MACROECONOMICS & INTERNATIONAL ECONOMICS

Orientation Lecture

Mathew Joseph

FORE School of Management

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This session will introduce:

The issues macroeconomists study The tools macroeconomists use

Some important concepts in macroeconomic

analysis

The subject matter of international economics Economic and financial interdependence

among nations

Important issues in macroeconomics

Macroeconomics, the study of the economy as a whole, addresses many topical issues, e.g.:

Inflation, what are the factors behind rise in prices?

What causes recessions or economic slowdowns? Why

fiscal stimulus and monetary easing might help?

How can problems in the worlds major economies

spread to the rest of the world?

What is the government budget deficit?

How does it affect the economy?
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Important issues in macroeconomics

Why are so many countries poor? What policies might
help them grow out of poverty?

How do we compare the economic performance of

different countries?

What is the trade deficit? How does it affect the

countrys well-being?

How exchange rate fluctuations affect exports and

imports?

Performance of Indian Economy

Indias from 4% pre-1991 to 6.5% after reforms Chinas rate of growth rising from about 5% pre-1978 to 10% after reforms

Per capita GDP somewhat higher in India till 1990 and now more than 3 times larger for China
While Indias per capita income rose three times since 1990, Chinas by 12 times

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15

20

10

12

-2

CPI (I W)

WPI Inflation

CPI Inflation

CPI (RL)

Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10
Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11

Why learn macroeconomics?

1. The macro economy affects societys well-being.
Social problems like homelessness, domestic violence, crime, and poverty are linked to the economy.

2. The macro economy affects your well-being.

A booming economy provide high-salary

employment opportunities

3. The macro economy affects investment climate, business and consumer confidence. 4. The macro economy affects election outcomes.

Economic models: Economists set of tools

are simplified versions of a more complex reality irrelevant details are stripped away are used to show relationships between variables explain the economys behavior devise policies to improve economic performance
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Example of a model:

Supply & demand for new cars shows how various events affect price and
quantity of cars

assumes the market is competitive: each buyer

and seller is too small to affect the market price Variables Qd = quantity of cars that buyers demand Qs = quantity that producers supply P = price of new cars Y = aggregate income Ps = price of steel (an input)
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The demand for cars

Demand equation: Q d = D (P,Y )

shows that the quantity of cars consumers

demand is related to the price of cars and aggregate income

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Digression: functional notation

General functional notation
shows only that the variables are related.

Q d = D (P,Y )

A specific functional form shows

the precise of the A list quantitative relationship.

Example: variables

that ) = 60 10 D (P,Y affect Q d P + 2Y

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The market for cars: Demand

demand equation:
P

Qd

= D (P,Y )

Price of cars

The demand curve shows the relationship between quantity demanded and price, other things equal.

D
Quantity of cars

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The market for cars: Supply

supply equation:
P
S

Qs

= S (P,PS )

Price of cars

The supply curve shows the relationship between quantity supplied and price, other things equal.

D
Quantity of cars

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The market for cars: Equilibrium

P
S

Price of cars

equilibrium price

D
Quantity of cars

equilibrium quantity

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The effects of an increase in income

demand equation:

Q d = D (P,Y )
An increase in income increases the quantity of cars consumers demand at each price which increases the equilibrium price and quantity.

Price of cars

P
S

P2

P1
D1 Q1 Q2

D2

Quantity of cars

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The effects of a steel price increase

supply equation:

Q s = S (P,PS )
An increase in Ps reduces the quantity of cars producers supply at each price

Price of cars

S2

S1

P2 P1 D Q2 Q1
Quantity of cars

which increases the market price and reduces the quantity.

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Endogenous vs. exogenous variables

The values of endogenous variables
are determined in the model.

The values of exogenous variables

are determined outside the model: the model takes their values & behavior as given.

In the model of supply & demand for cars,

endogenous: P, Qd, Qs exogenous:

Y , Ps
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NOW YOU TRY:

Supply and Demand

1. Write down demand and supply equations

for wireless phones; include two exogenous variables in each equation.

2. Draw a supply-demand graph for wireless

phones.
3. Use your graph to show how a change in

one of your exogenous variables affects the models endogenous variables.

The use of multiple models

No one model can address all the issues we
care about.

E.g., our supply-demand model of the car

market

can tell us how a fall in aggregate income

affects price & quantity of cars.

cannot tell us why aggregate income falls.

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The use of multiple models

So we will learn different models for studying
different issues (e.g., unemployment, inflation, long-run growth).

For each new model, you should keep track of its assumptions which variables are endogenous,
which are exogenous the questions it can help us understand, those it cannot

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Prices: flexible vs. sticky

Market clearing: An assumption that prices are
flexible, adjust to equate supply and demand.

In the short run, many prices are sticky

adjust sluggishly in response to changes in supply or demand. For example: many labor contracts fix the nominal wage for a year or longer many magazine publishers change prices only once every 3-4 years
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Prices: flexible vs. sticky

The economys behavior depends partly on
whether prices are sticky or flexible: If prices sticky (short run), demand may not equal supply, which explains:
unemployment (excess supply of labor)

why firms cannot always sell all the goods they produce

If prices flexible (long run), markets clear and

economy behaves very differently
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Issues in International Economics

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Important issues in international economics

Globalisation of the world economy Challenges and opportunities The benefits from trade The basis of trade

Effects of protectionism Tariff and non-tariff measures The balance of payments Adjustment of deficits and surpluses
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Important issues in international economics

Exchange rate determination Fixed vs. floating regimes International policy coordination IMF, WTO and G-20 International capital market and currency
convertibility

The global crisis 2008-09 and its aftermath

Reform of the international monetary system

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The Globalization of the World Economy

A globalizing world provides opportunities and

challenges to nations and people in the world. Cross-border flow of goods and services Flow of labor and jobs International capital flows

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The Globalization of the World Economy

Three periods of rapid globalization 1870-1914

Resulted from industrial revolution, opening up of new resource sources in regions of recent settlement (North and South America, Australia, New Zealand and South Africa) Millions of immigrants, vast amounts of foreign investments, increased production Ended with breakout of World War I in 1914.

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The Globalization of the World Economy

Three periods of rapid globalization 1945-1980

Dismantling of heavy trade protection led to rapid increase in international trade. Setting up of IMF, World Bank and GATT

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The Globalization of the World Economy

Three periods of rapid globalization 1980 to present

Most pervasive and dramatic period of globalization Fueled by advances in information technology, telecommunications and transportation Elimination of restrictions on capital flows led to massive international capital movements Most developing countries moving from inwardoriented to outward-oriented development strategies

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The Globalization of the World Economy

Anti-Globalization Movement Claims globalization sacrifices human and

environmental well-being to corporate profits of multinationals

Globalization is blamed for:

World poverty and child labor in poor countries Job losses and lower wages in rich countries Environmental pollution and climate change
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India's External Transactions (As % of GDP)

Exports 1990-91 6 Imports 9 Invisible receipts 2 Invisible payments 2 Capital inflows 5 Capital outflows 7 Trade 15 Invisibles 5 Capital flows 12 Total 32

1991-92
1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

7
8 8 8 9 9 9 8 8 10 9 11 11

8
10 10 11 12 13 12 11 12 13 12 13 13

4
4 4 5 5 6 6 6 7 7 8 8 9

3
3 3 3 3 3 3 4 4 5 5 5 4

7
8 7 5 6 6 7 6 7 10 7 7 10

9
9 10 8 7 9 10 8 9 12 9 9 13

15
18 18 19 21 21 21 20 21 22 21 23 24

6
7 7 8 8 8 9 10 11 12 12 13 13

16
17 18 13 12 16 17 14 16 22 16 16 23

37
41 43 41 42 45 47 44 47 56 50 53 60

2004-05
2005-06 2006-07 2007-08 2008-09 2009-10

12
13 14 13 16 13

16
19 20 21 25 22

10
11 12 12 14 12

5
6 7 6 6 6

14
17 25 35 26 25

10
14 20 27 25 21

28
31 34 34 41 35

15
16 19 18 20 18

23
32 44 62 51 46

67
79 97 114 112 99

Source: Reserve Bank of India.

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Outline of Macroeconomics course:

1. Definition and measurement of economic activity: GDP and its components 2. Determination of national income and its distribution 3. Money and Inflation 4. Business cycle theory: Introduction 5. The economy in the short run I: Building of the IS-LM model
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Outline of Macroeconomics course

6. The economy in the short run II: Applying the IS-LM model

7. Economic growth I: Exposition of different growth models

8. Economic growth II: Exposition of various growth models 9. Macroeconomic policies in India

10. The open economy: Introduction

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Outline of Macroeconomics course

11. Open economy: Mundell-Fleming model and the exchange rate regime 12. Aggregate supply and the trade off between inflation and unemployment 13. Government debt and budget deficits 14. Global crisis 2008-2009 and its aftermath

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Outline of the course on International Economics

International Trade Theory Analyzes the basis of and the gains from
international trade.

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Outline of the course on International Economics

International Trade Theory
International Trade Policy

Examines the reasons for and the effects of restrictions on international trade.

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Outline of the course on International Economics

International Trade Theory
International Trade Policy Balance of Payments

Measures a nations total receipts from and total payments to rest of the world.

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Outline of the course on International Economics

International Trade Theory International Trade Policy Balance of Payments Foreign Exchange Markets

The institutional framework for the exchange of one national currency into another.

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Outline of the course on International Economics

International Trade Theory International Trade Policy Balance of Payments Foreign Exchange Markets Adjustments in the Balance of Payments

Focuses on the relationship between internal and external aspects of the economy of a nation, and their interdependence with rest of the world economy under different international monetary systems.
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Session Summary
Macroeconomics is the study of the economy
as a whole, including growth in incomes changes in the overall level of prices the unemployment rate the trade deficit the budget deficit

Macroeconomists attempt to explain the

economy and to devise policies to improve its performance.

Session Summary
Economists use different models to examine
different issues.

Models with flexible prices describe the

economy in the long run; models with sticky prices describe the economy in the short run.

Macroeconomic events and performance arise

from many microeconomic transactions, so macroeconomics uses many of the tools of microeconomics.

Session Summary

International economics study the economic and

financial interdependence among nations

It explain why countries trade and examine the

benefits of trade

What are the effects of trade policies? Balance of payments, foreign exchange markets
and exchange rate determination

International policy co-ordination and the global

monetary system
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