MACROECONOMICS

IIFT- 2025 JAN- APRIL

Instructor : Swarna
Sadasivam Vepa
INTRODUCTION TO
MACRO ECONOMICS
Lecture PPT 1
Reference:Karl E. Case, Ray C. Fair, Sheron E.
Oster, Principles of Macro Economics, Chapter 5
What is Macro economics about?
■ It is a study of the structure and performance of National
economies and the policies that governments use to try and affect
economic performance
■ Macro economics concentrates on aggregates, unlike
Microeconomics that is concerned with individual households and
firms Macro economics is concerned about aggregate behaviour .
We talk about aggregate consumption, and aggregate Investment
and aggregate Income and aggregate savings
■ The major concerns are
■ 1. Output growth- long run and short run
■ 2. Unemployment
■ 3, Inflation
Output Growth- recession &
Boom
■ The main measure of how the economy is doing is output growth
■ When the aggregate output decreases, the total quantity of goods and
services produced in the economy falls then there are fewer goods and
services available and firms cut back on production and lay off workers and
people become unemployed
■ The output does not grow evenly. Some times it goes up and some times it
falls
■ Recessions are the periods during which the output declines. A
prolonged and deep recession is called depression.
■ The period in which the output expands and reaches a peak is called boom
■ Recessions and booms may differ from country to country. Normally in a
globalized economy, all countries experience a boom or recession, though
with a lag and at varying intensity.
■ For example India was less affected by 2008-09 recession compared to the
USA and other countries.
 Short term growth and long term growth
■ To judge if an economy is expanding or contracting, once should note the
difference in the level of economic activity and its rate of change.
■ When the economy is growing its rate of change is Positive and if the
economy is contracting the rate of change becomes negative as it
happened in 2020-2021, covid 19 time.
■ Short term changes occur in the economic activity and they are called
business cycles.
■ Business cycles are less pronounced after the world war II compared
to the business cycles before the world war II.
■ Long term growth is important for the country to consistently
achieve high standard of living for their citizens. Countries that
experience consistent high growth for long periods of time achieve higher
standard of living over time.
■ Largest contractions and expansion in the world occurred during 1930 and it
followed by a Boom in 1940 during the World War II.
Real GDP in India from 2004
to 2024
Quarter-wise Real GDP Growth Rates (%) for FY 2018-19 to FY 2024-25 (Q2)
(Constant Prices)
(Base Year: 2011-12)
Unemployment rate
■ Unemployment rate is the percentage of labour force that is unemployed.
■ Labour force consists of employed and the unemployed.
■ Unemployed are those who are willing to work but not able to find work. Those who
are not looking for work, for example students in the educational institutions,
housewives, Those who live out of inheritance etc, are not in the labour force.
■ Unemployment is a key indicator of economic wellbeing. More unemployed may
mean more misery. Unemployment rises during a recession and falls during a boom
■ Unemployment rate changes with economic activity. However there is always a
certain level of unemployment in all the countries. It is because people keep
changing the jobs and between jobs they are unemployed. New entrants into the
Labour force fresh out of college for example may take time to find a suitable job.
They are unemployment during that period.
■ Thus a certain positive unemployment rate is inevitable in an economy.
■ Unemployment can be seasonal, frictional or structure
■ If Unemployment is high, wages should fall and more labour should be demanded but
very often the supply and demand for labour do not equate to clear the market.
 Indian Unemployment
■ In a developing country like India Unemployment rate has to be
looked at differently. As you have seen in the diagram, the rural
unemployment is lower than the urban unemployment. It does not
mean that rural people are better of getting more income than
urban people. Rural people are poor and they take up any job that
is available to earn as little as possible, even if the rural wages are
lower than the urban wages.
■ In urban India educated people do not take up the jobs unless the
job and the wage matches their expectations. Hence there is more
unemployment in urban areas.
■ In a developing country like India the employment does not adjust
to the economic activity as in developed countries. The impacts
are much more muted than in a developing country
■ Definition of unemployment used also makes a comparison
difficult. It is because a large number of persons are self employed
Inflation /Deflation
■ Inflation is the overall increase in the price level. Keeping inflation low
is the policy of the governments.
■ The percentage increase in the average level of prices over a period
of one year is called the inflation rate.
■ Vey high inflation destabilizes the economy, creates hardships for low
income population.
■ A decrease in the overall price level is deflation. Prolonged decline is
experienced by countries such as Japan.
■ For most of the western economies and Japan the inflation is around
2-3% and for India.it is around 6%. For Switzerland it is 0.6 percent
and for China it stand at 0.1%. For Turkey it is 44% and 8.5% for
Russia in 2024.
■ Some countries experience hyper inflation and others worry about
ensuing deflation.
■ At present the inflation is measured in two ways, 1. Whole sale price
 Measures of Inflation: Headline Inflation and core inflation

■ Headline inflation is a measure of the total inflation within an economy, It includes commodities
that tend to have volatile prices (such as food items which fluctuate with seasons and energy
and energy prices which depend upon the seasonal consumption.
■ Core inflation ( non-food-manufacturing or underlying inflation) is calculated from a consumer
price Index minus volatile food and energy components.
■ Headline inflation may not present an accurate picture of an economy's inflationary trend since
sector-specific inflationary spikes are unlikely to persist.
■ Personal consumption expenditure price Index is used to compute Core Inflation
■ Since 2008 financial crisis, both core inflation and Headline Inflation have been computed
for many countries in the world
■ 2008 price spike was also due to shortage of food commodities.
■ India started calculating both core and headline inflation since 2011.
■ Contrary to conventional wisdom that the RBI should focus on core inflation and
“look through” volatile and transient food-price inflation, we find that food-price
inflation can de-anchor expectations and spill over into core inflation ( IMF 2023)
Indian Inflation
■ Inflation in India has averaged 8 percent or more since the
1980s, except in the early 2000s when it averaged 4
percent and more recently inflation fell with the RBI move
towards inflation targeting.
■ Levels have exceeded average global inflation for the
most part. while fluctuations have been broadly similar to
those in other low- and middle-income countries (LMI),
aside from 2009-2015.
■ Basu, Eichengreen and Gupta (2014) attribute India’s
relatively high inflation in this period to budget deficits
and monetary policy accommodation in years that
coincided
Source: withPoonam
Barry Eichengreen, national elections.
Gupta, Rishabh Choudhary, Inflation targeting in India , an interim
Assessment, Policy research Working Paper 9422 , World bank Group 2021
The components of Macro
economy
■ 1. Households
■ 2. Firms
■ 3.The Government
■ 4. Rest of the world (International economy)
Households work for the firms and the government and receive wages. Households also receive
dividends and Interest from firms and interest from government bonds. They also get transfer
payments from the government (social security).
Households purchase goods and services from the firms and pay the firms, They Pay taxes to the
government. If the income exceeds expenditure it is saving and if expenditure exceeds income it is
dissaving financed out of the sale of assets or borrowing. Savings considered as leakage in the circular
flow
Firms sell goods and services to the households and pay taxes to the government and they pay interest
and dividends to the households and taxes to the government.
The government collects taxes and buys goods and services from the firms and pays wages and
interest and transfer payments to the households. If government expenditure exceeds its income it
dissaves
Households buy imported goods from the rest of the world and firms sell (net exports) to the rest of the
world.
Every one’s expenditure is some one’s Income. Every transaction has a spender and a receiver.
Hence Gross domestic product (output) is measured as aggregate expenditure or aggregate income. As
incomes become expenditures and they equal each other
 Rest of the World

Net Exports Purchase of goods and services

Consumption
Imports

Financial Markets
Investment
Savings public savings
Taxes Taxes

Firms Government House holds

Goods & services Wages
purchase

Wages, dividends, interest, profits

Income

Every expenditure becomes some one’s income and the income receiver int urn incur
expenditure. Thus expenditure equals income in a circular fashion. ( flow of funds)
The three Markets
■ The Goods and services Market
■ The Labour Market
■ Money Market
■ Goods & services Market :Government and households buy
goods and services from the firms. Firms also buy goods and
services from each others. Firms supply goods and services
and households and government and other firms who demand
them.
■ Rest of the world sells goods and services to the firms,
households and the government. Rest of the world buys goods
and services from the firms.
■ Labour Market: Firms and Government purchase labour from
the Households. Household supply labour to the firm, the
government and the rest of the world, either directly or
remotely.
 Financial Markets

■ Money Market / Financial Markets: The households and firms

buy stocks ( shares in the ownership of a company are called
stocks) and bonds (corporate Bonds) from the firms and
government ( RBI Bond / Central govt bonds, State govt. Bonds/
Local govt. Bonds).
■ House holds borrow to purchase goods and services.
Government borrows from the households and firms by issuing
bonds, National savings certificates and so. Firms borrow for their
business from the banks, float corporate Bonds, and through
other non-banking financial Institutions. Governments and firms
may also borrow from the rest of the world.
■ Households and firms park their savings in the financial Markets
Households expect to earn interest and dividends from their
financial assets purchased. Households supply funds to the firms
and to the government ( govt. debt).
Financial Markets
■ All the financial lending and borrowing occurs through Financial Institutions.
Lenders except a return on the money given by way of interest, dividend or
capital gain (Difference between the purchase value and the sale value)
■ Government borrows by issuing Bonds and treasury bills. Bonds are fixed coupon
rate interest long term instruments and treasury bills are the short term financial
instruments of 91 days, 180 days, 365 days etc., with zero interest in India.
■ Firms and Corporations borrow by issuing Bonds and stocks to the households.
Stocks sell part ownership of the firm.
■ A critical variable in the Money Market is the Interest rate. The interest rates vary
with duration of the loan, risk of default, and the conditions of lending.
■ While the Interest rates are different, all of them go up together and go down
together in the economy. For example when the govt. announces the repo rate,
all the other rates go up.
■ The repo rate in India is the interest rate at which the Reserve Bank of India (RBI)
lends money to commercial banks. The reverse repo rate is the rate at which the
RBI pays interest to commercial banks for excess money they deposit with the
RBI. The repo rate/ reverse repo rate are key tools used by the RBI to control
inflation and manage the money supply
 Classical and Keynesian approach –
unified Modern approach
■ Classical approach date backs to the ideas since Adam Smith who wrote the Book “
“Wealth of Nations” in 1776. The basic idea of this approach is that the free markets
without any government controls, work smoothly as the supply and demand change to
make the demand match the supply by the adjustment of prices and interest rates. ( the so
called Invisible Hand)
■ However the classical approach does not bring equality or distributive justice.
■ The Keynesian approach is more recent and owes it origin to John Maynard Keynes and his
book “The General Theory of Employment, interest and Money in 1936. At that time
unprecedented high level of unemployment and deflation afflicted most of the world. It
was the great depression. Keynes argued that wages and prices adjust slowly. Hence the
markets will be in in-equilibrium for long periods of time. Government intervention is
necessary to create demand for goods and services, to stimulate the economy. Following
his suggestions the world was able to come out of the great depression.
■ In the seventies when stagflation ( high inflation and high level of unemployment)
occurred, Keynesian approach did not work. Since then both classical economists and
Keynesian economists changed and sharpened the theories and made them better and
more balanced. Neo classical approach refers to the revival of classical principles in the
eighties. The present approach combines best of both the approaches that work.
 Macroeconomic analysis and economic models
Macro economic analysis and research is about the study of
events that occur in an economy and making sense of
them and explaining as to how the economy works
Economic Models are simplified versions of a more complex
reality
– irrelevant details are stripped away
…are used to
– show relationships between variables
– explain the economy’s behavior
– devise policies to improve economic performance
Indian Informal sector and Own account enterprises

■ An own-account enterprise (OAE) in India is a business that is owned and operated

by a household and does not employ any hired workers on a regular basis. Own
account enterprises are equivalent to firms.
■ 83.5% of workers in India are informal workers in 2017-18
■ A Gig economy is characterized by short term contracts and freelance
work
■ Large percentage of economic activity occurs in the gig economy in India
■ Due to the existence of large informal ( un-incorporated enterprises)
sector in India, some of the macro economic policies do not respond in a
typical expected manner as in the developed countries such as USA.
Sometimes, they have a lagged impact and sometimes they do not work,
as there are structural issues.
■ However, a set of other macro economic controls are essential for the
working of the economy. With monetization and globalization and fully
opening-up of the economy, global events impact India. The fiscal and
monetary instruments of control such as taxes, subsidies, govt.
expenditure, transfer payments, interest rates, tariffs, exchange rates,
and so on become crucial to the working of the economy.