supply instead of aggregate demand.

The key elements of the Governments strategy are:

1. Delivering macroeconomic stability (a very broad
macroeconomic aim)
2. Meeting the productivity challenge (an important
supply-side target)
3. Increasing employment opportunity for all (a labor
market objective)
4. Ensuring fairness for families and communities
(commitment to equity)
5. Protecting the environment (green economics has a
macroeconomic dimension)

Objectives

Instruments

Output : high levels and rapid growth of output

(measured by real gross domestic product) and
consumption

Fiscal Policy (government spending and taxation):

helps determine the allocation of resources
between private and collective goods, affects
people's incomes and consumption, and provides
incentives for investment and other economic
decisions

Employment : a low unemployment rate and high

employment, with an ample supply of good jobs
Stable Prices : low and stable inflation

Stabilize the business cycle

Reduce government and international deficits

sound balance of payments coupled with a stable
currency value in foreign exchange markets

Monetary Policy (particularly the setting of shortterm interest rates by the central bank) : affects
all interest rates, asset prices, credit conditions,
and exchange rates. The most heavily affected
sectors are housing, business investment,
consumer durables, and net exports.
Growth Policy or Supply Side Policies: focus on
stimulating aggregate supply rather than
aggregate demand

The success or failure of a business is, to a large extent, dependent

upon how its managers perform in terms of financial controls,
marketing strategies, product design, R & D, etc.

A great deal of time and effort is spent by successful firms in

ensuring that the right decisions are made in a competitive
environment with the greatest attention being paid to the immediate
environment in which the firms are operating:

the workforce;
the production line;
the marketplace for products; and
direct competitors.

This immediate environment is described as the microeconomic

environment of a firm and involves a firms prices, revenues, costs,
employment levels, and so on.

 However, there are other facets of a firms

environment, like:

the general social and economic conditions of the larger

economic system of which each firm forms a part;

Fluctuations (Business Cycle) is most relevant to

business manager. Why?

changing social values (e.g. natural environment);

changes in international economic environment;

political and legal institutions of a country (and in some

cases international treaties, agreements, and laws)

also have a significant impact upon the

business sector and the way in which firms
attempt to carry out their activities.

The figure shows the extent to which firms are

vulnerable to both domestic and international
macroeconomic policies.
The most prominent macroeconomic policies at the
disposal of governments (including central banks)
are listed.
Research: See the paper Effects of Macroeconomic
Conditions on Corporate Liquidity - International
Evidence by Chen and Mahajan (2010)
Synopsis: The study investigates the effects of
macroeconomic conditions on corporate liquidity (cash
holdings) in 34 countries from 1994 to 2005. The results
show that macroeconomic variables like GDP growth,
inflation, real short-term interest rate, government budget
deficit, credit spread, private credit, and corporate tax rate
have a direct impact on corporate cash holdings. In addition,
the study reveals that macro variables have an indirect
impact on corporate cash holdings because the effects of
firm-specific variables on corporate liquidity can be
influenced by macroeconomic conditions.

By definition, since each firm is a

sub-unit of the larger economic
system, it is unable to exercise
control over the macroeconomic
environment in the way that it has
control over its microeconomic
environment.

Failure to adapt to a changing,

dynamic macroeconomy inevitably
results in business failure.

Successful firms pay considerably

more attention to these external
economic factors than those firms
that struggle to survive.

Ultimately,
the
changing
macroeconomy
determines
the
growth in the nations income and
the ability to expand demand for
products and services.

economic growth (stability/volatility)

the general level of prices and inflation
interest rates (How MPS and MPI are affected)
availability of credit and liquidity
total investment
public expenditure plans
personal and corporate taxation (How MPC is affected)
total consumer expenditure
total savings
wages and earnings at the national economy level
national employment trends
exchange rates
imports, exports and the balance of payments
Regulatory: price controls, wage legislations,
restrictive trade practices/FTAs

Which of the above aspects are important to business decision-making?

A stock is a quantity measured

at a given point of time.
E.g.:
The U.S. capital stock was $26
trillion on January 1, 2009.
Macro stock variables: Total money
supply; total bank deposits; wealth;
debts; inventory; capital stocks.
A flow is a quantity measured over a
period of time.
E.g.: U.S. investment was $2.5
trillion during 2009.
Macro flow variables: National
income and output, consumption,
investment, wages, profits.

 Besides money supply, capital has both stock and flow

magnitudes.
Capital is measured at a point in time (Stock), while
investment is the change in capital stock over a period of
time (Flow).
If Kt is the total capital stock at any time point t and Kt-1 was
the capital stock at time t-1, investment(It)/capital
formation is defined as:
It = Kt - Kt-1

 Generally used in the context of savings and

investment

Ex ante: planned or desired

Ex post: actual or realised

In equilibrium (ex post): Savings = Investment

They are not necessarily equal ex ante.

Ex post saving can diverge from ex ante investment

Ex post investment can be different from ex ante investment

 Three of the major concerns of

macroeconomics are:
Output growth
Inflation
Unemployment

 Inflation is an increase in the overall

price level.
Hyperinflation is a period of very rapid
increases in the overall price level.
Hyperinflations are rare, but have been
used to study the costs and
consequences of even moderate
inflation.

Deflation is a decrease in the overall

price level. Prolonged periods of
deflation can be just as damaging for
the economy as sustained inflation.

The business cycle is the cycle of short-term

ups and downs in the economy.
Every business cycle has two phases:

And two turning points:

A recession
An expansion

A peak
A trough

The main measure of how an economy is

doing is aggregate output:

Aggregate output is the total quantity of goods and

services produced in an economy in a given period.

An expansion, or boom, is the period in the

business cycle from a trough up to a peak,
during which output and employment rise.

A contraction, recession, or slump is the period

in the business cycle from a peak down to a
trough, during which output and employment
fall.

The Business Cycle

 A recession is a period during which

aggregate output declines. Two
consecutive quarters of decrease in
output signal a recession.
A prolonged and deep recession
becomes a depression.
Policy makers attempt not only to
smooth fluctuations in output during
a business cycle, but also to
increase the growth rate of output in
the long-run.

16000

Real GDP (billions of 2005 dollars)

15000

Recession

14000

13000

Peak

12000

Potential
GDP

11000

Real GDP

Peak
Expansion

10000
Expansion
Trough

9000

8000
1996-I

1997-I

1998-I

1999-I

2000-I

2001-I

2002-I

2003-I

2004-I

2005-I

This figure shows the most recent U.S. cycles.

2006-I

2007-I

2008-I

2009-I

2010-I

Economic Growth and Fluctuations

Decomposing output into a trend and cyclical component, we get:
10
Recession
(2001)

Recession
(1990 1991)

Log Real Output (trillions of 2005 dollars)

9
Korean War

1st OPEC Recession

(1973 1975)

World War II
(1939 1945)

Roaring
Twenties

Recession
(2007 - 2009)

2nd OPEC
Recession
1979

Recession
(1981 1982)

World War 1
(1917 1918)
Postwar
Recession
1960's
Expansion

6
1907 Banking
Panic

Great Depression
(1929 1939)

1890's Depression
Rapid
Industrialization

4
1869

1889

1909

1929

1949

1969

1989

2009

 The unemployment rate is the

percentage of the labor force
that is unemployed.
The unemployment rate is a key
indicator of the economys
health.

The existence of unemployment

seems to imply that the
aggregate labor market is not in
equilibrium.

Why do labor markets not clear when

other markets do?

 Macroeconomics focuses on four groups.

To see the big picture, it is helpful to divide
the participants in the economy into four
broad groups:

households,
firms,
the government, and
the rest of the world.

The Circular Flow Diagram

The circular flow diagram shows the income received and

payments made by each sector of the economy. Everyones
expenditure is someone elses receipt. Every transaction
must have two sides.

Households receive income from firms

and the government, purchase goods
and services from firms, and pay taxes
to the government. They also purchase
foreign-made goods and services
(imports).

Firms
receive
payments
from
households and the government for
goods and services; they pay wages,
dividends, interest, and rents to
households
and
taxes
to
the
government.

The government receives taxes from

firms and households, pays firms and
households for goods and services
including
wages
to
government
workersand
pays
interest
and
transfers to households.

Finally, people in other countries

purchase goods and services produced
domestically (exports).

Note: Although not shown in this diagram,

firms and governments also purchase
imports.

The Four Market Arenas

In Macroeconomics, we are concerned with choices in an intertemporal setting within four markets
Goods/Output and Services Market: This is the market for goods available for immediate use, or,
current goods. Firms supply to the goods-and-services market. Households, the government, and
firms demand from this market. All individual markets are aggregated into a single market for
goods, and all goods are measured using a single unit.
Market for Future Goods/Market for Bonds: A bond is a promise to deliver commodities at some
specified time in the future. The bond market allows goods that will be produced in future to be
traded for goods currently produced.
Market for a Factor of Production (The Labor Market): For goods to be exchanged, they must be
produced, requiring factors of production. In the Labor Market, households supply labor, and firms
and the government demand labor. The availability of goods changes as the amount of labor
utilized in production is varied.
The Money Market: To exchange goods, individual require an asset that can be used to purchase
and sell things money. Households supply funds to this market in the expectation of earning
income in the form of dividends on stocks and interest on bonds. Firms, the government, and the
rest of the world also engage in borrowing and lending which is coordinated by financial
institutions.

Type of Data

Publishing Authority

Frequency

Time Lag

Link

GDP; Index of Industrial

Production (IIP)

Central Statistics Office,

Ministry of Statistics and
Programme
Implementation (MOSPI)

Quarterly (GDP)
Monthly (IIP)

Two months (GDP)

1.5 months (IIP)

http://mospi.nic.in/Mospi
_New/site/home.aspx

Complete Economic and

Financial Data

Ministry of Finance

Periodically

http://finmin.nic.in/

Handbook of Statistics on
Indian Economy; Balance
of Payment (BOP);
External Commercial
Borrowings (ECBs)

Reserve Bank of India

(RBI)

Yearly, quarterly and

monthly respectively

http://www.rbi.org.in/ho
me.aspx

Export and Import

Ministry of Commerce
and Industry

Monthly

Foreign Institutional
Investments (FIIs) in
Indian markets; Mutual
Funds Investments

Securities and Exchange

Board of India (SEBI)

Daily

Wholesale Price Index

(WPI)

Office of the Economic

Advisor (OEA), Ministry of
Commerce and Industry

Monthly

1 month

http://eaindustry.nic.in/

Consumer Price Index Industrial Workers (CPI

IW)

Labour Bureau,
Government of India

Monthly

1 month

http://labourbureau.nic.in
/indexes.htm

Money Supply; Foreign

Exchange Reserves;
Deposit and Credit
Growth of Scheduled
Commercial Banks;
Indices relating to Real
Effective Exchange Rate
(REER)/Nominal Effective
Exchange Rate (NEER)

Reserve Bank of India

(RBI)

Weekly; fortnightly

1 month

http://commerce.nic.in/tr
adestats/indiatrade.asp?i
d=1
http://www.sebi.gov.in/In
dex.jsp?contentDisp=Dat
abase

http://rbi.org.in/scripts/S
tatistics.aspx

INTERNATIONAL
United Nations (UN): http://unstats.un.org/unsd/databases.htm [Cross-country data - COMTRADE; Census Knowledge Base;
Demographic Yearbook; Millennium Indicators Database; National Accounts; Services Trade; and Social Indicators among many others]
World Bank: http://data.worldbank.org/ [1200+ indicators spread across various databases including World Development Indicators
(WDI); Global Development Finance (GDF); Doing Business (DB); Global Economic Monitor (GEM); Education (EdStats); Gender
(GenderStats); Millennium Development Goals (MGDs); Country Policy and Institutional Assessment (CPIA); Actionable Government
Indicators (AGIs); Business Environment and Enterprise Performance Survey (BEEPS); International Comparison Programme (ICP);
Quarterly External Debt Statistics (QEDS); Remittance Prices; and Worldwide Governance Indicators (WGI) among others]
International Monetary Fund (IMF): http://www.imf.org/external/data.htm [Publishes a range of time series data on IMF lending,
exchange rates, and other economic and financial indicators including World Economic Outlook (WEO); International Financial Statistics
(IFS); Principal Global Indicators (PGI); Quarterly External Debt Statistics (QEDS); Balance of Payments Statistics (BOPS); Primary
Commodity Prices; Government Finance Statistics (GFS), etc.]
World Trade Organization (WTO): http://stat.wto.org/Home/WSDBHome.aspx?Language= [International trade statistics by trade, tariff,
and service profiles]
Organisation for Economic Co-operation and Development (OECD): http://stats.oecd.org/Index.aspx [Various economic and social
indicators across themes for member countries. Also, data on selected indicators for non-member countries are available.]
Eurostat: http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ [European statistics under various categories.]
Asian Development Bank (ADB): http://www.adb.org/statistics/ [Compiles recent key economic, financial, and social indicators from
developing member countries and other international sources.]
United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP): http://www.unescap.org/stat/data/index.asp
[Contains time series data for selected indicators covering a wide range of issues including demography, migration, education, health,
poverty, gender, employment, economy, government finance, employment, transport, and environment.]
International Labour Organization (ILO): http://laborsta.ilo.org/ [Data and metadata on 200 countries or territories on labour statistics]

NATIONAL
Economic Survey and Union Budget: http://indiabudget.nic.in/
National Sample Survey Organisation (NSSO): http://mospi.gov.in/nsso_4aug2008/web/nsso.htm
[ Under MOSPI. Conducts nationwide sample surveys on various socio-economic issues in
successive rounds]
Centre for Monitoring Indian Economy (CMIE): http://www.cmie.com/ [Databases available on
macroeconomy (including international economic statistics); sectoral services; firm-level data
services; state analysis; and other customized solutions]
IndiaStat: http://www.indiastat.com/default.aspx [The site collects, collates and compiles socioeconomic information about India and its states]
CapitaLine: http://www.capitaline.com/new/index.asp [Market data and financial information on
securities, derivatives and commodities traded on Indian stock markets.]
EPW Research Foundation: http://www.epwrf.res.in/
Ecofin-Surge: http://www.ecofin-surge.co.in/ [Compilation of Indian data covering Macroeconomic variables like GDP, Government Finances, Industrial & Agricultural Production indices,
Inflation, etc., and Banking & Financial market indicators like Interest rates, Stock & Commodity
market indices. Also contains economic and financial historic time-series data on the global
economy.]

International
Financial Times: http://www.ft.com/home/india
The Economist: http://www.economist.com/index.html
The Wall Street Journal: http://www.wsj.com
New York Times: http://www.nytimes.com/pages/business/index.html
Bloomberg BusinessWeek: http://www.businessweek.com/
National
The Economic Times: http://economictimes.indiatimes.com/
Business Standard: http://www.business-standard.com/
Livemint: http://www.livemint.com/
The Business Line: http://www.thehindubusinessline.com/businessline/
The Financial Express: http://www.financialexpress.com/

Gregory Mankiw: gregmankiw.blogspot.com

James Hamilton and Menzie Chinn: http://www.econbrowser.com/
Paul Krugman: http://krugman.blogs.nytimes.com/
Raghuram Rajan: http://blogs.chicagobooth.edu/faultlines
Nouriel Roubini: http://www.roubini.com/
Steven Levitt and Stephen J. Dubner: http://freakonomics.blogs.nytimes.com/
WSJ Blogs: http://blogs.wsj.com/economics/
McKinsey Global Institute: http://www.mckinsey.com/mgi/
Martin Wolf: http://blogs.ft.com/martin-wolf-exchange/
Mark Thoma: http://economistsview.typepad.com/
The World Bank: http://blogs.worldbank.org/governance/category/topics/macroeconomicsand-economic-growth
Tim Harford: http://blogs.ft.com/undercover/
The Economist: http://www.economist.com/blogs/freeexchange/
J. Bradford DeLong: http://delong.typepad.com/
Economic Policy Review at HBS: http://www.econblog.org/
New Economist: http://neweconomist.blogs.com/
Ajay Shah: http://ajayshahblog.blogspot.com/
Indian Economy Blog on Businessweek: http://bx.businessweek.com/indian-economy/blogs/
Google Public Data Explorer: http://www.google.co.in/publicdata/directory