Macroeconomics
Prof. Binilkumar Amarayil S
[email protected] What is
Macroeconomics?
• Macroeconomics is the study of the
structure and performance of
economy as a whole and of the
policies that governments use to
influence the economic
performance.
• it examines the behavior of
economic aggregates such as
aggregate income, consumption,
investment, and the overall level of
prices.
Macroeconomic Concerns
Three of the major concerns
of macroeconomics are
• Output growth
• Unemployment
• Inflation and deflation
National Income
Accounting
The Economy’s
Income and Expenditure
When judging whether the economy is doing well
or poorly, it is natural to look at the total income
that everyone in the economy is earning.
The Circular-Flow
Diagram
▪ The equality of
income and
expenditure can
be illustrated
with the circular-
flow diagram.
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The Economy’s
Income and Expenditure
When judging whether the economy is doing well
or poorly, it is natural to look at the total income
that everyone in the economy is earning.
GDP is the
market value of
all final goods
and services
produced
within a
country in a
given period.
The Indian Economy: A Bright Star in Global Economy
Country GDP Growth Inflation
Previous Quarter 2023 May 2024
USA 1.3 2.5 3.3
China 5.3 5.2 0.3
Germany 0.2 -0.2 2.4
Japan -0.5 1.8 2.5
UK 0.6 0.1 3.0
India 7.8 8.2 4.75
Year GDP Growth (%) Annual Change
7.20%
2022-23 -17.20%
2021-22 8.70% 15.28%
2020-21 -6.60% -10.33%
2019-20 3.74% -2.72%
India’s GDP
2018-19 6.45% -0.34%
2017-18 6.80% -1.46%
Growth 2016-17
2015-16
8.26%
8.00%
0.26%
0.59%
Rate 2014-15 7.41% 1.02%
2013-14 6.39% 0.93%
2012-13 5.46% 0.22%
2011-12 5.24% -3.26%
2010-11 8.50% 0.64%
2009-10 7.86% 4.78%
2008-09 3.09% -4.57%
The Measurement of GDP
• Output is valued at market prices.
• It records only the value of final
goods, not intermediate goods (the
value is counted only once).
• It includes both tangible goods (food,
clothing, cars) and intangible services
(haircuts, housecleaning, doctor
visits).
GDP = (Price of apples Quantity of apples)
+ (Price of oranges Quantity of oranges)
= ($0.50 4) + ($1.00 3) GDP = $5.00
2) Used goods are not included in the calculation of GDP.
3) The treatment of inventories depends on if the goods are stored or if they
spoil. If the goods are stored, their value is included in GDP. If they spoil,
GDP remains unchanged. When the goods are finally sold out of inventory,
they are considered used goods (and are not counted).
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Components of Expenditure
Y = C + I + G + NX
Total demand Investment
for domestic is composed spending by
output (GDP) of businesses and
households Net exports
or net foreign
Consumption Government demand
spending by purchases of goods
households and services
This is the called the national income accounts identity.
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The Components of GDP
▪ Consumption (C):
The spending by households
on goods and services, with
the exception of purchases
of new housing.
▪ Investment (I):
The spending on capital
equipment, inventories,
and structures, including
new housing.
The Components of GDP
▪ Government Purchases (G):
The spending on goods
and services by local,
state, and federal
governments.
Does not include transfer
payments because they
are not made in exchange
for currently produced
goods or services.
▪ Net Exports (NX):
Exports minus imports.
Real vs. Nominal GDP
The value of final goods and services measured at current prices is
called Nominal GDP. It can change over time either because there is a
change in the amount (real value) of goods and services or a change in
the prices of those goods and services.
Hence, Nominal GDP Y = P y, where P is the price level and y is real
output– and remember we use output and GDP interchangeably.
Real GDP or, y = YP is the value of goods and services measured
using a constant set of prices.
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Real vs. nominal GDP
n
GDPt = Pit Qit
i=1
n
RGDPt = PiBQit
i=1
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NOW YOU TRY:
Real & Nominal GDP
2006 2007 2008
P Q P Q P Q
good A $30 900 $31 1,000 $36 1,050
good B $100 192 $102 200 $100 205
▪ Compute nominal GDP in each year.
▪ Compute real GDP in each year using 2006 as the
base year.
NOW YOU TRY:
Answers
nominal GDP multiply Ps & Qs from same year
2006: $46,200 = $30 × 900 + $100 × 192
2007: $51,400
2008: $58,300
real GDP multiply each year’s Qs by 2006 Ps
2006: $46,200
2007: $50,000
2008: $52,000 = $30 × 1050 + $100 × 205
Limitations of the GDP Concept
The Underground Economy
underground
economy The part
of the economy in
which transactions
take place and in
which income is
generated that is
unreported and
therefore not counted
in GDP.
Macroeconomics and Business: Output
Growth
• business cycle The cycle of short-term ups
and downs in the economy.
• expansion or boom The period in the business
cycle from a trough up to a peak during which
output and employment grow.
• contraction, recession, or slump The period in
the business cycle from a peak down to a trough
during which output and employment fall.
Recessions
• Recession is the downward phase of a business
cycle when national output is falling or growing
slowly.
• Hard times for many people
• A major political concern
• 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.
Output Gap
• If the economy produces less than its
potential amount, the “negative output
gap” will also be responsible for slow
growth and recession.
• If the economy produces more than its
potential amount because labor and/or
capital is overworked, the “Positive
output gap” will be responsible for fast
growth.
• Output gap: Y - Y* . Actual GDP–
Potential GDP
Fiscal Stimulus and
Multiplier
A Fiscal Stimulus is an
attempt by a government
to increase economic
activity by reducing taxes,
increasing government
spending, or both.
The Multiplier In Action
Suppose the government The government could increase
increases public expenditure by transfer payments. Alternatively, the
$1 million, keeping taxation at its government might wish to invest in
existing level. public works or social capital (e.g.
road construction).
Further stages of
Households spend 0.8 income generation
Initial increase in of their increase in occur, with each
income large income on consumption successive stage being
($800,000) smaller than the
previous one.
The Multiplier In Action
The eventual increase in income resulting
from the initial injection is the sum of all
the stages of income generation
The value of the government spending multiplier =
Change in income
Change in government spending
or
k = Y
G
The Multiplier In Action
Providing that saving is the only leakage of demand,
the value of k depends upon the MPC.
The formula for the multiplier in this model is:
k= 1
1-b
(where b = MPC)
The larger the MPC, the larger the value of the
multiplier.
Solving for Y
equilibrium condition
in changes
because I exogenous
because C = MPC Y
Collect terms with Y Solve for Y :
on the left side of the
equals sign:
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The government purchases multiplier
Definition: the increase in income resulting from a $1
increase in G.
In this model, the govt
purchases multiplier equals
Example: If MPC = 0.8, then
An increase in G
causes income to
increase 5 times
as much!
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Why the multiplier is greater than 1?
Initially, the increase in G causes an equal increase in Y: Y = G.
But Y C
further Y
further C
further Y
So the final impact on income is much bigger than the initial change in
G.
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Multiplier and economic policy
Implications are that it is possible to use discretionary
fiscal policy to control or influence the level of aggregate
demand.
Monetarists would dispute the beneficial effects - would
point to the ‘crowding out’ effects of a widening budget
deficit.
Covid-19
Economic
Stimulus
Package
Inflation
Inflation
• When prices of most goods
and services are rising over
time it is inflation. When
they are falling it is
deflation.
• The inflation rate is the
percentage increase in the
average level of prices.
• Moderate rate of inflation keeps- economic
outlook optimistic, promotes economic activity,
prevents economic stagnation, mobilizes
resources by increasing S and I
• A rate of inflation higher than the desirable
rate of inflation is considered “considerable”
• Economy gets overheated and aggregates
get adversely affected
• 2-3% in developed and 4-6% in developing
countries is desirable
Measures of inflation
• % change in price index number (PIN)
• Rate of inflation = (PINt – PINt-1/PINt-1 ). 100
• CPI- 1981-82=100 increased from 182.7 in 1990-
91 to 207.8 in 1991-92
• Rate of inflation = (207.8 – 182.7/182.7) . 100
• = 13.75%
Exercise
Exercise
Money Supply and Inflation
▪ The quantity equation
MxV=PxY
follows from the preceding
definition of velocity.
▪ It is an identity:
it holds by definition of the
variables.
▪ This is the classical theory of
money demand. Classical
economists like Irving Fischer
believed that money demand
is a function of income
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Money Supply and Inflation, cont.
▪
The growth rate of a product
equals
the sum of the growth rates.
▪ The quantity equation in growth
rates:
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Money Supply and Inflation, cont.
π (Greek letter “pi”)
denotes the inflation rate:
The result from the
preceding slide:
Solve this result
for : π
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The quantity theory of money, cont.
▪ Normal economic growth requires a certain amount of
money supply growth to facilitate the growth in transactions.
▪ Money growth in excess of this amount leads to inflation.
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Hyper Inflation
• Hyper inflation-more than three digit rate
per annum, paper currency becomes
worthless, from Jan 1922 to Nov 1923 the
German price index rose from 1 to 10,
000,000,000
• Germany- to pay large costs of World War 1
Germany suspended convertibility of its
currency into gold and war was funded by
borrowing, exchange rate of the Mark
against the US $ fell and hyperinflation
broke out
What causes hyperinflation?
• Hyperinflation is caused
by excessive money supply
growth:
• When the central bank
prints money, the price
level rises.
• If it prints money rapidly
enough, the result is
hyperinflation.
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Cure of Inflation
Anti inflationary
measures
• Monetary Measures
• Fiscal Measures
• Regulatory Measures
Money: Definition
Money is the stock
of assets that can be readily used to make transactions.
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Money: Functions
▪ medium of exchange
we use it to buy stuff
▪ store of value
transfers purchasing
power from the present to
the future
▪ unit of account
the common unit by
which everyone measures
prices and values
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Money: Classifications
1. Fiat money
▪ has no intrinsic
value
▪ example: the
paper currency we
use
2. Commodity money
▪ has intrinsic value
▪ examples:
gold coins,
cigarettes in
P.O.W. camps56
Money Supply
M=C+D
C = Currency: coins & bills
(13.5%)
D = Demand Deposits: checking
account deposits (86.5%)
Concepts of
Money
A few preliminaries
• Reserves (R ): the portion of deposits that banks have not lent.
• To a bank, liabilities include deposits,
assets include reserves and outstanding loans
• 100-percent-reserve banking: a system in which banks hold all
deposits as reserves.
• Fractional-reserve banking:
a system in which banks hold a fraction of their deposits as
reserves.
Money creation in the banking
system
A fractional reserve banking system
creates money,
but it doesn’t create wealth:
bank loans give borrowers
some new money
and an equal amount of new debt.
Money Multiplier
•Money multiplier is the process through which banks create more money through
its excess reserves, thereby expanding money supply.
•In other words, its process of creating more money by banks from reserve money.
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