Macro economics: Session - 1

Dr. Prema Basargekar

Session Plan
 Micro and Macro economics
 Background of macroeconomics
 Macro economics paradox
 Policy goals of macroeconomics
Micro & Macro economics
 Micro- deals with the study of the behaviour of small
individual unit such as firm, consumer, product market
or service market & explains how the price & qty is
determined & resources are allocated
 Macro – deals with the study of the behaviour &
performance of the economy as a whole & studies
how the large aggregates such as national income,
general price level, employment, total output is
determined in an economy
Similarities
 Both are concerned with utilization of scarce
resources
 Methodology used is same
 Determination of price & output through interaction
of Demand & Supply
Differences
 Macro variables are not related to particular market
but to the economy at large
 Macro does not believe in full efficiency of market
 Micro is mainly a positive science but Macro is positive
as well as normative
 Micro assumes ‘all things remaining same’ – which means
emphasizes on partial equilibrium; macro looks into
interrelationship between various macro variables.
 Micro – bottom-up approach; macro – top-down
approach
Interdependence
 As economy is a collection of many households and
many firms interacting in many markets, micro and
macro economics are closely linked.
 Any change in macroeconomic variable such as
interest rate, aggregate demand, etc brings out
changes at micro or at organizational level.
 Similarly organizational effectiveness affects macro
level policies and indicators.
Aggregate Demand; Aggregate
Supply
 Aggregate output
 Total amount of goods and services produced
in economy in a given period: Real GDP
 Aggregate demand
 Quantity of aggregate output demanded at
given price level
Aggregate Demand
 Sum of D of economic decision makers
 Households; Firms;
 Governments; Rest of the world
 Inverse relationship between Price level & AD
 Other things constant
 Price levels in other countries
 Exchange rates
 Aggregate Demand Curve

The quantity of aggregate

Price level (2000 = 100)

output demanded is
150 inversely related to the
price level, other things
constant.
100 This inverse relationship is
reflected by the aggregate
50 demand curve AD.
AD

0 2 4 6 8 10 12 14 16 Real GDP
(trillions of 2000 dollars)
Aggregate Supply
 Positive relationship
 Price level
 Real GDP supplied
 Other things constant
 Resource prices
 State of technology
 Rules of the game – Govt. policies
Aggregate Demand and Aggregate
Supply

The total output of the

economy and its price
level are determined at
the intersection of the Ad
and AS curves.
Background of Macro economics
 US economy and major European economies
underwent various stages:
 1. Before & during Great Depression
 2. After Great Depression to early 1970s
 3. Early 70s to early 1980s
 4. 1980s onwards
Background of macroeconomics
 Period of laissez faire economy- no Govt interference
– classical economists
 1929- 1935: the period of Great Depression
 Originated in USA & spread to other European
countries
 High level of unemployment- as high as 25 %
 Collapse of stock market more than 50% - Black
Tuesday (Oct, 24th) , Black Thursday(Oct 29th)
 Low level of prices, low aggregate demand
 The Decrease in Aggregate
Demand from 1929 to 1933
AS
The Great Depression of the
1930s can be represented by
Price level (2000 = 100)

the shift to the left of the AD

curve, from AD1929 to AD1933.
12.0 In the resulting depression,
real GDP fell from $865 billion
8.9 to $636 billion, and the price
level dropped from 11.9 to 8.9,
AD1929 measured relative to a price
level of 100 in the base year
AD1933 2000.

0 636 865 Real GDP

(billions of 2000 dollars)
Few pictures of Great Depression
Great Movies based on GD
Background of macroeconomics
 Classical solution – Pigou – cut the wage rate to
reduce the level of unemployment
 Result- recession further increased & along with it
unemployment , agg demand, output also
decreased
 Situation started improving with rearmament &
second world war
Macro economics paradox
 Keynes: The General Theory of Employment, Interest &
Money – 1936 – most famous book of the 20th century
 Macro economic paradoxes:
 What is true for an individual may not be true for the
economy – paradox of thrift, paradox of wage cut,
paradox of high agricultural productivity
 Summation of individual parts do not necessarily
explain the whole truth – fallacy of composition – “Total
savings may fall when individual savings attempt to
rise.”
Keynesian economics
 Wages & income are two sides of same coin
 Fall in wage rate wd cut down the cost of
production, but along with it will also reduce income
level which wd reduce agg demand
 Aggregate demand is the economy determines the
level of output & employment in the economy
Keynesian economics
 Keynes proposed that the Govt jolt the economy out of
depression by increasing AD by increasing Govt expenditure.
 He proposed that Govt should implement expansionary fiscal
policy to offset contraction either by spending more or by
cutting taxes.
 He also recommended deficit finance for the government.
 Govt should play a very important role in the economy in
maintaining the stability & reduce the level of unemployment
 1935 to 1960- Keynesian revolution- increasing impact of
Govt on all economies
 Demand side economics
1973 to 1980
 Continuous increase in federal spending along with
war expenditures expanded economies between
1935 to 1970s.
 1973 – multiple reasons like crop failure, cost of
Vietnam war, OPEC countries cutting the supply of oil
resulted in high inflation.
 Aggregate supply shifted backwards resulting in
stagflation.
 It drew attention towards changes in AS affecting the
economy.
 Stagflation from 1973 to 1975
AS1975
The stagflation of the mid-
AS1973
1970s can be represented as
a leftward shift of the AS curve
Price level (2000 = 100)

from AS1973 to AS1975.

38.0 Aggregate output fell from
31.9 $4.34 trillion in 1973 to $4.31
trillion in 1975, for a decline of
about $30 billion (stagnation).
The price level rose from 31.9
AD to 38.0, for a growth of 19%
(inflation).

0 4.31 4.34 Real GDP

(trillions of 2000 dollars)
Since 1980
 Supply side economics to combat Stagflation
 More focus on increasing productivity
 Low price level, increase in output, increase in employment through
lower taxes
 Govt hoped to get higher tax revenue from a larger economy to
make up for the cut in tax rate.
 Federal budget deficits started swelling due to gap between
revenue and expenditure.
 This further led to higher tax rate and lower government
expenditure in early 21th century.
 The evidence shows that any economy undergoes lot of changes with
change in macro variable.
Summary
 Similarities and difference between micro and
macro economics
 Emergence of macro economics
 Aggregate Demand
 Aggregate Supply
 Linkages in macroeconomic variables
 Fallacy of Composition
 Macroeconomic objectives
 Inherent conflict in macroeconomic objectives