Introduction to

Macroeconomics
Prof. Binilkumar Amarayil
Sreeraman
 Leaning Objectives?

This chapter introduces you to

• What is Macroeconomics
• the issues macroeconomists
study
• the tools macroeconomists use
• some important concepts in
macroeconomic analysis
 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.
 Macroeconomics

• Macroeconomists collect data

on incomes, price levels,
interest rates, unemployment,
and many other
macroeconomic variables from
different time periods and
different countries
• They then try to build general
theories to explain the data
that history gives them
Microeconomics Vs
Macroeconomics

Microeconomics Examines the functioning

of individual industries and the behavior of
individual decision-making units—firms and
households.
Macroeconomics Deals with the economy as a
whole. Macroeconomics focuses on the
determinants of total national income, deals
with aggregates such as aggregate
consumption and investment, and looks at the
overall level of prices instead of individual
prices.
TABLE: Examples of Microeconomic and Macroeconomic Concerns

Divisions
of Economics Production Prices Income Employment

Microeconomics Production/output in individual Price of individual Distribution of Employment by

industries and businesses goods and services income and individual businesses
wealth and industries
How much steel
How much office Price of medical care Wages in the auto Jobs in the steel
space Price of gasoline industry industry
How many cars Food prices Minimum wage Number of employees
Apartment rents Executive salaries in a firm
Poverty Number of
accountants

Macroeconomics National production/output Aggregate price level National income Employment and
unemployment in
the economy
Total industrial output
Gross domestic Consumer prices Total wages and Total number of jobs
product Producer prices salaries Unemployment rate
Growth of output Rate of inflation Total corporate
profits
 First, macroeconomics is where we learn
how to think about the economy as a
collection of multiple markets that
affect, and are affected by, each other.

Macroeconomics:
interconnections
It is not enough to analyze the goods
market, and then the asset market, and
then the labor market, and so on; all
markets must be analyzed together, as
interacting arenas of economic activity.
 Macroeconomic Concerns

Three of the major concerns

of macroeconomics are

• Output growth

• Unemployment

• Inflation and deflation

Macroeconomic Concerns -
Output Growth

• business cycle The cycle of short-

term ups and downs in the economy.

• aggregate output The total quantity

of goods and services produced in an
economy in a given period.

• recession A period during which

aggregate output declines.
Conventionally, a period in which
aggregate output declines for two
consecutive quarters.
Macroeconomic Concerns - Output
Growth

• 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.
The Historical Performance of the U.S. Economy:
The Historical Performance of the Indian.
Economy:
 Measuring Fluctuations
• In order to claim a recession is big or
small, an unemployment rate is too high
or too low, one needs to have a standard
to measure against.

• The “normal” or “trend” or “potential”

or “full employment” output is the
standard to compare expansions or
recessions.
 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
Unemployment

• Recessions are usually

accompanied by high
unemployment: the
number of people who are
available for work and are
actively seeking it but
cannot find jobs.

Unemployed
Unemployme nt Rate =  100%
Labour Force
The Historical Performance of the U.S. Economy
 Okun’s Law

• Arthur Okun in the sixties observed that

every time unemployment rate in the US
rose one percentage point above the
natural rate, GDP fell 3 percentage points
below the potential GDP.

• Recent data indicate that the relationship is

now one percent deviation of
unemployment rate implies two percentage
point deviation in GDP.
 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.
 Effects of Inflation

• When the inflation rate

reaches an extremely high
level the economy tends
to function poorly. The
purchasing power of
money erodes quickly,
which forces people to
spend their money as
soon as they receive it.
The International Economy

• An economy which has extensive trading

and financial relationships with other
national economies is an open economy. An
economy with no relationships is a closed
economy.
The International
Economy (continued)

• International trade
and borrowing
relationships can
transmit business
cycles from country
to country.
 Trade Imbalances

• Trade imbalances (trade

surplus and deficit) affect
output and employment.
• Trade surplus: exports
exceed imports.
• Trade deficit: imports
exceed exports.
 The Exchange Rate

• The trade balance is

affected by the exchange
rate: the value of
domestic currency in
terms of a foreign
currency. It explains the
amount of domestic
currency required to
purchase one unit of
foreign currency (Amount
of INR required to
purchase one USD/ GBP/
EUR).
 The Components of the
Macroeconomy

• 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 workers—and pays interest
and transfers to households. Finally, people in
other countries purchase goods and services
produced domestically (exports).
The Components of the Macroeconomy
The Three Market Arenas

Another way of looking at the ways

households, firms, the government, and the
rest of the world relate to each other is to
consider the markets in which they interact.

We divide the markets into three broad

arenas:

(1) the goods-and-services market,

(2) the labor market, and

(3) the money (financial) market.

 Macroeconomic Policy

• A nation’s economic
performance depends on:
• natural and human
resources;
• capital stock;
• technology
• economic choices made by
citizens;
• macroeconomic policies of
the government.
 Macroeconomic Policy

fiscal policy Government policies

concerning taxes and spending.

Monetary policy The

tools used by the Central
Bank to control the
quantity of money,
which in turn affects
interest rates.
Macroeconomic Policy